ADT Inc. Q2 FY2022 Earnings Call

Thanks, operator, and good morning, everyone. We appreciate you joining our ADT's Second Quarter 2022 Earnings 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 financial performance and how that links to the mission and long-term strategy we laid out at our Investor Day in March. Jeff will then cover our financial performance in detail. After the prepared remarks, we'll take analyst questions. Also joining us from Q&A are Ken Porpora, EVP of Finance; and Jill Greer, SVP of Finance, Investor Relations and Communications. Earlier this morning, we issued a press release and slide presentation of our financial results. These materials are available on our website at investor.adt.com. And before we start, I do need to mention that today's remarks include forward-looking statements that represent our beliefs or expectations about future events. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of the factors that may cause differences are described in our SEC filings. We'll also discuss non-GAAP financial measures on the call. The most directly comparable GAAP measures along with a reconciliation to those measures are available on our website at investor.adt.com. And with that, I'll turn the call over to Jim.

Good morning, and thanks to everyone for joining today's call. We released our strong second quarter results this morning, showing substantial year-over-year improvements in total revenue and adjusted EBITDA, solid free cash flow generation, and for the first time since our IPO, positive adjusted net income of $50 million or $0.06 per share. We demonstrated continued progress on our key initiatives outlined earlier this year during our Investor Day and delivered what I believe is our best quarter ever at ADT. We have great momentum in our core engine, the consumer business, solid demand for ADT products and services, is driving subscriber growth, higher average pricing, and a record RMR balance, while also improving our operating efficiency. In addition, our unrivaled focus on the customer is producing enhanced brand loyalty along with record high retention. We remain committed to the plan we laid out for you at our Investor Day: a long-term strategy to grow our subscriber base, expand the share of wallet from each customer, and strengthen our brand loyalty and customer retention. Simply stated, we are giving customers even more reasons to choose ADT, stay with ADT, and spend more with ADT. We are driving numerous positive trends in our business that give us increasing confidence in achieving our long-term strategic plan. First, of course, is the Google partnership, which is a catalyst to accelerate growth. We reached another major milestone earlier this week, and with the national rollout of more Google Nest products, including indoor-outdoor cameras, after a West region launch a few weeks ago. I can't fully express the level of excitement we've seen from our customers, our sales team, and installation technicians for these Google products. We anticipate that excitement to grow, especially with the rollout of our new ADT+ app in concert with the self-setup Google product suite before the end of the year. To support these product rollouts, we'll be launching our first joint marketing and advertising campaign with Google in the fall, partially funded by the first $50 million in success fund from Google. The momentum from our Google partnership and product rollout underpins an improving trend in capital efficiency from both higher installation revenue per unit and stronger customer retention. Our residential installation revenue per unit increased 23% year-over-year in the second quarter and 7% versus the first quarter, on the strength of the doorbell launch earlier this year. We expect that trend to continue to improve with the additional Google camera and thermostat rollout. You'll begin to see this in the third quarter, with further expected improvements in the fourth and subsequent quarters. One of the strongest drivers of customer retention and our economic returns is this initial investment customers make in their system. Another important factor is the frequency of interaction with their system. With the extension of the Google products, we now see more ADT customers choosing interactive, integrated, and more comprehensive systems. We're already seeing these two factors and others start to flow through to better customer retention. Gross customer attrition over the last 12 months was 12.7%, a record low, with continued improvement from the first quarter and a 60 basis point improvement versus the prior year. And when we net resales, it's even more impressive at 10.1%. All of this combines to produce more capital-efficient growth, with our revenue payback dropping to 2.2 years. As our results demonstrated in the second quarter, the Consumer business is hitting on all cylinders. Turning to our Commercial segment. The momentum in Commercial sales has been very strong, with both new account wins and solid customer retention. Like many businesses, we're managing the impact of supply chain challenges. We're experiencing some installation delays due to lack of parts availability, which has driven a roughly $40 million increase or about a 10% increase in our installation backlog. Additionally, our commercial margins are pressured by cost inflation on hardware, some of which we have already offset with price increases, which we've successfully implemented. These dynamics have affected some efficiency in translating revenue to profit, which we expect to improve in the second half. In our Solar segment, we remain extremely enthusiastic and continue to see very strong demand for residential solar systems, resulting in a 50% increase in systems installed year-over-year. We also made progress in the quarter with cross-selling, with approximately 15% of solar sales generating from our ADT ecosystem. And we launched a successful pilot with a retail partner for additional solar sales in the retail space. With all this growth momentum, we face some temporary challenges during the quarter as we continue to build the requisite infrastructure and processes to manage this rapid growth. This was exacerbated as one of our financing partners began winding down operations and commenced an out-of-court liquidation, an unexpected event which is isolated solely to this lender. We have confidence our other solar financing partners remain healthy. And we have been working to transition impacted customers to these alternative financing partners. Net, we continue to be very confident about the long-term strategy and success of the Solar business, and we're encouraged by the incredibly strong demand we're seeing in this segment. Summarizing, on the whole, this was a fantastic quarter for ADT. In conclusion, I have four headlines to leave you with. First, we have incredible momentum and strength in our core CSB business. Second, the Google partnership is taking more shape and will serve as a catalyst for accelerated growth. Third, our pipeline for future revenue and profit is strong in Commercial, and the supply chain challenges are being managed well. And finally, our Solar business is experiencing terrific growth. We expect profitable growth and remain confident that this segment will absolutely become a material contributor to overall ADT. I want to thank all of our employees and dealer partners for an outstanding quarter. These results are a direct reflection of your great work. And now I'll turn the call over to Jeff to cover our financial performance and the quarter in more detail.

Thank you, Jim, and thank you, everyone, for joining our call today. As Jim described, we've continued our solid momentum across the business and are very pleased with our exceptionally strong overall second quarter results. Total company revenue was $1.6 billion, up 23%, including the benefit of our Solar acquisition. Excluding Solar, our revenue grew approximately 6%. Importantly, our recurring monthly revenue, or RMR base, grew to $369 million, the record level Jim mentioned, which was $16 million higher than last year. This reflects the benefits of our growth initiatives, improved customer retention, and higher average pricing. Our revenue growth, combined with efficiency improvements, drove a 10% increase in adjusted EBITDA to $597 million. The highlight for the quarter was the outstanding performance of our core consumer and small business or CSB segment, which delivered total revenue of $1.1 billion, an increase of $66 million or 6% versus last year. This performance was driven by the monitoring and services revenue resulting from the RMR growth I just mentioned. CSB adjusted EBITDA increased by $71 million or 14% and was driven by this increased revenue combined with strong cost performance. Our virtual assistance program has been a key driver of our efficiency. As a reminder, this initiative is allowing us to service our growing and increasingly interactive subscriber base while lowering our service costs by utilizing technology and video in place of more traditional in-person service visits. Year-to-date, we've conducted almost 0.5 million virtual visits, which also reduced our carbon footprint and improved satisfaction as customers increasingly value the convenience and speed with which we respond to questions and resolve problems. In our Commercial segment, we delivered solid revenue growth of 6% to $297 million on an increase in monitoring and services revenue. Commercial adjusted EBITDA was $31 million, reflecting a double-digit margin rate. This was relatively flat versus the prior year, as these higher revenues were offset by some inflation-driven challenges, and as Jim described, delays in fulfilling our strong demand. Our Solar segment posted revenue of $215 million and an adjusted EBITDA loss of $15 million, driven by reserves for the lender insolvency and challenges converting sales to installs as we solidify processes and structure to manage our rapid growth. Turning to cash flow and the balance sheet. Adjusted free cash flow was $185 million, up 13% in the quarter, on higher recurring revenue flow-through and lower net subscriber investments. We delivered meaningful improvement in net subscriber acquisition cost efficiency in the quarter, generating a 7% increase in gross RMR additions on 10% lower SAC year-over-year. This was driven by enhancements to our securitization program, higher installation revenue, and other net cost and mix efficiencies. Beyond growth funding, the top priority for our cash flow is improving the balance sheet. Our debt-to-adjusted EBITDA ratio was 4.2x this quarter, down from 4.4x at year-end 2021. Our debt-to-recurring revenue ratio was 2.2x, down from 2.3x at the end of last year. We remain committed to reducing our net debt by $1 billion by 2025. During the quarter, we repaid $90 million against our revolving credit facility, bringing the total drawn amount down to $80 million. Our next upcoming maturity is the $700 million first lien note due next June. We plan to access the capital markets to refinance some or all of that debt, with the exact timing, amount, and structure dependent upon market conditions. We expect to use our strong cash generation to repay the remaining revolver draw and are also considering paying down a portion of the 2023 maturity when it comes due. Regarding our outlook for the full year, we're focused on improving the key value drivers of our core business, adding new subscribers, improving retention, and increasing the amount each customer spends with ADT. This is producing the strong momentum in the business we've described and gives us increasing confidence in achieving our full year guidance, which we are affirming today. Our revenue trajectory remains strong, and we continue to balance growth investments with near-term cash generation across our business. The achievement of our full year guidance will reflect meaningful improvements over 2021 and further demonstrate the resilience, durability, and flexibility of the ADT franchise. I also want to note that as macroeconomic conditions are challenging and uncertain, our business is built to succeed in any scenario. We have several recession-resisting characteristics, a set of offerings that customers highly value, a durable $4 billion-plus recurring revenue stream, diversification across our business segments, and significant capital flexibility. Building on that solid foundation, we are executing on the strategy we laid out at Investor Day to drive growth, stronger customer loyalty, improved profitability, and higher cash flows. We are very pleased with the progress we made through the first half of this year. This progress will not be possible without our customers, employees, dealers, suppliers, partners, communities, and investors, all of whom I would like to thank for their continued support of ADT. Thank you, everyone, for joining our call this morning. Operator, please open the line for questions.

Our first question comes from George Tong with Goldman Sachs.

You mentioned seeing some installation delays in the quarter due to labor market tightness. Could you elaborate on what you saw there? And how much of an impact that had on the quarter?

George, it's Jim. In terms of the impact of labor on installations, it's relatively minor. We had some labor challenges in the Solar business which impacted throughput. But in the core CSB business, it was not particularly material.

And it also contributed in our Commercial segment to some of the backlog build that Jim described.

Got it. That's helpful. You also mentioned seeing some installation margin impact associated with rising hardware costs. Could you talk a little bit about those trends, whether you're seeing evidence of stabilization in those input costs and whether pricing throughput is sufficient to offset that?

Yes. So sure, George. It's Jim again. The inflation pressure that we see is mostly in the Commercial space. That's pricing pressure related to fuel, wages, products, and hardware delays. Our manufacturing partners are putting through price increases, and that puts pressure on margins in the Commercial space. We've done well with increasing prices to offset these inflationary pressures. The team has done a great job. We came in with EBITDA margins just a little bit south of 11%, up from the first quarter. So we feel pretty good about our pricing power to offset the inflationary pressure. On the residential side, we feel very good around the inflation pressures. We recently reached an agreement in principle with Resideo to amend our agreement with them. They've been an outstanding partner. And together with our own supply chain team, we've navigated through supply chain challenges and inflationary pressure in the core very well.

George, just to kind of add on that. What you're seeing also in the results on the CSB segment that the residential comments that Jim was mentioning, you're seeing margin expansion at 53% for the quarter and you see the SAC efficiency there. So not just are we offsetting the pricing increase, but the greater efficiencies flowing through on both the SAC efficiency side as well as our operating margins.

Our next question comes from the line of Toni Kaplan with Morgan Stanley.

Perfect. Wanted to ask a question on the macro environment. Just have you seen any changes in client conversations maybe more towards the end of the quarter or maybe into July? Just wanted to understand if there's any difference in converting customers into buying more things and if this is impacting the Solar business in particular at all or not.

Toni, it's Jim. We're encountering the same supply chain challenges that many businesses are facing in the current macro environment. Demand remains robust in the consumer sector and is very strong in Commercial as well. Due to the supply chain issues, our backlog has increased more than we anticipated, with about a 10% or $40 million increase in Commercial alone, primarily due to supply chain factors. However, demand continues to be strong. In Solar, demand is exceptionally high, with year-over-year growth for Q2 being between 50% and 60%. Fifteen percent of that growth is attributed to leads generated through ADT, and the rebranding of ADT Solar has also been beneficial. Organic searches for Sunpro ADT have tripled, and website traffic has jumped by 60%. We believe that the demand for Solar is strong, and the Inflation Reduction Act could provide an additional boost, as it extends tax credits for rooftop solar to 30% for the next 10 years, potentially serving as another growth catalyst in this area.

And Toni, this is Jeff. I want to add that I mentioned in my prepared remarks that we have several characteristics that we believe are resilient during recessionary periods, which are highly valued by our core customers. There’s some indication that they appreciate these offerings even more during times of uncertainty. Historically, we haven’t observed negative trends during recessions. There are many factors at play, and while it’s challenging to pinpoint individual causes, our low attrition rates and strong recurring monthly revenue additions, coupled with the strong efficiency mentioned by Ken, make us feel optimistic about navigating the current environment and any environment for that matter.

Super. Regarding the supply chain issues in Commercial, you mentioned the $40 million backlog. Are you anticipating that you'll eventually secure this business? Do these clients need the service right away and are they considering alternatives to meet their current demand? I assume others are facing similar challenges, so it's uncertain if they can fulfill the demand. Can you clarify how this situation develops?

Yes, we have had almost no cancellations in the Commercial business. Everyone in the commercial space is dealing with the same supply chain and product issues. I'm not aware of any cancellations in the backlog, although there may be some. We see this as delayed business that will increase once the parts arrive.

Our next question comes from the line of Brian Ruttenbur with Imperial Capital.

First of all, on IOTAS acquisition, that's a move for you guys in the multifamily, which you haven't been, I don't believe, historically very much involved. Can you talk about the size and the focus of moving into multifamily and what this acquisition means?

Sure. It's Jeff. Thank you for the question. IOTAS fits into our strategy of smaller acquisitions, specifically designed to enhance our CSB business and drive growth in the multifamily sector. There are over 40 million multifamily households in the U.S., presenting a significant opportunity. They are a recognized enterprise smart home company catering to owners, landlords, and residents, offering products like locks, thermostats, fleet detection, and access control. We are very eager to incorporate them into our CSB business. Importantly, beyond the immediate customer opportunities, this will also help us connect with customers early in their lives, who we believe could become ADT customers for many years ahead.

And Brian, it's Ken. Just to add to what Jeff mentioned, there's explosive growth in the multifamily market. The technology is almost table stakes now. So us working with IOTAS now is within the ADT family, expanding our platform there allows us to sharpen our skills and speed to market and technology with the platform made specifically for the multifamily space. So we're excited about it.

Okay. I have a financial question. On amortization, it dropped $75 million. Can you talk about this from first quarter to second quarter? Can you talk about this and going forward? Because that enabled you guys to be GAAP positive EPS. I just want to understand what you're looking for in terms of amortization going forward? And you talk about that drop from first quarter to second quarter a little bit.

Yes. Sure. It's just really the roll-off of some of the purchase accounting related asset step-ups that had been amortizing that goes back to the initial Apollo acquisitions of Protection One and ADT.

Okay. And then moving forward, this is the correct level to be using is kind of the second quarter numbers? Or should there be a further drop from here?

The most significant of those assets has rolled off. So you should expect to see future quarters look similar to the first quarter. No, I'm sorry, similar to the second quarter. Sorry.

Our next question comes from the line of Philip Shen with ROTH Capital Partners.

I wanted to see if you could share what you expect in terms of EBITDA from the Solar business in Q3 and 4. And maybe you could talk through a little bit of the charge that you took in the Solar business with that lender. Maybe how much that was? And how do you expect to transition that business? Have you found other lenders to work with and so forth?

I'll start, Phil, and then ask Jeff to add or Ken to add to the answer. I'll start with, I mentioned this earlier I think when Toni asked a question around the top line. And we couldn't feel better about the top line. We had a thesis that said that if customers trust us for smart home, they trust us for smart energy. And so it's been lights out from a growth perspective. And then the brand I'd mentioned is helping very significantly. Appointments are up. Conversion rates are up because customers have confidence in a trusted brand. We just developed a relationship with a retail partner to sell solar at retail. Launched in 28 stores in North Carolina. Will be in Florida in the fourth quarter. So we feel great about our ability to grow this business. To your question, financial results were obviously below expectations. The central driver was lender insolvency that impacted throughput in a major way. About 2,500 customers at varying stages of the installation process, we were unable to convert effectively. And we have shifted obviously away from that lender. They're in liquidation. We have two major dealer partners. One, Phil, is Dividend. You probably know those guys, owned by Fifth Third Bank. And then the second is Sunlight Financial, a publicly traded New York Stock Exchange company. And we've got good faith in both of those organizations.

Yes. I'd just add. We reserved 100% for the receivables from the lender insolvency. That's right at $11 million. We believe that circumstances are isolated with other opportunities, with other lenders to transition relatively smoothly, it just takes a little bit of time, as Jim described. We, of course, are continuing to pursue recovery even though the accounting rules require us to reserve 100%.

Looking ahead to the third and fourth quarters, your slide shows a decrease of $15 million due to the charge and possibly some integration issues for the second quarter of this year. Last year, you broke even. Considering the EBITDA outlook and the growth in Solar, what are your expectations for EBITDA in the third and fourth quarters? Do you anticipate breaking even again, or will there be a contribution?

We are not providing guidance for individual segments. However, we are very pleased to have reaffirmed our overall guidance and the company's performance. We are experiencing strong sales and revenue trends across all three segments. We always account for some contingencies, and we are seeing particularly robust results in CSB. In the current quarter, we managed to mitigate the challenges in Solar, and we intend to continue balancing our portfolio for the remainder of the year to stay within the guidance range we provided at the start of the year.

Our next question comes from the line of Ashish Sabadra with RBC Capital Markets.

I have a question about the Google partnership. Could you share any initial insights from the launches of Doorbell and Wi-Fi earlier this year? You mentioned an increase in retention, upsell, and interactive options. I would also like to know if you can provide any quantitative metrics regarding that and any information on the improved attach rate. As you roll out the Google campaign, what are your expectations for the second half of the year and into 2023? Any details would be appreciated.

Sure, Ashish, it's Jim. I'll provide a little bit of color on Google and then ask Ken to share his perspective on how it cascades through into our financials. As you would expect, we feel great about the relationship with Google. We rolled out the video doorbell earlier this year. That has resulted in an increase in doorbell attach rate from about 27%, 28% to right around 50% in the second quarter. The attachment rate for the other devices, Hub, Hub Max, Mesh Wi-Fi, is off to a really impressive start, and that is helping drive record installation revenue per customer. And now just this week, we've launched the indoor camera, outdoor camera, floodlight, and the Nest thermostat. And we'll be supporting that launch by joint marketing, partially funded by the release of the first tranche of $50 million from the Google Success Fund. And as a reminder, we're going to market co-branded with Google. And our marketing teams already working together on the creative. So net-net with Google, both organizations have worked well together. We've done a lot of work, setting the pins to roll this out, making sure the customer experience is excellent. And it's terrific to see it come to fruition.

And Ashish, on the economic side, what you saw here in the quarter is that the 23% increase in installation revenue per unit, that was largely driven by some of these Google devices that Jim just mentioned. To put that in perspective, that's about $1,200 per home in installation revenue. Again, that's a 23% increase year-over-year. So a significant jump year-over-year. And we've only launched a couple of devices. So we'll continue to see more of this upside in installation revenue per unit. And that brings me back to what you're seeing on the SAC efficiency side. Every $100 of net reduction in SAC per home or business drives in total $100 million of increased annual cash flow. So if you think about what this opportunity can do for us on the installation revenue, it's hugely profitable and exciting for the consumer to get more of these products in the home as well.

That's great color. Maybe just on the macro or the consumer. I was just wondering, have you seen any kind of delays in payment or any increased attrition among the lower-income consumer as those consumers are getting stretched?

Yes. Overall, attrition has been a great success for us. We ended the quarter with a 12.7% attrition rate, which is an improvement from Q1 and about 60 basis points better than last year. July also looks strong, coming in about 40 basis points better than last year. There are several reasons for this success. We are selling more equipment at installation, which leads to better customer retention. Our save offers have become more sophisticated, and our service backlog is at a record low. Additionally, there are fewer relocations in the macro environment, all of which are positive factors influencing attrition. There has been a slight increase in non-pay cancellations, but it is relatively small, and the positive factors have easily outweighed the challenges posed by non-pay. However, to answer your question, there has been a modest uptick in non-pay.

Our next question comes from the line of Pete Christiansen with Citi.

Nice trends, gentlemen. Really nice. I have two questions. First, regarding the average install increase and the SAC efficiency you're observing in CSB. Is much of that due to offering Google equipment? Are customers choosing this equipment outright and paying more upfront? Is that a significant factor?

Pete, it's Ken. Thanks for your note. What you're observing in this initial phase of Google is an improvement in revenue quality. As we proceed with our rollout, co-branding, and advertising, we will see an increase in quantity. To answer your question directly, yes, Google is enhancing revenue quality, particularly from our residential consumer base. Additionally, we are pleased to provide this service to our existing customer base of over 6 million.

That's really helpful. To address the recession questions, I noticed that provisions for bad debt have only increased modestly quarter-over-quarter, and you mentioned that no pay is also up modestly. How are bill pay delinquencies looking in particular? Many clients are curious about this, especially since a major telecom is facing similar issues, and I wanted to explore this further.

No, it hasn't just been building on. What Jim mentioned earlier is that we've seen a slight increase. We believe we are sufficiently reserved. There's no indication that it's a significant issue. Additionally, I want to point out that this also enhances SAC efficiency and creates a kind of flywheel effect that I briefly touched on in my prepared remarks, along with some improvements to our securitization program, which effectively results in a slightly higher advance rate, indicating that the overall performance of the book has been quite good.

And Pete, part of that, too, is our existing customer base has an average credit score of over 700, closer to 710 previous analysis. So the average customer in the ADT service space tends to lead a little higher on the demographic side and discretionary spend especially.

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Okay. Thank you, operator. Thanks, everyone, for taking the time to join us today. I'd again like to extend my appreciation to our employees and to our dealer partners. Your efforts are directly reflected in great quarter results. We continue to be optimistic about the year. And again, appreciate everybody joining us today. Have a great day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.