ADT Inc. (ADT) Earnings Call Transcript & Summary

Good morning everyone. Thank you all for joining us for today's session on ADT. I'm George Tong, and I cover business and info services at Goldman Sachs. I'm really pleased to be joined by Jim DeVries, President and CEO of ADT. Jim, thanks for joining us.

Thanks for having me, George.

Of course. So, Jim, before we dive into the questions, would you like to start by giving us an overview of ADT and a state of the union on the business?

Sure. I'd be happy to. The business is generally performing as expected. The market for security and smart home is robust. George, as you know, we've talked about demand catalysts in de-urbanization, homebuilds and a macro trend around smart home adoption, all are serving to provide tailwind for the business. We're on track to deliver results within the guidance ranges that we provided earlier in the year and affirmed after the second quarter earnings release. The partnership with Google is proceeding well. As you know, we have a 7-year commercial relationship with Google, but they also own 6.6% of our company. They invested a year ago, August, in ADT and so we have a deep partnership with Google, it's arguably our most important partnership. I'm feeling optimistic about the business, I'm feeling optimistic about our growth. We'll continue to focus on our do-it-for-me business. We've got some interesting bundling opportunities, some smart monitoring, differentiation, some unique things that we're doing in monitoring that has me excited. The commercial business is doing well, hitting on most cylinders, and we're exploring some new opportunities in everything from the insurance space. We're kicking tires a bit in solar, there's some interesting opportunities to leverage some of our assets there. And you know about our mobile business, we're looking at some interesting things in mobile, all the way from on person to protecting in the car and automotive. So headline is, things are going well and bullish about the future.

That's great.

Now residential and commercial security trends have remained relatively resilient during COVID. How has the pandemic altered ADT's market opportunity and longer-term growth outlook?

Yes. I would say, you know that the revenue for ADT is durable revenue, 80% or so of our revenue is recurring revenue. We have performed well during the pandemic. There were some speed bumps that we ran across like many companies but generally managed through it. The pandemic had the most impact on us in our commercial business, and that was largely because we couldn't get access to the customer's premises. But I think long term, it hasn't really affected our market. There's some things that we'll do different operationally as a result of changes that we made during the pandemic. Like a lot of companies, we have adopted work-from-home in our call centers. We've got about 5,000 employees that are working from home. We won't be bringing those employees back. We have done some experimenting with virtual service that's gone exceptionally well, and from an operating standpoint, we'll continue to provide some service customers virtually that we hadn't done before the pandemic. But outside of those operating changes, work-from-home, virtual service, I don't see an impact long-term as a result of the pandemic.

Yes. Makes a lot of sense. Taking advantage of increased demand for residential home security, ADT has decided to increase its investments this year into subscriber acquisition costs. How much of a step-up are you making in SAC? And where specifically are these investments going?

So the lens that we use to deploy cash, and in this case, subscriber acquisition dollars, the lens that we use is internal rate of return. And the big step increase for us this year was in growth SAC and principally, George, in residential. We had a lot of interesting opportunities this year, and those returns are coming in high teens, 20%, sometimes even a little better than that. And the step-up in SAC this year was all around residential and fueling growth.

Right. As a result of the higher SAC investments, you've guided to gross RMR additions of mid-teens in 2021 versus low- to mid-single digits in prior years. Which segments of the market is this growth coming from? And how much of this is from the purchase of bulk accounts from partners such as Ackerman versus other channels of growth?

Yes. So the channel that's doing exceptionally well for us is our dealer channel. We have a relationship with D.R. Horton, that's through one of our dealers, and that growth has been outstanding. And so the mix of our business is skewed a bit towards dealer this year, and I would say as a channel that's really on fire, it's that one. We have a terrific group of dealers about 200 strong and really hitting on all cylinders. SMB is doing well, our DIY business is doing well, but overall, that skew that mix is very much influenced by dealer this year. The question on Ackerman. So we did an acquisition of some accounts from a company called Ackerman, headquartered in Atlanta. And that initial purchase was just under 5%, George, of our growth this year. They have signed on as a dealer, and so we're getting subsequent growth from Ackerman via our dealer program, but the initial purchase was about 5%.

Right. Earlier this year, you had guided to an increase in subscriber acquisition costs of $150 million to $250 million versus 2020 levels. What's the likelihood that you would exceed the upper end of this range given the growth initiatives that you're currently pursuing?

Let me share this. We're not -- I'm probably today not prepared to update guidance or change guidance. We have an Investor Day coming in a couple of months. I'm anxious to talk about the future with more specificity then. But I'll offer that there's really no change to the guide. There are some opportunities for us potentially several opportunities that may be available to us in the bulk space that could inch our RMR adds up a little bit. We are not generally -- we're no longer going after pure bulk deals like we had historically. We're much more interested in Ackerman-like deal, where it provides great economics and the opportunity to acquire, if you will, a new dealer. And so if one of those came to fruition, it could boost it up a little bit, but outside of that, the guide is really unchanged.

Right. Makes sense. Based on your spending so far year-to-date on subscriber acquisition costs, it looks like we might come in let the upper half of the range of $150 million to $250 million in increase. Given that, does that suggest that you might potentially exceed your guidance of mid-teens gross RMR additions growth for 2021 as well, given the positive momentum in SAC investment?

Yes. Much of that is driven by the mix change for dealer versus direct. And one of the things that I want to mention that gives some context to that is, we really focus on returns. And in the dealer channel, the SAC on a per unit basis is a little bit higher than it is in the direct channel. But there are some attrition characteristics via the way that we purchase those accounts for customers, essentially a warranty on first year attrition that results in a better retention curve for us. And so, although the upfront SAC is a little bit higher, the returns are quite good because we look at the deployment of our capital through that lens of IRRs. And we're always balancing what does it cost to play our customer? How much does it cost to serve that customer? And what are the retention characteristics? And so to answer your question, the mix of dealers this year skewing a little higher absorbs more SAC, but the internal rate of returns are still healthy because of the retention characteristics.

Got it. That makes a lot of sense. The increase in SAC spend is quite significant this year. Do you expect SAC spend to experience another similarly sized step-up next year as you pursue growth? Or will it return to a more historical rate of growth off of a new baseline?

Yes. This is -- I don't mean that -- keep going back to not sharing guide for '22, but I today won't comment on SAC spend next year. I would share with you, George, we're optimistic that the demand catalyst that I shared earlier, those demand catalysts are serving us well. Customers want our products. We're excited about the Google relationship and believe that, that will serve as a significant advantage for us. And so while I will stop short of sharing a perspective on precise numbers for next year, SAC spend or what precisely we think our gross add growth will be, I would share that we're feeling really optimistic.

That's great. So you mentioned that gross RMR additions growth this year should be mid-teens or higher, but mid-teens is a good baseline. What's your longer-term view for what gross RMR additions growth should be? Not asking for guidance, but just a structural view based on the characteristics of the business model based on the characteristics of the industry, the competitive dynamics, secular and perhaps cyclical trends. What's the view on what gross RMR additions growth can be longer term?

Yes. It's a little premature. It's a little premature to estimate. We're still finalizing our plans for '22. I would say we're mid-single digits, perhaps more over the long term. The leveraging the relationship and all of the assets that the partnership with Google brings to the table serves as a sort of as a catalyst as well and is a cause for optimism for us. So it's -- I'd say in that mid-single-digit range.

Perfect. That certainly makes sense. Attrition, certainly a big area of focus as well for investors and for the company. In 2Q, attrition came in at 13.3%, which increased 20 bps year-over-year and quarter-over-quarter. Could you talk about what caused this increase and how you would expect attrition to evolve, both over the near-term and longer term?

Okay. So the increase in attrition for Q2 was largely driven by relocation. Customers relocating is our #1 reason for attrition, and there was a slowdown of relocations during the pandemic in 2020, and that's snapped back to more historical levels and maybe even a little bit of pent-up demand that drove attrition higher. So the #1 reason for the pickup was relocation. And offset to that was our non-pays, cancellation for non-pay were better than what they've been historically. And our loss to competition was modestly better than what it had been historically. So relocation was a bad guy and non-pay and lost competition were good guys.

Got it. Sticking with the topic of attrition, what drivers do you have remaining to improve attrition performance? And again, longer term, where do you think attrition can potentially go?

Yes. I think -- George, I think we can get in the 12s, and I think longer term, we can get in the 11s. There are some very good lead indicators that are cause for optimism for me. One of those is, we are now -- when we install a system, we are on average installing 20 devices in the home. And that becomes a stickier customer when you have that many devices and a customer is interacting with their smart home much more than they would have in the past. So, I'm embolden by 20 devices per home, interactive for us today, customers that are interacting with their phone -- interacting with their system via their phone, via the software controlling lights, locks, doors, thermostat, looking at their camera. That interactive rate is now about 80%, a little north of 80% take rate on interactive. About 50%, 55%, I think of our base is now interactive, and we know that when a customer interacts with their system that it's a stickier customer. And so the lead indicator of more devices, the lead indicator of more customers using interactive should bode well for us in terms of customer retention. We're doing some really interesting things operationally to improve our save rates. We continue to work on customer service and customer service excellence and providing a premium service that will continue to bode well for us. So, I think long term, we can continue to chip away at it.

Got it. Makes sense. Switching gears a little bit. The growth of DIY competitors, such as Vivint and Ring and Nest certainly has had an impact on ADT's gross RMR additions and attrition. What are you seeing in the DIY space? And how much of a competitive threat are these providers?

Yes. I contend that the do-it-for-me customer is a unique customer from a DIY customer. Our do-it-for-me customers as I said, have on average, 20 devices. It's a more complex system that do-it-for-me customer skews are little older. The do-it-for-me customers skews homeowner. And I will tell you that when we lose do-it-for-me customers to competition, it's not exceedingly often that it's a do-it-for-me than it's a DIY customer. We're not losing them to DIY competitors. So, I'd start by offering that it's really discrete customer. That said, I think that it's becoming less and less the case. I think that the overlap, if you drew a Venn diagram, the overlap would be increasing in the do-it-for-me and DIY customers. And so I see DIY as a competitive threat to us, maybe not today as much as it will be. I think that the extent to which customers are asking for their homes to be smarter and have more and more devices in the home helps us, and I think the fact that we, too, are in the DIY business will be helpful. I look at DIY as a big opportunity for ADT, especially when you look at it through the lens of customer lifetime value, where we have a relationship with a customer when they are a renter, maybe a little bit younger and then have an opportunity to grow with them as their smart home needs mature and become more complex. So, I think DIY is -- and some of those competitors are formidable competitors, but I think DIY in the main is an opportunity for ADT.

Got it. So related to that topic, ADT is increasing the mix of interactive solutions, which help enable consumers to manage their home security systems on their smartphones, sort of incorporating that DIY element into the mix, what percentage of new customers is adopting interactive solutions? And what percentage of our total subscriber base has interactive solutions?

Yes. So, it's been a big area of emphasis for us and the customer demand for interactive has really skyrocketed over the course of the last couple of years, in particular, George, in video. Everybody is interested in cameras, doorbells, and that has really put some wind in the sale for interactive. Our take rate for interactive for new customers is just north of 80% and the overall base is, I'm going to say, between 50% and 55% now who have interactive. I'd mentioned this a little bit earlier, but we think that, that is tremendously helpful for us from a retention perspective because our interactive customers are stickier customers.

Right. Interactive technology in many ways is a gateway to the smart home. On that note, ADT's partnership with Google is on track to launch its first-gen smart home platform in the second half of this year. What's the latest with the Google partnership? And when do you expect to go-to-market with your joint platform?

Yes. So there's a couple of pieces here. The overall Google relationship is going well. They're a tremendous partner every single day, and we have teams from marketing, engineering, communications, working together. It's just been -- it's been a terrific relationship so far. The product rollout is really more of rolling thunder than it is a lightning strike. We have already adopted and integrated and are selling voice assistant, Google Voice assistant, a product called Hub Max. We're in pilot right now, selling Google Mesh WiFi, and all of those products are on our [ trucks ], and are in market today. Next up for us is the Doorbell, and that's likely Q1. I had hoped, frankly, for that to be Q4, but I think that's going to be Q1. We only get one opportunity to launch Doorbell, and we want to make sure that we're putting quality on the top of the list. And that doesn't just include the product, but it includes the marketing and the training and the rollout. And so I think Doorbell will probably be Q1. And then cameras, some short time after that, Q1, maybe Q2. The platform, George, that we're developing internally, basically building our own interactive, that's what we call ADT Plus. That platform will be completed late in 2022, but we'll be rolling out Google Doorbells, Google Cameras without that platform, either on a [ 2 F ] experience or working with Alarm.com to integrate it into our existing command and control panel.

Got it. At a high level, how would you expect the ADT Google product rollouts as well as the later platform launch, and then maybe the partnership more broadly to impact ADT's financial performance?

I feel good about it. In the short term, I think the biggest advantage for us is around branding. We'll be going to market as ADT + Google. And we've done a good bit of brand research and ADT has brand attributes around reliability, brand attributes of trust, but we don't have brand attributes around tech forward or contemporary. And when we have done our research and assess what the brand perception is, when we go together, co-marketing -- co-marketed with Google, we don't lose those positive attributes of reliability and providing peace of mind and trust and instead acquire the brand attributes, the positive attributes from Google. And so I'm eager to go-to-market as ADT + Google. We're in the process of beginning to wrap our trucks. We're ordering new uniforms for our techs, our marketing folks and their marketing folks are working on some joint advertising. And I think the brand is going to be a lift for us in the short term. I love their hardware, the aesthetics are beautiful, and I think that will be beneficial for us as well. It's just really good hardware, but I think the brand is -- will serve to be a lift for us. Long term, we talked about Horizon 3, where we're working together with Google on next-generation smart home, ambient computing, bringing a whole new level of video analytics to the party. And I think long term, working together with them will be hopeful to recreate an industry and really push the envelope on smart home.

All right. Makes a lot of sense. Switching gears a little bit to talk about commercial. Commercial revenues now make up over 20% of ADT's total revenue. How do you expect commercial revenue to perform this year, especially given the rise of the delta variant that could have an impact on the pace of reopenings?

Yes. We love this business. It's about 20% of our revenues. You win in this business by taking share. Most businesses that are in the commercial space already have some version of card access, fire intrusion, video and you win by taking share and you take share by having outstanding service. And there's nobody in the business that has better service than ADT does. And so we've been growing it nicely. I'd expect that we'll continue to see double-digit top line growth. The Delta variant has had some impact, but not as significant of an impact as the early days of COVID. We've had more than Delta, George, we're managing through some supply chain issues that we're working through, but that had served to impact the business a little bit. We're waiting for parts, working with our manufacturing partners as best we can to deliver on those parts. But short term, supply chain has been a bit of a roadblock and more so than Delta. But we'll deliver what we said we would on commercial despite supply chain and Delta, and feel good about this business going forward.

Right. You mentioned double-digit growth expectations for the commercial business. How quickly do you think commercial revenue could grow relative to residential revenue over the longer term?

Because so much of the residential business is recurring, the top line moves less quickly because such a significant part of residential is recurring revenue. And so I would expect commercial to outpace revenue growth in residential meaningfully for the foreseeable future.

Right. So, perhaps turning to free cash flow. Because of an increase in SAC spend, your free cash flow generation is guided to be $450 million to $550 million this year. That compares with free cash flow of $675 million in 2020. What's your framework for managing free cash flow performance overall?

I mentioned this earlier, it's -- the north star for us is capital efficient growth. And we look first at returns, who are IRR driven. And it's in that context that the priorities for us are: first, our core residential business or organic growth, both in direct and through our dealers. We think that SAC is -- the deployment of SAC in that space is the best return for our shareholders. As I mentioned, it's 20-or-so percent IRRS, and so that becomes our #1 priority. The second priority for us is around commercial M&A, and if the bulk opportunities are strategic opportunities, bulk opportunities in residential. But we've done pretty consistent tuck-in acquisitions in commercial. We've just done the one Ackerman bulk in residential, but that would be the second priority in terms of free cash flow framework or use of capital allocation. And then third would be delevering. We're at 4x now, and we'd like over time to get it to something that starts with a 3x. We know that with 3G, the big conversion project that we've had the last couple of years is in the rearview mirror. We'll have more cash available to us, and so those 3 priorities: growing organically on residential; M&A, principally in commercial; and delevering is how we're looking at it.

Right. That makes a lot of sense. As you think about free cash flow performance longer term, what's a reasonable rate of free cash flow growth that ADT can deliver perhaps on a steady-state basis, looking beyond COVID and beyond the difficult comps or any step-up in SAC?

I'm going to save that for Investor Day and share a more precise perspective on sort of how we're thinking about free cash flow and where we sort out on how much we deliver versus deploying that capital for growth SAC.

Got it. You touched on this a little bit earlier, but targeting perhaps a little bit deeper into capital allocation priorities, you talked about organic reinvestment, certainly residential, commercial, M&A. How do you intend to balance these reinvestments with dividend increases with a pay down in organic plus M&A opportunities? What's your overall waterfall in terms of priority for free cash flow deployment?

Yes. I mean, from a capital allocation perspective, very much consistent with what I mentioned a couple of minutes ago. The top priority for us is growth SAC. And I would say the last priority for us would be dividend changes. So, if we stack it up, #1 would be organic growth in resi; #2, the M&A that we talked about; #3 would be delevering; and I'd say, dividends and dialing up the dividend would be #4 for us.

Got it. Well, it looks like we've come to the end of our session. Jim, thank you for joining us, and thanks for the helpful color and insights.

I appreciate your time, George. Thanks for the invite. Always good to see you, and looking forward to that Investor Day.

Thank you. Likewise.

Thank you.