Greetings. Welcome to ADT Inc.'s Third Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jason Smith, Senior Vice President of Finance and Investor Relations. Thank you, sir. You may begin.

Thank you, operator, and thank you, everyone, for joining ADT's Third Quarter 2019 Earnings Conference Call. This afternoon, we issued a press release and slide presentation on our quarterly results. Both 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 that could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These risks include, among others, matters that we've described in our press release issued this afternoon and our filings with the SEC. Please note that all forward-looking statements speak only as of the date of this call, 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 mainly dependent upon future uncertainties. For a complete reconciliation of historical non-GAAP to GAAP financial measures, please refer to our press release issued this afternoon and our slide presentation, both of which are on our website at investor.adt.com. Joining me on today's call are our President and CEO, Jim DeVries; and our CFO, Jeff Likosar; also joining us and available for Q&A is Don Young, our CIO and EVP of Field Operations. With that, I'll turn the call over to Jim.

Thank you, Jason, and welcome, everyone, to our call. We're glad you can join us today. We've been looking forward to sharing our third quarter results and our progress across multiple fronts. Starting with our strong financial performance, our revenue, adjusted EBITDA and free cash flow are trending well. During the third quarter, we grew revenue 13% year-over-year to $1.3 billion. Excluding the Red Hawk acquisition, which was completed in the fourth quarter of 2018, we grew our business 5%. This top line performance was led by the ongoing strength in our residential interactive take rate as well as the rapid expansion of our commercial business, which grew double digits at 17% on an organic basis. Our adjusted EBITDA expanded 2% over the past year, benefiting from our top line growth and our ongoing drive for cost efficiencies, offset by the margin impact from the Red Hawk acquisition in late 2018. Our free cash flow before special items was $167 million, which brings year-to-date - the year-to-date total to $459 million. Taking a closer look at our consumer business. Our success driving higher levels of automation inside the home, not only continues to enhance our results, but sets the table for continued improvement for years ahead. During the quarter, more than 80% of our residential installations included our best-in-class interactive services, which brought our total overall interactive base to 44% of our customers. Within that take rate, we're seeing higher levels of automation, more premium video services as well as more connected devices per new installation. Each of these characteristics helps drive higher per-customer revenues. We're very pleased with the strong demand for ADT Command, and we expect this 44% mix of interactive customers will continue to climb with positive implications for both upfront and recurring revenue as well as…

Thank you, Jim, and thank you, everyone, for joining us on today's call. I'm pleased to share with you today some highlights of another strong quarter, where we again grew revenue and adjusted EBITDA and continued our strong free cash flow generation. Starting with our top line. Total revenues grew 13% year-over-year or 5%, excluding the Red Hawk acquisition, both consistent with last quarter. Monitoring and services revenue grew by 6% or 2%, excluding red Hawk. And our installation and other revenue grew by 74% or 29%, excluding Red Hawk. We are especially pleased that we had our second consecutive quarter of double-digit organic growth in sales to commercial customers, which grew by 17% over the prior year. Our adjusted EBITDA was up 2% to $624 million driven mainly by the revenue growth I just mentioned. We continue to focus on cash flow, and our free cash flow before special items was $167 million during the quarter, bringing our year-to-date total to $459 million. Our year-to-date free cash flow performance was driven positively by our EBITDA growth and some favorable working capital timing benefit in the third quarter and negatively, by higher year-to-date CapEx spending, the timing of cash interest payments this year compared to last year and an outflow associated with a legal matter dating to 2014 for which we were fully reserved. As Jim mentioned, while we have an increasing number of exciting growth opportunities, we also continue to execute on improving our core business, and that includes our focus on customer acquisition efficiency through more installation revenue, installation and sales and marketing cost efficiencies and growth in commercial. During the third quarter, our net subscriber acquisition costs, or SAC spending, was down 8%. Meanwhile, our new recurring monthly revenue or RMR additions were approximately $13 million, which…

[Operator Instructions]. Our first question is on the line of George Tong with Goldman Sachs.

So I wanted to dig into the attrition guidance, the update to 13.5% for the year. I understand that it's consistent with the performance that you've seen so far year-to-date. Can you go a little bit deeper into the reasons in the dealer-generated accounts as to whether or not this is something that is controllable on the part of ADT, whether or not it's structural? And how long these headwinds do you expect will persist over the near term and then as you move through 2020 and into 2021?

Thanks for the question, George, this is Jim. I'll offer some comments on attrition. The encouraging news on retention is that it's improved in the direct residential channel. And we think this speaks to the continued health of our business and the overall stickiness of our customer base. The overall attrition result was driven by some lower credit score customers that were acquired by our dealers as well as some expectations that were - some headwinds that were below expectations in Canada. On the dealer front, we're continuing to work with our dealers to optimize our economics and best align our interests. And one additional comment here. It's worth noting there are a number of levers to drive the highest customer lifetime value. And while attrition is a key ingredient, revenue payback or what we sometimes call creation multiple is equally important. For example, in the dealer accounts with higher attrition, we actually acquire those accounts for lower creation multiple and that results in higher unit economics for those customers.

Got it. And then switching gears to Command and Control. Can you provide a little bit of detail and insight as to how the continued rollout of Command and Control will have an impact on subscriber acquisition costs at the increment?

On the margin, the Command and Control product is modestly less expensive than the equipment that it replaced. And so we'll have lower - modestly lower equipment costs going forward. In addition, and probably more importantly, one of the things that Command and Control facilitates is selling more devices and that offset - that revenue offset will help us improve the creation multiple as well.

And George, this is Jeff. One thing I'd add, too, is still relatively early days. We've been out there for a few months now. But we've seen - unlike historical new product rollouts, we've seen an increase in our technician's productivity. Historically, technician learn something new, it takes longer, and you see the other way around. So we're encouraged to - about there being some labor productivity over time.

Our next question comes from the line of Gary Bisbee with Bank of America.

I guess encouraging to hear that despite losing two months of Canada, the guidance is maintained for the year. I wonder if you could talk about some of the deltas there. And really, what I'm getting at is, is it reasonable to believe that you can absorb that through the - those upside factors will continue into 2020? Or would it maybe be more prudent for us to think about bringing our numbers in. I realize you're not giving guidance, but to absorb the rest of the loss of Canada.

Yes. So your first were, we're confident in how the year is playing out overall. Another way of interpreting our guidance is had we not sold Canada, we would have been towards the higher end of the ranges or maybe even taking some of the ranges up. It's just continued execution of all the things that we have talked about, and particularly, our disciplined approach. Clearly, next year, we'll have the entire 12 months without Canada in the results. So the effect will be greater than just a couple of months on. We're in the process of planning and budgeting for next year. You're focused on our objectives of expanding our offerings. You're growing our commercial business, becoming more of a residential end-to-end platform, still in that budgeting process. So as you point out, we're not in a position to give guidance for 2020 to date. But we're confident in how we're closing out 2019.

So I mean, is it right to say that commercial drove much of the revenue delta? Is that a fair statement? Or were there other factors that contributed to...

The revenue - yes, on the top line, it's particularly commercial. As you guys know, margins in commercial are a bit lower than residential. On the residential side, there's a lot of puts and takes, of course, but throughout the year, we've been relatively more efficient than we had originally planned on in our service cost execution. We continue to be disciplined in our cash generation. You're managing, as always, a lot of puts and takes. So there's no one factor I'd point to overall, but for sure, on the top line, it's commercial.

And then, Jim, you talked about an awful lot of initiatives you have going on. One that we haven't had an update on in a while, and I realize it's small, but the launch of the DIY business you acquired earlier this year under the ADT brand, is that still on track? Or how are you thinking about that these days?

Sure, Gary. Yes, it's still on track. The DIY market is growing quickly. We view this essentially as a new opportunity for ADT. We think we can do well in this market. Our early progress has some healthy growth from the original LifeShield organization that we acquired. It's not yet material in the context of our overall business, but we're pleased with the team and really pleased with our progress here. We generally see, as you know, DIY, not as a threat, but as an opportunity for us.

Our next question comes from the line of Toni Kaplan with Morgan Stanley.

This is Jeff Goldstein on for Toni. I want to ask on the RMR additions declining by 2% versus the prior year. Because on one hand, it sounds like you're expanding the credit box, which is worsening attrition, but then RMR additions are not necessarily increasing year-over-year. So how should we think about the push and pull of those 2 metrics? And what will it take to drive an acceleration in RMR additions?

Yes. One thing worth mentioning I'd referenced in my prepared remarks, but last year was a particularly strong third quarter. RMR as - if I recall, were up 7% last year compared to the prior year. One of the drivers we mentioned on the call last year was we had some bulk purchases that were about $0.5 million of RMR adds. So you're excluding that. We were up a couple of percent. If you look at us on a year-to-date basis, our subscriber acquisition spend is down and our RMR adds are up. So you're consistent with our objective of becoming more efficient in revenue payback, even though you see the number still rounds to 2.4.

Okay. Got it. And then just given the Canadian divestiture and the decision to pay a dividend from proceeds, how should we now think about your leverage target? And how this impacts your capital allocation philosophy going forward? So does this rule out M&A and buybacks for the foreseeable future? Or just how should we be thinking about that?

No overall change to our capital allocation policy, which we viewed to be well rounded. It will include delevering over time as a high priority, along with continuation of accretive commercial or other M&A, organic investments. And then we'll continue to evaluate how to ensure that shareholders get a return. So it could also include dividends or even potentially repurchases in the future. But because it can all by itself, I would - there's no change I would call out.

Our next question comes from the line of Kevin McVeigh with Crédit Suisse.

So I guess, it sounds like you're really scaling the consumer finance to citizens. Any sense of how much that contributed to revenue in the quarter? And if I heard right, it sounds like you're in 21 markets versus the initial 5 or so. Any sense of how we should model that out in Q4 as well?

Yes, not really material, Kevin, in the quarter. Most of the quarter, we were in the markets that we had launched in July or early August. During the last several weeks, we've expanded to be now in approximately 20 markets. We're encouraged by what we're seeing. There's a lot of internal transformation and change in terms of how the sales force sells, but we're seeing strong installation revenue. We're focused especially on IRR-centric approach to drive optimal customer lifetime value. So we're fine-tuning that precise pricing, the precise offers, how we go-to-market to make sure that we find the right price volume trade-offs and generate more IRR over time. So we're encouraged by where we are, but a lot of work yet to do. As we've said before, it continues to be our plan to launch nationally in 2020.

Got it. And then, I guess, what drove the decision to use the proceeds for a dividend as opposed to buyback or maybe other strategic M&A, just as we're thinking about the optionality on the Canadian business?

Kevin, it's Jim. We're essentially looking at alternatives to return capital to our shareholders. Our stock hadn't been performing as well as we would have liked. And we engage in a discussion with our Board. And we thought that it was an effective way to return some cash to our loyal shareholders. And it was a decision ultimately that we had unanimous Board support for and the management team supported as well.

Understood. And then just, I guess, one more, if I could. With commercial closing in on almost 1/3 pretty quickly the revenue overall, any sense to how that impacts the attrition going forward? Should we expect to see some benefit from that as that business continues to scale?

Yes. I mean we're incredibly excited about the commercial business. The results have - speak for themselves. The pipeline that we see in our commercial business is strong and a tremendous opportunity. And as we continue to grow the commercials - commercial business at a pretty good clip, we're pretty bullish on the future, competing in a fairly fragmented market and a market where we're going to be able to leverage our scale and our outstanding service. In terms of attrition, commercial should be a tailwind for attrition. It's a business that we've talked about in the past that has pretty good retention characteristics. And we feel good about its overall impact on attrition.

Our next question comes from the line of Ashish Sabadra with Deutsche Bank.

So on the 3G upgrade, you talked about potentially coming in at lower end of the expense range, maybe can you just provide some more color on that front? And also talk about cross-sell opportunity. Have you had any initial feedback on that front as well as you go ahead with your 3G upgrade?

I'm sorry, I'm not sure we fully comprehended the question. I think the first part of the question was about the service costs?

Yes. So yes. So the first part was about the expense coming in at the lower end. So what's driving that? And then maybe as you would roll out 3G, you talked about potentially cross-selling other service like commoditization or other products or services into that customer base. I was wondering if you had any thoughts on any initial feedback on that front as well.

Okay. Ashish, it's Jim. I'll offer a couple of comments on the 3G front, and then ask Jeff to add to your - to answering your other questions. On the 3G front, our range, as you know, was $200 million, $325 million. It's still relatively early in the process but we are confident in our range. We spent approximately $13 million through the end of the third quarter. Our full year range net amount is $25 million to $35 million. We don't have comments or really insight on predecessor company performance, but a couple of variables that will influence whether we're on the high end or the low end of that range, our ability to generate cost offsets via revenue. So selling into that base, vendor contributions and potentially some technology solutions. And there's a long way to go here. We're happy with our results so far. And as I've said, we have confidence in the range that we set.

And the first part of your question around the service costs. I was just mentioning earlier to - in response to Gary's question that there's a whole variety of factors that has enabled us to maintain our guidance even not having Canada and the results for the last couple of months. And among those is we talked normally on these calls about some of the more strategic-type initiatives, but we continue with the day-to-day tactics of just executing the business in our call centers and in the field. And one of those factors is that we've done pretty well during the course of the year relative to our initial budget of managing service cost. And then some of that is the reason that we're able to maintain our guidance. And then some of that has been able to help us fund some of the investments that we made. And then one follow-up, too, to Gary's question, as we look in 2020 that that will ultimately be, as we work through the budgeting process, the determinations we'll make is how much of that carries into next year, how much of that to invest in the business and then how much of that to let drop-through as the cash flow and/or EBITDA growth in 2020 which we'll describe more on our subsequent call.

That's extremely helpful. And then maybe just a quick question on - a follow-up question on the Citizens Financial. If you roll that out, how should we think about the subscriber acquisition cost? How should we - like how much can that come down? And how should we think about the benefit to the free cash flow from rolling that out?

Yes. We'll share more on our next call. Some of the answer to your question will be dependent upon the final decisions we make on the pricing levels, the ability to finance. We have pretty - well up and running. What we're spending our additional time on before we launched nationally is as I was saying earlier, fine-tuning the exact pricing and the exact offers that we go out to with customers. Two advantages that this should give to us. One, the ability to enable our customers to pay a higher price, meaning, we will not be in a position to have to discount or subsidize as much as we have historically. And then the second, as Jim alluded to earlier, is the ability to enable our sales teams to become more effective to better protect and better connect to consumers with more comprehensive offerings. Both of those should lead to lower net customer acquisition costs.

Our next question comes from the line of Jeff Kessler with Imperial Capital.

Yes. Now that you're about a year into the acquisition of Red Hawk, I know that the margins on Red Hawk, particularly in the Fire business, tend to be a little bit lower. But on the other hand, the cash flows and the ancillary businesses - and the ancillary business that comes off of a company like that should begin to help margins, actually, in the business that Red Hawk touches. Can you go - can you walk us through a little bit about when you expect to see the integration of Red Hawk begin to affect the financials on a more positive basis? Obviously, we're seeing it on the top line. The question is, is now with the - and by increasing the amount of fire and other emergency capability through Red Hawk, how do you get the margins in that business up and in sync with the rest of ADT commercial?

Yes. I'll offer - thanks, Jeff. It's Jim here. I'll offer a couple of overall comments about Red Hawk and then ask Jeff to weigh in as well. You asked about the integration and how things are going from a Red Hawk perspective overall. And the short answer is we've made a ton of progress, including the selection of the commercial leadership team. Our approach was to integrate quickly, but without any disruption to the customer. So we've been very methodical about this integration, very disciplined about the integration. We'll be substantially complete with the entire integration by the end of 2020, and we have important milestones for integration over the course of the full year.

Those milestones are financial milestones in addition to operational milestones?

They are, and they include the synergy target that were built into the base case. We've got some revenue synergy opportunities and technology and human resource milestones as well.

Okay. My follow-up question is on - as you know, I know you guys know what I think about verification and what's going on in the DIY section - sector with regard to false alarms. My question though is now that you folks have acquired I-View Now, is this going to be something that you view as something proprietary? Or is the fact that you folks are like the leader, the largest company in the industry, also the thought leader in the verification area, are you going to be able to share this technology with other groups? Or are you going to just go out and just be #1 with I-View Now, so to speak, since its technology is fairly advanced?

Yes. So Jeff, this is Don. Good question. We've been working with I-View Now for a while. As you know, there's some significant things that will differentiate us from the competition that we're going to enjoy rolling out first on behalf of ADT. As far as the question, call it, longer term, whether this becomes, call it a prelude to a standard way of providing professional monitoring for the whole industry to consume, we haven't made commitments yet to that. We're still waiting. Our first and primary goal is to see how far we could go in and take ADT with this technology first, okay?

Our final question comes from the line of Manav Patnaik with Barclays.

This is actually Greg calling in. Maybe this is piggybacking on the DIY question. But other topic we haven't talked about much recently is the e-commerce channel. So I was just hoping to get an update on the efforts there and how that's progressing to start kind of selling more and more through the digital channel.

Yes. The brief answer is it's a high priority for us. We've made some progress in e-commerce. We think that it will drive some gross add volume for us and will improve the SAC efficiency, high priority. And our marketing and technology folks are working together to continue to move us forward on that front.

Okay. And then nice results on the commercial side. I saw that you're standing up its own commercial team. Just a little color on what the goal is there in terms of taking that business to the next level, and what having its own team could potentially provide.

Yes. So we've brought the best of all of the organizations together, ADT Legacy Protection One, Red Hawk, Aronson, all of our tuck-in acquisitions. And selected amongst all of these very great companies, the most talented leaders. And they, together, are leading the commercial space. We feel - as I mentioned earlier, we feel really good about our commercial results. We feel fantastic about the pipeline and the backlog. And we feel great about our ability to compete in this space, not only leveraging our brand, but our reputation for having the best service in the commercial business. We're hitting on all cylinders. Red Hawk is doing well. Our national account business is doing exceptionally well. And it'll continue to be a very high priority for ADT going forward.

Since that was our final question, this does conclude today's question-and-answer session as well as today's conference call. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.