Alarm.com Holdings Inc

NASDAQ:ALRM

Earnings Call Transcript 2018-Q4

[Operator]

Good day ladies and gentlemen and welcome to the Alarm.com's Fourth Quarter 2018 Earnings Conference Call. [Operator Instructions] As a reminder, today's conference may be recorded.

I'd now like to introduce your host for today's conference, Mr. David Trone, Vice President, Investor Relations. Sir, please go ahead.

[David Trone, executive]

Thank you. Good afternoon, everyone, and welcome to Alarm.com's fourth quarter 2018 earnings conference call. As a reminder, this call is being recorded. Joining us today from Alarm.com are Steve Trundle, President and CEO; and Steve Valenzuela, CFO.

Before we begin, a quick reminder to our listeners. Management's discussion during the call today will include forward-looking statements, which include projected financial results or operating metrics, business strategies, anticipated future products and services, anticipated growth, investment and expansion, anticipated market demand or 4 current or future offerings or opportunities to expand into new markets and other forward-looking statements.

These forward-looking statements are based on our current expectations and beliefs and on information currently available to us. Statements containing words such as anticipate, believe, continue, estimate, expect, intend, may, will and other similar statements are intended to identify such forward-looking statements. These statements are subject to risks and uncertainties, including those contained in our updated Risk Factors section of our most recent quarterly report on Form 10-Q filed with the Securities and Exchange Commission and subsequent reports that we filed with the Securities and Exchange Commission from time to time that could cause actual results to differ materially from those contained in the forward-looking statements.

Please note that these forward-looking statements made during this conference call speak only as of today's date, and Alarm.com undertakes no obligation to update these statements to reflect subsequent events or circumstances, except to the extent required by law.

Also during this call, management's commentary will include non-GAAP financial measures and provide non-GAAP guidance. Management believes that use of these non-GAAP financial measures provides an additional tool for investors to use in understanding the company's performance and trends, but note that the presentation of non-GAAP financial information is not meant to be considered in isolation or as a substitute for the directly comparable financial measures prepared in accordance with GAAP.

Reconciliations between GAAP and non-GAAP metrics for our reported results can be found in the financial statement tables of our earnings press release, which we have posted to our Investor Relations Website at investors.alarm.com. This conference call is being Webcast and is also available on our Investor Relations Website. The Webcast of this call will be archived, and a telephone replay will also be available on our Website.

With these formalities out of the way, I'd now like to turn the call over to Steve Trundle. You may begin.

[Stephen Trundle, executive]

Thank you, David. Good afternoon and welcome to everyone. We're pleased to report that fourth quarter results were above our expectations. Our SaaS and license revenue in the fourth quarter was $77.8 million, up 19% over last year. Our adjusted EBITDA in the fourth quarter was $20.9 million. Our fourth quarter results helped close out a strong 2018. Throughout the year, our service providers continued to be very effective with our technology in their markets. We owe much of our success to their performance. We saw nice growth in our core residential and commercial security business and in other markets as reported by our other segment businesses.

We believe that our progress in 2018 successfully extended our leadership in the connected property space. Today, more than 8000 service providers service our technology in more than 6.1 million properties globally and more than 90 million connected devices and sensors are enabled in the solutions provided by our cloud services. With our growing scale in the connected property space, we plan to continue to accelerate our pace of innovation, strengthen our service providers advantages in the marketplace and increase our participation in the Internet of Things secular trend. Before I go further, I want to thank our service provider partners, our ecosystem partners and our employees who all contributed to our progress in 2018.

On today's call, I want to spend more time on several key elements of our 2019 strategy. Those elements include driving growth through innovation in our core channels, increasing the differentiation and adoption of our video services, developing international markets and building our vertical businesses.

Product innovation is the cornerstone of Alarm.com's strategy. Last year, we launched a number of new products and expanded the Alarm.com platform to enable our service providers to attack additional market opportunities. In April, we launched Alarm.com for Business. This new service is engineered for the needs of small and medium-sized businesses. It offers commercial grade security, video surveillance, intelligent automation, sophisticated user management, multi-location awareness and intelligent operational reporting. Importantly, it's all delivered through a single integrated solution.

We see a good opportunity for our service providers to upgrade small and medium-sized businesses from traditional, locally managed systems to our always-on connected solution. As part of our Alarm.com for Business initiative, we also recently launched smarter access control. This commercial grade solution securely manages access to facilities and fully integrates with our entire spectrum of commercial services. We complimented the release of this offering with a series of new commercial grade cameras that expand the applications for our video services.

Successfully driving adoption of a significant new service line, like Alarm.com for Business through a channel requires a concerted sales, marketing and support effort. In 2019, we plan to work to engage our partners on multiple levels in order to drive further adoption of our commercial services in the market. To support this goal, we recently expanded our partner education program. This training gives our service providers access to the required technical skills for installing and implementing our commercial solutions and establishes a consistent training standard for our service providers.

During the year, more than 900 service provider businesses participated in our commercial training program and more than 1500 technicians completed and passed the required training for deploying our smarter access control solution. We plan to continue to work hard to develop our service provider base in this area in 2019. We also enhanced the direct hands-on support we provide technicians and installers. With the launch of Alarm.com for business, we saw an expected increase in overall support volume last year. At the same time, our customer satisfaction and quality assurance metrics exceeded our internal benchmark goals providing reliable, trustworthy service to our partners is a core tenet of our strategy.

Over the long term, that helps our service providers become more efficient with our technology and helps us retain our valued partners. As we roll into 2019, we will also be focused on the success of ADT's new Command and Control Smart Home System. We worked in close partnership with ADT to develop this new offering. ADT recently launched the deployment of this new offering and early indications are positive. As ADT transitions to this new system, we will also continue to support and improve the existing Connect platform that supports the ADT Pulse offering, which is used by more than 2 million subscribers.

Also key to our 2019 strategy, it is the expansion of our artificial intelligence platform to drive differentiation and adoption of our video services. In October, we launched our video analytics offering. This launch was the result of a multiyear effort to extend our leadership into the fields of artificial intelligence and computer vision. Our new AI architecture enables video cameras to distinguish between people, vehicles and animals. It can also track an objects direction of movement and duration of activity. We offer these advanced analytics capabilities as part of an accessible and very cost effective video solution.

With our video analytics platform now deployed at scale, we plan to extend the analytics capabilities to our full range of cameras and continue to train the system to address additional high value use cases; particularly for SMB applications.

Furthering the development of our international business is also a key element of our 2019 strategy. As I mentioned on our call last quarter, we feel that we have the right base of ecosystem hardware partners and carriers in place to enable international service providers to deploy our solutions at scale. In early 2018, we reached a milestone of 100,000 active international subscriber accounts and our international team continued to add new markets and partners throughout the year. I'm very happy with the global service provider relationships we have been fortunate to cultivate and in 2019 we plan to focus on building out our global team and making sure that we can do an outstanding job in supporting these partners.

Europe is one of the stronger international markets and one where we continued to make good progress. In August, we announced the partnership with Aviva, a leading global insurance company. They are launching a Smart Home Security and Energy Management offering to their customers in Ireland. Our partnership with SecurityTrax also remains strong. They are now offering smart security services in the Netherlands, Belgium, Norway and Sweden. And SecurityTrax Iceland is also successfully deploying our solution.

We also see continued momentum in Turkey, Australia and New Zealand as well as in Latin America where we added key strategic partners in the second half of 2018. Claro Americas is a large telco in the region and we've partnered with one of their subsidiary called NET. NET is one of the largest cable television providers in Latin America and they are piloting a video-based solution in Brazil. GTD, another large Telco in Latin America will launch our services in Chile and G4S, a well-respected global security company, has launched our services in Colombia and Guatemala. We have more work to do together to make these promising partnerships successful in 2019 and beyond but these early relationships give us additional confidence in the global opportunity for our business.

Our vertical businesses are another key element of our 2019 strategy. We report these businesses in our other segment and they include PointCentral, EnergyHub and Building 36. PointCentral offers an enterprise level smart home automation service for property managers of both short-term and long-term single-family and multifamily rental properties. The PointCentral market includes vacation rental properties, residential REITs and other businesses requiring an unattended access and delivery solution. PointCentral has developed particular momentum in the residential REIT space. For example, in 2018 they announced a partnership to deployed solutions to Invitation Homes portfolio of 80,000 properties.

In 2019, PointCentral will focus on executing rollouts to many of these properties already under an agreement while continuing to build their pipeline of new enterprise customers. EnergyHub offers an enterprise software solution that manages distributed energy resources for utilities. Through its Cloud platform, EnergyHub intelligently orchestrates a range of IoT devices to provide a rich set of grid management services.

In 2018, EnergyHub announced new and expanded programs with leading utilities including National Grid, Lincoln Electric System, Salt River Project, Seminole Electric Cooperative and Sawnee EMC. They also recently announced an expanded partnership with Arizona Public Service.

EnergyHub's platform will manage grid edged devices that include battery energy storage, smart solar inverters, water heaters and connected thermostats and provide APS with critical grid services such as load shifting, renewable's matching, voltage support and peak demand reduction. Meanwhile Building 36 continues to make strides developing the HVAC channel and building their product offering. They also play a key engineering role in our energy management technology and were instrumental in developing our HVAC safeguards capabilities.

This machine learning capability monitors HVAC systems and can alert service providers and homeowners to trouble conditions before they escalate into more expensive damage or complete system failures. Although each of these vertical businesses are in different stages, I'm pleased with their collective overall progress. With skilled teams in each business, we'll continue to invest to develop these opportunities through 2019 and report further on their progress as the year unfolds.

To summarize, I'm very pleased with our performance this quarter and throughout 2018. We also have a strong plan for 2019 that I am exciting about leading. Thank you again to our service provider partners and the Alarm.com team for their hard work and to our investors for their trust in our business. And with that, let me turn things over to Steve Valenzuela. Steve?

[Steve Valenzuela, executive]

Thank you Steve and good afternoon everyone. I will start with a review of our fourth quarter and full-year 2018 financial results and then provide guidance for 2019 before opening the call for questions. SaaS and license revenue in the fourth quarter grew 19% from the same quarter last year to $77.8 million. This includes Connect software license revenue of approximately $10.7 million for the fourth quarter compared to $9.6 million for Q4 2017. For the full year of 2018, SaaS and license revenue grew 23% from 2017 to $291.1 million. I should note that 2017 represents a partial year for Connect software license revenue from the closing of our acquisition of the Connects Business Unit of Icontrol on March 8, 2017. Our SaaS and license revenue visibility remains high with a revenue renewal rate of 93% in the fourth quarter at the midpoint of historical range of 92% to 94%.

Hardware and other revenue in the fourth quarter was $33.6 million, up 42% over Q4 2017. The increase in hardware revenue was primarily due to an increase in sales of our video cameras. We continued to see strong sales over video cameras with about 1 in 4 installs going to our existing install base of subscribers and the remainder going to new subscribers. Total revenue of $111.4 million for the fourth quarter grew 25% from Q4 2017.

For all of 2018, total revenue grew 24% to $420.5 million. SaaS of license growth margin for the further quarter was 85.1% down slightly from Q4 17 gross margin of 85.5%. Hardware gross margin was 18.8% for the fourth quarter compared to 21.9% for the same quarter last year primarily due to product mix. Total gross margin was 65.1% for the fourth quarter compared to 68.6% for the same quarter last year mainly due to the lower hardware margins.

Turning to operating expenses. R&D expenses in the fourth quarter were $24.4 million compared to $18.9 million in the fourth quarter of 2017 as we continued scaling our planned investments in R&D to support the opportunities we see in our markets. We ended the fourth quarter with 500 employees in R&D, up from 447 employees in the same quarter last year. Total headcount increased to 884 employees compared to 784 employees at the end of Q4 2017.

Sales and marketing expenses in the fourth quarter were $16.3 million, or 14.7% of total revenue compared to $10.9 million or 12.2% of revenue in the same quarter last year. Marketing expenses will fluctuate from quarter to quarter based on plan marketing events and as we make decisions that affect the timing of various marketing campaigns. Our G&A expenses in the fourth quarter were $17.8 million compared to $13.6 million in the year-ago quarter. G&A expense in the fourth quarter includes a $3.3 million impairment provision on a promissory note we provided to one of our suppliers who is implementing a financial restructuring. This $3.3 million charge is recorded as an expense against both our GAAP and non-GAAP financial results.

G&A expense in the fourth quarter includes non-ordinary course litigation expense of $3.2 million compared to $2.3 million for Q4 2017. Non-ordinary course litigation expenses are part of our adjusted measures and are excluded from our measurement of our non-GAAP financial performance.

Non-GAAP adjusted EBITDA in the fourth quarter was $20.9 million, which includes the previously mentioned $3.3 million impairment charge of a note to our supplier. For 2018, adjusted EBITDA was $93.1 million, up 30% from 2017. In the fourth quarter, GAAP net income was $7.9 million, compared to GAAP net income of $320,000 in Q4 2017. Non-GAAP adjusted net income increased to $14.5 million in the fourth quarter compared to $13 million for the fourth quarter of 2017. Non-GAAP net income for 2018 was $66.1 million or $1.33 per diluted share, up 47% from non-GAAP net income of $45.1 million or $0.92 per share for 2017.

Turning to our balance sheet, we ended the fourth quarter with $147.1 million of cash and cash equivalence. Note, in Q1 2019 we paid $5 million on the TCPA legal settlement and expect to pay the remaining $23 million later this year.

In the fourth quarter, we generated approximately $25.7 million in cash flow from operations compared to $18.6 million for the fourth quarter 2017. Our free cash flow for the fourth quarter was $24 million up from $15.8 million free cash flow for the same quarter last year. Through the 12 months ended December 31, 2018, we generated $49.7 million of free cash flow compared to $46.7 million for the same period in 2017.

Turning to our financial outlook, for the first quarter of 2019 we expect SaaS of license revenue up $78.5 million to $78.8 million. For the full year of 2019, we expect SaaS and license revenue to be between $328 million to $332 million. We are projecting total revenue for 2019 of $440 million to $450 million, which includes estimated hardware and other revenue of $112 million to $118 million. We estimate that non-GAAP adjusted EBITDA for 2019 will be between $101 million to $103 million. Non-GAAP net income for 2019 is projected to be $69 million to $71 million, or $1.37 to $1.41 per diluted share.

We expect our non-GAAP tax rate to remain at 21% for 2019. EPS is based on an estimate of $50.4 million in weighted average diluted shares outstanding. We expect full-year 2019 stock based compensation expense of $17 million to $18 million. In summary, we are pleased with our performance in the fourth quarter and full-year 2018. We are focused on executing on our business strategy and investing in our growth opportunities while continuing to deliver solid financial results.

Thank you for joining us on our call today, and with that, operator, please open the call for Q&A.

[Operator]

[Operator Instructions] Our first question comes from the line of Nikolay Beliov with Bank of America.

[Nikolay Beliov, analyst]

My first question is for Steve Trundle. Steve, can you talk about the product and technological differences between ADT Pulse and ADT Command, and what's the likelihood that ADT might become keen on moving the Pulse subscribers to ADT Command?

[Stephen Trundle, executive]

Sure. I -- the ADT team designed a new -- entirely new application which is being called Control. The architecture is more of a SaaS architecture than an on-premises architecture. There are a number of new feature sets there. They established a new hardware platform for the offering as well, and I've got to be careful in that it's -- they're offering, I want to let them talk about it, but it's a significant upgrade over what they have been offering and that's not to say that with Pulse we won't continue to make a number of upgrades and continue to enhance that platform as well.

[Nikolay Beliov, analyst]

Got it. And a question for Steve Valenzuela. Steve, when you look at the subscription revenue guidance for 2019 at a high level, what is the underlying assumptions you have embedded into the guide, looks a little bit lighter than that's expected.

[Steve Valenzuela, executive]

So consistent with our past practice, when we're giving a guidance range, we're considering what we have or what we know today, and so we don't factor in additional upsides or we don't factor in a lot of the growth initiatives that we know are out there that are still early stages. So we've just consistently provided guidance based on that methodology and we think that's worked well for us and we've really -- we really stuck with that.

[Operator]

Our next question comes from the line of Adam Tindle with Raymond James.

[Adam Tindle, analyst]

I just wanted to start -- Steve Trundle, you've talked about being very thoughtful about the investments that the company makes. In the past, you've talked about every dollar of marketing typically brings about a dollar or more of incremental SaaS revenue, but I know you have a number of initiatives and vertical market expansion that you outlined. So I'm just hoping that you can touch on how did the payback rules of thumb change because kind of to the point of the last question, it seems like a step function decline in payback in SaaS growth rate based on 2019 guidance versus what you would expect if payback is still less than one. Acknowledge that you outperformed initially in 2018, but just hoping that you can touch on those dynamics.

[Stephen Trundle, executive]

Sure, yes. I mean, you first keep in mind that 2018 had a partial benefit from the Icontrol acquisition. But looking at those other segment businesses, the payback is just a lot longer and then more material. So there are certain investments we can make where we're looking inside of the year, and we can see sort of instantaneous results, not instantaneous but you can see certain customer creation activity results from certain sales activity. And then with the other segment businesses, these are more R&D investments at some level where if our experience with Alarm.com as an indicator, we're looking out over a 10-year horizon and thinking about where we want to be in half a decade and then a decade and which markets we want to be in. So it's much harder to sort of do an NPV calculation on the investments we're making there but we think that the upside merits of our speculative investment and likewise we think that the strength of the company is enhanced with the breadth -- with adding sort of increasing breadth of markets that we're able to serve and enable. So that's sort of how we look at it. I think we're probably a little less focused on spreadsheet mechanics when we think about our other segment businesses and sort of the long-term goals that we have there.

[Steve Valenzuela, executive]

I would say that the other segment is growing faster than overall Alarm.com. And if you look at it in 2018, the other segment, which includes energy of PointCentral, Building 36, contributed 8% of total revenue, that's up 100 basis points from 2017 when they contributed 7% of total revenue. So while they're still early stage, they are contributing more revenue and becoming more significant to overall Alarm.com total revenue.

[Adam Tindle, analyst]

That's helpful. Maybe just a quick follow up. I wanted to touch on kind of more near-term differentiated results. We've seen significant weakness from the publicly traded DIY players like in the security camera market, even the pro-install players at the high end and the CDA channel have experienced some slowness. So I'm just hoping that you can maybe reflect on the different channels around you and how you've been able to navigate with strong double-digit growth while they've seen turbulence?

[Stephen Trundle, executive]

Yes, that's a good question Adam. We're not in those markets as much, so we don't see sort of the day-to-day pressures and activities that exist there. We have noted some of the results that have come in. I think what we've been sort of stating fairly consistently is, it really isn't all one market. There is a market that prefers what we characterize as real security, robust security where the homeowner views the implement of the Smart Home System, and particularly the Smart Security System to be an investment in their property. And therefore, it's important for them to have a trusted relationship with a professional service provider, and that market has been robust. So I think we've been probably less exposed to some of the volatility -- if you think about the DIY markets, they tend to be affected by where you are in the early adopter versus mainstream sort of adoption curve, and you never really know where you are on that curve at any given point in time. So it's easy to extrapolate that you're already in the mainstream and you're sort of kicking along at a certain rate and then you really realize you were sort of at the tail end of an early adopter stage and you've got -- you don't -- it's much harder to predict those businesses, I think.

So fortunately, ours -- our business is proven and it's been around for a while and we have a lot of confidence in our service providers. If I think about the high end, I think probably the reason we've maybe have not seen some of the same indications there as what we've heard there, our first where -- we're slightly less exposed to new construction starts and second I think that the buyer is still, at least our buyer is a security first customer and people always have a need for security and safety and through thick and thin. So I think, again, we've been able to maybe not see as much volatility there as some of the others.

[Operator]

Our next question comes from the line of John DiFucci with Jefferies.

[Julian Serafini, analyst]

This is Julian Serafini on for John. So I guess I just want to touch back on the guidance again. I know you've touched on it earlier, and Steve, you talked about not factoring in all the upside necessarily. I guess I just want to confirm, right, the core business is still growing strong and going well because even if you factor in some upside rise to a little bit of a decel from 2017, 2018, so I just want to confirm that things are still going well in the core business at least.

[Steve Valenzuela, executive]

Yes, we're still very busy. I think we've seen sort of mid-teens growth come in. We provided an initial outlook last year and actually, I think, on the total side we raised that number some with this outlook. So business is still doing well. We're growing nicely. On a percentage basis, we're not growing at quite the rate we were when we were a smaller company, but we're still enthusiastic about the growth we see and the outlook for the year and then about a lot of the upsides you see in some of the emerging opportunities. So generally, our feelings are pretty positive right now.

[Julian Serafini, analyst]

Okay, understood. And then just a second question, too, on the video product. I think you talked about wanting to drive us some of the video products and video analytics going forward this year. Are you going to do anything in terms of like incentivizing subscribers to maybe discounts in the video hardware or something to like incentivize people to want to upgrade to the video products?

[Stephen Trundle, executive]

That's a really -- that's a good question and it's a -- I'm chuckling because it's a question that reflects the conversation we've been having over the last week which is exactly what is the upgrade cycle on video cameras. At what -- if a customer has video cameras that are 3, 4 years old, is there sufficient sort of gain in the capability that we really should do more to drive adoption. We're already seeing, as Steve V. said a moment ago, we're already seeing 1 out of 4 of the new cameras going into existing customer accounts. So I -- my belief is the functionality is so materially -- so much better with the new cameras and with the analytics capability that we probably don't have a need to do -- just for the purpose of video to do any sort of inducement to purchase, but I think that there may be reasons to package up the new video analytics capability with something like an LTE upgrade offer and use it to generate pull-through for some other types of goals we may have in the company.

[Operator]

Our next question comes from the line of Kevin McVeigh with Credit Suisse.

[Kevin McVeigh, analyst]

You spoke a little bit about the commercial initiative. I wonder if you could give us just an update on that. Any thoughts as you kind of roll that out, maybe more so in 2019 and specifically as you think about the dealer network, is it an expanded dealer network given it's a bit of a different skillset from an installation perspective or do you still focus on kind of the core dealers in the residential that offer both type services?

[Steve Valenzuela, executive]

Yes, it's both actually. So the existing base of service provides, quite a few of them have serviced commercial in one frame or another, in one way or another historically and some have not. But in any case, all of them have one thing in common which is hopefully they have a trusted relationship with Alarm.com. and they therefore will be open to levering our capabilities on the commercial side or developing a commercial business around our capabilities. So that's what I'd say about the existing partners. It is -- there are a set of players in the industry that are purely commercial that really aren't residential, and now we have a reason to have a dialogue with those parties. So we anticipate some expansion of the partner base. I think we even saw that a bit towards the end of last year where we're in discussions and going through the process with service providers that focus really on the suite -- focus on the SMB segment where we've designed this offering to focus and still fairly early, but we did see meaningful uptake last year of the commercial service plans and made a lot of progress, I think, also in getting the access control component of that commercial plan embedded in the market.

[Kevin McVeigh, analyst]

It's helpful. And then should the traditional relationship between kind of the SaaS and the hardware lines across the revenue stay constant as you get more commercial or should we expect that to flex up or down a little bit?

[Steve Valenzuela, executive]

That one's a bit of a hard one for us to predict because it's a little bit partner dependent on -- or ecosystem dependent and at various points we will engage with the other parties in the ecosystem in different ways. Sometimes we'll make a product, sometimes we'll introduce a new partner. So the long-term trend there is hard, challenging, for us to really predict.

What I will say is in the near term, obviously, with commercial plans we're creating more value. There's a wider range of services and therefore the ARPU there is higher. At the same time, those customers tend to not be satisfied with one camera but instead need several and there's a more meaningful hardware component as well as they sort of build out a full solution. So I -- I don't know that I have an exact prediction for you, but I would probably say something in line with historical numbers is probably the right place to be right now.

[Kevin McVeigh, analyst]

Great. And then just one last one, if I could. With ADT's partnership with Amazon, have you started to see any impact on that in terms of flow through to your business from ADT or are we still too early in that process?

[Steve Valenzuela, executive]

We're still too early in that process.

[Operator]

Our next question comes from the line of Matt Pfau with William Blair.

[Matthew Pfau, analyst]

Wanted to get a little bit more detail on the video analytics product and so in terms of initial uptake of video analytics, has that primarily been from new customers or have you seen uptake from existing customers. And then, your [indiscernible], I believe that's only available on 2 of the cameras that you deploy. So as you make that more broadly available, maybe you could give us an idea in terms of maybe percentage of your base of video customers that would potentially be able to adopt a product as you implement it into more video cameras.

[Stephen Trundle, executive]

Right, I'd say we've seen the adoption on both existing subscribers who have video cameras that have the processing power required to support our analytics offering. There are a number of folks that are sort of waiting and then we're definitely seeing the adoption on new installations because they're using a mix of cameras that are more likely to support the capabilities. You're absolutely correct though that at the moment, in the camera portfolio, there are a handful of our cameras that are, especially the POE cameras, that are not yet generally available in a way that supports the analytics capability. So I think as the full portfolio supports the video analytics ability, we'll continue to see a rise in the adoption rate there. But it's already at a rate that I can almost envision over the next few years that some base level functionality will become sort of standard table fair and sold into every installation.

[Matthew Pfau, analyst]

Okay. And then have you been working with your partners to educate them more on the offering and get them to push it through to customers or is there more of an opportunity there and from a marketing perspective with your dealers?

[Stephen Trundle, executive]

Yes, I definitely think there's more of an opportunity there to educate the service providers and also the consumer and there's always a bit of a lag. People hear about it, but until they have actually done a few installations, sort of watched what happens to their customer service intensity, get comfortable that the customers are happy, it just takes a while, it takes a while for us to train and we're still in the pretty early part of that cycle. So we definitely have an opportunity to do more there.

[Operator]

Our next question comes from the line of Gabriela Borges with Goldman Sachs.

[Gabriela Borges, analyst]

Steve Trundle, I wanted to follow-up on some of the earlier comments. I understand that you're limited in what you can say about ADT. So I'll focus instead on the implications for your business model. How should we think about the ARPU and gross margin on some of the new SaaS-like architecture product versus the classic SaaS business? Thank you.

[Stephen Trundle, executive]

Gabriela, I'm not sure you're comparing our traditional SaaS business to what -- which...

[Gabriela Borges, analyst]

The new ADT interact -- the new ADT SaaS like [stack].

[Steve Valenzuela, executive]

Oh, I see. I see, okay. The new model is more like our traditional Alarm.com model and that we're trying to deliver a fuller range of services that includes all the operations of hosting the offering, or redundantly hosting the offering, managing a set of carrier communications relationships and doing as much as we can to provide the maximum amount of efficiency and leverage from our abilities as we can. So it's more like the traditional Alarm.com business model. That's very helpful, thank you. And the follow-up is a high-level question on the earlier comment on early adopters versus maybe interactive technology becoming a little more mainstream.

So maybe for Steve Trundle, I would love to get your thoughts. Where do you think we are in terms of adoption on the transition from classic traditional security to something more interactive like what Alarm.com offers?

[Stephen Trundle, executive]

Sure. Yes, and I was almost speaking about the adoption curve. Someone had asked me about the DIY products and trying to know where you are, why are we seeing the turbulence there? And I was sort of speculating that we just don't know where they are on the curve. In our case, I think we do know a little bit more about where we are in the curve just because we've been at it for a decade, and I think we're into the mainstream and have been into the mainstream for the last couple of years and are gradually executing the process of moving, hopefully, the entire market from one that was dominated by a thought space [indiscernible] sort of not always connected solution to one that is always connected. I guess rough math would be that there are somewhere between 20 and 25 million of those historic customers and we're probably $8 million or $9 million into that base at this point with interactive capabilities and then of course we are working to increase the size of that market as well. So it all depends on how you define the market but I think in the space that we serve, which is really the professionally serviced customer on the residential side, we're in sort of the mainstream component of the curve. On commercial we're probably still in the early adopter part of the curve at the moment.

[Operator]

Our next question comes from the line of Jeff Kessler with Imperial Capital.

[Jeff Kessler, analyst]

First question would be on the introduction of Smart Signal and what you're going to do with it? Can you give us some time line with regard to, number one, who are the main -- what's -- how are you going to train and get Smart Signal out into the marketplace because it seems like Smart Signal is the first part of a maybe ASAP to PSAP type of jumpstart but it's also obviously a lot more to -- it's a lot more of a personal item to be able to actually com -- make things convenient for the end user. So the first question is around Smart Signal and what you're going to do to get it -- greater adoption and how you're going to do it?

[Stephen Trundle, executive]

Right, no. Good question Jeff. So we're excited with the award we were able to get on that capability at CES. The whole goal here is to give the user control and at the same time, in this case, to really cut back on the false dispatches and false alarms that central stations unfortunately and first responders have to deal with.

So with Smart Signal we're giving the customer a lot of control in terms of the ability to cancel out alarms and do that from their mobile app and the process there, and then of course we're also -- the second thing is also very important which is we're giving the customer the ability to initiate a panic from their mobile device and route that into both the control panel and into the central station and ultimately to PSAP.

So in both cases the way it works is the app, the functionality is actually built into the platform and is now available, essentially, to any subscriber with one caveat. Their service provider and then the underling central station has to be comfortable with the functionality and be ready to turn it on because the way the signals come in, there are new types of signals that they may not have previously needed to deal with. There are new types of response regimens that they need to train their operators on. So what we're seeing is sort of a -- everyone's enthusiastic about it. The initial service providers that have deployed are confirming that we're seeing a slightly -- a reduction in the number of signals hitting the central that require the operator to make calls and we're also seeing a reduction in the number of false dispatches.

But each central and each service provider will have to go through our training program and really test the functionality and then train their folks on how to handle these signals so that -- so that there's no deviation from protocol. So that's what we're doing right now. Longer term, you're correct, it's part of an overall goal that we have to make more efficient the way that -- with the wealth of information, the wealth of content that we have about a location and about what typically happened at that location and provide better content and better information to the first responder so that everyone in the entire value chain is able to work most efficiently. So it's part of that cycle.

[Jeff Kessler, analyst]

Yes, as a follow-up to that, as you know in December, federal court upheld an ordinance from a small community in Georgia against the local alarm companies. And while it is a good, probably deserved, kick in the butt for some of these alarm companies who have been cruising on this for a while, it also brings up the -- it brings up the, I would say, need for an accelerated verification capability on the part of the leading companies in the industry who want to -- who want to avoid the problems of these ordinances. And the question to you is, beyond Smart Signal, what are you doing, what can you do to essentially become more of a verifier for -- and obviously increase the value proposition for Alarm.com? I mean I'm not -- I'm seeing beyond the integrated companies, it is also some of the independent monitoring companies that are using -- that are monitoring the DIY guys are beginning to incorporate some of your stuff along with some of other people's verification stuff because they realize that this is not something that is going to be for 4 or 5 years from now. This is something that they've got to do in the next year or 2.

[Stephen Trundle, executive]

Right, so 2 thoughts on that and then I'll -- I think that's a good point. I think that's a -- probably a constructive trend for us in that folks do want to make sure that what they're passing to the first responders is a valid alarm signal. So what can we do about it and how does that sort of help Alarm.com? First, for a long time we've used machine learning to differentiate from routine activity -- between routine activity and unexpected activity. So we're at a point where you can imagine with the data we have on a property, and if you take the algorithms we're using for example in healthcare, we can predict the likelihood that a signal is false or real and provide one more data point there. The second is -- relates directly to data analytics that I've already spoken to which we can tell a lot about what's actually happening in a property, give people a first view of that and I think we'll see our service providers move to increasingly lay on verification layers to increase the value of what they're providing to the first responders.

[Jeff Kessler, analyst]

Okay, thank you. One final question, what can you do to integrate and become part of the ecosystem of some of those companies that have been involved in both access control and video for midsized and larger commercial companies that are trying to come down into the marketplace now and come down meaning into the smaller commercial area. They could be competition for you, but they can also be -- they can also be partners with you as well. I mean, the names are well known in the security industry and it seems to me that you have the opportunity here to not just integrate with smaller camera folks and smaller access control folks, but with people who have some larger systems out there to get your applications into a just slightly higher level of the commercial -- of the small business and commercial area.

[Stephen Trundle, executive]

Right, no. Good question again. So definitely, we're starting with an SMB focus, you have -- I think you have to focus and you have to train in one area. That said, the platform is not limited by the square footage of a facility in any certain way and we're seeing -- we're seeing a few installs that are a hundred access point plus that demonstrate an ability of the platform to scale up but if we think about our base of service providers, we think that initially the sweet spot for them is in the SMB and then we'll move from hopefully what we will build as position of strength, we'll begin to move up market after that.

[Jeff Kessler, analyst]

And I'm sorry, one last question. And I'll make it -- I will make it quick. You've got 4 or 5 businesses in the other category, you've gone from 7% of the business -- of your total revenues to 8% of your total revenues. Can you talk about which of those businesses are actually seeing the greatest traction right now?

[Stephen Trundle, executive]

At the moment, the greatest traction is from EnergyHub and PointCentral.

[Operator]

Our next question comes from the line of David Gearhart with First Analysis.

[David Gearhart, analyst]

So my first question has to do with the homebuilder channel. You recently announced the relationship with DR Horton and earlier in 2018, in June, you announced the revised program and you had a relationship already with a large builder, I believe Toll Brothers. Just wondering if you could talk about adoption since that revised homebuilder program in 2018 and how we should think about attach rates for recurring service on new builds. Is there a percentage that you're seeing that we could use as a proxy to kind of handicap DR Home -- DR Horton builds and try to get a sense of how that could shape?

[Stephen Trundle, executive]

I'd say that roughly, so assuming you have a relationship with the homebuilder and you have the opportunity to speak to the customer, that the range of sort of the take rate or the acceptance rate is between 40% and 50% is what you're generally seeking to obtain there and it may be of a higher percentage that are using more of an automation only type of offering but when we get to security that's the take rate that we would like to see, be seen, as a minimum.

[David Gearhart, analyst]

Okay, and then in terms of ADT, you're supporting their new platform and their prior platform. The company recently announced earlier this month that it actually acquired a do-it-yourself solution. So I just wondered if you could provide some color, how you're thinking about DIY in terms of their having a solution. Is it something that Alarm.com can support or is it just something that's too early to kind of discuss in terms of where you could fit in with that offering with ADT?

[Stephen Trundle, executive]

Yes, I guess what I'd say David is it's probably a little early for us to discuss much there. I think we've seen for a long time, if I roll the clock back a year or 2, there was a DIY partnership there with Samsung, I think it's not really a new dynamic that ADT is growing their business in a number of different dimensions. Our role to-date has been more on professional services side so we haven't really focused much on the DIY component and it's probably a little early for me to comment any further on that one.

[David Gearhart, analyst]

Okay, and then lastly, litigation obviously picked up in 2018 versus 2017. How should we think about the direction of litigation expenses in 2019? Should it be flat, up, down, just for modeling purposes.

[Steve Valenzuela, executive]

Hey David, it's Steve Valenzuela. I would look at it at about the same level as 2018, not including the $28 million TCPA settlement. So if you take that out of litigation, legal expenses -- litigation expense was around $17.5 million or so in 2018 compared to about $7 million in 2017. So I would model right around the same level and I have to say, litigation is hard to predict but I would use about the same level as 2018, not including the $28 million TCPA settlement.

[Operator]

Our next question comes from the line of Darren Aftahi with ROTH Capital Partners.

[Darren Aftahi, analyst]

I just want to follow-up on the homebuilder question, and kind of 2 parts to it. First, of the other major homebuilders you kind of haven't maybe publicly said you were working with, is there any pushback to working with you or just kind of a function of time. I'm kind of curious if there's more of a broader strategy with some of the commercial property side folks that build on that side in terms of breaking into your SMB as part of a long-term strategy. And I think last year you guys disclosed your ending sub number for 2017 and I'm curious what that was for 2018, thanks.

[Stephen Trundle, executive]

Sure, I'll start with the last question, which is -- and in my prepared remarks I commented that we have -- we ended the year with more than 6.1 million subscribers and that's not inclusive of any sort of subscribers that are IP license only. And then back to the former question on the builder business. There are a lot of builders that are big name builders, there happen to also be a lot of local builders and there's a lot of activity there that wouldn't rise to the top of being sort of press release worthy but that is happening every day. I don't think yet there's a standard for -- I think builders are still experimenting with what their strategy should be and some are beginning to move, like they -- one indicator of a mover is DR Horton where they've probably moved and been maybe a little more visionary. But I think it's not -- there's not yet an answer for what -- if I'm a builder, it's not yet known or the market hasn't said this is what you do if you are a builder. They're still sort of trying to figure out what they should be doing around Smart Home, experimenting with a lot of things and therefore the sales cycles can be drawn out as opposed to say in other markets where folks know they need to do something and we're simply trying to win versus one of our competitors.

Your question on commercial, and can we parlay that offering into a builder oriented program, to answer the question, we have not gotten that far so we're not doing that today but it -- one can envision if we have strength, for example, with REITs on the resi side that perhaps we could build strength with the REITS on the commercial side and try to do more there, but we're not doing that today.

[Operator]

Our next question comes from the line of Mike Latimore with Northland Capital Markets.

[Unknown Analyst]

This is [ Pavan ] on for Mike Latimore. I have 2 questions. Like, how many distributors are now selling your commercial offering?

[Stephen Trundle, executive]

So the question is how many distributors are currently selling our commercial offering? So yes, we have a total of service provider partners of 8000 plus that we've announced. We've typically added about a thousand service providers per year. If you look at a number of those service providers, they're coming up -- going through our training program. We haven't actually disclosed the number. It's still a relatively small number, relative to the overall 8000, but basically each quarter we're going through a training program, we're training the service providers and their technicians on a regular basis. We haven't really disclosed that number. I don't know if we know the exact number. I think maybe the color that I gave in my prepared remarks was on the access side we had trained 1500 technicians and then I think on the broader commercial line we -- I stated a number of folks that we actually have -- of individual companies that we've trained. So that would be a pretty good indicator. Roughly right now on -- the commercial is still a small part of our base but around 3% of the base in terms of those who are paying for commercial subscription plans.

[Unknown Analyst]

Yes, and could commercial revenue surpass 10% percent of total revenues this year, can we expect that?

[Stephen Trundle, executive]

So 3 -- 10% of revenue, certainly the opportunity is there for the future. I wouldn't say that that would be a realistic goal for this year. Certainly, the potential is for commercial to contribute given that it's early stage. Keep in mind we just launched Alarm.com for business, little bit -- actually less than a year ago in Smarter Access Control. While we're seeing good performance there, it's still off of a small base. The longer-term opportunity clearly is quite significant given that there's over 4 million properties just in North America that we think actually are valid TAM for us for commercial. But as Steve said, today about 3% of our subscribers are commercial paying businesses. So they are paying at a -- the ARPU there is about 2 times that of the residential, 2 to 3 times, so there is a higher amount of ARPU from commercial but I would say a 10% number would be an aggressive percent of revenue for 2019.

[Operator]

Our next question is from the line of Jack Vander Aarde with Maxim Group.

[Jack Vander Aarde, analyst]

Steve Trundle, so given earlier commentary regarding Connect Platform Enhancement in the new ADT offering, do these enhancements to the Connect platform create potential for new or multiple pricing tiers within the existing Connect SaaS business model?

[Stephen Trundle, executive]

Within the -- so the existing Connect model is slightly -- it's SaaS like but it is, just to be clear, it is an on-premise or a deployment of the Connect software and the new offering is more like the traditional Alarm.com hosted SaaS offering. If I think about Connect, on that I think we're going to take direction from our customer on what capabilities they feel are most important for their base of more than 2 million subscribers on Pulse and let the -- really let the customer drive the way they want after that pricing tier. So I probably don't have an answer for you there.

[Jack Vander Aarde, analyst]

Okay. And does the -- can you answer if the new enhancements to the Connect platform result in higher operating costs to you guys as Alarm?

[Stephen Trundle, executive]

So yes -- we -- the new offering is just, for clarity, is not based on -- it's not a Connect-based offering. It's a different software offering and the new offering will have, for us, higher operating cost because we're rendering sort of the full stack of services with that offering, yes.

[Jack Vander Aarde, analyst]

Okay, that's helpful. And then do you plan to continue to break out this Connect versus [Core] alarm SaaS profile going forward?

[Stephen Trundle, executive]

So we've broken it out for 2018 given that the transition to Command for ADT we'll -- we'll decide whether or not -- we haven't decided whether or not we're going to be breaking out going forward, honestly at this point in time. We've provided it in the past. It may not be as relevant breakout for the future given the change to the new Command platform below. We'll update you on the first quarter conference call.

[Jack Vander Aarde, analyst]

Okay, and then if I could just ask one more, is there any change given the hardware GM was flat Q over Q, but down year-over-year, strong video sales again, is there a change in the margin profile or the cost structure of the new video hardware versus last year's models of hardware that was sold?

[Stephen Trundle, executive]

Probably a bit of a change just -- it's mainly mix driven. It's -- what are the higher volume products that are being sold. And then given, I think, someone earlier asked a question about analytics and are we anxious to get analytics more broadly deployed. The answer there would be yes. So you can imagine if you are in our shoes, we want to do as much as we can to lower the impedance of getting that capability in the market. And as I've said before, we're not -- our goal is to help our service providers create new customers; the customer lifetime value, we think, is very high. So there will be times where we're not that worried about the hardware margins if we think we're going in the right direction in terms of creating customer lifetime value.

[Operator]

And that concludes today's question and answer session. Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.

[Stephen Trundle, executive]

Thank you.

[Steve Valenzuela, executive]

Thank you.