ADT Inc.

advancing us towards our 2025 goals. All of this success is a direct reflection of the hard work and dedication of our 22,000 employees and our 200 plus dealer partners. I want to thank all of them for what they do for ADT and for our customers each and every day. I'm now going to turn the call over to Ken Papora. As many of you know, just after last quarter's call, we announced Ken's promotion to CFO. I'm pleased to officially welcome him to our earnings call in this new role. Congratulations, Ken, and handing it over to you.

Appreciate that, Jim. Thank you, and thank you, everyone, for joining our call today. As Jim indicated, we have solid momentum across the business, and we are extremely pleased with the results delivered by our team in the third quarter. Total company revenue was $1.6 billion, up 22% versus prior year, including the benefit of our solar acquisition. Excluding solar, our revenue grew approximately 8%. Our recurring monthly revenue, or RMR, subscriber base grew to $372 million, or 4% year-over-year, a record for the company and a strong reflection of the benefits of our higher average pricing, growth initiatives, and improved customer retention. Adjusted net income was $83 million, or $0.10 per share, an improvement from a loss of $54 million last year. Stronger revenue and margin expansion translated into higher adjusted EBITDA, which increased 12% versus prior year, third quarter, and is up 11% year-to-date. Our gap results included two notable non-cash special items. First, a $158 million non-cash charge associated with our tender offer, where the proceeds from State Farm's equity investment were used to repurchase an equal number of shares, offsetting any dilution. For accounting purposes, this was considered a financial instrument. Based on the share price at closing of the tender, we'll see a partially offsetting non-cash gain in Q4 of $95 million. The second special item was $149 million non-cash goodwill impairment charge associated with our solar business. This charge is based on the solar segment's operating performance and reflects changes to macroeconomic conditions. Moving to our segment highlights, our consumer and small biz, or CSB segment, delivered total revenue of $1.1 billion, an increase of 7% or $75 million versus last year. This performance was driven by a 5% increase in monitoring and services revenue, resulting from higher average pricing, subscriber growth initiatives, and improved customer retention. CSB adjusted EBITDA increase by 63 million, or 12%, and was driven by this increased revenue combined with strong cost performance. EBITDA margin expanded year-by-year by 200 basis points for the third quarter and nearly 300 basis points year-to-date. Our virtual service program is continuing to drive high levels of customer satisfaction, in addition to significant cost efficiencies. This initiative is allowing us to service our growing subscriber base by using technology and remote video as an alternative to more costly in-person visits. We have completed over 650,000 virtual service visits this year, and in-person service tickets decreased by 26% in the third quarter versus the prior year. Turning to our commercial segment, we delivered solid revenue growth of 12% to $314 million. Our sales remained strong. However, supply chain delays are driving a growing backlog. We view the growing backlog as a pipeline for future revenue and margin as supply chain continues to decongest. Commercial adjusted EBITDA was $34 million, reflecting a double-digit margin rate as our increased revenues in this segment were partially offset by some inflation-driven challenges. Our solar segment posted revenue of $179 million and an adjusted EBITDA loss of $6 million, driven by installation delays associated with a third-party lender's insolvency in the June quarter and cost inefficiencies from lower install throughput. With these near-term pressures on the business and additional headwinds from rising interest rates, we've taken several recent actions to improve operating margins in solar. These include process improvements in scheduling and labor planning, workforce right-sizing, and pricing adjustments. And as Jim mentioned earlier, we're starting to see the improved margin benefits in recent results. Switching our attention to cash flow, adjusted free cash flow is $145 million, up from $62 million last year on higher recurring revenue flow-through and lower net subscriber investments, partially offset by higher cash interest. Our core ADT adjusted free cash flow is essentially on plan for the year, with outperformance in the consumer business offsetting solar pressures. The recent sharp rise in rates, however, is pressuring our cash interest, which will be approximately $20 million higher in the second half of the year compared to the first half of the year. We are nearly fully hedged on our variable rate debt, though this offsetting benefit flows through cash from financing activities and therefore outside of adjusted free cash flow. This cash flow geography is an important contributor to why our 2022 pre-cash flow guidance is trending towards the lower end of the range, while our revenue and EBITDA is trending towards the higher end. Our top priority for cash is capital efficient growth. We delivered meaningful improvement in net subscriber acquisition cost efficiency in the quarter as we achieved 11% lower SAC spend while growing our overall customer base by 2% to more than 6.7 million customers. A big improvement driver? With a 22% increase in installation revenue per unit, a measure we've seen trend higher as our Google Nest product rollouts have progressed. Another critical capital allocation priority is strengthening our balance sheet. We've lowered our net leverage ratio to four times this quarter, down from 4.4 at year end 2021. As a reminder, our goal is to have that ratio at or below three times by the end of 2025. During the quarter, we repaid $80 million against our revolving credit facility, ending the quarter with no outstanding revolver borrowings. We also entered into a new debt commitment letter for up to $600 million of term loans under a senior secured term loan aid facility. We expect to use the proceeds of this facility, together with cash on hand, to repay next year's $700 million maturity. With this action, we have now addressed all of our significant maturities in 2023. Our manageable debt maturity schedule, combined with our strong recurring revenue mix and limited variable rate exposure, reduces balance sheet risk and makes our company more resilient against rising interest rates and any potential recession. I'll wrap up now so we can transition to Q&A by simply sharing that we are very pleased with ADT's performance this quarter, and I, too, would like to add my personal thanks to our entire team. As Jim mentioned, our performance to date gives us confidence in achieving our full-year guidance and, importantly, meeting the long-term goals that we laid out at our investor day. Operator, please open up the call to questions.

Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. We ask that you limit yourself to one question and a follow-up so that others may have an opportunity to ask questions. You may reenter the queue by pressing star 1. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question is from George Tong with Goldman Sachs. Please proceed with your question.

Hi, thanks. Good morning. Wanted to start with State Farm. Congrats on the partnership. Can you talk about your milestones with going to market together with joint product offerings when you expect to see benefits from that partnership materialize and how you expect jointly to deploy some of the co-investments into products and marketing?

Sure, George. It's Jim. Thanks for the question. So a little bit of background on State Farm. I'll share a couple of high-level comments and then for context and then get to your specific question. As you know, State Farm invested $1.2 billion, now owns 15% of our company. The opportunity fund that you referenced is $300 million. That will be invested together to advance the partnership. Paul Smith, the Chief Operating Officer at State Farm, has joined our ADT board, already providing value. We're thrilled to have him in the boardroom. The vision for the partnership, George, is to evolve homeowners insurance from purely restoration to include prediction and prevention to avoid losses. And we'll be going to market with a offering that we call Circle of Protection that is intended to reduce losses related to water and intrusion and fire and smoke. We had our first kickoff session a couple of weeks ago with State Farm and Google and ADT executives. We're setting up a governing structure to manage the opportunity fund. We're planning to offer that circle of protection product that I just mentioned in two or three states in the spring of 2023. The objective of those pilots is test and learn as we prepare for a wider launch across the country. It's a bit early to comment on the financial impact that it will have for us in 2023, but we're, you know, as you would expect, super excited to have State Farm as a partner, and we think that this partnership unlocks new TAM for ADP. We're excited to get started.

That's very helpful. And then as a follow-up, you delivered record attrition rates in the quarter. Can you discuss trends contributing to that improvement and whether those trends are persistent and whether you expect additional improvement down the line?

So the retention stat for us will always move a little bit from quarter to quarter. As we've commented before, and as you know, George, it won't be linear for us. That said, we continue to be bullish about this metric. Quarter ended at 12.6. That's a record for us, an improvement of 10 bits from last quarter, 80 bits better than Q3 of last year. October was solid for us as well. There's some modest improvement. headwind from non-pay cancels. I mentioned this on our last call, but because non-pay is a smaller percent of total cancels, the positive momentum in all the other categories is more than enough to offset it. To highlight the point, net canceled accounts for us, George, for non-pay was approximately 4,500 accounts higher in Q3 of this year than Q3 of last year. So every customer matters. We don't want to lose anybody, but in the grand scheme, non-pay cancels are a pretty modest number for us. And there are just a host of positive indicators related to customer retention. The devices sold at time of installation are up pretty significantly. We're getting more and more sophisticated in our save offers. Our service backlog is at a record low. There's an uptick in credit scores in both our dealer and direct channels. We've seen improvements in voluntary and lost competition results. Then, as with last quarter, very importantly, the macro environment is leading to fewer relocations. That continues to be a tailwind for retention. It's a good story for us, and we're feeling optimistic long-term about customer retention.

Very helpful. Thank you.

Our next question is from Tony Kaplan with Morgan Stanley. Please proceed with your question.

Thanks so much. I know you mentioned, Ken, the free cash flow expected to be towards the lower end of the range, and you talked about the 20 million higher cash interest expense. So it sounds like that's the main driver there, but is there anything else that's leading you to expect a little bit later for your cash flow?

No, Tony, the interest piece on the second half versus the first half is the main driver. You can see some of the trends that we've talked about, the operating performance, the EBITDA performance flowing through from each of the segments. We're happy how the businesses are performing. But we just couldn't offset the interest piece. But the reminder on the interest piece, we do have that fully hedged. So we're getting the benefit of those hedges that we put in place years ago. It's just happening in the financing section. So when we think about true cash flow, we feel really good where we're at. It's just the adjusted free cash flow we're measuring here does include the higher interest in the second half of the year.

Great. And then, Jim, on the solar, the installations obviously below last year. You called out the macro environment, also the financing partners and solvency, which you had mentioned last quarter. So I know you have a couple of new partners there. I guess how long should we expect solar to be a little bit of a drag? How quickly does that turn around and start growing like you had expected originally? Thanks.

Sure, Toni. Thanks for the question. Yeah, in many respects, we're slowing down in solar now so we can go faster later. We're navigating the operating challenges. As you just mentioned, the liquidation of a major financial partner was a speed bump for us. I'm pleased with the progress we're making. Each successive month, we're building an operating engine that's stronger. The investment thesis is still intact. The brand is helping drive volume. Conversion rates are up. We're excited about a relationship with Lowe's that's just getting started. So I feel good about our ability to grow this business. And when I think about the year to come, in many respects, I think we'll deliver in 2023 what we had intended to deliver in 2022. The financial results are below expectations, but each of those issues that we're creating a logjam and throughput are being addressed, and I expect us to deliver in 23 what we anticipated in 22. So another few months of shoring up operations, and we should be in good shape.

Terrific. Thanks.

Our next question comes from Brian Ruttenberg with Imperial Capital. Please proceed with your question.

Yes, thank you very much. Great quarter. First of all, on the competitive front, can you talk a little bit about what you're seeing in terms of competition? One tangent you could go down, there's a couple you could go down, but Vivint recently announced they're cutting ties with Alarm.com. I know that you're moving forward with Google. Can you talk about anything legacy that you have with Alarm and what your plans are moving forward?

Thanks for the question, Brian. I can't speak to Vivid and Alarm. I'm not sure of what their plans are or the relationship for us. Alarm.com has been a great partner. We made the decision a year or so ago that we were going to build our own platform, something we call ADT+. We're super excited about it. We'll roll out that product in very early 2023 for DIY and mid-year for DIFM. And that is the platform that we'll use for new customers rather than continuing to use the alarm.com product. We'll still have a relationship with Alarm. They will continue to support our existing customers. And we have a long-term contract with the organization that we're satisfied with. But ADT Plus, by mid-year next year, will replace them for all DIY and pro install customers.

Great. Then as a follow-up on a different tangent, what are your plans in terms of going into other areas out there? You've gone solar, you've gone insurance, you've got a great customer base. Can you give us a glimpse into directions that you may be thinking about in terms of additional services you may be selling into your existing base?

I would say the All of the tools for growth are available to us. We feel great about the setting of the pins, the State Farm relationship, the State Farm partnership is going to be massive for us. You know how optimistic we are about Google. And so for us, it really is an execution game more than a foray into any new areas. We're excited about our JV with Canopy. And auto security, I think, opens up some new TAM for us. But outside of what's before us, Brian, it's a focus and execute game and leveraging all the tools that we now have to help us grow. So I don't anticipate a new foray or a new area.

Great. Thank you very much.

As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from Ashish Sabudra with RBC Capital Markets. Please proceed with your question.

Thanks for taking my question. I just wanted to focus on the consumer segment. Have you seen any kind of elongation in the sales cycle or any change in the attach rate or the products that are getting adopted by the consumer on the security side? Thanks.

Thanks, Ashish, for the question. There's not a fundamental change. We're continuing to see a renaissance in video. The number of cameras, indoor and outdoor cameras, video doorbells, the customer's desire continues to increase. The Google products are selling well. I had mentioned earlier, Ashish, when George asked about attrition, A positive trend that we're seeing is the customers are just asking for more devices. This year, for example, the number of new customers with 10 or more devices in their system is actually double what it was last year. And it bodes well from a retention perspective, and it's why you're seeing record installation revenue per unit and a lower revenue payback as a result of it. The demand for devices to fill out the smart home ecosystem just continues to grow for us. So that's probably the most substantial trend that I'd see.

Hey, Ashish, if I could just add on a tiny bit to what Jim just said. We talked about an IRPU of 22% year-over-year last quarter. We talked about around $1,200 as our average in our residential segment. We saw another $30 pop this quarter. So we continue to see this nice inching up of the installation revenue per unit. And as a reminder, we just launched the indoor-outdoor cameras for Google in the month of August. So we probably got maybe a quarter – I'm sorry, half of a quarter benefit from some of the new devices that we're offering. So we like the trends, and we continue to see the upside in IRPU as it helps at our SAC efficiency.

That's great, Culler. Thanks, Jim and Ken. Maybe just a follow-up, similar follow-up on the commercial side. How much of the business is tied to new business starts versus existing businesses? Have you seen any kind of slowdown or elongation of sales cycle on the commercial front? Thanks.

So commercial is hitting on many cylinders. Q3 was solid for us, revenue up 12% against a very good Q3 last year, EBITDA up significantly. We have, like a lot of businesses, Ashish, our commercial business has some supply chain constraints that are impacting backlog and elongating the sales cycle. Insulation backlog now for us is at $445 million. That's a record. And $100 million of that is associated with parts delays. So it's a longer sales cycle, but we're not seeing cancellations out of the backlog. Everybody has the same parts issues, and so customers are hanging in there with us. Lots of irons in the fire. We have new verticals that we've talked about a handful of times. Super excited about energy, education. We have some big wins in Oregon, Texas, I think Kentucky recently. Government, we're starting to get some traction. There's some interesting work and innovation that I'm pretty excited about. So net-net, we feel good about the business. The leadership team is outstanding. The supply chain organization at ADT is managing supply chain as best we can. And the business is doing really well.

One of my favorite charts is to add on that what Jim was just talking about. If I rattle off the last four quarters for commercial and EBITDA, which is one of the measures we look at for the business, $16 million, $24 million, $31 million, $34 million. So we love the shape of that chart. I'm not saying that every quarter will be linear like that, but we like the momentum in the business, even with the current congestion going on within the supply chain.

That's a very helpful color. Thank you. Thanks.

Our next question is from Philip Shen with Roth Capital Partners. Please proceed with your question.

Hey, guys. Thanks for taking my questions. First one's on what you think the shape of revenues look like as we get through 23. I know you haven't provided full year guidance or anything, but was wondering if you could help us understand, do you see a reacceleration from a quarterly standpoint on a year-over-year perspective in Q1 or Q2, or do you think we need to wait until back half until we see some reacceleration of the business? Thanks.

Yeah, great. So I'd say generally we see 23 consistent with our 2025 investor day plans. The only aberration to that would be that the revenue expectation that we had for solar this year will be largely pushed to 2023. But outside of that, I'd say the overall shape of the pie and the allocations between CSB commercial and solar are very much consistent with what we shared at Investor Day.

Okay. Thanks, Jim. Do you have a sense? Can you share which quarter you think EBITDA flips back positive? Can we see it in Q4, or do you think it's more likely first half next year?

Phil, we're not given specific guidance for solar, even the timing of it, but we were encouraged. Jim mentioned in his prepared remarks that in the month of September exit rate, we saw EBITDA profitability for solar. So we're happy with the turnaround we have there and the actions that the team has put in place give us confidence to improve that margin profile going forward. So we'll talk about in our next call kind of our 23 guidance and a little more color there. But for now, I think the prepared remarks cover the trending for solar.

Great. Thank you. And then historically, you guys have been working with the loan companies as a financing partner. source, to what degree with the IRA being pretty rich for the lease and PPA options, to what degree are you opening up to potentially partnering with a lease company that could provide potentially healthier economics with the ITC adders?

Phil, we're looking at all the options there. We think diversity in the loan portfolio is important. given some of the volatility in the marketplace. We do have some great partners in this space that have been there for us. But we are, I think the word there is diversity. As we think about 2023 and making sure we have the flexibility to move quickly in these different opportunities. So I won't share much more about our specific diversity plans, but know that we think of our lender partners as key partners. But we want to make sure that we have the diversity to grow the market aligned with our plans. And we think the financing piece is a very critical component, even subject with the benefit of the IRA and the greater tax incentives. The financing piece is critical for such a large installation and purchase for the consumer, so we know that partnership is critical.

Great. Thanks to you both. I'll pass it on. Thanks, Phil.

We have reached the end of our question and answer session. I would now like to turn the floor back over to Jim DeVries for closing comments.

Thanks, Operator. We've got great momentum in the business, catalysts for growth with State Farm and Google Partnerships. We're optimistic about finishing the year strong. We're confident in our long-term strategy and the goals presented during our Investor Day. I'd again like to extend my appreciation to our ADT employees and dealer partners for an outstanding quarter. And thanks again, everyone, and have a great day.

This concludes today's teleconference. You may disconnect your lines at this time.