ADT Inc. (ADT) Earnings Call Transcript & Summary

Good afternoon, investors. My name is Pete Christiansen. I'm on the payments, processors and IT services team here at Citi. This afternoon, great to have ADT participate in our conference. We have CEO, Jim DeVries; and CFO, Jeff Likosar; from ADT. Gentlemen, thank you for joining us today.

Thank you, Pete. It's great to be here.

Thanks, Pete.

Jim, one of the things I've realized, and actually, it happened on an earlier one-on-one is that there's a lot of new investors perhaps that are new to the ADT story. A lot of investors probably who are aware of ADT, but maybe less familiar with your business model and maybe perhaps some current trends that you're seeing. I think it would be a good idea, perhaps, if you could just go through a run-through there that -- to help some new investors get acclimated to the story.

Yes. Great. And again, Pete, thanks for inviting us. And anybody that's joined today, thanks for investing the time to learn a little bit more about ADT. I'll share just to your question, Pete, a little bit of a high-level overview of who we are. So ADT is a 146-year-old company. Historically, we've been very security-centric. We'll get into how and when and why that's changing a bit going forward. But the brand is -- has come to meaning security and safety and peace of mind. It's an unparalleled brand, 98% unaided brand awareness, 60% -- 98% aided awareness, 60% unaided, what we call brand short cut that is the frequency with which customers only consider ADT when they're buying is 60%. And so we enjoy a phenomenal brand in the security space. We're a mission-driven organization. I think many of our 20,000 associates feel something akin to first responders playing a role that we do to protect customers, both their businesses and their families. We have a lot of long-tenured employees who do a terrific job for us. We're national. We operate in the United States only. And we are effectively a SAC business. So we have an outlay of cash that we invest to acquire customers. And then via a revenue payback of about 2.3, 2.4 years we get a return on that investment. Roughly 80% of our revenue is recurring revenue. So it's a durable, recession-resistant -- recession-resilient business. About -- give or take, about 80% of our revenue is also in the residential and small business sector. And then we've got a fast-growing commercial segment as well. And in that commercial business, Pete, we're about $1 billion. About 20% of our revenues are in commercial. We're bullish both about the residential business and the commercial business. Commercial, prior to the pandemic, was growing at low double digits and is the area of our business that during the pandemic has had the most stiff headwinds. But when the pandemic passes, we continue to be bullish about that business. We've said a number of times we think that the business is delayed, not diminished.

That's helpful. Let's dig into some of the end segments that you have. We'll start off with commercial. Then we'll talk more on residential and certainly on the recent Google partnership, which was recently announced. But first on commercial. Just wondering if we could dig a bit deeper there. If you can dissect some of the trends and performances you're seeing between your national multisite kind of accounts business versus small business. What are some of the trends that you were seeing heading into COVID there? And perhaps, what has changed? And what are you keeping an eye out for?

Yes. So the -- so as I mentioned, the commercial business is the area of our business that has had the most softness as a result of the pandemic. And most of that is a result of having limited access to the customer premises. It's a very diversified business. We are benefiting from the fact that a healthy amount of commercial -- of our commercial business is of a recurring nature. The revenue is recurring in commercial as well as in residential. Not the same proportion, but there's a nice healthy recurring base of revenue in commercial as well. And then, Pete, that diversification in many ways is helping us withstand the pandemic in a better way than we otherwise would. For example, we have a lot of depths in warehouse and distribution protection in that space, and that sector is doing well. We have a lot of work, a lot of expertise in hospitals and hospital business is doing well. And then not unimportantly, you mentioned the National Account business. We have a National Account team that's second to none. And just a month or so ago, we announced our largest ever deal with Family Dollar, Dollar Tree, which was a terrific addition to the National Account team. So premises have been tough to get into, and that has caused us to tap the brakes a bit. But we're bullish that we can get back to that double-digit growth level once it passes, and the headwinds won't be quite as severe because of, a, the diversification of the business; and b, the fact that there's some recurring revenue in commercial as well.

And Pete, one thing I'd add. Jim talks about diversity. That's been a focus of ours, over the past few years to diversify the portfolio. A couple of comments that I'd also make just on our overall model for anybody new to the story. Jim said, we're a subscriber acquisition model and our mission is serving our customers and protecting our customers, of course. But for shareholders, it's about optimizing the return on invested capital, generating long-term positive cash flow. And while there's a number of metrics that people could use to evaluate our business, our focus is really on balancing those measures. So to generate that return, we're focused on profitably serving our existing customers. If you look at EBITDA or measures like that, we're focused on retaining our existing customers. We're taking actions, providing good service so they stay with us longer. And then we're focused on reducing the cost that takes us to acquire new customers. So becoming more efficient in spending or SAC. If we start to optimizing in one of those, we, of course, could, if we're willing to sacrifice the others. And one of the points about commercials that gives us diversity. Our residential business tends to have higher margins, but it also costs more to acquire those customers. Commercial customers on average don't cost quite as much to acquire. The margin rates are quite as high. The attrition characteristics are a little bit better. So one thing we love about the diversity in the portfolio is it helps us balance each of those objectives. And then one other thing I'd add for anybody who's new to the story is we've made a lot of progress doing that. Over the past several years, we're about -- we're more than a $5 billion company today. 5 years ago, we were a $4 billion company. We've grown our EBITDA by more than $450 million 2019 compared to 2015. Our customer attrition is 300 basis points approximately better than it was because of all of those service improvements. We've grown our cash flow by an amount sufficient to cover our debt service. In other words, our levered free cash flow is greater than our unlevered cash flow used to be. And one of the things that's really exciting now is having made a lot of progress in a lot of those areas. We were at a spot network turning to a little bit more of a forward growth posture with the Google deal recently announced being a very exciting item that underpins that transition.

I agree with you on the free cash flow front. I think I was looking at an earlier chart, and comparing old ADT versus new ADT. And your free cash flow margins are markedly higher, and it seems that diversification is playing into that. But one of the things I wanted to ask about was in commercial, particularly in National Accounts, and I want to dig more into the Dollar Tree deal, which is very impressive. It's a 100% penetrated market. So how does ADT compete versus some of its rivals, particularly a brand that was once a part of ADT there? So what is the differentiating factor that's allowing you to win deals like a Dollar Tree?

Yes. Pete, this is a service business. This is a commercial business. And we rounded out our portfolio. The business can be broken into 4 major areas: intrusion, card access, video and fire. And with the acquisition of Red Hawk in December of 2018, that filled that last area of fire for us and allowed us to create some revenue synergies and bring on one of the most talented, if not the most talented, group of fire experts in the country with the acquisition of Red Hawk. The way to win in commercial is all about service. These are large customers. They're very demanding. And everyone has, for the most part, access to the same hardware, the same service, same software and you win by day in and day out, great service to the customer. And the only way to grow as rapidly as we've grown is through taking share and we've been successful in doing so.

That's a good transition into residential, is on the service capability and quality. And that was a big tenet in your IPO comparing versus the older brand -- I'm sorry, the older company, where service had been lackluster. Can you give us an update on -- and you made great strides while you were in private for a period of time there. Can you give us an update on how service quality has trended? And what you -- what are some benchmarks KPIs that you've been particularly focused on nowadays?

Yes. The lead indicators on KPIs have been fantastic for us. We measure Net Promoter Score, and our Net Promoter Scores are at or near record levels. Our call centers are performing well. Our field service folks have done a phenomenal job right through the pandemic, extending through the civil unrest. And couldn't be more proud of what the team has achieved from a KPI perspective. Productivity is tracking well, all customer SAC measures. So we feel great about the lead indicators on the KPI front. And then, unimportantly, a lag indicator that gets a lot of attention, it's customer retention. As you know, Pete, we've said a number of times that the improvement in customer attrition won't be linear, but we've had a terrific first half of the year. Our trailing 12 as of June 30 was 40 basis points improvement, going from 13.5% to 13.1% And so retention as a lag indicator has continued to improve as well.

That's great. More on the residential side. So the last couple of months, we've all been stuck at home. There's also been an element of some social unrest in the country. Perhaps you can discuss maybe how some of those issues have played into recent trends and in greater context of talking about how resilient the ADT model can be in a downturn? But it would be great to see how you interpret some of the trends that have occurred during COVID impacting the ADT residential business?

Yes, you bet. So the trends around COVID have very much been sort of the opposite of the trends around civil unrest. As you can imagine, civil unrest has served as a demand catalyst for our business, and COVID was a headwind. In particular, at the height of shelter-in-place, when like in the commercial business, we had difficulty getting into the customer's home, there were 3 -- I'd say, 3 themes that we anchored on as we navigated our way and continue to navigate our way through the pandemic. The first is -- I talked about this earlier. Our employees have been incredibly resilient. And we were and have been an essential service in every jurisdiction in which we operate. And our employees have done a really good job stepping up, providing great service, installation, sales throughout this pandemic. Jeff and I were talking a little bit earlier to an investor. We have about 5,000 monitoring and customer care employees. And in early March, roughly 100% of those employees operated out of call centers -- 9 different call centers throughout the United States. And as a result of what was really an existential threat of COVID-19, we needed to move those employees to remote work locations, principally their homes. And over the course of 9.5 days, we moved almost 100% of our employees to work from home. And the outcome from a service standpoint has been not to skip a beat. So the first theme has really been leveraging the commitment and resilience of our employees. A second theme for us has been really playing the long game. We wanted to go through the pandemic and manage our business in a way that we're playing for the long game. And so we've resisted extensive cost cutting. We've offered a lot of flexibility to employees. If employees were interested in taking furlough, we were very accommodating to try to make that happen. And essentially tried to optimize for the long-haul, not optimize for a stronger second or a stronger third quarter. So there's been this long-term orientation to how we interact with and manage within the pandemic. And then the last thing is taking safety very seriously. We've done a lot of work around communication and training and education. We've done a lot of work to make sure that our employees, even in the early days, had the appropriate PPE to protect themselves. And so our management of COVID-19 in both the residential and commercial space has kind of orbited around those 3 things: leveraging the resilience and prime dedication of our employees, ensuring that they're safe and playing for the long game.

Have we seen signs, I would imagine, during the peak COVID? Obviously, many customers wouldn't want to service technician in their home, which makes sense. But did you notice any trends, I guess, as state started opening up as we got into the summer, an element of pent-up demand?

A little bit. A little bit. Not as much as you might expect. Again, the service that we provide is a service that provides peace of mind. And customers made their way to allowing us more access than some might expect. Security is important to them. Peace of mind is important. And if there was something wrong with the system, we, for sure, had some depression in demand. And as May and June rolled around, some of that pent-up demand came through with increased service tickets but it wasn't terribly depressed even during the height of shelter-in-place in late April or early May.

We also found, to Jim's point, people value peace of mind, like they always value peace of mind and are inclined. In many cases, we observe if there is -- if they needed service on their system to have that service perform despite the COVID-19 dynamic. But as that started to abate, was around the same time, there were other social dynamics at play, some of the same dynamics that caused demand for new systems to come back rather quickly in June as compared to April. We also saw an uptick in our normal service call rate and then the other measures we can look at and see that customers are using their systems little more. Maybe somebody who only arm their system periodically now they're arming it with a higher degree of frequency. So if there were some reason to need service, it will become more evident. So I would characterize it now as having come back to a degree from a demand level perspective, that's approximately normal. But there's a whole host of dynamics that are in play and it's just hard to parse the effect of each of those dynamics.

Well, it makes sense. At least it makes sense, engagement sales usually follows engagement, right? So no, that's good to see that.

And one of the things that we've told investors for some time as we believed our model to be recession resilient, but we hadn't actually -- fortunately, I would say, it's unfortunate where the economy is in the situation it's in -- but we hadn't experienced it. Now that we are experiencing it, we're seeing as our hypothesis -- consistent with our hypothesis that consumers who value peace of mind value it as much, if not more in challenging economic times. And customers, even if they've fallen on some financial difficulty, they tend to cancel other things before they cancel the service that provides that peace of mind for them.

That's interesting. One of the themes that had been going on for ADT leading into COVID was the idea of offering financing for the equipment. So a little derivation from the SAC model, Jim, that you've talked about, but clearly an opportunity to improve capital efficiency. I'd love to hear your thoughts on some of the early days on how that effort is going. What have been some of the challenges that you've faced? And how do you see the financing option progressing over time for residential customers?

Yes. I'll take that. So just a reminder, people ask us a lot about financing, but a reminder of what we sought out to accomplish was to improve our overall pricing model, make it easier for our salespeople to sell basic systems and more comprehensive instructions or more comprehensive systems, make for a more simpler structure, more options for the customer, including the availability or facilitated by the availability of an upfront financing model. And really, our objective is and was to drive more install revenue and larger systems, more add-ons, more upgrades, more ancillary devices, automation devices. So financing is a component. We piloted a host of different changes throughout much of 2018 for different upfront pricing structure, made -- experimenting with some different things with our recurring pricing, different offers and packages, including financing alternatives. We launched with the pilot in 2018 that included a third-party financing option that was in the form of a consumer loan. So we initially launched that way in certain pilot markets. That actually worked pretty well. But it caused the customer to engage with a third-party that added a little bit of clunkiness to the process for the customer who was having to interface in the 2 different parties go through 2 different versions of credit checks, ultimately would have been built. So in parallel, we were pursuing another alternative that involves a Bank Mizuho, who we ultimately structured this arrangement with that allow the customer to continue to interact just with ADT. Importantly, it also allowed us to maintain our historic ownership model. I mean for people new to the story, I'd highlight that in our normal model, ADT retains ownership to the equipment installed in most residences because we subsidize the cost of the installation to such a large degree. The third-party consumer loan model didn't lend itself to that, and we, therefore, transferred title to the equipment. So we ended up launching nationally this program with Mizuho Bank, the customer relationships only with ADT. We package the groups and receivable sell them monthly instead of every single transaction. So much more seamless experience for the customer. Single party, single credit check, easier for our sales team, better economics for us. It allows us to convert back to our historic ADT owned model, which we largely did for legacy ADT sales in the first -- but actually in the second quarter -- in the middle part of the second quarter. So this is now out nationally. It's effectively the model. If a customer -- a little different for legacy defenders, which we can talk about at some point of legacy ADT. They would be offered the opportunity to finance. We've seen nice increase in our installed revenue. We haven't seen any material effect on volumes. So we're same monthly rates, more install revenue coming from less reliance on subsidies and promotions and discounts on behalf of our sales team, and we're seeing uptick in the take rate on more services. So we're really pleased at how it's played out. As I mentioned earlier, it's hard to parse the effect of this offer from the effect of COVID-19 from some of the effects that caused demand to be higher or about the reasons. But certainly, it's a contributing factor to the some of the successes we've had in growing our adds despite the macroeconomic environment and also increasing our average install per new add, the availability of the financing structure. I'm sure we'll tweak it a little bit as we go because we're only a few months in. But out of the gate, it's off to a really good start.