ADT Inc. — Q2 2018 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2018. ADT provides monitored security, automation, installation, and related services in the U.S. and Canada; it reported approximately 7.2 million customers and operates as one reportable segment. The January 2018 IPO and related financing actions materially affected the period.
Financial results
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $1,131.5M | $1,067.8M | $2,247.9M | $2,127.0M |
| Operating income | $73.9M | $89.6M | $145.3M | $95.2M |
| Net loss | $66.7M | $92.7M | $224.1M | $233.5M |
| Net loss per share | $(0.09) | $(0.14) | $(0.30) | $(0.36) |
| Operating cash flow | Not provided by quarter | Not provided by quarter | $962.8M | $743.4M |
| Adjusted EBITDA (non-GAAP) | $610.4M | $582.9M | $1,230.2M | $1,159.9M |
| Free cash flow (non-GAAP) | Not provided by quarter | Not provided by quarter | $289.3M | $68.8M |
Q2 revenue increased 6.0%; monitoring and related-services revenue rose 1.6%, while installation and other revenue increased to $108.3M from $60.7M, partly due to outright equipment sales and acquisitions. Operating income fell 17.5%; operating margin was approximately 6.5%, versus 8.4%. Net loss narrowed; net margin was approximately (5.9%), versus (8.7%). For the first half, operating margin was approximately 6.5%, versus 4.5%, and net margin approximately (10.0%), versus (11.0%).
Management attributed recurring-revenue growth to higher average pricing, including new customers choosing higher-priced services and price increases to existing customers. Recurring monthly revenue (RMR) was $338.1M versus $332.1M a year earlier; gross customer revenue attrition improved to 13.6% from 14.1%. Management cited improved customer service and lower voluntary disconnects. Cost of revenue rose with higher equipment sales; Q2 SG&A also rose, primarily due to IPO-related share-based compensation.
Liquidity, debt, and capital allocation
- At June 30, cash and cash equivalents were $344.3M, with a further $753.9M of restricted cash, primarily reserved for the preferred-security redemption. The restricted balance should not be treated as generally available liquidity.
- Total debt carrying value, including capital leases and excluding preferred securities, was approximately $9.57B. Long-term debt on the balance sheet was $9.52B; current maturities were $48.3M. The company reported $350M of undrawn revolver capacity and compliance with debt covenants.
- Operating cash flow was $962.8M in the first half. Investing cash outflow was $696.1M, including $327.6M for dealer-generated and bulk accounts, $280.7M for subscriber-system assets, and $65.2M of capital expenditures. Financing cash inflow was $705.4M, primarily reflecting IPO proceeds and debt repayments.
- The January IPO generated $1.406B net proceeds. ADT used about $649M to redeem $594M principal of 9.25% Prime Notes, recording a $61.6M first-half extinguishment loss. It also reserved $750M for redeeming Koch Preferred Securities.
- On July 2, 2018, after quarter-end, ADT redeemed the preferred securities for approximately $950M, including about $200M of premium, accumulated dividends, and tax reimbursements. Management expected an approximately $215M extinguishment loss in Q3 2018. ADT declared a further $0.035-per-share dividend for October 2018.
Changes, outlook, risks, and unusual items
- Six-month revenue increased 5.7%; operating income improved to $145.3M from $95.2M, while net loss narrowed modestly. The comparison includes a $61.6M debt-extinguishment loss in 2018 and $39.7M of merger, restructuring, integration, and other costs in 2017 versus $8.5M in 2018.
- First-half Adjusted EBITDA rose 6.1%. Free cash flow improved substantially, but is a company-defined non-GAAP measure that deducts dealer account purchases, subscriber-system additions, and capital expenditures from operating cash flow.
- The company adopted the new revenue standard in 2018. It increased opening equity by $34.4M net of tax; the standard increased reported first-half operating income by $14.8M and reduced net loss by $11.3M compared with the prior accounting method. Prior-year results were not restated.
- First-half results included $22M of licensing-fee income and a $7.5M investment gain arising from settlements, and a $10M litigation-settlement benefit in SG&A. Share-based compensation was $95.1M, versus $4.9M a year earlier, largely related to IPO-linked awards.
- Management said cash, operating cash generation, and revolver availability should meet operational needs over the next 12 months and longer term, while emphasizing that ADT is highly leveraged and has significant debt-service requirements. No specific revenue, earnings, or cash-flow guidance was provided.
- Risks include six shareholder class actions alleging IPO-registration-statement and prospectus misstatements; unresolved California investigations into electronic-waste practices; potential exposure from independent-contractor classification; and proposed U.S. tariffs on Chinese-made alarm and electronic equipment that could raise costs or affect customer demand. The filing also describes IRS disputes over historical tax deductions and potential impacts to tax attributes. Management stated that other ordinary-course legal matters were not expected to have a material adverse effect, but outcomes remain uncertain.
Important facts for investors to verify
- Whether recurring-revenue and attrition trends continue, and whether higher pricing offsets customer-volume pressure.
- The cash and earnings effects of the July preferred redemption, including the expected Q3 extinguishment loss and remaining unrestricted liquidity.
- Debt repayment capacity and leverage, considering recurring investment in dealer accounts and subscriber systems.
- Underlying operating performance after considering non-GAAP adjustments, IPO-related compensation, settlement income, and the revenue-standard change.
- Developments in IPO litigation, contractor-classification matters, tariff proposals, and tax disputes.