Timothy J. Perrott - Vice President of Investor Relations Naren K. Gursahaney - Chief Executive Officer, President and Director Michael S. Geltzeiler - Chief Financial Officer and Senior Vice President.

Ian A. Zaffino - Oppenheimer & Co. Inc., Research Division Shlomo H. Rosenbaum - Stifel, Nicolaus & Company, Incorporated, Research Division Jason B. Bazinet - Citigroup Inc, Research Division Jeffrey T.

Kessler - Imperial Capital, LLC, Research Division Charles Clarke - Crédit Suisse AG, Research Division Jiayan Zhou - Morgan Stanley, Research Division James Krapfel - Morningstar Inc., Research Division.

Very good morning, ladies and gentlemen, and thank you, all, for joining. Welcome to the Third Quarter 2014 ADT Earnings Conference Call. My name is Lisa, and I'll be your event coordinator today. Today's conference is being recorded. [Operator Instructions] Now I'd like to turn the conference over to your host, Mr.

Tim Perrott, VP of Investor Relations for opening remarks. Please proceed, sir. Thank you..

Great, Lisa, and good morning to everyone. And thank you for joining us for our call to discuss ADT's third quarter results for fiscal year 2014. With me on the call today are Naren Gursahaney, ADT's CEO; and Mike Geltzeiler, ADT's CFO.

Let me begin by reminding us all that the discussion today contains certain forward-looking statements about the company's future performance, which are subject to the risks and uncertainties and speak only as of today.

Factors that could cause actual results to differ from these forward-looking statements are set forth within today's earnings release, which was furnished to the SEC in an 8-K report, and on our Form 10-Q for the quarter-ended June 27, 2014, which we expect to file with the SEC later today.

In our third quarter 2014 earnings release and slides, which are now posted on our website at adt.com and on our Investor Relations app, we have provided a reconciliation of the company's non-GAAP financial measures to GAAP. We urge you to review that information in conjunction with today's call.

For those of you following on the webcast, we will be using this slide deck to supplement our commentary this morning. And please note that, unless otherwise mentioned, references to our operating results exclude special items, and these metrics are non-GAAP measures. I would now like to turn the call over to Naren.

Naren?.

the first being the integrated monitored security, life safety and automation solutions; and the second being stand-alone home automation solutions.

In the monitored arena, where we have our focus and strength, we find traditional security firms plus certain cable and telco companies that have entered the space over the past several years focusing on bundled packages, including automation with monitored security.

In this segment, although the competitive environment has increased over the past few years, it remains relatively stable. And today, about 1 out of 4 homes with monitored security has chosen ADT.

In the stand-alone home automation arena, we have various technology companies that are leveraging opportunities in the other 80% of the market that historically, we have not pursued. They're offering essentially over-the-counter, self-monitored, do-it-yourself products focused on automation.

This segment also includes other non-security companies involved in the manufacturing of peripherals, as well as software companies.

While historically, we've not focused on this part of the market, we do recognize the need for tailored products and services in this segment, as well as the potential value that ADT can provide by making a monitored security solution an important component in this segment. Let me share a few of my observations.

First, ADT's position in the monitored security, life safety and automation industry remains strong, and the opportunity to capture more of this market is before us. Innovation is spawning new products and services, and there are many opportunities to bring more value to customers and expand this market segment.

Second, despite a more competitive environment over the past couple of years, the market dynamics remain healthy. Pricing remains strong. In fact, our ARPU continues to climb each quarter, and we attracted 250,000 new customers during the most recent quarter.

And third, the more recent entrants appear to be focused largely on the unmonitored or self-monitored product segment of the market, that today remains unpenetrated and hasn't been reached by traditional security solutions.

All of this creates more opportunities for ADT, from driving development, allowing us to bring exciting new products and capabilities to our existing customers, to partnering with others to enhance our offerings, leveraging our brand, sales and installation capabilities and monitoring infrastructure to expand beyond our traditional market.

Our new Pulse Voice App, as well as partnerships with Life360, McAfee and State Farm are recent examples of these opportunities. This is an exciting time for our industry, and we believe that ADT is in the right place, at the right time with the right capabilities to capitalize on these new opportunities.

Recognizing that a connected home is not necessarily a safe home, our focus continues to be on monitored security and life safety, and we are a clear leader in this segment with the most trusted brand, the largest sales and installation network and an innovative portfolio of products.

We believe these are very valuable assets and recognize the opportunity to not only strengthen our position in the traditional market, but also expand our influence into new segments.

We're taking action to align our core competencies with our vision, a vision that's rooted in extending our leadership position, enhancing the value of ADT's services and executing against our priorities to drive strong returns.

And we're continuing to enhance every aspect of our business, from adopting new sales approaches, to opening up our platform and allowing third-party developers to innovate and enhance the value of the services we provide. And all with a security and safety-first mindset.

Last quarter, I commented that there was a lot happening beneath the surface in support of our goal to improve our performance in the second half of the year and beyond. This quarter, you saw evidence of our progress.

Since our slow start at the beginning of the year, we've taken actions to strengthen our industry-leading position, generate quality growth and streamline our cost structure in order to improve our performance for the second half of the year.

Our plan's focused on reducing attrition, improving the customer experience and driving higher quality sales growth. We also implemented cost-savings initiatives focused on lowering the cost to add new subscribers and serve our existing customers.

And although we're still in the early stages of executing upon these initiatives, our results in the third quarter clearly indicate that we're making solid progress and are on the right path.

In the quarter, we drove meaningful sequential improvements in attrition and gross adds, while improving our cost structure in margins and delivering better bottom line results.

We also made significant progress in enhancing our foundation for future growth, closing a major acquisition shortly after the close of the quarter and entering into new partnerships that will enhance the customer experience and provide additional reach into the market in the future.

Now let's turn to our performance highlights for the third quarter, as summarized on Slide 3 of our presentation. In the period, we improved both our financial results and key operational metrics. From a financial perspective, we drove healthy increases in EBITDA, profit margins and bottom line results.

EBITDA margins improved significantly, surpassing our goal for the year, driven largely by progress we're making on our cost-efficiency initiatives. Recurring revenue was up over the same period last year, however, modestly related to the slower customer adds at the beginning of the year.

It's important to note that we continue to drive higher ARPU, largely as a result of increasing traction in Pulse take rates. Operationally, we made meaningful sequential improvements in attrition and gross adds in both sales channels and improved our cost structure.

Revenue attrition improved sequentially for the first time since we became a public company, ending at 13.9%, benefiting from the progress we've made on our initiatives, as well as a more stable housing market.

Our initiatives in the areas of non-pays, customer loyalty and resales are beginning to take hold, and we believe we will continue to drive attrition lower over time.

Our strong brand recognition and promotional offers drove improved new subscriber growth in both our direct and dealer channels, highlighting that we continue to win in the marketplace and that our products and services remain in demand. Our dealer channel nearly reached a level of production of last year's fourth quarter.

On the direct side, we ran a limited time promotion that helped drive improved results. Marketing leads were up sequentially and our efforts to increase self-generated sales, which were up 17% to 4.4 monthly units per rep, also contributed to our growth.

The success of Pulse continues to be an important driver behind our results, as Pulse take rates continued to increase across all channels for new system sales, as well as Pulse upgrade activities, which also grew nicely.

As you can see on Slide 4, 49% of our total gross adds during the quarter were Pulse units, up from 44% last quarter and 28% 1 year ago.

In our residential direct channel, the take rate for new and resale units was over 56%, which was almost 6 percentage points higher than the prior quarter and up almost 18 percentage points over the same quarter last year. And 71% of all new residential customers we added via our direct sales channel were Pulse customers.

In our small business channel, the Pulse take rate was 39%, up 9 percentage points over the third quarter of last year. In our dealer channel, the Pulse take rate ramped up in the third quarter to over 43% from about 36% last quarter and 15% last year. In addition to new system sales of Pulse, we upgraded about 20,000 existing customers this quarter.

This is nearly double what we did in the same period last year. Our Pulse upgrade efforts allow us to provide additional functionality to our existing customers and yield higher ARPU. In addition, these upgrades allow us to enter into new contracts with these customers and enhance the customer experience.

We currently have approximately 875,000 Pulse customers, representing about 14% of our total customer base, showing that we still have a tremendous opportunity to further increase Pulse penetration.

On the strategic front, summarized on Slides 5 and 6, we made significant progress in positioning ADT for future success by enhancing our capabilities and extending our partner network. As I stated last quarter, our strategy is to continue to invest for growth in our business, both organically, as well as through M&A and partnerships.

On the M&A front, we completed our previously announced acquisition of Reliance Protectron, a growing security services firm in Canada with a total customer base of approximately 400,000 residential, commercial and contract-monitoring accounts, generating about USD 11 million in recurring monthly revenue.

Protectron has a high-quality subscriber base, industry-leading attrition performance and a strong dealer network. This acquisition creates a significant growth platform for us in Canada, strengthens our core business and adds to our capabilities. We will begin to consolidate Protectron in the fourth quarter.

Mike will provide additional details of the expected financial impact of this acquisition as we move forward. We also formed a commercial partnership and took a minority equity investment in Life360, a leading family networking and location-based services firm with over 38 million customers, 18 million of which are in the U.S. and Canada.

This partnership fits very well with our strategic imperative of enhancing the value of the services we offer and extending our security services beyond the home.

This partnership will provide a valuable lead-generation source for ADT and will enable the development of innovative, co-branded mobile security applications to provide greater safety and security services to families. Lastly, but certainly not least, our noncompete with Tyco expires at the end of September.

We believe that this represents a threefold increase to the market opportunity for our existing small business channel. We're preparing our plans and readying our strategy, and we'll share more with you on future calls. I'll follow up with some additional comments at the end of the call.

However, now I want to turn things over to Mike for a more detailed review of our operational and financial results..

revenue attrition and unit attrition. 12-month trailing net revenue attrition was down sequentially for the first time since our separation from Tyco, dropping 30 basis points to 13.9%. This is the same level we ended 2013. Also on this slide is unit attrition, which measures customer attrition for our residential and small business customers.

Unit attrition was 13.5% for the quarter, down 20 basis points versus Q2. Over the past 12 months, existing home sales has stabilized with prior year, which is consistent with what we're seeing in gross relocation disconnects.

We are aggressively implementing all of the customer retention actions that we've previously communicated, including tighter credit screening, enhanced resale efforts, improved non-pay procedures and pursuing Pulse upgrades.

Our objective for 2014 was to focus on the levers we can control to stabilize attrition around year-end 2013 levels, and having already met that goal, we look to drive this number even lower in the future.

Slide 10 details the recurring revenue margin on our existing customer base was 68.3% for the quarter, up 40 basis points versus prior year and 170 basis points sequentially.

The increase in margin is driven by operating leverage created from higher recurring revenue, the effects of our cost-efficiency programs, lower maintenance cost, a decrease in bad debt expense and some G&A timing benefits.

On a per-unit basis, cost to serve was up 2% to $12.97 per month versus prior year and was down sequentially despite a higher percentage of our base using our Pulse platform. We made sequential improvements in our overall net creation multiple.

Excluding the impact of Pulse upgrades, our net creation multiple improved 1.1x to 31.0x, while our net creation multiple in our direct channel improved 2.8x to 31.1x.

Although Pulse take rates continue to increase, creation multiples have improved since the first half of this year, driven by our cost-efficiency programs, higher volumes of customer adds and stronger new and resale ARPU.

We have a solid pipeline of initiatives to further improve creation multiples, including the launch of electronic contracts and planned hardware efficiencies, which will go live in fiscal 2015. Turning to Slide 11. Let me focus your attention on free cash flow and steady-state free cash flow.

Cash flow from operations was $408 million, an 11% decrease from Q3 last year. This is primarily due to higher incremental interest paid on our outstanding debt and some timing issues with working capital. Capital expenditures for the quarter were $323 million with all but $23 million of that investment going towards new customer adds.

This compares to $308 million of total CapEx in the third quarter of last year. Direct channel subscriber CapEx increased, reflecting higher Pulse generation and greater volume of Pulse upgrades, whereas dealer channel CapEx declined due to lower level of gross additions.

Factoring all of this, free cash flow before special items for the quarter was $98 million. Our steady-state free cash flow for the quarter was $934 million versus $983 million in last year's third quarter, but this was up $148 million sequentially from Q2 2014.

This metric is heavily skewed by current-quarter EBITDA, creation multiple and last 12-month attrition, all of which improved significantly in Q3 versus Q2. Slide 12 addresses our capital allocation and debt levels for the quarter. Leverage improved to 2.7x at quarter end. We ended the quarter with $250 million of cash on the balance sheet.

In early July, the Protectron acquisition was funded from cash on hand and from drawing $375 million from our existing credit facility. Post the impact of the acquisition, we expect to still be below our leverage target of 3x.

In Q3, we paid a quarterly dividend of $0.20 per share and during the quarter, we repurchased 2.6 million shares for $79 million. We ended the quarter with 175 million shares outstanding after dilution, which is a reduction of 26% in the share count since we began our repurchase program.

In fiscal 2014, we repurchased 1.4 billion in shares at an average price of $38.49 per share. We have approximately $400 million remaining in the share buyback authorization. Turning to Slide 13. I want to provide a little more color on our fourth quarter expectations and full year guidance.

Given our strong Q3 performance, we're maintaining or slightly enhancing the guidance we provided last quarter for the full year. As expected, Protectron will be consolidated into operations in the fourth quarter, as reflected in our guidance update on Slide 13.

Today, Protectron generates about $11 million of recurring monthly revenue, which we will consolidate in our financial results for about 11 weeks in the coming quarter. Today, Protectron's EBITDA margins are below the EBITDA margins of our business overall.

However, if we combine the businesses in Canada, realize the synergies and drive growth, we expect that margins will be improved for both Protectron and ADT Canada.

Also, factoring in the intangible amortization and some other noncash purchase accounting adjustments, we expect slight dilution from the transaction on an EPS basis in the fourth quarter. By 2016, we expect this transaction to be EPS accretive. Year-to-date, we've reported recurring revenue growth of 3.4% on an exchange-neutral basis.

For both recurring revenue and total revenue, we still expect growth for the year in a range of 3% to 4% on a constant dollar basis. Regarding EBITDA margins, we surpassed our full year goal in the third quarter by reporting 53.2%.

But given my commentary earlier about the timing of some expenses, the lower margins from Protectron and some additional investments we expect in Q4, we expect Q4 margins to be reduced from Q3 levels. However, full year margins will be in excess of our initial guidance of at least 50-basis-point improvement over 2013.

And as I stated earlier, steady-state free cash flow is highly dependent on current-quarter EBITDA, creation multiple and last 12-month attrition. We are progressing towards our growth goals for this metric, which has been held down until this quarter by higher attrition and subscriber creation multiples.

Following our favorable Q3 trends in these levers, we're progressing towards year-over-year growth and steady-state free cash flow and have provided a range of $900 million to $950 million of expected full year outcome.

Steady-state free cash flow is a good long-term indicator, but given the nature of its calculation, it is susceptible to large short term swings, as we witnessed this quarter. Underlying this outlook, we expect sequential improvements in gross adds for both direct and dealer channel in Q4 and further improvement in attrition.

Now I'd like to turn the call back over to Naren..

Thanks, Mike. I know that we've covered a lot of information today, and I want to make sure we leave time for your questions. In summary, we're pleased with the progress we're making, and we're executing against our initiatives. We're delivering upon our promise to improve performance in the second half of the year, in line with our expectations.

Our position in the industry remains strong, and we believe that the market opportunity continues to grow for ADT. That said, we recognize that we have much more to accomplish in the future and our entire team remains committed to executing our plan and delivering results. Now we can open up the mic for questions.

Lisa, can you remind people of the instructions for those who want to ask questions?.

[Operator Instructions] Okay, our first question is from the line of Ian Zaffino of Oppenheimer..

You guys made great progress on the churn side.

Where do you think you are in terms of innings, maybe, in your churn-reduction efforts? What can it go to? What sort are your targets that you're looking at? And what should we expect going forward?.

I would say, based on the fact that we just saw it turn for the first time since we've spun off from Tyco, that we're definitely in the early innings of the improvement opportunities that we see ahead of us. As Mike and I both mentioned, we do believe that, that will come down further in the fourth quarter.

We're not in a position to provide guidance right now on a quarterly basis, and I think when we get to report our fourth quarter total year results at the end of next quarter, we'll provide some directional information on where we think FY '15 is going to play out.

But again, I still think we're very in the early days of the opportunity we see ahead of us..

So I guess, when you look at your churn and you kind of comp yourself versus the rest of the industry, do you think you're in a position to achieve the industry average, maybe best the industry average? I'm just trying to think structurally what that number could look like..

Again, I'd hesitate to put a number out there right now. I would say that, historically, we've been very aggressive on the pricing side and managing the balance between gross adds, pricing and attrition. I think you're seeing us focus a little bit more on the attrition side especially over this past year.

So we're going to continue to make those trade-offs, but again, I think we've got plenty of room ahead of us. Mike, I don't know if you want to add anything..

Yes, I mean, I think -- again, we're trying to move people to the unit attrition metrics, so at 13.5%, we're in line with several of our peers. But as Naren and I said, we're not satisfied with that number. We think we can go lower.

I think the other thing that continues to boost -- the industry is going through an automation transformation, and as we get 14% of our customers now on Pulse, we think that bodes well for attrition in the future.

So I think some of the churn we have seen is people moving off of -- as Naren said, a reasonably high-priced burglar alarm systems and looking for better technology. I think we feel confident that, once we get people on our latest technology, that retention will be stronger..

Okay. And then the other question would be -- looks like you're doing a good job in your Pulse penetration rates.

With the introduction of some of the new products like the Pulse Voice, do you anticipate maybe the penetration rates going above and beyond what you original anticipated? Or is there any opportunity for upside there? Or is it pretty much as you said before?.

Yes, Ian, I guess I'll kind of take the bullet on this one. If you go back to what our original expectations when we launched 3.5 years ago, I think I got out on a conference call and said we thought we'd get somewhere between 10% and 20% of our new customer adds going on to Pulse.

Yet clearly, we're at almost 50% in aggregate across all channels, and new customers are coming in about 70%. So I think at some point in time, especially for new customers, we will hit a ceiling.

But that said, considering our dealer is still significantly below our direct channel at this time, small business is both below resi in total, both dealer and direct, I think we've got plenty of upside opportunity. And I think, as far as the total base goes, we need to and we are being more aggressive on driving upgrades there.

As Mike mentioned, one of the reasons customers might leave us is because they see the opportunity to get new technology from a competitor. We've got to make sure that they're aware that we have those capabilities and that we have a competitive upgrade opportunity and offer for those customers.

So I think the total base will continue to move, and our total penetration rate should continue to grow..

Our next question is from the line of Shlomo Rosenbaum of Stifel..

I want to ask just a couple of like housekeeping items just on calculating attrition. I know that 13.5% is a methodology that you guys have. I want to ask if you can just kind of bridge me. If you did a simple attrition calculation, meaning if I took unit attritions over prior quarter on a quarterly basis, it looks like unit attritions were 18%.

And if I look at them sequentially, it looks like the unit attrition was flat.

What -- how do I bridge that? And when I -- around the 18% level, what is the bridge between that and the number you're getting for the 13.5%?.

It really is just a gross versus net, so you're looking at the gross attrition numbers. We net out resales there, so the difference in there would be resales and potentially charge-backs to our dealers, where our agreements allow them to charge back certain customers in the -- within an initial 12- to 15-month period..

And I think our gross attrition for small business resi was lower in the third quarter this year than the third quarter last year, which is what brought the numbers down..

Okay. And then, if I do the math just in terms of the CapEx on the direct side per subscriber, it looks like it was down sequentially, which is good. You're showing that it's costing you less on the equipment.

I'm just -- want to know just from some commentary of what was going on in terms of the sales during the quarter? Historically, that's been an issue for you guys, and you've had to throw in extra equipment. And it seems like despite the promotions, your message is getting through -- or is getting through better than it was before.

Can you talk a little bit about what you're hearing from the people on the ground?.

Well, I think couple of things. One is the promotion clearly did help us drive greater lead activity, greater appointment activity. I think our sales team did a very good job of upselling versus the promotion package and driving more content and driving more revenues from those customers.

And just the volume of activity we got on our direct channel gave us better absorption of our installation resources and teams.

Mike, anything you want to add on that?.

Yes, I mean, I think basically, the -- we call it CapEx but really it's the subscriber acquisition cost, which includes marketing. We have savings on the web search optimization. It includes the labor efficiency on the installation. As Naren mentioned, we have higher volumes.

We have -- we've been doing some work on when we outsource installation versus insource and optimizing that. And of course, you got the equipment side. So it's a combination of all 3 of those, not just the equipment, as well as the promotion that goes into that figure. And we've been saying it all along.

The first quarter, SAC was high and it's not where we intend to be. We have a pretty good pipeline of initiatives to bring it even lower, and we were pleased to see the direct creation multiple go down to 31x. Again, our goal is to go lower than that as well, so stay tuned..

One more question. Just -- what seems to be a potential game changer would be the hardware efforts and kind of being able to roll out an integrated hardware platform that's lower cost and just would be a quicker install. Where does that stand right now? You were in beta last quarter.

How much longer is it going to be in beta? And can you give us some more detail on what the potential impact could be?.

Yes. Well, again, we've been in friends-and-family pilot testing. We continue to expand that friends-and-family group. The success has been very positive. We're seeing meaningful reductions in installation time and, hence, installation labor associated with that.

The product cost is higher and our sourcing team is working with our partners to see how we can continue to bring that down. I had the opportunity to meet with one of our larger suppliers, and they provided a couple ideas that we're going to move on. And I've opened the door for them to come back with other value-engineering ideas.

We expect that in FY '15, we will start ramping up that across our base. Again, that will be for new systems we put out there. For existing systems where we do upgrades, we'll continue, for economic reasons, to use the existing equipment, including the panel, and then add in the hub for the automation side..

Our next question is from the line of Jason Bazinet, Citi Investment Research..

a, do you think it's the right way to frame it; and b, which one do you think is the most likely area where ADT may go, if you migrate to any other sort of adjacent opportunity?.

Yes, Jason, I guess, that is one lens to look at it. We have not really been a wholesale monitoring company for competitors or other third parties. So -- and honestly, I don't think we would necessarily go down that path in our current market.

I do think that if you looked at that 80% that seems to be interested in the DIY solutions that, today, don't have a monitoring option with those, I think that's probably the space that we would look at.

Is there the potential for a robust, reliable from a security and life-safety perspective, DIY product that has professional monitoring tied to that? I think that's probably the area we're more interested in and that's the area we're continuing to explore..

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

Granted that some of the improvement in your attrition -- sequential attrition for the quarter probably is due to the slackening of relocations or moving, so to speak, could you perhaps, to your best ability, parse out where efficiencies and the customer touch and your ability to use effectively analytics on your customers was part of that attrition decrease versus what was just purely out of your control, so to speak, the lower amount of moving?.

Yes, Jeff, remember we use a trailing 12-month attrition number. So when you look at it on a year-over-year basis, look at external trends around the housing market, I would say it's about flat year-over-year, when you look at just home sales in total -- existing home sales, because that's what would drive potential attrition there.

So I would say, that piece has really stabilized for us and the improvement you're starting to see is more on the operational side. When I look at the reason codes, where we're making the biggest impact, I think the biggest impact in the short term or recent term has been on the non-pay area.

I think -- and Mike has kind of been leading this effort with the finance team and the operations team. And I think we've made some good progress there. I think clearly Pulse is having some -- the Pulse take rates and the increased Pulse penetration is benefiting but that's more of a long-term benefit rather than a short term.

And resales, I would say, are starting to pick up at this stage, so we're getting good momentum there. But the housing piece, I think, is more kind of neutral versus last year..

Okay, I know Mike has talked at a number of lunches about going from -- getting -- going from 20% -- let's just say 20% reconnect, if you want to call it, to maybe 70% or 80%.

You're still at the very beginning of that, I'm assuming?.

Yes, very much so.

And this is for those who disconnect because of relocations?.

Yes..

We're still very early in that.

Mike, anything to add?.

I'm not predicting 70% or 80%. We're shooting for 100%. But I think that would show up, as Naren mentioned, in resales. I mean, on the gross relocation, there's nothing you can do about it. We can cover that on a net basis by increasing resales of the person who bought the home..

Okay. Next question is -- congratulations on your contract with Defender Direct. These are guys I respect a lot.

They are -- this Premier annotation you've given to them, what does this mean? And what does this mean in terms of the potential of you actually getting a positive comp on your dealer program, maybe by early 2015?.

Well, again, they are the first dealer that we've given this special designation. And honestly, Jeff, it was because when you look at the volume that they provide within our channel, they are significantly different from any of our other dealers.

Now clearly, we have other dealers who are performing very well and now aspire to achieve that same level of performance.

And it's -- while it's somewhat symbolic, it also does reflect a much stronger and tighter relationship that we have with Defender, where we have regular meetings with them, we encourage them to bring their ideas to us on how we can jointly grow the business, and we work closely with them on those partnership opportunities..

Okay. If I could just follow up on that -- on the hub panel and equipment question on lowering cost.

Can you go through the step process that you intend for us to see in terms of lowering, not just your absolute SAC, but the customer creation cost? What will the equipment side of this equation -- how -- when will that begin to kick in now that you have this in front of family and friends? Is this a -- is this something that we're going to see somewhere in the middle of 2015, late 2015?.

I would say kind of beginning of the calendar year is when you'll start to see a ramp-up of that..

I think as Naren said, I mean, at this stage, we have 1 more quarter left in the year. This thing is being tested with the SAC effort. And I think we will try to provide more guidance about 2015 when we report our fourth quarter earnings..

number one, as if your -- the initial, let's say we'll call it Pulse penetration has been slowing there.

My assumption is, is that -- my assumption is, as you begin to verticalize and figure out exactly what you want to do in these markets, this is going to somehow be pent-up demand when you start coming out with -- not just this, but some of the other technologies that you are going to be adding to the small business project, whether it be your VSaaS business or whether it be the -- or whether it be some of the other DVD or cloud-based systems you're putting in..

Yes. No, Jeff, I think your assertion is right on the mark. As we develop more of those bundles, we need to integrate those into the Pulse platform, and then you'll see the Pulse take rates grow accordingly.

The one thing I will say about the small business channel in the third quarter, their percentage of automation, the higher-end Pulse, was significantly higher than what we've seen in the past. And throughout the year, they've been driving that improvement mix.

And again, as we look at retention characteristics of our base, the higher-end Pulse always seems to do better. So again, I'm encouraged by what we're seeing there..

And they're, also -- unlike the residential business, where you're linking your automation to cameras, we have this cloud-based hosted video, which works well with the traditional system as well. So someone need not get Pulse automation in small business to get the video, which is hosted in the cloud..

Our next question is from the line of Charles Clarke, Crédit Suisse..

Just to confirm the question on attrition. So sequentially, just the number of disconnects was higher in the third quarter compared to the second quarter.

That's also a function of just seasonality throughout the year, isn't that correct?.

Yes, if you looking just at the 3-month disconnects, absolutely. [indiscernible].

Yes, third quarter and the fourth are the highest. That's where the doorknockers, the summer season. There's more relocations, et cetera. So for us to move down -- that's why we use a 12-month rolling number.

So for us, to move down, the attrition figure as we did 30 basis points, we had to produce better results this third quarter than third quarter 2013..

Right. And then, so I think everyone was pleased just to see the attrition start to come down. And then personally, I was further pleased just to see that credit screening, the fully automated credit screening process didn't roll out fully to the direct channel until May. So that short-term effect there.

So I guess, do you think that -- when will the fully automated credit screening process be rolled out to both the -- to the dealer channel as well? And when do you think that, that will start to have an impact on attrition?.

So let's just take a break here. So I think the dealer channel already does have credit screening. Because we have a charge-back process with the dealers, so we only buy the accounts with the credit score, et cetera. The 10-year screening or credit screening we're discussing is for the direct channel.

Exactly to your point, not -- it will be fully rolled out at the end of this year. But just so we're on the same page, you don't really -- people are allowed to non-pay for a number of months before they disconnect, so it really is almost a 6-month lag, 5-, 6-month lag from when you fully roll it out to when you see the attrition lower.

So exactly to your point, I think the benefits of -- that right now, we're mentioning it, that the credit screening of anything is probably going to slow down adds, but it's probably not helping attrition quite yet, and it will help attrition in '15 because of the customers you didn't bring in..

So in terms of kind of sequentially the pressure that you'll see on gross adds in the direct channel related to kind of enhanced credit screening, you shouldn't see tremendous kind of pressure sequentially relative to this quarter on adds because of that, but you'll see the benefit..

We're rolling it, so I -- we are phasing it between now and the end of the year. By the end of the year, it will be fully in. So it's being rolled out sequentially. So it was a little bit in this quarter, and it will continue a little bit in the fourth quarter.

That said, we're giving guidance that we expect fourth quarter adds to be higher than third quarter anyway. But by the end of fourth quarter, you'll see, right -- the full year effect will be less on the add side and you'll get the benefit of attrition in '15..

Great. And then just lastly, just on Pulse, I heard you say that, just for the small business, that the mix shift towards kind the higher-end Pulse.

Is $50 still a good number for kind of residential, just normal Pulse?.

Yes, it's still running about $50 on average. We haven't seen any meaningful moves there..

[Operator Instructions].

Our next question is from the line of Nigel Coe, Morgan Stanley..

This is Jiayan filling in for Nigel. Can you please just provide an update on your dealer fleet? I think the number you provided last year was you ended 2013 with 350 dealers? Have you been increasing dealers, recruiting more? And maybe a little bit update on the new 5-year contract with Defender Direct.

Is there any difference in terms of -- like how is it different from your contract with other dealers?.

So on the first question, Jiayan, I would say our dealer count is kind of stable. We were up, I think, 2 for the quarter, but that's on a net basis. We added a few good, high-quality dealers. We continue to weed out on the other side. So I'd say, we're pretty stable, but it's in the low 300s, not as high as 350 at this stage.

I think we're right around 335, just if I remember correctly, in that range. And as far as the new agreement with Defender. Again, it was an extension of the existing agreement. We did change some of the multiples we pay to make sure that their incentives were aligned with ours.

So they do get a little bit more, not just for Pulse, but for higher-end Pulse, to make sure that they want to drive the same products and the same mix of business that we're looking to drive internally..

And our next question is from the line of Jim Krapfel, Morningstar..

So I just wanted to get some more color on the competitive environment. Just sounds like -- or it appears that your competition really started to advertise more aggressively in the fall and winter. It may have pulled back a little bit in the spring and the summer period. I just want to hear if that's what you're seeing as well.

And then, just trying to get a sense of your share of new customer additions in the industry and how that's trended really over the last 12 months or so..

Yes. Jim, I would say it has stabilized, would probably be the best description. We did see an aggressive ramp-up in that December-January time frame. I think we've adjusted, and we have ramped up our advertising spend, even though it may not show in our dollars because we've become more efficient in other areas.

And I think the past, I'd say, quarter and a half or so, I'd characterize it as stable at this stage.

It's -- there are no good external metrics as to what's going on from a share perspective, so I kind of look at how we're performing, 250,000 gross adds in the quarter between our direct and dealer channel, again, slightly below last year still, but clearly, nice sequential improvements.

So I feel pretty good about where we are, and especially with our focus on quality growth. I'm comfortable and we'll continue to improve that, while maintaining the quality as we move forward..

Great. Lisa, that's all the time we have for today. Thanks, everybody, for joining our call. And if there's any follow-up, please feel free to give us a call here. Thank you..

Thanks very much. Ladies and gentlemen, that concludes today's conference call. You may now disconnect your lines. Have a good day. Thank you..