ADT Inc. Q2 FY2021 Earnings Call

Greetings. Welcome to ADT Inc. second quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to host, Derek Fiebig, Vice President of Investor Relations. You may begin.

Thank you, operator, and we appreciate everyone joining ADT's second quarter 2021 earnings conference call. Speaking on today's call will be ADT's President and CEO, Jim DeVries, and our CFO and President of Corporate Development, Jeff Likosar. Jim will provide an overview of our recent performance and our progress against the company's strategic objectives. Jeff will then cover in more detail our financial performance and outlook for 2021. Also joining us for Q&A are Don Young, our EVP and COO, Ken Porpora, Executive VP of Finance, and Jill Greer, Senior Vice President of Finance. This afternoon, we issued a press release and slide presentation of our financial results. These materials are available on our website at investor.adt.com. Today's remarks include forward-looking statements and forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those forward-looking statements. Some of the factors that may cause differences are described in our SEC filings. Today's call will also include non-GAAP financial measures. For a complete reconciliation of our non-GAAP financial measures, please refer to our press release. With that, I will turn the call over to Jim.

Thanks, Derek, and welcome everyone to our call. We are off to a very solid start through the first half of the year, and I want to thank our entire ADT team and our dealer partners for serving our customers so diligently and delivering solid results for our shareholders. During our February call, I outlined several key priorities for 2021 including growing our RMR additions and improving the performance of our commercial business, and driving innovation both through our internal expertise and through our strategic partners. Jeff will walk you through our second quarter results in a few minutes. In summary, a number of areas within our business are performing exceptionally well. Our small business channel, our commercial segment, DIY, and our dealer channel are all delivering strong results. In the second quarter, across the business, we grew gross RMR additions by 28% compared to last year. We also see some opportunities. We are working to further increase volume in our direct residential channel. And on the expense side, we are making progress on addressing service cost pressures we experienced in the quarter. Overall, we feel very good about our results for the first six months and have good momentum going into the back half of the year. This evening, I would like to share perspective about what we have achieved as well as where we are headed, not just in 2021 but into the future. During the past several years, we have grown revenue by more than 20% from just over $4 billion to more than $5 billion with approximately 80% of that revenue from recurring monthly service to our customers. We have established a sizable commercial business through acquisitions and organic growth, now approximately $1 billion of revenue. We have pivoted to include more smart home products, increasing the number of devices installed per customer from 14 to almost 20 today, which correlates to an increase in average revenue per unit. We have improved our service levels, increasing customer satisfaction with gross revenue retention, improving from approximately 84% for legacy ADT to just under 87%. We have increased our revenue generation and strengthened customer satisfaction, which has translated into an improvement on our trailing 12-month revenue payback from 2.7 years to 2.2 years. Importantly, we captured these positive outcomes in our financial results, growing our cash generation capabilities during the same time with adjusted free cash flow of $675 million last year. As to the direction we are heading in, at our core ADT is a mission-driven company and that mission is dedicated to making our customers' lives safe as well as simple. From our SoSecure app offering free protection options to residential customers who have made us the most trusted name in the smart home security space to multi-million dollar commercial installations, we deliver on our mission every day to over six million customers. ADT's scale and breadth of offering is unmatched in the marketplace. Our path forward is focused on three areas. The first is driving revenue growth through differentiated service to a larger customer base in our core business. The U.S. smart home and commercial protection markets are expected to grow steadily with a total revenue opportunity north of $100 billion in the next five years from just under $75 billion today. Through our direct channels, our dealer network, and our partnerships with leading homebuilders like D.R. Horton, we are connecting with more customers than ever before as we respond to increased customer demand for smart home automation. Of note, our new customers are increasingly choosing more integrated offerings and we firmly believe that the more our customer interacts with their system, the greater the opportunity we have to build a longer-term rewarding relationship with them. This relationship is further solidified by the premium service ADT provides, from installation by best-in-class technicians to always-there customer service to operating the industry's highest certified monitoring centers, no one takes better care of customers than ADT's team of 20,000 people. We remain focused on the customer experience and continually research areas where we can modernize and refresh. By investing in our digital capabilities, we will deliver the level of service customers value most and provide it in a more streamlined cost-effective way. We had an excellent quarter on the commercial side of the business. Our growth is largely attributed to higher market share. We continue to see tuck-in acquisition opportunities where we can increase our market footprint and expand the offerings we provide to our customers. The second area of focus on our path forward is driving adjacent growth. This includes building relationships with our strategic partners in spaces such as multifamily property management, building and construction, insurance, and ridesharing. We are also actively looking at ways to further capitalize on consumer confidence in ADT's brand, which has earned tremendous trust from our customers and maintained over 95% brand awareness. The opportunities afforded to us run the gamut from expanding to new commercial verticals or beyond the home to new opportunities like automotive or solar. These adjacent markets provide potential growth and expand the market opportunities for ADT. Additionally, a number of the adjacent opportunities provide for deepening relationships with our current customers. The final area of focus is shaped by increased innovation, both through our internal expertise and through our strategic partnerships, especially through our relationship with Google. ADT was founded nearly 150 years ago, and we are proudly one of the longest-tenured companies in American business. But I am even prouder of ADT's growing culture of innovation and reinvention, which is crucial to continuing to thrive in the future. Related to our commitment to innovation, it has been almost a year since we announced our Google partnership along with their equity investment in ADT. Over that time, we have made progress while simultaneously learning from each other along the way. We are now offering integrated Google products such as the Voice Assistant, Hub Max, and piloting mesh Wi-Fi. Shortly, we will include the Google Doorbell in our portfolio of products, with expanded offerings planned, including a refreshed DIY lineup in early 2022. Additionally, we are working closely with Google to develop our joint marketing plan. We have already begun some marketing and promotions that feature Google products and we are working with Google closely to develop our joint advertising plans, which we expect to deploy in 2022. During our planned fourth quarter Investor Day presentation, we will present our long-term strategy for the company. We look forward to providing a holistic update then on our partnership with Google, both in the context of our current transformation efforts and our long-term strategy. I will now turn the call over to Jeff to take you through our second quarter financial results.

Thanks, Jim, and thank you everyone for joining our call today. As Jim described, we delivered a solid quarter, continuing our progress on many objectives, especially including growth in additions to recurring monthly revenue or RMR and improved commercial performance. For the second quarter, gross RMR additions increased by 28% compared to 2020, reflecting our investment in customer acquisition, our continued focus on differentiated service and offerings and pandemic-related weakness last year. On a year-to-date basis, we have grown our RMR additions by 26% or 20% excluding this year's initial Ackerman purchases and the smaller bulk account purchases in the first quarter of last year. Our resulting RMR base grew to $352 million, an increase of $14 million versus last year. Over time, we expect RMR growth to lead to more monitoring and services revenue, which increased by 4% in the second quarter. We are fortunate that our portfolio includes a variety of customer segments that are enough to market. Our dealer channel has been especially strong and contributed a larger percentage of new RMR additions than we planned in the second quarter and the first half of this year. While they come at somewhat higher incremental acquisition costs compared to direct addition, dealer-generated accounts delivered solid returns. Importantly, we have remained disciplined while growing with early attrition on recent customer additions trending favorably. Our trailing 12-month revenue payback remained at 2.2 years through the second quarter despite this mix shift toward dealer. Total second quarter revenues were just over $1.3 billion with adjusted EBITDA at $542 million, both slightly exceeding our internal budget. RMR growth, improved commercial performance, lower bad debt expense, and general cost controls all contributed positively to our results. Offsetting headwinds versus 2020 included the non-cash effect of our ownership model changes and higher service costs. As you will recall, we changed our segment structure effective in January of this year and I will share a couple of comments on our segment results. The highlight in our CSB segment continues to be strong RMR additions. We again also grew our net subscriber count in the quarter, and customers are increasingly selecting more integrated smart home systems. Interactive customers now make up more than 55% of our total CSB subscriber base, which contributes to a modest increase in average revenue per unit. Our CSB monitoring and services revenue at $965 million increased by 3% versus last year. Installation and other revenue declined as planned, reflecting the non-cash effect of ownership model changes. Our broad offering investing flat service set the foundation for future CSB growth. In our commercial segment, we continued performance improvements after a pandemic-induced set of challenges in 2020. Second quarter revenue grew by 23% in aggregate, with installation and other up 32% and monitoring and services up 12%. Our commercial segment also delivered strong EBITDA margins. We are very encouraged by our first half progress in commercial and our strong backlog gives us confidence entering the second half. We also are pleased with our cash generation, which remains a priority even as we invest in subscriber acquisition costs and our next generation platform. Adjusted free cash flow was $227 million through the first half of this year, in line with our internal plans. We also continued to improve our capital structure to support our growth objectives including the completion of three transactions during the past month. We renewed and improved our receivables securitization agreement. We extended our revolver to 2026 and upsized the capacity to $575 million. Most notably, we refinanced our $1 billion 2022 note with a new 2029 note. As a result of these and other transactions over the past several quarters, we have addressed near-term maturity, strengthened liquidity, and reduced our borrowing cost. We remain very comfortable with our overall capital structure and liquidity conditions, which enable us to invest in our future. As we look to the rest of the year, we are maintaining the full-year outlook ranges we shared in February. If first half trends continue, we may be at the lower end of our adjusted free cash flow range due to more spending on subscriber acquisition costs. However, our full-year tax payment depends on second half RMR additions, which are affected by residual dynamics from COVID-19 and other factors that have altered normal seasonal trends in quarterly comparisons. We continue to expect full-year RMR additions growth in the mid-teens with a lower growth rate in the second half compared to the first half as we originally planned. As always, we remain focused on the efficient deployment of capital to generate strong returns over time. In summary, we are entering the back half of the year with solid momentum. Our overall revenue and growth initiatives are expanding our RMR base, and our commercial business is performing well. We also continue to advance the longer-term objectives that will shape our next chapter. We remain excited by our future and we are well-positioned to deliver positive results for our employees, dealer partners, customers, communities, and investors, both in 2021 and in the years to come. Thank you for joining our call today and thank you for your support of our company. Operator, please open the call for questions.

Please proceed with your question.

Great. Thanks so much and congratulations. Jeff, just to follow-up on the guidance question, I noticed the slide wasn't in the deck. Are you reaffirming that the revenue and EBITDA guidance as well for the full year? And any reason why it's not in the deck or in the press release, the guidance?

No page just because there's really no news beyond what I said on the call. We are running the business so well in line with our expectations so far, we expect to be within the same ranges that we shared at the beginning of the year. And as I described on the call, the ultimate cash will depend a bit on the RMR additions in the second half of the year. And then the seasonal trends are affected, of course, by COVID dynamics last year, some of which are continuing to affect the trend this year. But our full-year guidance remains in the same ranges as what it was at the beginning of the year.

Great. And then just on the retention, I think the retention would beat my estimate by about 30 basis points. Any thoughts on that? And then is there any way to think about how the retention fits with smart customers related to the core residential in terms of the delta on that?

Sure, Kevin. So yes, we ended the quarter at 13.3% attrition. A little bit of color. We are favorable in lost to competition and non-pay relocation cancels like last quarter. We are a little worse year-over-year. We think some of that is the COVID effect of delaying relocations. We also experienced the expected headwind from the absence of the Defenders chargeback. On a trailing 12-month basis, that's about 35 to 40 basis points. Some of that was offset by our save efforts. To your point, there are some really good lead indicators in terms of the shift in product mix that should be a tailwind to retention. For example, we know that customers with cameras and video services have better retention characteristics. Sales of command and video are at their highest level ever in 2021. Importantly, credit score correlates pretty heavily to attrition. Customers acquired in the first half of 2021 had the highest mix of credit scores in the past five years. So we felt pretty good about the quarter. Long term, we feel bullish on retention.

That's great. Thanks so much. I will get back in the queue.

Our next question is from Ashish Sabadra with RBC Capital Markets. Please proceed with your question.

Thanks for taking my question. I just had a question on the Google partnership. You have introduced some integrated products there and launched joint marketing. I was wondering if you can share any early results on what kind of traction you have seen from the joint product and joint marketing? Thanks.

Sure, Ashish. I will give a little bit of color on Google. Anticipating this question, I really want to start by sharing some context with you. Much of our work this year is about building a foundation for future growth. So we are developing our own software platform. We are improving our DIY offering. We are making investments in our commercial business and essentially putting the pieces in place to leverage the Google partnership over the long term. So it's in that context of building a foundation that I will share a couple of comments about Google and how things are coming along. As you would expect, we continue to feel good about the relationship with Google. We have got several products that are already integrated into the ADT ecosystem, including the Mini, the Hub, and the Hub Max. Mesh Wi-Fi is in pilot. We will have the Doorbell in our product portfolio still this year. We anticipate DIY product in Q1 of next year. As with many of our partners, not just Google, we are navigating supply chain. Our dates are based on successfully navigating the supply chain. But so far, it's going well. I have seen some of the early advertising work and it's very good. We are already in market with some light co-branding with Google. We are working closely with them on quality testing and basically ensuring that the infrastructure, supply chain, and customer experience are all in great shape.

That's great. Good to hear the solid progress that you are making on that front. Maybe if I can ask a question on the commercial side. Obviously, there’s really strong growth significantly beat our expectations and you highlighted strong backlog as well. You also mentioned share gains there. I was just wondering if you could provide any color? Are there some big wins? Obviously, you won the Dollar business last year. Any big wins there? And within the commercial, perhaps any products in particular that are gaining more traction? Any incremental color level will be helpful. Thanks.

Sure. I wouldn't point to any single individual win. It's a lot of successful business across a pretty broad spectrum of customers. Our national account business is doing exceptionally well. We have just an outstanding team in that space. I would say the success is largely due to market share gains and it was across a significant customer base and across all of our products, fire, intrusion, card access, and video. We had a solid Q2 with revenue and EBITDA recovering well. As I shared on the call, our backlogs on June 30 were at another record level. This continues to be a business where we are confident we can compete and win. We have got, in addition to a strong backlog, we have got a strong sales pipeline and we are pleased with our progress. Growth and margin improvement will always be linear in this business. We are playing for the long innings and investing in a number of new verticals, including healthcare, government, and education. We think this business has a lot of runway and we feel great about the quarter.

That's great. Thanks once again and congrats on a good quarter.

Our next question is from Brian Ruttenbur with Imperial Capital. Please proceed with your question.

Yes. Thank you very much. A couple of quick questions. First of all, on attrition. It was up slightly from the previous period. That's not necessarily indicative of anything. But I want you to address that and then talk about where you see attrition by year-end of 2021? Are we going to hold in that low-13%? Can we break into the 12%? Can you talk a little bit about that? And then I have a follow-up?

Sure. Thanks for the question. So there's not a great deal to add beyond what I shared already. The favorability for us was largely around lost competition and non-pay. I am hesitant to predict where we are going to be at the end of the year. We have got a headwind, as I mentioned, from the absence of the Defenders chargeback. That's about 35 to 40 basis points. But there's just a number of positive lead indicators. Our customer care metrics are improving. Our service backlog is currently at a six-month low. We had fewer service requests in July than in any of the last nine months. Our customer save efforts are tracking nicely, Brian. So I feel good about it over the long term. I would love to get into the 12% and even lower than that over the long term, but hesitant to predict how we will end the year.

Okay. Thank you. And then about the commercial recovery, that's the next question. Can you address that? You guys are gaining a lot of market share. Can you maybe say what you are doing in terms of gaining that market share? Is any of this in new offices? Or is it retrofitting offices? Talk a little bit about that because I am seeing out there in the market with the lead-gen and others, suppliers as well as providers, that new office is dead, retrofit is on the way up. I want to know where you are gaining your traction in the commercial space?

Yes. It's across the business. There's for sure some retrofit work. There's some new construction. I think that accounts for about 10% to 12% of our revenues. It's a business that, for us, is hitting on a lot of cylinders. It's tough to tie it to a particular sector. I shared this earlier. We have got a fantastic leadership team in commercial, great commercial technicians, and you win in this business by great service and building a reputation for great service. Brian, that's what the team is doing day in and day out. We are being rewarded for it.

Great. Thank you very much.

Our next question is from George Tong with Goldman Sachs. Please proceed with your question.

Hi. Thanks. Good afternoon. Your gross RMR additions were strong this quarter, up 28%, which actually accelerated from Q1. I think the prior indication was that it would be the peak for those RMR additions. Could you talk about perhaps if there was any pull-forward in gross RMR additions in the quarter? If not, would you say you have an improved outlook from what you had previously for full year gross RMR additions, given your strength so far in the first half of the year?

Hi, George, Ken. I agree. We have a 28% revenue increase in the quarter for Q2. As Jim mentioned, the high quality of performance at the credit scores and the number of devices. It was a great installation quarter for us. I would like you to go back to last Q2 and look at 2019 just to normalize, especially since Q2 last year has really been in the top versus 2019 Q2 it's actually up 13% in probably the same period. So we saw pretty healthy RMR growth. We did see that across multiple channels. Dealer is probably the first one that comes to mind, but DIY, small business, as Jim mentioned, and also residential direct showed that year-over-year growth. So Q1 was boosted by Ackerman and Q2 was heavy organic growth and we worked out, I guess, pretty neatly compared to Q2. Jeff mentioned in his comments that we don't anticipate the same level of growth in the second half of the year, but we like where we are at from a growth perspective, especially with our RMR base ending at 4% higher for the quarter.

And George, just to follow up to Kevin's question. Again, no change to our perspective on the full year where we have shared previously we expect our full year growth rate to be in the mid-teens. That goes with the financial ranges that we shared. And had we really more invested a bit more SAC vice versa growth into the growth with no direction to reduce the SAC. It generates more cash flow but consistent with our full year guidance unchanged and what we shared back in February.

Got it. That's helpful. And we are getting closer to Google joint product launch in the second half of the year. Could you perhaps elaborate on what the remaining milestones are in order to make that a successful launch? At this point, do you have the messaging to contemplate including some benefit of impact from the launch into your full year guidance?

Hi, George, it's Jim. We won't include or I would say very minimally include any incremental revenue as a result of Google. We have a handful of products in play. That significant advertising for Google and ADT together will be next year. In addition to the products that we have now, the only new product and an important product that we are anxious to have in the portfolio, but the only new product will be the Doorbell. There’s light touch promotional work today. There's some light touch co-marketing today, but nothing incremental this year built into our plan as a result of Google.

Got it. Very helpful. Thank you.

Okay. Thank you, operator. In closing, I would like to extend my appreciation to our ADT employees and our dealers. We had a terrific first half of the year. I am proud of your collective efforts. Thanks as well for everyone joining our call this evening. We are optimistic about the second half of the year and ADT's future and looking forward to the growth ahead. Have a good night, everybody.

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.