ADT Inc. (NYSE:ADT) Q1 2023 Earnings Conference Call May 2, 2023 10:00 AM ET

Company Participants

Elizabeth Landers - Senior Director of Investor Relations

Jim DeVries - President & Chief Executive Officer

Ken Porpora - Executive Vice President & Chief Financial Officer

Conference Call Participants

Peter Christiansen - Citigroup

George Tong - Goldman Sachs

Toni Kaplan - Morgan Stanley

Brian Ruttenbur - Imperial Capital

Ashish Sabadra - RBC Capital Markets

Operator

Good morning. My name is David and I'll be your conference operator today. At this time, I'd like to welcome everyone to the ADT First Quarter 2023 Earnings Conference Call. Today's conference is being recorded. All lines have been placed mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

Elizabeth Landers, Senior Director of Investor Relations, you may begin your conference.

Elizabeth Landers

Thanks, operator, and good morning, everyone. We appreciate you joining ADT's first quarter 2023 earnings call. Speaking on today's call will be ADT's President and CEO, Jim DeVries; and our EVP and CFO, Ken Porpora. Following the prepared remarks, we'll take analyst questions. Also joining us for Q&A are Don Young, EVP and Chief Operating Officer; 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.

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 will 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 the ADT Investor Relations website.

And with that, I'll turn the call over to Jim.

Jim DeVries

Thanks, Elizabeth. Good morning and thank you to everyone for joining us today. This morning, ADT released our first quarter earnings. I am pleased to share that we had a solid start to the year with growth in revenue adjusted EBITDA, adjusted free cash flow and adjusted EPS, each growing nicely year-over-year, while concurrently our net leverage ratio continued to decline.

Our total top line grew 4%, with commercial delivering very strong growth at 15% and we ended the quarter with a record recurring monthly revenue balance of $378 million. Our revenue payback now stands at a record low of two years down from 2.3% a year ago, with gross attrition remaining at a record 12.5%.

These factors are driving better capital efficiency and drove a year-over-year increase and adjusted free cash flow, including interest rate swaps, of over $70 million versus Q1 last year. This improvement is consistent with our goal of growing this cash flow metric by 20% for a second consecutive year.

Looking forward, the resiliency of our business is evident. There are many favorable factors that have ADT well positioned to meet our 2023 guidance. First, the market is showing strong spending and supply chain pressure is easing, boosting our commercial segment to outperform our expectations and capture market share.

While commercial revenue grew 15%, our installation backlog remains steady at approximately $420 million, demonstrating the enormous strength of recent sales and reinforcing a strong pipeline for continued revenue growth.

Equally impressive within commercial was our profitability. EBITDA margins exceeded 12% for the quarter. Second, overall customer retention rates are stellar and ending RMR continues to grow at a healthy rate.

As a reminder, when homeowner relocations are down, near the levels experienced recently, there's an inverse relationship between existing customer retention and new customer ads, worth mentioning we’re benefiting in retention from both the macro move trends and the continuous innovations to improve the customer experience.

Third, in partnership with State Farm, we've just launched our initial offering in three states with plans to expand to six more states before the end of the year. Next, our Google partnership is helping improve our product offering and increasing our installation revenue per unit, which is up $150 over the prior quarter and $300 over the prior year period. We continue to see high attachment rates on Nest doorbells and cameras compared to our previous offering and customers are buying more devices, increasing the average device per system by more than 20% year-over-year.

In February, we launched ADT self-setup, the first system to integrate our internally developed ADT+ app with Google's Nest products. The launch of these products led to over a 30% increase in DIY sales this quarter versus the first quarter of 2022. We're driving more awareness of our integrated product offerings with our new No Worries marketing campaign, which is being partially funded by Google Success funds.

We anticipate receiving the first $50 million of success funds this year and are working collectively to unlock the next $50 million tranche. Most of this fund will be spent in various forms of marketing to accelerate subscriber growth. We expect our Google partnership to accelerate even more when we introduce an integrated Pro Install solution later this year.

Finally, we're advancing our CSB cost reduction efforts by streamlining our organization, rightsizing our real estate portfolio and placing greater focus on our key priorities. We expect to generate meaningful cost savings through these efforts and believe our efforts will lead to increase speed and efficiency. There are many positive outcomes in our business, but we're also cognizant of and monitoring the external environment we're operating in.

For example in our CSB segment, consumer economic pressures are resulting in somewhat higher non-pays in our attrition. The solar business has experienced some continued pressure as well. At an overall industry level, higher interest rates are pressuring growth as financing for residential solar has become more expensive and more sensitive, which is offsetting some growth potential from the Inflation Reduction Act.

Additionally, we still have work ahead of us integrating ADT Solar. This quarter's decline in revenue is not the performance we expect and we're executing a number of strategic actions to improve operations, customer experience and financial results. These actions include scaling or cross-selling, launching a new dealer program and implementing and streamlining the business to improve cost and efficiency. In light of these actions and our efforts to strengthen our foundation for growth, we anticipate meaningful improvement in ADT's solar performance by the end of the year.

In closing, we remain focused on achieving progress among all our segments and advancing toward our 2025 goals. We believe ADT has a recession resilient business model and we have plans to manage the challenges presented in our solar business and across the broader macro environment. We have encouraging momentum in our CSB and commercial businesses and great partners in Google and State Farm. ADT's impressive results reflect the dedication and determination of our 20,000-plus employees and dealer partners. I want to thank them for all they do to take care of our customers every day.

I'll now turn the call to our CFO, Ken Porpora, who will take you through our results in more detail. Ken?

Ken Porpora

Thank you, Jim, and thank you everyone for joining our call today. As Jim mentioned, we're off to a solid start this year. Total company revenue was $1.6 billion for the quarter, up 4% versus prior year with CSB and Commercial showing strength at up 7% and 15% respectively. Recurring monthly revenue, or RMR from our subscriber base was up 4% year-over-year to $378 million, a company record and outcome of our continued higher average pricing and improved customer retention. This translated to adjusted EBITDA of $625 million, up 4% versus prior year with strong margins in both CSB and Commercial. Adjusted net income for the quarter was $102 million, or $0.12 per share our fourth consecutive quarter of positive adjusted net income.

Moving to segment highlights. Our Consumer and Small Business, or CSB segment delivered total revenue of $1.1 billion in the first quarter, up 7% versus prior year. CSB adjusted EBITDA increased by $34 million, or 6% for the quarter, driven by increased revenue combined with cost discipline. We are continuing to see strong demand for Google Nest products, which have accelerated our SAC efficiency and are driving a record revenue payback of 2.1 years within CSB, an improvement over 2.4 years from a year ago.

Our installation revenue per unit for Pro Install is now approximately $1,450, up 27% versus prior year. Our attachment rate for Nest Doorbells is approximately 50% and realizing a roughly 20% increase in cameras per home versus the same time last year, because new customers are buying larger interactive systems, the new RPU for residential Pro Install is over $4 per month, or approximately 8% higher than our average existing customer base.

We are also seeing benefits from the ADT Virtual Assistance Program, which continues to drive high levels of customer satisfaction with roughly 50% of all service tickets currently being satisfied virtually. As committed in our Investor Day just over a year ago, we are improving returns in our CSB business by now generating an average core customer value of approximately $3,000 per subscriber, up about $500 since 2021. The ratio of customer lifetime value to net SAC per subscriber is up to 3.2 times versus 2.8 times in 2021. As a reminder, core customer value equals the estimated recurring revenue during the expected subscriber life less net SAC and less expected service costs.

Turning to our Commercial segment. We delivered total revenue of $335 million in the quarter, up 15% versus prior year with strength in both sales and installation revenue. This strong revenue performance drove commercial adjusted EBITDA of $41 million, up 73% versus prior year and margin expansion of 400 basis points to over 12%. We continue to be very pleased with the momentum we have in our Commercial segment.

Our Solar segment posted revenue of $145 million in the quarter with an adjusted EBITDA loss of $11 million. In the quarter, we also took a non-cash goodwill impairment charge of $193 million associated with the Solar segment. This charge was a result of current macroeconomic conditions and operating results of ADT Solar relative to expectations and has been excluded from adjusted EBITDA. As Jim mentioned, we anticipate our actions will improve Solar's growth and profit performance by the end of this year.

Turning our attention to cash flow. Adjusted free cash flow including interest rate swaps was $16 million in the quarter, up $71 million versus prior year as lower SAC from efficiency and lower volume of customer additions was partially offset by higher technology investments.

Strong EBITDA growth in our CSB and Commercial segments and improved capital efficiency helped us overcome the shortfall in our solar segment. Our improved efficiency enabled us to grow our ending RMR by 4%, on 27% lower year-over-year SAC spend, which is reflected in our record two-year revenue payback. We continue to focus on strengthening our balance sheet. As of the end of the first quarter, our net leverage ratio declined to 3.8 times, down substantially from 4.4 times at year-end 2021. This gets us closer to that ratio being at or below three times by the end of 2025.

In March, we used a senior secured Term Loan A facility to redeem $600 million of 2023 notes. We plan to redeem the approximately $100 million remaining outstanding balance at or prior to maturity in June 2023, using proceeds from our term loan borrowing and cash on hand. Following debt repayment, we have no meaningful maturities left this year allowing us to shift our focus to maturities coming due next year. And today we are redeeming $150 million, up to $750 million 2024 notes with cash on hand reflecting our confidence in our continued cash generation.

By the end of the second quarter we will have completed approximately $220 million in debt pay down this year. We are planning to reduce total debt by over $400 million in 2023 a solid step to achieving our goal of $1 billion in net debt reduction by 2025. With manageable debt maturities, limited variable rate exposure and our strong recurring revenue mix, we are well positioned against rising interest rates.

And finally turning to guidance. We remain on track to achieve the full year 2023 guidance metrics that we first announced on February 28, as we continue to expect the momentum of our business to overcome macro trends and result in growth in revenue, earnings and cash flows for the full year.

Before we transition to Q&A, I'd like to add my sincere thanks to the entire ADT family for their extraordinary effort this past quarter. I am confident that we are on a path to achieve our 2023 guidance, illustrating continued progress towards our 2025 long-term goals, and with nearly 11% free cash flow yield, we believe our stock represents an attractive opportunity for investors.

Operator, please open up the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We'll take our first question from Peter Christiansen with Citigroup. Your line is open.

Peter Christiansen

Thank you. Good morning, guys. Thanks for the question. Jim, obviously, you've shown quite a bit of improvement in efficiency in the last many quarters actually and the latest attrition that looks particularly nice. At the same time though, you are seeing CSP new unit growth declining. And I'm just curious how are you thinking about the balance between efficiency versus growth? And perhaps I guess once we get into the do-it-for-me Google release later this year into 2024, do you think that balance could shift? Thank you.

Jim DeVries

Thanks for the questions, Pete. The -- yes, Q1 for us on a gross adds side was most definitely impacted by the macro environment. As you know well, relocations represent a significant portion of our adds and that coin is a two-headed coin, it benefit us from a retention perspective, provides a little bit of headwind when it comes to gross adds. And we experienced some of that in Q1.

I feel good about the product launch that you just mentioned coming later this year when we integrate our DIFM product with Google and I'm bullish -- continue to be bullish about State Farm. I think some of our dealers are coming around nicely. So, I think we can offset it, but the relocations -- the lack of relocations is definitely an impact from a macro perspective.

Peter Christiansen

Thanks. That's helpful. And then just as a follow-up, I want to dig a little bit into Solar. Obviously we know California was 40% of the market pre changes in net metering and it's likely a sore spot today.

Just wondering if you juxtapose -- and certainly interest rates are a factor for everyone. But just wondering if you could juxtapose some of the traction you're getting in California and outside, just so we can get a sense of how you see the market evolving over the next coming months as consumers digest some of the new economics?

Jim DeVries

Yes, the -- so there's obviously puts and takes. For us, the California market is relatively small. Less than 5% of our installations are in California, so the net metering impact for us within California has been pretty modest.

Interest rates are definitely an issue making solar more expensive. There are some puts and takes there. The Inflation Reduction Act as you know will be a nice tailwind for this business. And as utility rates increase, energy prices increase, that is somewhat of an offset as well.

We're one term bullish about Solar Pete. We've got some work to do from an operations perspective to get our legs under us, but I continue to think -- we continue to think that this market is a significant growth market for us going forward.

Peter Christiansen

Really helpful. Thank you, Jim. Take care.

Operator

Thank you. And next we'll go to George Tong with Goldman Sachs. Your line is now open.

George Tong

Hi, thanks. Good morning. You talked about launching a new joint State Farm offering in three states and then plan to launch in six more states this year. Can you talk about traction that you're seeing with customer adoption with the offerings that you've launched so far and some of the terms that are involved with the joint offering?

Jim DeVries

Sure George. Thanks for the question. So, the vision here with State Farm is to transform the homeowners -- homeowner insurance business from purely restoration to include prediction and prevention, to essentially avoid losses and the product is a what we call Circle Protection and we are using fire, intrusion, and water detection devices to help mitigate claims.

We rolled out in Indiana a few weeks ago. We rolled out in Illinois and Pennsylvania last Thursday. We are very early on in the experience. The teams are working well together. I think we have something in the zone of 100 sales or so, but we're excited about it. We'll be in at least another six states throughout the rest of the year. The traction, it's early in the game, but feels pretty good. We're still working on buy flow and training agents and the upsell process. But we're out in the wild, its early in the game, we feel good about it, George.

George Tong

That's helpful color. Thank you. And then you also mentioned you're undertaking a number of strategic actions to improve the operations of your Solar business including launching a new dealer program various cost and efficiency initiatives. Can you elaborate on some of these plans what your key milestones are? And how long it will take you to improve overall underlying performance of Solar to the point of where you would like to see the business grow at?

Jim DeVries

You bet. So we're playing the long game in Solar. I mentioned, this on our last call, where we're going slow now so we can go faster later. Midyear last year, we ran into some challenges around permitting. One of our dealers liquidated. We went through a name change a panel supplier change. And all of that caused Solar to grow less rapidly than what we would have liked. It also exposed some operational challenges.

And we made the decision to invest in our reputation. We made the decision to invest in customer experience, clean up our backlog. Incompletes are down 50%. Inspection backlogs down 50%. So we're in the process of rebuilding our operations for scale. We opted frankly for short-term pain for the long term. The sales cycle in Solar is longer than in our CSB business. From sale to install call it three to four months sometimes. And for the improvements in our operations to start to show, that's going to be later in the year. I think we start to turn the ship more materially in Q3. And expect more positive output in Q4 George.

George Tong

Very helpful. Thank you.

Operator

Next we'll go to Toni Kaplan with Morgan Stanley. Your line is open.

Toni Kaplan

Thank you so much. I wanted to actually follow up on that last question with the Solar actions. I guess, is there an analogy Jim that you could give on -- have you had an example of operational challenges in the past where like you could point to that you've been able to turn it around. I guess, just give us confidence that Solar will improve by the end of the year? That would be very helpful.

Jim DeVries

Yeah. So the work -- much of the work that we're doing now Toni is around process improvement on the operations side of the house. We are investing in infrastructure. We're improving cycle time. We're reducing leakage. We're doing a great deal of work in data analytics, so that we could have better reporting. I mentioned a couple of the improvements earlier. Our backlog needed pretty significant cleanup, where the inspection backlog is down a little more than 50%. Incompletes are down 50% and we are moving customers at record levels to PTO to permission to operate. And so I like the early signs of improvement in solar. We've got a great team out there. And like I shared with George, because of the cycle time it's going to take some time before we start to see the financial results. We wanted to show on the operation before we turn on marketing again and before we lean into cross-selling. And as we gain confidence that the customer experience will be what we need it to be then we'll turn on the jet fuel.

Toni Kaplan

Great. Wanted to ask about commercial as well, I thought that that looked pretty good this quarter. Maybe just talk about sustainability there? Any drivers in the quarter in particular to call out, and also the profitability was very good as well. So, maybe just any additional color on commercial?

Jim DeVries

Yeah. So commercial is hitting on most every cylinder. We're doing well in our day-to-day blocking and tackling. We're developing capabilities. I've mentioned this before in new verticals that are starting to show green shoots in energy and education and government. Q1 was rock solid, revenue up 15%, against a solid quarter last year. EBITDA was up very significantly. And not unimportantly we didn't do -- we didn't grow that way at the expense of drawing down our backlog.

Our backlog both in IR and RMR are still at record levels. This Toni is a business, it's about service. We provide excellent value to our customers and the business has been rewarded for it. On the margin front, we continue to improve productivity. The team has done a great job from a cost management perspective and the EBITDA expansion as a result of that.

Toni Kaplan

Thanks so much.

Jim DeVries

Thank you.

Operator

Next we'll go to Brian Ruttenbur with Imperial Capital. Your line is open.

Brian Ruttenbur

Yeah. Thank you very much. Question on State Farm. Can you talk a little bit about the structure that you have right now or ARPUs or anything that you can give us to grab on to as you're putting these systems in the fire leak detection. So you go into an existing State Farm homeowner policyholder, and you put these in and what is your ARPU? I assume, it's lower than your normal or is it higher than normal? Give us something to reference.

Jim DeVries

Yeah, Brian, the ARPU is lower as is the SAC. So the return on the circle of protection business is pretty good for us. And the way that the model works is, it's a sort of -- think of it as smart home light where there's a handful of devices including water mitigation, but excluding some of the Google products. The core circle of protection product doesn't include video, doorbell or cameras. It's basically smoke and water detection.

And when that product is installed, the tech engineer is seeks to upsell the customer to other devices and other services. And again, this is very early. So it's too soon the curtain bow, but I think that the early experience suggests that the thesis of being able to upsell is real. We don't have -- again, we don't have enough under our belt to celebrate, but early indications would lead to bullishness.

Brian Ruttenbur

Okay. And then just to follow-up on that to understand fully, the State Farm representative gets a lead and say, hey, you need to sell it into X, Y and Z house. And therefore that homeowner gets a discount of $10 a month or whatever off their insurance. So it basically becomes a wash for that kind of system. Is that the sale?

Jim DeVries

Yes. So the State Farm agent during the process of selling insurance introduces the customer to the alternative of the circle of protection. And customers of State Farm that have monitored smoke fire and intrusion have a discount. That discount varies by state, but the intent is for that discount to provide an offset of sorts to the monitoring fee that the customer incurs.

Brian Ruttenbur

Okay. Perfect. And then last question real quick on attrition. Last we spoke on the last call, you were looking for attrition to kind of be flattish on the year. I don't know if that was your exact words flattish, but that's what I at least write, because I'm rereading my stuff. Is that where you're thinking on the year as flattish attrition?

Jim DeVries

So tough to predict. We have a little bit of pressure on non-pay cancels. Our relocation continues to be a tailwind for us, but I'd say Brian, like a lot of the lead indicators continue to be positive for us. Installation revenue per unit is right around $1,450. We know that the more a customer invests upfront the stickier they are. Our service backlog is at just about a record low. We have an uptick in credit scores. So the quality of our new customers has been excellent. So as of now, I'm feeling pretty good about it, with again a little bit of pressure on non-pay cancels, but positive momentum in the other categories to offset it.

Brian Ruttenbur

All right. Thank you, both.

Ken Porpora

I'd also add Brian, Brian just a quick add to that one. On the last couple of weeks and I think we've seen that nationally as well some of the delinquency rates are starting to come down, which is a good sign. I think we felt a little bit of pressure in the first quarter. specifically in the delinquency side, but starting to see some positive signs in the last couple of weeks.

Brian Ruttenbur

All right. Thank you for the additional color.

Operator

[Operator Instructions] We'll go to Ashish Sabadra with RBC Capital Markets. Your line is open.

Ashish Sabadra

Thanks for taking my question. I just wanted to better understand on the gross RMR addition. How does the Google partnership and the State Farm also help you drive an improvement in the RMR addition going forward particularly as you unlocked at $50 million of marketing fund on the Google partnership side and get 3,000 agents from State Farm also onboarded onto the program? Thanks.

Ken Porpora

Sure. Hey, Ashish it's Ken. I'll grab this one, if it's okay. So on the State Farm side and Google, a number of catalysts start to kick in this year and into next year as well, which has us bullish in the RMR going forward.

On the State Farm side, as Jim mentioned earlier, we're only in three states for a couple of weeks now. We'll be in nine by the end of this year and continue to expand there. So the opportunity there is tremendous with State Farm as far as RMR adds; especially with the circle of protection package that Jim outlined earlier.

So, again, we'll start to see that more and more ramp. We're learning in the pilots now and then we'll accelerate as we get to more states and also tweak the offer and the package as we learn more from the early customers.

On the Google side, two main catalysts -- by the way back to State Farm for a second, we also will tap into the opportunity fund several hundred million dollars to kind of grease the skids on growing our subscriber count with State Farm is an exciting opportunity for us.

On Google, two main callouts, the first one is, we just launched a couple of months ago our new DIY product with Google. So this is the ADT self-setup product. We see that as an increasing opportunity to tackle some of that DIY TAM that's been accelerating in the last couple of years. And this product is killer that we've designed, essentially with Google and our partners. So that is just essentially fresh in the market and we're seeing some really nice signs in DIY growth.

And then later this year, as we mentioned in our prepared remarks, we're launching our new next-generation pro-install product with Google as well. That will be our next-generation hardware that we'll offer some very cool services with our ADT+ app and that will allow us to fully tap into all of the marketing an opportunity and success fund there as well. So those couple of catalysts that we see with those key partners have us very excited over the near term and long term.

Ashish Sabadra

That’s very helpful, so thanks. Thank you.

Operator

All right. And I show there are no further questions. I'd now like to turn the call back over to management for any additional or closing remarks.

Jim DeVries

Thank you, operator, and thanks everyone for taking the time to join today. As you heard today, we're effectively growing our business, building brand loyalty, improving our capital efficiency. We have good momentum in our businesses, catalyst for growth with State Farm and Google and we're off to a strong start in 2023.

I'd like to extend my appreciation to our ADT employees and dealer partners for a terrific quarter. Our results are a direct reflection of your efforts. Thanks again, everyone, and have a great day.

Operator

This concludes today's conference call. You may now disconnect.