ADT Inc.
Q4 2020 Earnings Call Transcript

Published: 26 Feb 2021

[Operator:]

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the ADT Fourth Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. I will now turn the conference over to your host, Derek Fiebig, Vice President, Investor Relations for ADT. Thank you. You may begin.

[Derek Fiebig:]

Thank you, Operator, and thank you, everyone, for joining ADT's Fourth Quarter 2020 Earnings Conference Call. This afternoon we issued a press release and slide presentation of our financial results. These materials are available on our website at investor.adt.com our remarks today will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied by such forward-looking statement. These risks include, among others, matters that we've described in our press release issued this afternoon and in our filings with the SEC. Please note that all forward-looking statements speak only as of the time they are made and we disclaim any obligation to update these forward-looking statements. During today's call, we'll make reference to non-GAAP financial measures. Our historical and forward-looking non-GAAP financial measures include special items, which are difficult to predict and/or mainly dependent upon future uncertainties. For a complete reconciliation of historical non-GAAP to the most comparable GAAP financial measures, please refer to our press release issued this afternoon and our slide presentation, both of which are available on our website. With me on today's call are

[Jim DeVries:]

Thanks, Derek, and thank you to everyone for joining us today. I'd like to begin our first call of 2021 with some comments reflecting on our 2020 overall performance, and then share some thoughts regarding our new partnerships and current growth momentum. Finally, I'll offer some perspective on ADT's priorities as we advance into 2021. I'll then ask Jeff to cover our financial results, as well as our 2021 outlook. With the world proxed into an unexpected pandemic, 2020 was an extraordinarily challenging year for so many and impacted everyone's lives in different ways. There was also a year which brought us at ADT the gift of perspective. We were reminded more than ever of the importance of protecting one's home and family. For all of us at ADT, 2020 brought a new-found appreciation for the essential role we play partnering with first responders and serving our customers and communities continuously and reliably. After witnessing the tremendous collaborative efforts of our team during the past year; I'm humbled to be able to lead such a great organization and couldn't possibly be more proud of the collective performance of our more than 20,000 ADT associates and our dealer partners.

[Jeff Likosar:]

Thanks, Jim, and thank you, everyone, for joining our call this evening. As Jim described, we performed very well in a highly unusual 2020 environment. Like most companies, we encounter many unexpected dynamics and we are very pleased that we were able to execute on opportunity to offset several of the unplanned challenges we faced. More importantly, we maintain our long-term focus and continued our strategic progress and are especially encouraged by the trends we saw in the second half of the year into 2021.

[Operator:]

Thank you. At this time we will be conducting a question-and-answer session. Our first question is from Peter Christiansen with Citi.

[Peter Christiansen:]

Good evening, gentlemen. Thanks for the question and nice execution in a tough year. Jim, it's really good to see you guys in a position to up the offense in 2021. That makes a ton of sense, but I want to dig a little bit into the cadence on how you're thinking about the incremental SAC throughout the year and introducing new products, particularly the next phase of Google. Is that something that you kind of save your powder for a little bit and then act a little bit more aggressively once that comes out? And as a quick follow-up, it sounds to me that this joint product could have a much higher value proposition for the customer. So is there any preliminary thoughts on pricing and relative to the current interactive offering that you guys provided in the residential side? Thanks again.

[Jim DeVries:]

Yes. Thanks, Pete. So, I'll give a little bit of context to the pivot to growth and then ask Jeff to address your question in a little more detailed way. Much of the last several years, Pete, we've been focused on operational excellence. Our retention improved 300 basis points, customer satisfaction improvement as you're aware, better operating KPIs across the board, revenue paybacks come down 2.7 to 2.2 years and at the same time as we're getting our operational house in order, we have macro trends and the demand catalysts that we've been talking about and in discussing is tailwinds are essentially our products, we see our products and services are in demand. And then in addition to getting our operational house in order and the macro tailwinds, we have worked really hard on building strategic relationships. It's a long list -- DR Horton, DISH, Ackerman, some relationships in the insurance space, and when you combine all those factors, operational excellence macro trends, new partnerships and now Google, we're able to allocate capital to high return growth and pivot more assertively to capital efficient growth. Jeff, do you want to add some?

[Jeff Likosar:]

Yes. I'll just add that that it's energizing for the whole organization to be in a growth mode, so there's a lot of enthusiasm across the company -- a lot of fun. Your specific question about the cadence, the comparisons will be odd, because last year was odd. So the second quarter of course, was the most depressed quarter, so the compares are easy. The Ackerman alliance with an initial account purchases from that agreement will be helpful in the first quarter. But a way I would think about it is our pace of ads has are our piece of SAC spending setting aside the acronym purchase in the first quarter, we would expect to be relatively normal with historic patterns, excluding last year. So a bit higher in the summer season when it tends to be more activity, but aside from that, we're modeling as it returns to a more normal cadence, of course, the year-on-year it will be affected by if we have normal cadence in 2020.

[Peter Christiansen:]

Great. So not really like a first half/second half story pretty normal cadence throughout the year?

[Jeff Likosar:]

Yes, we're expecting to layer things in as we go through the year, but we exit 2020 with really strong momentum having grown U.S. RMR by 15% in the second half of the year. So we're entering the year with momentum. We have additional benefit coming from even the recent partnerships we've announced just over the past several days, which we was easiest comparables in the second quarter of 2021, because of the soft 2020 and then the tougher compares in the second half of the year.

[Peter Christiansen:]

That's great. Thanks, gentlemen. Very helpful.

[Operator:]

Our next question is from George Tong with Goldman Sachs.

[George Tong:]

Hi, thanks. Good afternoon. I wanted to dive deeper into your plans to deploy a $150 million to $250 million of residential SAC in 2021. Can you elaborate on which customer segments you plan to go after with this incremental spend and what returns we expect from the investment?

[Jim DeVries:]

Yes, George, it's Jim. So there's a handful of different opportunities in front of us. Most of the incremental SAC will be spent in the residential business. We've got the demand catalyst that we've talked about since the third quarter, bringing some pretty significant headwinds are tailwinds for us and some unique opportunities to really allocate capital to that business and grow. The returns are high-teens in and above and will also allocate some of that capital to opportunities in the commercial space. But most of the incremental capital will be in residential.

[Jeff Likosar:]

Hey, George. One other thing I would add is that if you look at our historical financials included a slide in our deck that shows back 2017, the year prior to the IPO. But we're planning to generate these RMR ads still with more free cash flow generation, adjusted free cash flow as compared to 2017, which is just a testament kind of quantitative testament to some of that points Jim made earlier about all the progress we've made in recent years, becoming more efficient, better attrition, better SAC efficiency, improving our capital structure. So we're very excited to be in a position to have the capital structure and the cash generation capability to be able to grow at a higher rate.

[George Tong:]

Got it. That's helpful. And just as a follow-up, do you view the increase in SAC as a permanent/structural step up or do you expect it to reverse and then perhaps related to that question, what kind of payback period do you expect? Is that a two-year payback? So in other words you get back this 1.50, 2.50, 2.0 years down the line. How are you thinking about that?

[Jim DeVries:]

I would think about it, and we plan to share more in an investor day in the second half of the year, but I would think of it as we are raising the water level with respect to the quantity of new subscribers and/or new RMR that we had each year. So we would expect to continue to grow. Of course, we will seek to become more SAC-efficient and improve revenue payback over time and then in terms of your question on payback, I would describe that in the context of IRRs, we target IRRs in the teens in higher and as we've talked about many times in the past, the IRR is the combination of the upfront cost to acquire the profitability of the customer on an ongoing basis. And then how long the customer stays with us. So we're always looking at each of those variables among others with an eye on optimizing the return on the capital that we deploy.

[Jeff Likosar:]

Two quick points of elaboration, George. The first is that as a philosophy, we'll continue to pursue our growth in a very disciplined way. We won't retreat from our standards on credit, we'll continue to be disciplined and ensure that this growth is good growth and then specifically on your question on payback, I think we'll continue to have a revenue payback that's in the zone of where we are now. It might move a bit up, it might move a bit down, but will be in a range that will facilitate the returns that Jeff just mentioned on IRRs and in a revenue payback range consistent with those higher IRRs.

[George Tong:]

Got it. Thank you. Very helpful.

[Operator:]

Our next question is from Toni Kaplan with Morgan Stanley.

[Toni Kaplan:]

Thanks so much. I just wanted to understand the revenue impact versus RMR growth. So, I understand the equipment financing shift but excluding that, I guess revenue would maybe be up about 4% and you're RMR estimate, looks like more of a high-teens growth. So is that largely due to a decline in installation revenue? Why doesn't the RMR addition flow more through to the top line?

[Jim DeVries:]

Yes. It's definitely that. It's a somewhat complex topic, but because we are in the process of converting legacy Defenders to our historic ADT ownership model and because last year, we for a portion of the year, had legacy ADT in an outright sales model. We have meaningfully more installation revenue last year. We included some description of this in our earnings materials. We estimate this about $350 million to $400 million of lower revenue. It will predominantly be lower install revenue which is worth about seven points. So, if not for that pressure then we'd have additional revenue. The drivers of that additional revenue is a recovery in the commercial part of our business, which we expect to get back to something that looks more like the trajectory pre-COVID-19 and then the flow through of our M&S revenue growth that comes from the top RMR ads that we had last year and expect to continue until this year.

[Toni Kaplan:]

That makes sense. And I wanted to ask about attrition. So, just given the fewer customer relocations during COVID, that was a real benefit to the attrition this year, and of course it's a trailing 12-month metric. So, just help us out with how you're expecting attrition to trend this year? I just want to make sure that we have a good sense as the year goes on, just expectations for what you're thinking there.

[Jim DeVries:]

Sure, Toni. The retention for us in 2020 was a real strength and ending the year at 13.3% down 30 basis points from last year, some companies report net attrition. If we use that metric, we're actually closer to 10% attrition level, and so we feel good about the progress that we've made. We saw improvement in most categories and they had a record low in Q3. In the fourth quarter, we continued to improve in the categories of lost competition and non-pay. What real estate activity is, as everybody knows, picked up late in the year and we saw pressure on relocations in particular. So we're long-term, we're optimistic about customer retention, especially as we enter the smart home space more aggressively. We know the more our customers use our systems when devices are more plentiful, when the devices and the system is integrated in the daily activities of our customers and we know that retention improves, so we think that we'll trade -- we think that we'll be in a range here for attrition with some relocation headwinds and some smart home and interactive rate tailwinds that will carry through 2021. One additional thing to mention to you when we acquired Defenders, we continue to receive a chargeback benefit for accounts so prior to the acquisition and that benefit expired over 12 months, and with a slight metric headwind in 2020, the impact of the chargeback change in 2021 is about 40 basis points.

[Toni Kaplan:]

Very helpful, thank you.

[Jeff Likosar:]

And Tony, one other point that I don't believe I mentioned, when I talk about the change in revenue recognition because of the ownership model for residential customers that is a non-cash change. So we're still collecting the same amount of revenue from customers, in fact, we're requesting even more revenue because of the success of our pricing in our financing initiative. But we capitalized that revenue netted against the equipment cost and we recognize that revenue over time. So this is a different accounting treatment, because of the different ownership model. We have nothing to do with taking cash and in fact more install revenue as one of the contributors to the improved acquisition cost efficiency or revenue payback improvement that you see.

[Derek Fiebig:]

And Tony, this is Derek. If you look at Page 25 in the deck, we provided some of the cadence on this. This could be helpful to model.

[Toni Kaplan:]

Great, thank you.

[Operator:]

Our next question is from Kevin McVeigh with Credit Suisse.

[Kevin McVeigh:]

Can you just give us a little more context on what the $50 million investment next-gen technology platform; and would you expect having to impact the business longer term?

[Jim DeVries:]

You're breaking up a little bit there, Kevin. But, I think you were asking about the $50 million...

[Jeff Likosar:]

About the platform in which we're investing the $50 million.

[Kevin McVeigh:]

Yes, that's right.

[Jim DeVries:]

Yes, just for context and then I'll ask Don to describe a bit more. But the 2 areas of investment that we called out is a higher SAC spending that goes with the -- or more ads in the teens. And in the second, we noted in our materials is approximately $50 million associated with the development of our next generation platform, which we described on our last call. There is of course, lots of other puts and takes to go into our cash flow guidance, but there is a couple of that to describe a bit more about the platform itself.

[Don Young:]

Yes. So, Kevin, we have actually inherited some nice IT and project engineers from three acquisitions

[Kevin McVeigh:]

Thank you.

[Operator:]

Our next question is from Gary Bisbee with Bank of America.

[Gary Bisbee:]

Hey, guys, good afternoon. Jeff, I wonder if you could just be real clear with us because it's been difficult to know. What was revenue growth ex the different accounting treatment for install revenue? If we pull that out of 2020, what was the revenue growth for the year and what does 2021 guidance imply for revenue growth if that normalizing that revenue not recurring? What's the clean number both backwards and forward?

[Jim DeVries:]

So forward, there is about 7 points of revenue pressure that comes from the change associated with the ownership model and backwards, a bit more complex because of the interplay with Defenders, with the Canada disposition, and with the ownership model change. But I would point you to our install revenue and the predominant driver of our install revenue growth was more installed revenue associated with the ownership model change.

[Gary Bisbee:]

So if we just take the actual revenue, the midpoint of the guidance range, calculate the growth rate that implies, add seven points and that's what the growth rate would imply or is that not?

[Jim DeVries:]

Yes.

[Gary Bisbee:]

Okay, all right.

[Jim DeVries:]

Yes.

[Gary Bisbee:]

Fair enough. And then two small ones. On the Google investment, the $150 million do you have any more insight on timing of when you'd spend it and what's CapEx versus OpEx? And the other small one, you've had a couple of press releases out about this technology that could eliminate or reduce the impact of the 3G conversion because people could just plug and play, what's the update on that and what's implied in your guidance in cash flow for spending related to the conversion thank you.

[Jim DeVries:]

I'll take both of those, Gary, and then ask for done to elaborate on the technology associated with the radio conversion. On Google Play, as a reminder, both parties agreed to invest an incremental $150 million in the partnership, so there is a total of $300 million. The Google funds can be used for marketing product and employee training and are generally earmarked for those 3 categories. We haven't yet agreed with Google on the specific expenditures, we will likely make a meaningful investment in the launch campaign the ADT plus Google launch campaign later this year and expect to invest an incremental $50 million and that's built into our guide. On radio conversion, we started the year with 3.6 million conversions, shared an initial range of $200 million to $325 million net of revenue. Our replacement plans are essentially on pace, despite the pandemic we'll finish Q1 with about 1.3 million radios remaining to convert, we've updated the range from $225 million to $300 million, the majority of that will be spent this year. So, the short answer on the radio conversion is that we're on track and I'll ask Don to comment on your question related to the technology, a company we acquired called CellBounce.

[Don Young:]

Sure. And quick correction, I think Jim said 3.6 million in the start off, which is actually 1.6 million to start off the year with. But, so first we're calling it Cell Bridge internally for our ADT recipients of the device, CellBounce externally because we do have an agreement with AT&T to provide this device for those elsewhere in the industry, but we have successfully tested this device both in the lab and at a handful of homes. We are looking and as we stated on the last call nationally this quarter and we're exceptionally excited as you can see how well it's working with some of the panels that all their alarm systems are particularly more difficult than others to be able to go ahead and swap up the radio wave. So we're very bullish on how it's and looking for the first quarter rollout.

[Gary Bisbee:]

And then, if I could sneak one more in, Jim, since you've become CEO, you've obviously pivoted hard towards investment, a flurry of partnerships, you invest a lot in commercial, the DIY, the ADT mobile stuffy, and obviously Google, there's been a lot of activity. What I hear from many of your investors is while each one of these on their own makes sense and it's logical, we don't all understand exactly what the vision is in particular because you haven't really given any color on sort of what's the end game, what are you aiming for here? What is the return for ADT and its shareholders from this flurry of activity? I guess one of the challenges is you haven't given any long-term targets, so that we get to assess your performance, and so I guess I want to put that to you as a comment. Certainly, here the optimism, but what does this all mean for revenue growth, 2 years, 3 years, 4 years down the road? What does it mean for profitability? What does it mean for cash flow you know because I just, there is a lot of excitement and certainly we understand it, but profits have been stagnant for years and we haven't seen revenue accelerate, and so it's just, I think, there is some frustration that it all sounds good, but we don't have a great sense what the return for the company and shareholders is from all of this activity in the last few years? I don't mean that to sound critical if it does, I'm just trying to get some color on where this is heading and maybe what some targets might be to help us understand the vision you're aiming for? Thank you.

[Jim DeVries:]

Yes. I'll talk a little bit about the vision from a high-level perspective, we're going to have a chance to elaborate a good bid on this in the Investor Day that we do later this year. I'll ask Jeff to weigh in here as well. But, Gary, what might appear as a flurry of activity externally is all really engineering to get our organization position for capital efficient growth. I mentioned this earlier too when I was answering Pete's question. The work that we've done over the course of the last 24 to 30 months has been to get the operational house in order. Get attrition where it needs to be, get our revenue payback where it needs to be, set the pins from a marketing perspective to more efficiently acquire customers, develop partnerships, Google being central to that to facilitate growth and then to really take advantage of these macro headwinds that are out there and I think that in 2021, the evidence that those pins are set and we're ready to knock them down is mid-teen RMR ads. I think over the course of the last 4 years or so, our figure on RMR ads was something like 3% and we're talking in 2021 about the mid-teens, and that's before Google kicks in a major way, and the second half, and in 2022. Jeff, additional comments?

[Jeff Likosar:]

Yes, it's something we've spent significant time on internally – after spending the first 3 or 4 years. Over the past 3 or 4 years, more focused on operational execution. Our next chapter is going to be more about growth being more innovative, taking the customer experience to an even better place leveraging our brand, especially in partnership with Google, with further differentiating our frontline search capability which nobody else has, and then building as part of the innovation point more of the technologies that further extend the realm of the various offerings that we provide for smart home and security together and we think, nobody is positioned to do this better than ADT is, and as Jim alluded to, we plan to hold an Investor Day later in the year and go through that in more detail, including some perspective as to exactly your question. What that means in terms of economics over time with some longer-term targets and objectives that goes with it.

[Gary Bisbee:]

Fair enough. Thank you. I appreciate the color.

[Operator:]

Our next question is from Manav Patnaik with Barclays.

[Manav Patnaik:]

Yes, thank you. So just kind of a follow-up to Gary's question. I mean the partnership with Google. So I think you kind of answered it in that last statement, but on the high level, you're just trying to get a foot into the door in the smart home and therefore hopefully expand the stand, is that how we should think about the real benefits of this partnership?

[Jim DeVries:]

Much more broadly than that, Manav. We think we can leverage Google to not get our foot in the smart home space but to grow significantly and be a major player in the smart home space. I've mentioned this before we're super excited about the hardware that Google brings, the ADT plus Google branding is something that our marketing research reveals is pretty exciting. But I'm most excited about what the partnership does from an AI perspective, video analytics, and data analytics perspective. We think that we can not only compete in the smart home space but really be a -- with Google as a partner, a technology leader and provide customers services that don't exist today. That's all part of a second generation offering some of which will be available in the second half of this year but will be launched when we have our own interactive platform built in-house combined with Google hardware and video analytics to launch the next-generation 1123.

[Manav Patnaik:]

Got it. And another -- another broad question, the residential space, obviously has been toughened, and I think all the efforts you're doing makes sense in order to grow better in that market, but a commercial has always been the preferred area, and I'm just curious like at some point down the road, you used the word pivot earlier like, is there a pivot to become just more exposed to commercial or is residential just such a big animal for you that that's probably not something in the near future?

[Jim DeVries:]

No, I would say it's not in our future, commercial, we expect to return to growth in 2021 in commercial, I mentioned in my prepared remarks. Our backlog, both install and recurring revenue are higher at the end of 2020 then at the end of 2019. The pipeline is healthy. We've got incredible upside in some of the growing verticals, healthcare, education and critical infrastructure. We think the leadership team is outstanding. We provide the best service in the space. That's the most critical source of differentiation and we expect to grow the commercial business in a capital efficient way and get back to double-digit growth as we were prior to the pandemic.

[Operator:]

Our next question is from Jeff Kessler with Imperial Capital.

[Jeffrey Kessler:]

It's ironic, I feel like Obi Wan having my two pupils go right in front of me. The first question I have is on Defenders, you've talked a bit about Defenders today, but Defenders has been a growth company for basically its entire history, regardless of what it was selling and right now, it's focused solely on security. And I'm wondering, given the fact that you've had --- accounting adjustments having been made, what I want to know operationally, what are you doing to get Defenders and have they been already -- has the group in already integrated into what we call not just the interactive platform, but because they're able to sell. Do they have and are they being trained on the IT level to be able to sell a new platform that you folks are going to be coming out with over the next couple of years? And how is Defenders going to come out in the wash since it doesn't come out in the accounting, but it, but it should come out in the way the operations are handled?

[Jim DeVries:]

Yes, that's absolutely right. The Defenders integration is going well. We're on track, parts of the teams have been integrated into the ADT branch infrastructure already. We expect that the integration will be complete in the March, April timeframe. We are leveraging all of the skills that the Defenders organization brought to our company in a way that's incredibly efficient, we're training the organization in the ADT processes and they're doing well. We had started using our command panel -- Defenders had started using our command panel even prior to the acquisition and now they're using the panel exclusively just like core ADT. In terms of the future and the products that will be integrating with Google, both Defenders and ADT technicians and customer care professionals will be trained on that new equipment and will be standardized as part of our offering.

[Jeff Likosar:]

And one thing I'd add, we talk about this internally periodically. And even if you look in our deck on Slide 10 where we show our view as to RMR and growth, we worked on that Page 4 factors. But the point I'm making, there is a lot of factors and it's difficult to decompose the factors because they are they interplay with one another. The macro drivers, changes to our pricing model, it's the financing, stuff we've done to simplify our offered advertising effectiveness, install efficiency analytics, but included in those internal initiatives, it's just the sharing of best practices between legacy ADT and legacy Defenders. So we would struggle to tell you precisely how much of the 15% growth in RMR adds that we're guiding Q4 next year comes from that, but it's an important ingredient into that mix overall.

[Jeffrey Kessler:]

Great. Second question, my follow-up is, having gone through the earnings results of a lot of the industrial companies in security that I cover, clearly they are looking for -- it's still a slow first half of 2021, hopefully picking up in the second half. I'm not going to call the vacation, but your commercial industrial guys who were killing it two years ago, obviously, let's call them, they had a vacation or part of it, while they could not get out the premises or they were unable to unable to finalize deals that were that were put off. In the interim period, what have you done with your commercial industrial Group to actually get them ready to be accelerating out of the box and not lose a step relative to some of your other large competitors, so that when the market does come back, they will -- whether it's national accounts or whether it's for the specific large enterprise installations, you will be ready to essentially take over that growth that you had before? And not be enough or far behind these other companies whose only business is commercial and industrial.

[Jim DeVries:]

Four key areas, Jeff, that we took the opportunity when we couldn't have access to customer premises to really bolster up. The first is training. I don't think that we expanded as much energy in training in the commercial space in any year like we did in 2020, and so we doubled down in a significant way and employee development. Number two is recruiting, from the start we play the long game and if organizations weren't as healthy overall as ADT, we took the opportunity to recruit some excellent talent in 2020 both at the technician level and the leadership level. The third is integration; we've done a number of tuck-in acquisitions. Red Hawk, a couple of years ago and so we cleaned up the house from an integration perspective. And then lastly, we advance the cause on IT systems and IT integration. So we feel good about the positioning of that business. And as I mentioned earlier, expect 2021 to be a really good year in commercial.

[Operator:]

We have reached the end of the question and answer session. I would like to turn the call back to management for closing remarks.

[Jim DeVries:]

Thank you, operator. In closing, I'd like to again extend my appreciation to our employees and our dealers. 2020 was a unique year, an extraordinary year. I'm completely proud to be associated with all of you. Thanks to everyone for joining our call this evening. As you heard, we're exceedingly optimistic about ADT's future, looking forward to the growth ahead. And have a great night everybody.

[Operator:]

This concludes today's conference. ADT, thank you for your participation. You may disconnect your lines at this time.