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

Ian Zaffino - Oppenheimer Charles Clarke - Credit Suisse Shlomo Rosenbaum - Stifel Jason Bazinet - Citi Jim Krapfel - Morningstar Brian Chin - Bank of America.

Good morning, ladies and gentlemen, and welcome to the Q1 2015 ADT Corp earnings conference call, hosted by Tim Perrott. My name is Benny, and I will be your event manager this morning. [Operator Instructions] And now, I'd like to hand over to Tim. Please go ahead..

Good morning and thank you for joining our call to discuss ADT's first quarter results for fiscal year 2015. With me on the call today are Naren Gursahaney, ADT's CEO; and Mike Geltzeiler, ADT's CFO.

Let me begin by reminding everyone 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 release, which was furnished to the SEC in an 8-K report and in our Form 10-Q for the quarter ended December 26, 2014, which we expect to file with the SEC later today.

In our first quarter 2015 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 discussion.

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

Naren?.

Thanks, Tim, and good morning, everyone. Thank you for joining our call today. I hope you had a chance to review our earnings press release we issued earlier this morning that highlights our results for the first quarter of 2015.

This morning I'll discuss our key performance highlights and accomplishments for the quarter, then Mike Geltzeiler will provide additional details on our financial and operational performance.

As you can see from our results, we've continued the trends we saw in the second half of 2014 and we are off to a strong start to the New Year, delivering another quarter of improved performance.

Solid execution of our initiatives is driving stronger financial and operational results, and the investments we continue to make in our business are positioning us for future profitable revenue growth.

All of our key customer metrics continue to move in the right direction during the quarter, as we take advantage of our industry-leading position and strong brand recognition. We remain excited about what we see in the business today and the evolution occurring in our industry that is creating even more opportunities for future growth.

I'm proud of our team's performance this quarter, while recognizing the opportunity for an even brighter future. As we review our highlights for the quarter, I think it's important to look at our performance in the context of our strategy and against the backdrop of our rapidly evolving industry.

We've made significant progress since becoming a standalone company, a little over two years ago. This progress has accelerated over the past several quarters, as we begun to benefit from the initiatives that we have pursued to enhance our operations and competitive position, resulting in improvements in our performance.

This quarter we continued to invest in growth and strengthening our leadership team, all in support of our strategy to achieve our vision for ADT, a vision that's rooted in extending our leadership position in the security, life safety and home automation markets, enhancing the values of ADT's services and executing on our initiative to drive strong returns.

A common thread running throughout every aspect of our vision is creating a superior customer experience. The results from the actions we have taken are continuing to shine through in our results, giving us confidence that we're on the right path.

As I have discussed on previous calls, I view the recent activity in our industry in two distinct areas, integrated professionally monitored security life safety and automation solutions, where ADT has traditionally focused, currently serving about 20% of household, an unmonitored or self-monitored standalone home automation solutions, where many new entrance large and small are focusing in their efforts on the remaining 80% of households.

The majority of these efforts are targeting a wide range of home automation applications with only a small portion addressing security and life safety.

While our traditional market is more competitive than it was five years ago, the environment has been relatively stable and we're continuing to win in this market, as evidenced by our improving operational and customer metrics and solid financial results.

Slide 3 shows our strong performance over the past 12 months on four key metrics that are affected by the competitive environment.

Over the past years we have driven increases in gross adds in all lines of business and in our direct and dealer channels, improved customer retention by 120 basis points, increased the average price paid by newly added customers and reduced our creation multiple or in other words the cost we incur to bring on a new customer.

I think this chart is the best evidence that we are wining in the market and our performance is accelerating.

Specifically for the first quarter, as highlighted on Slide 4, we drove double-digit gross subscriber growth with year-over-year increases in both our direct and authorized dealer channels for the first time since 2013, driven by stronger lead generation, increases in our self generated business and improved close rates.

Unit and revenue attrition continued to improve meaningfully versus prior year and sequentially, as we reduced attrition to its lowest level since we became a public company.

As a result of these improvements in gross adds and customer retention, we narrowed our net subscriber loss significantly and are focused on returning to growing net subscribers.

From a financial perspective, our improved operational performance allowed us to deliver strong recurring revenue growth, increase EBITDA margins and bottomline results on a year-over-year basis.

Because of the strong returns we drive in our business today and the many opportunities we see to generate profitable growth in the years ahead, we continue to invest in ADT's future, as shown on Slide 5.

We're investing to enhance the customer experience by implementing new technologies and processes, including the rollout of a new electronic order management platform and the deployment of our new wireless Total Security panel.

We're expanding our presence in the midsize commercial market and making investments in products and distribution to generate future growth through our health service offerings. We also added a new key leader to run our combined business in Canada and appointed a new board member from the technology sector, Chris Hylen, of Citrix Systems.

We are also continuing to invest in driving profitable growth through Pulse. Pulse continues to be an important driver behind our results, and in Q1, Pulse take rates increased, as did Pulse upgrades. As you can see on Slide 6, over 53% of our total gross adds during the quarter were Pulse units, up from 51% last quarter and 37% a year ago.

In our residential direct channel, the Pulse take rate for new and resale units was nearly 57%, up 15 percentage points over the same quarter last year, and 71% of all new residential customers added via our direct sales channel were Pulse customers.

In our small business channel, the Pulse take rate was 50%, up 14 percentage points over the first quarter of last year. In our dealer channel, the Pulse take rate ramped to 50%, from about 47% last quarter and 29% last year. In addition to new system sales of Pulse, we upgraded about 31,000 existing customers this quarter.

This is nearly double the number 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.

I'm happy with the progress we are making in our operations and with the investments that we're making in our future. Before I turn the call over to Mike, I want to share some of my thoughts on the evolving landscape in our industry and some observations from the Consumer Electronics Show that took place earlier this month.

At CES this year, the connected home and Internet of Things continued to gain significant traction. In fact, there was an entire venue dedicated to the connected home and IoT innovations, where ADT was well-represented and traffic was very robust.

The conference showcased several new technology companies, along with many of the biggest names in the consumer electronics industry, offering point solutions for the connected world and smart home. ADT's prominent presence at the event features several of our products with a primary focus on Pulse.

In fact, Pulse was recognized by Time Magazine as one of the six coolest smart home innovations at the show.

Pulse was also featured in a CES keynote address by Brian Krzanich, the CEO of Intel, who demonstrated the integration of Pulse with Intel Security's True Key multifactor authentication to provide a new level of security and convenience for users.

This jointly developed proof-of-concept was hailed by Brian, as an example of our IoT partnership can make a smart home also a safe home. At CES, we also showcased our new Total Security wireless panel for Pulse automation installations, which we rolled out last quarter and installed approximately 8,000 units during the quarter.

What I saw at CES this year, reinforce several thoughts on ADT's positioning for the future. First, much of the product innovation and many new point solutions are geared towards the 80% of the market, not reached or targeted by traditional professionally installed and monitored security and automation solutions.

The growing interest in this segment is raising the awareness of and the growth opportunity for monitored security and home automation. Second, the self-monitored smart home solutions are not necessarily creating a safe home, as notifying and seeing are not the same as monitoring.

Additionally, customers are growing weary of the large and growing numbers of apps needed to manage all the despaired devices in their home. Most customers prefer to have a single platform with an easy and unified customer experience to manage their connected home. Finally, a primary driver of consumer interest in smart home applications is security.

This was reinforced by recent research conducted by several third parties, including Lowe's and the Consumer Electronics Association. I believe ADT is well-positioned to capture additional growth in the future.

Given our large customer base, trusted brand, robust monitoring infrastructure, strong field sales and installation force, and fully developed Pulse platform, ADT is viewed as a partner of choice by many well respected companies in the industry.

I believe that ADT is in the right place at the right time, with the right platform, services and products to capitalize on this opportunity to makes homes and businesses both smart and safe. Now, let me turn things over to Mike to provide some additional details on our financial and operational performance during the quarter..

Thanks, Naren. As Naren mentioned, we're off to a strong start this year, delivering another quarter of improved financial and operational results.

The metrics that drive our business are moving in the right direction and we're continuing to invest in new growth opportunities in health and commercial security, working diligently on improving our customer's experience.

While we are committed to delivering improved financial performance as evidenced by the strong start to the year, we have an ambitious plan to invest and build on these results to create a better ADT for both our customers and shareholders.

This includes investing to improve customer experience, automating and streamlining processes, opening our platform to partners, expanding our services and distribution and integrating our Canadian business. Over the next few slides, I will review our Q1 performance and highlight our accomplishments during the quarter.

Slide 8 provides an overview of our GAAP and non-GAAP results. Recurring revenue grew 6.5%, to $825 million and accounted for 93% of our total revenue, while total revenue rose 5.7%. When adjusting for the decline in the Canadian dollar, recurring revenue was up over 7%, and total revenue increased by 6.4%.

We remain focused on growing our business to a highly profitable recurring revenue model, continuing the trends you've seen in our historical results. We continue to integrate Protectron into our results, as we recognize a full quarter of contribution in Q1.

Protectron contributed over half of the recurring revenue growth in the period, but since it currently operates at a lower margin in the ADT business, the consolidation had a dilutive impact to EBITDA margins, increased our D&A, and was neutral on EPS. EBITDA before special items for the quarter was $453 million, up 6% or $27 million over prior year.

The weak Canadian dollar diluted this growth by $1.5 million. This translated to an EBITDA margin of 51.1%, an increase of 30 basis points year-over-year. Excluding the dilutive impact of Protectron, EBITDA margin before special items increased by nearly a 100 basis points from last year.

Year-over-year recurring revenue growth combined with our cost efficiency initiatives drove the increase in our margins. Cost to serve was up 6%, due primarily to the consolidation of Protectron.

However, without Protectron, cost to serve expenses were flat with last year, despite a higher mix of Pulse subscribers, additional investments in customer experience and launching our commercial business. GAAP EPS was $0.41 a share, which includes special items and a tax rate in the quarter of 33.3%.

Excluding special items, non-GAAP diluted EPS was $0.51, up 19% from Q1 2014. Using our Q1 cash tax rate of 4.6%, our earnings per share before special items was $0.73 for the quarter, up 11% over last year. The chart also details the special items for the quarter.

In Q1, we accelerated the conversion of 2G radio customers, successfully converting 113,000 customers, a portion of which we were able to upsell to ADT Pulse. We also incurred a minor level of integration expenses related to Protectron acquisition as well as some restructuring charges.

Activities to integrate Protectron will accelerate following the recent appointment of the new President for our combined Canadian operations. Our 2G conversion program will continue through 2016. We are comfortably ahead of plan and are opportunistically balancing this program against resource availability and customer demand.

Turning to the operating levers. Slide 9 shows strong gross add growth and increases in average revenue per unit for Q1 versus the prior year. Total company gross adds increased over 13% year-over-year, driven by improved performance in our direct and dealer channels as well as across our residential business and health units.

Gross adds in our direct channel were up 10%, marking the first time we've experienced year-over-year growth since 2013. The increase in gross additions was due to stronger lead generation, higher closed rates and greater self-generated sales. Protectron counted for about 20% of the growth rate in direct channel.

New subscriber growth was accomplished despite the headwinds caused by our fully implemented enhanced credit screening procedures, which management estimates filtered out about 4,000 potential sales.

We expect this enhanced process to improve future attrition by filtering credit challenge customers into different payment plans, which allows us to focus on profitable growth.

Gross adds in our dealer channel rose 19% from last year as we experienced higher sales from existing dealers, added some new dealers and benefited from the dealer volume production of Protectron. Returning dealer volumes to growth was a 2014 priority, which we accomplished in Q4.

We are very pleased with our partners delivering a 100,000 customer adds for Q1, a 16,000 increase over Q1 2014. Our ability to grow ARPU shows that pricing remains healthy in our business.

Our continued investment at ADT Pulse, combined with incremental service offerings like small business bundles and hosted video, have helped drive higher revenue per user. For the quarter, new and resale ARPU was $47.28, an increase of 5% over the prior year. And ARPU for our overall customer base was $41.76, an increase of 2% year-over-year.

As a reminder, Protectron generates lower ARPU than our traditional base in the U.S., which diluted the overall year-over-year growth figure as did the weaker Canadian dollar. Excluding Protectron, ARPU rose 4% over last year.

Over the course of the last year, we launched a number of initiative designed to improve the customer experience and increase customer retention. Our results on Slide 10 show that these initiatives are paying off, as we improve attrition for the third consecutive quarter and reduce it to its lowest level since becoming a public company.

Q1 trailing 12-month net revenue attrition was 13.0%, a sequential improvement of 50 basis points and a significant reduction of 120 basis points versus Q1 prior year.

Unit attrition, which measures customer attrition for just our residential and business customers was 12.9% for the quarter, a 30 basis point improvement versus Q4 and 70 basis points lower than last year.

Our focus on enhancing the customer experience, reducing non-pay disconnections, and increasing re-sales, coupled with stable existing home sales contributed to the lower attrition.

The key to driving higher recurring revenues is increasing average revenue per customer through new offerings, greater automation and price escalations, all of which we are executing well, as well as growing the subscriber base. For the past two years, we have grown our subscriber base primarily as a result of M&A.

Organically, we reported a net subscriber loss of over 100,000 customers in 2014. As we progress our dual goals of growing gross adds and lowering attrition, we are positioning the company towards its ultimate objective of organic net subscriber growth. In the first quarter, we reported a decline in our customer base of 8,000 subscribers.

However, this compares favorably to Q1 2014 when we lost 48,000 customers. This is a major step forward and bodes well for future revenue growth. Slide 11 shows recurring revenue margin and SAC. For the quarter, recurring revenue margin on our existing customer base was 66.4%, up 10 basis points versus prior year.

Current quarter included investments in our commercial expansion in health business, the dilutive effect of consolidating Protectron, and inefficiency from the Tyco separation. Excluding Protectron, recurring revenue margins would have been 67%, an increase of 70 basis points.

As I mentioned earlier, cost to serve expenses flat with last year on higher revenues. We continue to make progress in driving down customer acquisition cost and lowering our overall net creation multiple, despite higher Pulse take rates, which require a larger upfront investment.

Excluding the impact of Pulse upgrades, a combined net creation multiple improved by 0.7x to 31.7x in Q1. While the net creation multiple in our direct channel fell to 31.9x, a 2.1x improvement from last year.

As a reminder, the first quarter has historically been our highest level of SAC, mostly due to absorption issues and it's our lower quarter in volumes.

Average net SAC, excluding upgrades for our direct channel was about 1,500 hours per unit, which was actually below the same figure last year despite the increased sales of more expensive Pulse and automation units. This is possible because of productivity improvements, marketing savings and hardware efficiencies.

In the quarter, we began deploying our new Total Security panel for new Pulse automation customers, continued our implementation of electronic contracts, and delivered on our cost efficiency program. ADT business has now rolled out e-contract nationally and resi will do the same in February.

As mentioned earlier, we are investing in our business, in customer growth, Pulse, commercial expansion, health, and customer experience, all in order to build a stronger and more profitable subscriber base. On Slide 12, we detailed the components of free cash flow for the quarter.

Cash flow from operations before special items was up 14% from last year to $390 million. The increase in operating cash flow was driven by past investments, our improved financial and operational performance in the quarter and improvements in working capital management.

This 14% growth is despite a $25 million year-over-year increase in cash interest expense, a large portion of which rose from debt issued to buyback our shares. While the interest burden at higher debt levels impact free cash flow, the company's cash flows are benefited by 27% fewer shares outstanding.

Capital expenditures before special items for the quarter were $344 million, up from $274 million last year, of which 94% of the CapEx invested during the quarter was used for driving increases in new subscriber adds, including increases in Pulse customers and upgrades.

Direct channel subscriber CapEx increased by 13%, reflecting a 10% increase in gross adds, higher Pulse penetration and Pulse upgrades increasing from 17,000 to 31,000 year-over-year. Our dealer channel saw CapEx increase by 33% attributed to a 19% increase in gross adds, the inclusion of Protectron and significantly higher Pulse take rates.

Factoring all of this, including the investment in new subscribers, free cash flow before special items for the quarter was $46 million. And as shown at the bottom of the chart, the improvement in the drivers of our business has led to stronger pre-SAC EBITDA, resulting in steady-state free cash flow, increasing 14% to $893 million.

With returns on invested capital in the teens on our subscriber investments, investing in growth makes sense for the business and our shareholders. New customers are generating higher ARPU, and we believe it will stay with us longer, generating higher future cash flows.

Some of this investment is transitional, such as higher Pulse take rates and Pulse upgrades. These will stabilize the decline over the next few years, resulting in a sizeable improvement in free cash flows. Slide 13 highlights our capital allocation and debt levels for the quarter.

On a pro forma basis reflecting a full year for Protectron, leverage was 2.9x at quarter end. Q1 is a historically low cash flow period and we repurchased 94 million of our shares during the quarter. The company raised $300 million of debt in the quarter, enabling us to pay down a portion of our revolving line of credit.

Total debt increased by $158 million from yearend. Overall, the company's total cost to borrowings was below 4% for the quarter, giving us the flexibility to invest in our business and customer growth, which continues to be the best use of capital for ADT.

In Q1 we paid a quarterly dividend of $0.20 per share, a 60% increase over last year and announced a 5% increase to our quarterly dividend effective with our next payment.

We continue to be opportunistic when buying back shares and repurchased 2.9 million shares at an average price of $32.35 during the quarter, bringing the average diluted share count to 175 million. We have approximately $286 million remaining under share buyback authorization and we remain opportunistic when evaluating future buybacks.

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

Thanks, Mike. Over the past year, there have been a lot of questions about ADT's ability to compete against a variety of new companies, who have shown interest in the residential security and automation market.

Over the past several quarters you were seeing the value of the tremendous assets and capabilities ADT has developed over its 140-year history as a leader in the security industry, and a renewed energy and focus, since we became independent company.

We're excited about our strong start to the year and the progress we are making in achieving our goals for 2015. As shown on Slide 14, we're making solid progress towards achieving our goal for the coming year, with both our financial and operational results tracking well to our previously issued guidance.

Rest assured that we are not resting on our laurels, as we understand we need to continue to raise the bar and accelerate our efforts to innovate, grow, become more efficient and most importantly enhance the customer experience every day.

Our entire leadership team is excited about the challenges and the opportunities that we see in this incredibly dynamic market. And I remain confident our best days are still ahead of us. With that, we'll open up for questions. Benny, can you remind the call participants, how they can ask a question..

[Operator Instructions] Your first question comes from Ian Zaffino from Oppenheimer..

Wanted to just kind of drill down a little bit on the reduction in the net customer losses.

When do you see a crossing over to net customer gains? What's the path to get there? Is it going to come from ongoing churn reduction? Is it going to come from an increase in gross additions? How do you think about that and where should our expectations be?.

our continued drive to increase gross adds in all of our channels and all of our lines of business; and two, is to continue to drive improvements in unit and revenue attrition, but this will clearly be more tied to the unit attrition.

I hesitate to pick a specific quarter, because you do get seasonality both on the gross add side as well on the disconnect side. So all I will say is that we're continuing to drive towards that. As you saw in the first quarter, we've narrowed that gap dramatically.

And I think the trends in both gross adds and in unit attrition are very favorable and I feel confident we're going to continue to move in the right direction there..

Maybe I could add one thing as well. I think what's amazing about what we reported this quarter is its all organic. If you look at many people on our states, we clearly can close the gap with bulk purchases and there are tuck-in acquisitions as well. So I think those could be in our future. Again, we've been very careful at evaluating bulk purchases.

Some of those do result in future attrition. But I think to be able to sort of get that balance organically, which is our goal, I think would be industry-leading..

And then just a follow-up question. There is actually some talk about cooperation with you guys in an Internet company.

Could you give us maybe an idea of what type of shape that would come in or maybe what advantages you offer that an Internet company doesn't have that they would need you for cooperation or need your cooperation? Just so if you could kind of frame that a little bit for us, that would be helpful..

Clearly, we wouldn't comment on any specifics rumors. Again, I go back to what ADT brings to the table in security and the automation space now. One is an incredibly strong brand, well-recognized, well-trusted brand, the monitoring infrastructure that we bring.

Again, going back to all of the interest in this space, much of it is driven by the need or desire for more security and that monitoring is critical. Our field force of sales representatives as well as install complemented with our telesales operations.

And finally I think the Pulse platform that we've developed and continue to build out are the reasons why people are coming to us and interested. And I think the big change over the past couple of years is our willingness to open up that platform and integrate other partners into that platform..

Next question comes from Charles Clarke from Credit Suisse..

Just a quick question on capital allocation and then a follow-up on attrition. I know you guys have previously stated that 3x was your leverage target.

How would you guys describe the outlook for capital allocation given that you reached around 2.9x today? Would you guys feel comfortable going above that for a deal? Where do you think you could take the company, within the context of your current credit rating?.

Sure, I'll handle that. I mean, our long-term policy and goal is 3x. As you properly stated, we're getting closer to that number, we have not exceeded that time. We are absolutely committed to retaining a BB rating, and I think the cash flows we generate and the growth in EBITDA give us sufficient capital to do the things we need to do.

So at this stage, we're sticking with that policy and those targets. And I think we definitely have flexibility, but I think right now we're very comfortable, we have enough cash to sort of invest in the business and do the things we want..

And then I was just wondering if you could give us just an update. Obviously, every quarter you guys get more data on attrition.

How much better is the Pulse attrition than the attrition in the traditional accounts? And what percentage is Pulse today? And where do you guys think that will be a year from now within your total subscriber base? And what impact do you think that may have on attrition?.

Well, again, Charlie, remember we're four years into Pulse versus what we know on our traditional is, many, many years of those life incur. So I hesitate to draw any firm conclusions at this stage.

I think we can clearly say that in aggregates Pulse customer retention is better than what we see on traditional and that's specifically true as we get into the automation side. We just see better engagement of those customers and what they use.

So we're continuing to focus not just on driving Pulse, but driving more Pulse customers up to that high end. Its still represents less than 20% of our base today, despite all the work we've done both on new adds where we're seeing great traction and even with the upgrades.

So I still think there is plenty of incremental opportunity and we're going to continue to be aggressive both on gross adds and in driving Pulse upgrades to the base..

And we have visibility now past the contract period, so we have more than 36 months of visibility. We'll continue to update the chart we did at the Investor Day at our next Investor Day as well, and dive into that in a little bit more detail.

But the trends continue to show, as Naren said, on average, Pulse customers are staying longer than non-Pulse customers..

Next question comes from Shlomo Rosenbaum from Stifel..

Mike, you touched a little bit about the seasonality and SAC costs. I wanted to ask you to explore that a little bit more because year-over-year the SAC accretion multiples are down, but sequentially they are up.

And if you could just talk to us a little bit about the reasons why they are up and why you think that seasonality versus a change in the trend, I'd appreciate that..

Look, the first quarter last year was not a strong quarter for SAC, but what we did indicate was it was also our lowest quarter for volumes and there is an absorption issue in our business, where we take the cost and the organization that focuses on installing systems, that is part of SAC, so it's not up to a variable cost that's being allocated.

So I think we have guided for SAC creation multiple, I should say, to be down for the year. We're down significantly in this quarter. Yes, that we had a nice ride last year, where sequentially we continue to improve, but if you look at the results sequentially adds improved as the year went on as well.

So going from the fourth quarter to the first quarter, this is probably the one metric that sequentially this metric get adds. You can't really compare as well fourth quarter to first quarter, but I think the key with SAC is we're really just scratching the surface on our SAC productivity initiatives.

We talked about rolling out the TS panel, we only rolled at 8,000 of our 260,000 adds this quarter, were on TS. That's going to accelerate and that as we identified as labor savings. I talked about the e-contracts. We really just started to roll out into small biz or into biz and now it's being rolled out in the second quarter into resi as well.

There is efficiencies there. We have other hardware and peripheral savings too. So the initiatives that we have on track had some benefit in the first quarter. I think we'll have bigger benefit as the year goes on.

And I think we feel that with the seasonality and all this stuff we're off to a good start and feel good about our guidance that we can bring this down for the year..

So what in specific would you say is the biggest factor in seasonality that makes a difference like 4Q to 1Q?.

It's just the number of gross adds we put in, which is driven by one market driven. I mean, you tend to have more gross adds during the summer months, during the moving season, in our fiscal fourth quarter. And then, you get into the first quarter, it tends to be less moving activity.

And then, two is, we actually have just fewer workdays because of the holidays with both Thanksgiving and Christmas..

To give you an idea, we don't spend materially more in marketing in the fourth quarter than we do in the first quarter. If you divide that marketing spend over the volume, it's a higher amount per add. So there is some fixed cost divided by --.

And I have a couple of few more if you don't mind. Just a commentary that you had in the earnings releases that the new subscribes are getting like a mid-teens return on invested capital.

I would have thought with the Pulse being such a high percentage of the total now and that would have been a higher number than that, maybe high-teens, because you're mixing in just a better return on capital subscriber in there.

Can you comment on that exactly, how we should think of that?.

That phraseology wasn't designed to be so precise. So I think as we've shown in the past, whether it'd be an add we get from a dealer or a direct, business, there's a different return on all of them. I mean, we're referring back to kind of on average, it's in the teens. I think you are on the right track.

I think as Naren said, we are trying to stay grounded here, but if Pulse indeed does help customers that on average stay with us seven years move out to an eighth and ninth year, those returns would be probably in the 20s.

So we are not ready to call that yet, but we are comfortable to say that kind of using historic customer lives and customer experience coupled with what we're investing and what it costs us to system monitor and on average kind of consolidating the business, the mid-teens was the expression I use..

And again, I think that's something in the Investor Day, we'll probably provide more detail on the various sources of customer adds, but you're absolutely correct, if attrition curves do turn out to be better for Pulse customers that return will increase..

Then just a couple of more. Last year was a very tough quarter, because of competition in the national advertising market. You had a much better gross add quarter. Was that in the face of increased advertising from competitors as well as far as you can tell or was that in the absence of the competitors advertising the way that they did last year..

I would say, Shlomo, it's been very consistent over the past few quarters. So it wasn't at the level that we saw last year in the first quarter, but I'd say consistent with what we've seen two, three and four, and that's why my comment was the competitive environment had been relatively stable..

And then just lastly, just can you comment if there is a big deal for you guys in terms of integrating with large Internet company and it can clearly open you up to, I'd say, more of the 80%.

How helpful would a deal like that be if it's not exclusive to ADT, that just ADT is maybe an icebreaker?.

Again, it's hard to kind of comment generically. We'll look at any partnership opportunity as to what we think we bring to the partnership, what we think they bring to the partnership and does it create value for our shareholders..

Very good. Thank you very much and I'm seeing some things move in the right direction here..

As Shlomo leaves the call, just one last point, I'm thinking about on SAC. I mean, we don't want to make over highlight this, but even with Protectron, the SAC in Canada is higher than the SAC in the U.S., the creation multiples as well, so we have a little bit of mix issue there too.

When we look at overall SAC, we are comparing kind of the consolidated business with Protectron against last year where we didn't have Protectron. It's not a material difference, but it is a little bit higher in Canada, but also their customers stay longer and they have lower attrition..

Next question comes from Jason Bazinet from Citi..

I just have two questions, one high level and one housekeeping.

At a high level, does your firm have a hypothesis for how this 80% of households that don't get home security will ultimately trend? I mean is your expectation that the adoption rate goes up in home security? Is that sort of the default assumption as you think about how to go after that market?.

Yes. I will give you my observations rather than in the form of a hypothesis. But Jason, I think what we are hearing from those customers is, and it's through surveys, it's through our own research with intenders is there is a strong interest in security. Yes.

They want better protection where the resistance is on long-term contracts and potentially very high monthly rate. So I think as we look at it, it would require potentially a different business model or some different economics for those customers in order to bring them into the category or a much stronger value proposition.

Clearly, Pulse we think because of home automation and security brings a much higher value proposition, but its still has a pretty high upfront cost, and we still as an industry require multiyear contracts.

So I think the demand and desire/need for security is very high and I referenced a couple of those studies, and believe it was the Lowe's one that was over 60%, so the primary driver for getting a home automation solution was security..

And then on the housekeeping side, you mentioned I think $1,500 of SAC across all channels in the quarter, which is the same number I get, but I think you also mentioned that it was down and I had it up about mid-single digit year-over-year. I just wanted to clarify that..

The direct SAC, excluding upgrades, just direct was $1,500 this year and last year it was $1,510 -- it was $1,503 this year and it went to $1,515. So what we're saying is forget about creation multiples.

The absolute cost to get a new subscriber was lower this year than last year, despite the fact we're putting more expensive and better systems in people's home and they are paying us higher ARPU..

But across all channels, SAC went up?.

Across all channels, it was still up, but it was up because the dealer was up and the dealer in particular had a much higher growth than the Pulse take rates..

Next question comes from Jeffrey Kessler from Imperial Capital..

There's a lot of debate as to what the ultimate ceiling on ARPU can be for companies in this business, but there is no I think debate on customer lives going out one or two or three years.

So what I'm asking you is what investments are you making in the critical monitoring signaling dispatch and to get the customer experience to a point at which they are going to stay that extra one to two to three years, then that we see the attrition, the off-contract attrition spikes begin to go down definitively that you can talk about it, perhaps this time next year, you'll be able to show us charts of Pulse versus traditional, but what I'm interested specifically in is what investments are you making in getting that customer experience on the service end to get out that extra two or three years?.

Jeff, I guess, again, I go back to the pieces of attrition that we believe we can influence. There's always going to be people moving from one household to the next, so we're always going to have disconnects tied to relocations.

As we've discussed in the past, our goal is to recapture the house through re-sales and recapture that customer by doing a better job of following and I think we are making good progress there, but that doesn't necessarily impact the gross disconnect piece. The areas we can control is the voluntary and the non-pay.

On the non-pay side, clearly driving the incremental screening that we're doing will result in better quality customers who will stay with us longer and then continuing to drive and we're at a very high percentage of our new customers coming on auto-pay or some type of easy pay solution there. So then it really comes down to the voluntary.

And we've got two paths that we're pursuing aggressively on that.

One is driving the Pulse upgrades, because as we talked about on this call and in the past, Pulse has better retention characteristics, because customers are more engaged with their system, using it more frequently, and that's why we're pursuing both new Pulse customers as well as upgrades.

And the other one is just continuing to improve our service levels. It's not as much on the monitoring side. I think when you look at our monitoring and response levels, they are very good.

The percentage of calls, the speed at which we answer the calls, our ability to work through the call list or dispatch immediately in life safety, it's more on the service side making sure that we're staffed appropriately in our call centers, that we are driving more customer self-service on myADT.com.

So it's a whole portfolio of programs that we're driving. And a piece of that is just the cultural transformation, and since we've been an independent company, we've been driving this mindset around customer obsessions and the metrics around customer obsessions, and driving more recognition and reward around delivering that great customer experience.

So again, I don't know that I can sit here and say, what the end game looks like, because some of those other pieces are a little bit out of our control. But we still feel like we've got room ahead of us and we're going to continue to drive it aggressively..

Second question on what I'll call IT IQ at ADT, relative to its competition. Just quickly, what are you -- how is Chris Hylen has been hired? It looks like it's a really interesting hire.

Can you talk about how he fits into the puzzle of you driving a better customer experience with what you're putting out, but also how you relate to your technology partners that you've been signing up?.

I mean, Chris was just recently announced he was going to joining our board. He has not attended his first ADT Board meeting yet. So I don't want to speculate too much. But that was based on, as a board we decided that we wanted to have more tech-savvy capabilities. We think we're very good today.

The opportunity to bring in someone like Chris, allows us to just raise the bar. And again, I think it's just an indication of where we think the future is for our business..

Finally, can you talk about how are you going to position Total Pulse within your current product offerings? You've got level I, level II, level III so far and you've got Total Pulse.

Is that going to be positioned in a specific niche for a while before it displaces one of your offerings or is this going to be more of an evolution of how you present the product to your customers?.

Just to be clear, Jeff, Pulse is going to continue to have level I, which is the remote arm and disarm; level II, which allows you to manage home automation, door locks, thermostats, et cetera, in the home; and then level III, includes video.

TS is not a different level, this is just the panel platform, the panel product that we use in order to deliver those services. Our initial rollout is using the TS platform for the level II and level III for the automation packages within Pulse..

And it's worth mentioning, Jeff, I mean we throw out the Pulse take rate stat, but that's for new and resale. Of new customer that we sell, 71% bought Pulse. And the reason we still need to offer non-Pulse is that there are some people who don't have smartphones. Without smartphone you really can't use Pulse. But we are certainly promoting Pulse..

Benny, I think we have time maybe for one more question..

Next question comes from Jim Krapfel from Morningstar..

I was hoping you could quantify the subscriber acquisition cost for a Pulse customer versus a non-Pulse customer? And to what extent do you expect the new ADT Pulse keypad and panel and other initiatives to be able to drive Pulse SAC down?.

What was the second question?.

The cost impact, SAC impact on TS..

I mean, generally speaking, we don't throw out, we already have so many SAC numbers going out there. So it's fair to say in the 20% to 25% range higher would be a Pulse customer on average. And of course, the more someone has Tier 3 with the video, both the equipment and labor costs are a little higher, but so is the ARPU.

So the creation multiple isn't that much different, as you go up the level, but the total SAC is. So with regard to TS, I think we're just scratching the surface. As we've talked in the past, it's north of two hour labor saving and a little more than $100 saving on the installation.

This quarter we rolled out 8,000 of our panels, and then there is the potential. Nice thing about TS, it's a standalone box and when people do leave us, we will be getting the boxes back. So there is a possibility of getting some contra-SAC as well, recovering some of the equipment, which today we don't generally do when we lose a customer.

So that's a benefit that's not reflected in our numbers, but it's something, hopefully we don't lose these customers who are putting TS in, but it's something down the road that could also help the cost position..

And then the second question was just looking out maybe five years from now, curious to hear your thoughts about the ultimate size of the midsize business opportunity for you.

And businesses of greater than 7,500 square feet, do you think that will be a larger revenue source for you than the small businesses currently?.

Again, we were limited at that 7,500 square feet between expanding beyond the 7,500 square feet and pursuing that midsize commercial. From a total addressable market, we believe it's 3x to 4x what we were able to serve prior to the expiration of that non-compete.

Again, it does require, especially as you get into that midsize commercial, some different capabilities from the service side as well as some different products and we're in the process of building that out. But again I think from a market size perspective, it's about 3 to 4 times what we were serving prior to that..

And then just in terms of your ability to actually penetrate that market, do you think as far as the revenue will --.

Yes, I think we feel very good. Again, we're only 90 days or now maybe 120 days into that effort. I think the market response has been very favorable. The ADT brand name continues to be well-known in that space, because of ADT having been in that space before when we were part of the combined business. So we are well-recognized, well-received.

I think we just want to make sure that we are very measured in our pursuit of that market to make sure we've got the capabilities and the products to deliver there. Last thing we want to do is tarnish our brand in any way by not being able to deliver on the commitments we make to our customers. So this is a very measured roll-out.

But clearly over time as we build out our capabilities, I think we're in roughly 12 markets today, just north of 30 or so of our branch offices and we're still in the relatively early stages..

Benny, I think we actually have time for just one more question, and this will be our final question..

Your last question comes from Brian Chin from Bank of America..

Just had a quick question, I know we're running out of time here.

I just wanted to see if there is any update on the competition that you guys are seeing from the telcos? And I guess you talked a little bit about the Internet companies, but just the competition you're seeing from the cable companies and the AT&Ts on the monitored side?.

Yes, Brian, again, my comment earlier was I think the credit environment in that professionally installed, professionally monitored space has been relatively stable. Again, I'd say market-by-market some are up, some are down, but in aggregate I think it's been pretty stable..

And do I have time for a quick follow-up then?.

Sure..

I know you were talking before about you have like a target of about 3x leverage or BBs, but which one is like the one that's more important to you guys? So for example, I don't know if you are or not, but if you're having conversation with the rating agencies and you can keep your BBBBs at 3.5x, how would you guys think about not just acquisitions, but like share repurchases to do that?.

I'll answer it this way. Obviously, we have regular dialogues with the three agencies. We are committed to the BB. Some of them have issued reports that certainly allow our leverage to go above where we're at today. I think it's important to know our 3x is not a cap, it's our long-term policy.

If for some reason we went above 3x for the right strategic reasons, we would lever ourselves back down to 3x, because 3x is our goal. And I think the bondholders are important constituents of ours as well.

So I think it's the BB commitment that we're most focused on, and our financial policy isn't changing and 3x is what we think the appropriate target leverage for this firm..

And so just to be clear, so you're saying that for an acquisition target, you guys would be flexible in going above the 3x. But it sounds like from a share repurchase it's more just opportunistic and you're not --.

Probably a fair way to look at it. End of Q&A.

Great, Benny. Thanks so much. That's all the time we have for our call today. And thanks everyone for joining..

Thank you. Ladies and gentlemen, that concludes the call for today. You may now disconnect..