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

Jason Boisvert Bazinet - Citigroup Global Markets, Inc. (Broker) Ian A. Zaffino - Oppenheimer & Co., Inc. (Broker) Jeffrey Ted Kessler - Imperial Capital LLC Adam Parrington - Stifel, Nicolaus & Co., Inc. Ronnie Weiss - Credit Suisse Securities (USA) LLC (Broker) Jeffrey T. Sprague - Vertical Research Partners LLC Jane Zhao - Morgan Stanley & Co. LLC.

Good day, ladies and gentlemen, and welcome to The ADT Corp. Fourth Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now turn the call over to your host Tim Perrott. Please go ahead..

Thank you, Stephanie, and good morning and thank you for joining us for our call to discuss ADT's fourth quarter and full year 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 earnings release, which is furnished to the SEC in an 8-K report, and in our Form 10-K for the year ended September 25, 2015, which we expect to file with the SEC later this week.

In our fourth quarter and full year 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 call.

For those of you following us 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 financial measures. Now, I'd like to turn the call over to Naren.

Naren?.

one, bringing on the right customer; two, onboarding them in the right way; and three, providing them a great customer experience. Doing these three things right is the key to further reductions in attrition. And the right formula for improving customer economics and generating higher free cash flow.

We made much progress over the past two years in improving in these areas, which is why we have seen the significant improvements in retention and net add performance. However, with new tools and analytics now at our disposal, giving us better insights into customer behavior and tendencies, we will make further improvements in the future.

We started last year with enhanced tenure screening to target higher-quality customers up front, before we spend money to add them into our network. This effort alone has filtered out nearly 16,000 potential customer adds in a year, and has contributed to a significant drop in attrition in the non-pay category.

With the additional insights into customer behavior and the new tools such as our electronic order management platform, we are continuing to refine our approach and putting in place new customer requirements that will result in more engaged and longer tenured customers. Improving the customer experience is at the core of our strategy.

And Pulse customers continue to exhibit better economics and retention. On slide number 9, you can see that over 59% of our total gross adds during the quarter were Pulse units up from 51% a year ago.

In our residential direct channel, the Pulse take rate for new and resale unit was 65% while more than 75% of all new residential customers added via this channel were Pulse customers. In our dealer channel, the pulse take rate ramped up to 57% from about 47% last year. And in our small business channel, the Pulse take rate was 41%.

In addition to new Pulse sales we also upgraded about 39,000 existing customers this quarter. Pulse upgrades allow us to provide additional service to our existing customers and yield higher ARPU. In addition, these upgrades allow us to enhance the customer experience and enter into new contracts.

We now have approximately 1.5 million Pulse customers with total interactive customers now comprising about 23% of our customer base. As we discussed during our Investor Day, Pulse customers continue to demonstrate better retention characteristics than traditional security customers.

Our analysis also shows that retention further improves when customers use automation features such as thermostat, light switches, door locks and cameras.

Equally as important, our initial data also shows that the resale rate, the rate at which we sign up a new customer who moves into a home where Pulse automation is already installed is higher as compared to non-Pulse customers.

Now, let me turn things over to Mike to provide some additional details on our financial and operational performance for the quarter and year..

Thanks, Naren. 2015 was a transitional year for ADT in which we improved both our operational and financial performance, positioning the company for future growth and increased profitability. In our core operations, this means a disciplined, more acute focus on customer economics and return on invested capital.

Hence, the term smart growth, quality growth and profitable growth, describing our business objectives.

As Naren said, by enhancing the customer experience and using data analytics to drive our customer acquisition practices, we believe we can attract the right customers with the right offering at the appropriate SAC and ensure that these customers remain with us longer.

This approach does put some top-line pressure on gross add growth, but pays dividends and customer retention, lower SAC, higher margins, and increased free cash flow. As we look ahead to 2016, we expect more of the same. I will discuss 2016 guidance later in my remarks. First, I'll review our Q4 and full year performance.

Slide 10 summarizes our GAAP and non-GAAP financial results for the quarter. In Q4, recurring revenue, which accounts for approximately 93% of our total revenue, grew 2% to $835 million and total revenue increased by 1.8% to $899 million.

Recurring revenue growth outpaced total revenue growth as we continue to add different products and services to our portfolio that generate recurring revenue in place of lower margin onetime sales. For example, late in 2014, our business channel began to offer hosted video services that generate recurring revenue in place of onetime DVRs sales.

All this being said, in 2016, we will have the opportunity to grow non-recurring revenue as our commercial channel continues to gain traction, and we broaden our service capabilities and product offerings when adjusting for the Canadian dollar, which impacts approximately 10% of our total revenues and has declined significantly versus prior year.

Recurring revenue is up 3.4%, and total revenue increased by 3.3%. In Q4, reported operating expenses before special items were up 3.9% over last year including a 5% increase in depreciation and amortization.

Excluding the $8 million impact to the marketing efficiency program, total operating expenses before special items were up just 2.7% in the quarter.

Besides depreciation, the increase in total expenses was driven by the growth of Pulse, investments in our commercial expansion and development of our new Pulse app and all-in-one DIY product, as well as investments we have made to improve our service levels.

EBITDA before special items was $460 million, which includes a negative impact of approximately $8 million related to the previously disclosed change in the way we account for our marketing efficiency program, as well as a negative impact of approximately $5 million due to the decline of Canadian dollar.

Adjusting for these two items, EBITDA was $15 million favorable in prior year. EBITDA margin for the quarter was 51.2%, a 100 basis point improvement from Q3. The improvement reflects continued execution of our cost efficiency program.

Excluding special items, non-GAAP diluted EPS was $0.51, which includes the impact of $0.03 per share related to the prior-mentioned marketing efficiency program. This compares to non-GAAP diluted EPS of $0.55 per share last year. Using our Q4 cash tax rate, diluted earnings per share before special items was $0.73 for the quarter.

Our effective tax rate was 30.8% compared with 24.8% last year. Slide 10 also details our special items for the quarter. In Q4, we continue to make progress on our 2G radio conversion program, upgrading or converting nearly 3,000 customers in the quarter for a total of approximately 276,000 for the year.

We have made significant progress since the start of this project and have about 500,000 customers left, we either need to upgrade or convert to a new radio. We plan to complete most of these conversions in fiscal 2016 and finalize the program in our first quarter of fiscal 2017. Turning to the operating levers.

Slide 11 shows gross add and average revenue per unit for Q4. Overall, total company gross add, excluding bulk acquisitions, were 278,000, the highest level of 2015 but flat versus last year.

Our company's focus on quality growth, combined with enhanced tenure screening, created some slight headwinds to overall year-over-year growth but resulted in better financial results. Gross adds in our direct channel were up slightly, offset by dealer gross addition which were nearly flat to last year.

Gross adds for ADT business were up 17% and health adds were higher by 27%. Pricing continues to be an area of strength, as both average and new and resale ARPU continued to grow in the fourth quarter.

Overall, pricing remains healthy in our business as we continue to drive higher Pulse take rates with greater automation, and grow our business channel, which has a higher ARPU. For the quarter, new and resale ARPU was $48.40, an increase of 3.4% over the prior year.

Our ARPU for the overall customer base was $42.65, an increase of nearly 3% year-over-year. When adjusting for the Canadian FX, ARPU was up by 4% over last year. As I indicated earlier, the company is committed to pursuing possible growth and enhancing customer experience, which leads to greater customer retention and loyalty.

Slide 12 shows the progress we made and our customer retention. Attrition has improved for six consecutive quarters reaching a new low in Q4. Net revenue attrition was 12.2%, sequential improvement of 20 basis points and a significant reduction of 130 basis points versus last year.

Unit attrition which measures customer attrition for just our residential and business customers was also 12.2% for the quarter, a 10-basis-point improvement versus Q3 and 100 basis points lower than last year.

Improvements are led by the progress we made in gross attrition throughout 2015 as we reduced non-pay, voluntary and loss to competition disconnections, combined with a 21% year-over-year increase in resale.

Relocations skewed higher this quarter as the housing market improved but this is more than offset by attrition improvement elsewhere and by the higher resale. We are pleased with the progress we made this year as our attrition results are materially favorable to both our guidance and prior year results.

However, we see ample opportunity to perform better and are targeting further improvement in 2016. Slide 13 shows our quarterly results for recurring revenue margin and SAC creation multiples. For the quarter, recurring revenue margin on our existing customer base was about 66.6% compared to 67.5% last year.

Although recurring revenue margin is down versus last year, it increased sequentially by 70 basis points in Q4. Margins throughout the year have been pressured by our investments to expand into commercial, development of our new Pulse app and costs associated with the launch of our all-in-one DIY product.

Additionally, increased spending to improve customer service levels and response times have negatively impacted margins that contributed to improvements in customer experience and attrition. SAC is another favorable story for 2015.

We have consistently lowered SAC in 2015 through marketing efficiencies, sales effectiveness and the installation processes by implementing electronic contracts, total security panel and lower cost equipment.

Our combined net creation multiple improved by 0.8 times to 29.8 times in Q4 while the net creation multiple in our direct channel fell to 29.1 times, a onetime improvement versus the last year. Net SAC in our direct channel fell to nearly $1,400, below the average SAC levels in Q4 2014.

We have lowered both total and direct channel creation multiples, excluding upgrade in every quarter this year while also increasing Pulse take rates. Slide 14 details the components of our fourth quarter free cash flow results.

The chart segregates cash flow into cash generated from existing customers and cash invested to secure a new or upgrade existing customers. Free cash flow before special items was $77 million in Q4, up $23 million or 43% versus last year.

This is the second consecutive quarter of free cash flow growth, enabling us to finish 2015 with free cash flow before special items of $321 million, which is about 30% higher than the 2015 figure we base-lined at our Investor Day in May.

Pre-SAC free cash flow before special items was driven by lower attrition, operational improvements and growth in Pulse customers. For the quarter, pre-SAC free cash flow before special items increased by 5.6% to $510 million, up $27 million from last year.

Investing in new customer growth is the main driver behind our ability to generate future free cash flow. And our quality growth initiatives enable us to focus on the customers, which we feel are most likely to meet our return criteria. Total SAC before special items for the quarter was $433 million, marginally above the $429 million in Q4 last year.

For the year, free cash flow from our existing customers increased $116 million to almost $2 billion. This was partially offset by a $1.7 billion investment in new customers. This investment represents an increase of about 8%, driven by a 6% growth in gross adds, and about 50,000 more Pulse upgrades.

Slide 15 highlights the improvements we made in our steady-state free cash flow results over last year. Steady-state free cash flow is a long-term valuation metric, which allows us to measure the free cash flow generated by maintaining the recurring revenue from our existing customer base before investing in new subscriber growth.

The key drivers to this metric, pre-SAC EBITDA, SAC creation multiples and attrition are all continuing to move in the right direction, which allowed us to improve our results over last year. Steady-state free cash flow before special items was $996 million, up $30 million versus prior year.

When analyzing our results in constant currency, steady-state free cash flow exceeded our guidance of $1 billion. Slide 16 highlights our cap allocation and debt levels for the quarter. Trailing 12-month leverage reads 3 times EBITDA, and trailing 12-month debt to pre-SAC EBITDA was 2.4 times.

As a reminder, we began reporting pre-SAC leverage ratio to provide a harmonized view similar to how most, if not all our security competitors report leverage, are removing the expense investment in new subscribers.

In addition, our EBITDA results were negatively impacted by about $25 million in 2015 as a result of a non-cash change in how we report the marketing efficiency program. Our long-term leverage target remains 3 times EBITDA. Our total cost of borrowing was below 4% in Q4, and our debt continues to trade at favorable levels.

Having a low cost of borrowing provides us the flexibility to invest in growth and return capital to our shareholders. In the fourth quarter, we paid a quarterly dividend of $0.21 per share or 5% increase over last year.

In Q4, we also repurchased 4.3 million shares at an average price of $32.70 per share, contributing to the total of 9.8 million shares worth $324 million of repurchases for fiscal 2015.

With our cash flow increasing, our business stable and our growth initiatives adequately funded, we continue to view share repurchases at current price levels as a preferred vehicle for excess cash. We have now reduced the diluted ending share count to 167 million, a 29% reduction from our share count at spin.

We currently have more than $1 billion available in our share repurchase program. Our company has significantly improved its operating and financial results since going public in 2012. Had a challenging first quarter 2014, we've improved our performance since then, meeting or exceeding our guidance again in 2015.

On slide 17, we highlight the quarterly trends for key financial and operational metrics for ADT. When analyzing the last eight quarters, it's clear that our commitment to driving improvements in the five operating levers has been successful.

Pre-SAC EBITDA and recurring revenue margins before special items have been steadily improving throughout the year, ending at their highest points in Q4. Steady state free cash flow also hit a new high this year, and we delivered 6% growth in gross adds for the year as we grew sequentially throughout 2015.

The most important driver of our business is attrition. Improvements we have made in the last six quarters are significant as we improved attrition by 230 basis points. And last, but not least, we've consistently lowered our direct SAC creation multiple throughout 2015 despite increases in automation take rates.

We expect our focus on quality growth to continue to drive improvements of these metrics in 2016. So, let's move to slide 18 and address our 2016 guidance. We feel optimistic about the upcoming year due to the progress we made in 2015 and the initiatives we have underway and in the pipeline.

We expect 2016 to be a year of improved operating metrics and financial growth, driven by an even greater focus on improving customer retention. This should drive better customer metrics, increased profitability and higher levels of free cash flow growth before special charges.

The chart details our five primary financial and operating metric guidance for 2016. All growth levels are assumed to occur at constant exchange rates with prior year. Number one, we're calling for total revenue to grow between 3.5% and 4.5%.

Most of this growth will come from increases in recurring revenue, although we also expect non-recurring revenues to grow as we expand our commercial activities. We expect expansion activities in ADT business and health to grow at accelerated rates. We also expect a modest level of recurring revenues from the launch of the LG all-in-one product.

Two, we are targeting EBITDA before special items to grow in the range of $75 million to $90 million. Higher quality sales, IT leverage, cost efficiencies and synergies from the Protectron integration are expected to increase EBITDA margins for 2016.

We will also continue to invest in growth as we look to improve the customer experience, accelerate our expansion into the commercial market and launch our security offering targeted at the DIY marketplace.

The EBITDA growth would have been higher if not for the estimated $12 million negative impact expected from the 53rd week we'll experience in 2016. I will address this more in a moment. After finishing 2015 on a favorable note with $321 million of free cash flow before special items, we are guiding free cash flow to be higher for 2016.

Better customer retention and more favorable mix in Pulse customers, higher ARPU and margins will drive at least 5% increase in free cash flow from operations. Somewhat mitigating this improvement is an expected increase in short-term interest rates.

On the SAC side, we expect further improvement in subscriber creation multiples resulting in capital spending increases driven primarily by increase in gross adds and incremental Pulse upgrades.

We do expect Pulse upgrades to temporarily increase in 2016 as we make a push to convert the remaining 2G customers to Pulse versus just replacing the radios. Four, improving the customer retention will continue to be our top priority in 2016. We are targeting net unit attrition to fall below 12% versus the Q4 rate of 12.2%.

This will be driven by smarter customer acquisition, a retention program, and higher account resale, particularly on relocation disconnects. And finally we're targeting to increase our customer base in 2016 from our current position of 6.6 million customers. In 2015 we lost about 70,000 customers, a 50% improvement over 2014.

For 2016, we expect to grow gross adds, reduce customer disconnect and attract new customers via small, opportunistic account acquisitions at appropriate price levels. Two last points on guidance before I turn the call back to Naren for concluding comments.

First, we're targeting to step up completion of the 2G conversion program in the course of 2016. Secondly, we have until the calendar year-end 2016 to complete this conversion. We'll be actively seeking to upgrade 2G customers to Pulse, but those that won't we'll just have to replace their radios.

As is the case in 2015, we will report a special charge for the radio replacement cost. Lastly, I referred earlier to the 53rd week we report in 2016. Dating back to the Tyco period, ADT has utilized a 4-5-4 weekly calendar for reporting its quarterly earnings. This necessitates that once every six years or so, you have a 53rd week.

2016 is the year we have this extra week. As previously reported, our management and board have decided to use this timing to convert ADT to a traditional calendar month-end period for reporting results beginning in 2016.

Although this does not eliminate the 53rd week for 2016, it does ensure that this will not happen again, and also aligns our reporting more appropriately with how we run the business. Six of these extra seven days will occur in the first quarter, as our reporting period began on September 26 and ends December 31.

Most of our revenues are monthly-recurring revenues, so there is little impact to revenues as a result of the extra days. However, certain costs are negatively impacted, such as hourly labor, variable cost and marketing spend. For Q1, we expect the extra week to negatively impact EBITDA by $10 million and EPS about $0.04.

This impact is cash neutral and onetime in nature. We expect Q1 2017 to be incrementally favorable than 2016 by this onetime expense before factoring in any business improvement. Statistically, this will not affect our major operating metrics. Only gross adds and gross disconnects will be affected by the extra days.

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

Thanks, Mike. As I reflect on our first three years as a public company, I'm very proud of what our team has accomplished despite some bumps in the road.

We completed a very complex separation from Tyco which included over 100 shared IT systems, hundreds of collocated field offices, and over 2 million customer monitoring lines which needed to be moved between the two companies' monitoring centers.

During this time period, we also significantly strengthened our focus on enhancing the customer experience through adding more automation capabilities to our Pulse platform, improving customer service levels, and screening out prospective customers who do not have the potential to become customers for life.

These improvements resulted in a 150 basis point improvement in customer retention.

In addition, we continue to position ourselves for future profitable growth by investing in Pulse, expanding our business activities into the midsized commercial market, completing two acquisitions to bring new capabilities and increase our scale and coverage in the Canadian market, and establishing new partnerships and solutions that will allow us to enter previously un-penetrated segments of the residential market.

As a result of these investments, we've been able to grow our Pulse customer base to over 1.5 million, increase recurring revenue by nearly 15%, and expand our customer base by 279,000 subscribers during our first three years as a standalone company.

As I look forward over the next few years, I'm even more excited about the potential to further improve business performance and deliver profitable growth. Our focus on quality growth and enhancing the customer experience should allow us to bring customer attrition down to historic low levels for ADT below 11%.

This will put us on a path for consistent annual net add growth organically. Our continued investment in and customer preference towards Pulse should result in Pulse growing to at least half of our customer base over the next few years.

And I expect our new business platforms to continue to grow with our business and health channels growing double digits annually for the foreseeable future as a result of organic initiatives and some small acquisitions while our efforts in the previously unpenetrated residential market could attract up to 1 million new customers over the next several years.

This growth should allow us to continue to improve our profitability and position us to deliver over $500 million worth of free cash flow annually, which will be used to further invest in the business or reward our shareholders with higher dividends and/or share repurchases.

Needless to say, this is a very exciting time for ADT as we work hard to build on our market-leading position in the security and automation market. With that, we can open up the call for questions.

Stephanie, can you provide the instructions for dialers to ask a question?.

Our first question comes Jason Bazinet with Citi. Your line is open..

Thanks. Just a question for Mr. Geltzeiler. I know that you touched on it in the prepared remarks, but maybe you could circle back to it. I think a number of investors want to take your revenue guidance for 2016 and just remove 2% from that based on the extra week.

Can you just go over again why this won't affect – this change won't affect your revenue materially for fiscal 2016? Thanks..

Yes. Really, the only effect that this extra week will have on our revenues is for nonrecurring revenue which, as you know, is miniscule. We are $64 million for the quarter. So, nonrecurring revenue is revenue we record every day, you have seven more days realized nonrecurring revenue. So, that is the only impact.

The reason it will not affect regular revenue is and the best way to kind of describe that is describe it on a monthly basis. If the month of February, a customer pays $45 for their services, when there's 28 days in that month or 30 days to 31, we charge a monthly fee. We don't charge a per-day fee.

So, we are charging customers that are going to pay one-twelfth of or they're going to pay their annual amount divided by 12. So, recurring revenue has been – is not affected by this extra week. We still will have the same amount of months as we had last year.

So, really only affects – and that is true with a lot of our fixed costs and our salaries aren't affected either. It's really the hourly costs and it's the strict variable costs like marketing, as well as nonrecurring revenue. So, revenues are not affected by this.

A customer will still pay 12 times their monthly amount and will be booking a year's worth, regardless of how many days are in the month..

Okay. And then unrelated to the accounting change you mentioned a couple of times on the call that you do expect a step-up in nonrecurring revenue growth as you move into small business.

Can you just frame that for us in terms of how we should think about how much the number could move, in other words what would you...?.

It's not significant, I mean, there's two things that happened. In the last year or two, we've been moving away from some nonrecurring activities like selling DVRs and we're moving more to hosted products that's sort of – well, that's recurring.

I think that now would no longer be a year-over-year effect, so we'll not have the negative effect of that transition.

As we start to move more aggressively into the commercial business, the biggest area of non-recurring revenue is the installation revenues you get from making this out and that is a bigger portion of the commercial business than it is in traditional resi business..

Got it. Okay. Thank you..

But as Mike said, that's a relatively small piece of our business today, but it should be growing in 2016..

Understood. Thank you..

Our next question comes from Ian Zaffino with Oppenheimer. Your line is open..

Hi. Great. Thank you very much. On slide 18, you talked about the subscriber base increasing from 2015 levels.

Is that inclusive of commercial or any of the other initiatives or is that in the core business?.

That's reflective of all of our businesses, our total customer account which includes all the pieces..

Okay. So, the core base may or may not be higher than it was in 2015? I just want to understand that..

Yeah. I'd say again, it's consistent with the way we reported in the past. Our 6.6 million customers includes U.S. resi, U.S. business, Canada and health. So, it's going to be – it will be apples-to-apples in 2016..

I mean, to put in perspective, we have about 1,000 commercial or high-paying customers. But the numbers don't materially move. The numbers, we have about 1,000 commercial customers now..

Okay. I just want to make sure it's apples-to-apples. Okay. Which it seems like it is.

And then so, would that also then include any type of acquisitions or is that going to be organic?.

Again, I think what Mike said in his comments is we always do "small tuck-in" kind of acquisitions, so if there are small tuck-ins or bulk account purchases, those would be included. We treat those the same as the accounts we buy from our dealers. So, from a process and the way we look at them, it's very similar.

If we were to do a meaningful acquisition of any kind of size, then we would call that out separately. Mike....

Okay, good. And then just one other follow-up question would on the working capital side, Mike, maybe going into a little bit how you are able to extract that working capital out this quarter and what should we expect in 2016..

Yes, I mean, I think you have to look at it in its entirety (41:58). When you look at year-over-year, I think you got to look at the timing of the interest payments. But generally speaking, I would focus on the free cash flow from the customers all-in. There was not anything extraordinary in working capital this quarter that generated that.

I mean clearly, certain basic things like we're having a better year, the bonuses will also be a little higher relative to maybe what they were last year. So, you have maybe more noncash-type expenses for being able to just show up in favorability, in working capital.

But I wouldn't say that there's anything anomalous about that that precludes it from – in this particular quarter, results from working capital that drove it..

Okay. Okay, good. Thank you very much, guys..

Great. Thanks, Ian..

Our next question comes from Jeffrey Kessler with Imperial Capital. Your line is open..

Thank you. I have a couple questions. First, you've been talking pretty openly about bringing on the right type of customer. And the fear was that bringing on the right type of customer was going to cut down on your gross adds and it probably has in some way.

Can you talk about beyond FICO scores what are the things you are doing to bring – what is the right type of customer? And what are the factors that you use and what is the effect of that right type of customer beyond just better attrition? What are the other things that you are getting from it?.

Yeah. Jeff, I think – and I don't want to kind of share all of our secrets on what we're trying to do to drive group quality because I don't want to give the competitors necessarily our playbook. Clearly, credit quality, it was the up-front piece. That's the piece we'd drive.

But I think we've talked in the past as to what are the characteristics of a customer that deeply – that lead to higher engagement and, hence, longer retention. And some of the things we've talked about in the past are the products they buy. We talked about the fact that ADT Pulse automation customers have higher retention.

So, clearly, we want to be pursuing more customers who are inclined to buy Pulse and Pulse automation specifically. Now, we've indicated that those who buy life safety solutions versus just intrusion solutions tend to be stickier. How they pay, again, and I think we've been very good at this, but making sure that we get credit card or ACH payments.

And then I'd say the final thing that we continue to look at is how much the customer invests up-front. Their level of engagement is driven by the investment that they make up-front. So, it's a variety of parameters. I think our analytics are much better than they were two years ago, three years ago.

We have a much better understanding of what are the ideal and optimal characteristics, and we're gearing our sales force into pursuing those kinds – not just those kinds of customers, but those kinds of sales characteristics..

Okay. Thank you.

Secondly, can you just go through what was the reason for the fall in the take rate in a small, medium business on Pulse?.

Yeah. Similar to what we're driving on the residential side, we are steering our business customers – our small business customers to more automations, more higher value-added services like the hosted video that Mike talked about, like analytics. Today, many of those solutions are not yet integrated into Pulse. They are stand-alone solutions.

So, we don't count them in our Pulse numbers, although they still are automation or higher value-added services. Over time, we will be integrating more of those into our Pulse platform, but....

I get it. Okay. Yeah..

...but they stand separately. They still have similar types of characteristics..

All right. And can you – finally, I want to talk – just talk about two things that you touched on today, but maybe you can get into it a little bit further.

Number one, the change in the nature of what you're selling in health and how you view the health market for both your products and your services over the next couple of years as the form factors change. And number two, please talk a little bit – give us a little bit more about Canada, given that the economy is not that great up there.

How is the integration going? How is the management integrating with the rest of the people? How's the culture changing and likewise?.

So, on the health side, I'd say, Jeff, it's changed both in the product over the past two years, but then also, the distribution channels for the product. As you're probably aware, you go back two years ago, we simply had a landline-based, in-home solution.

We supplemented that with a cellular product that allowed us to at least serve customers who didn't have a landline. And then in February of this year, we introduced the mobile PERS solution that isn't even necessarily tied to a home that's got GPS in it, so you can use it on the go.

Similarly, both for our wireless product and our mobile product, we added fall detection. So, if you fall, you don't have to reach out and hit the button to call our monitoring center. Our monitoring center – the product detects that, and our monitoring center will call the individual or reach out through that pendant or that bracelet.

So, we have changed and added the products, and those make up more than 50% of our sales these days. And we're seeing good take rates on the fall detection as well.

From a channel perspective, it is more looking at bulk sales, looking at nursing homes or other organizations that may have a large versus a traditional residential model, where you're looking at individual consumers. We're continuing to sell to individual consumers, but we're also looking at more of those bigger account opportunities.

And we've retooled the sales force, brought in a new sales leader to pursue those kinds of opportunities. We expect to see continued acceleration there. And we're also working with retailers to see if there's an opportunity to sell either in the store or more likely, via their websites, and we've used e-commerce sales on our own platform..

So, retailers, payers and perhaps providers will be a larger and larger part of the Pulse offering?.

Of the health offering not the Pulse....

On the health. Well, I'm sorry. I'm sorry. The health offering..

Absolutely..

Okay..

And from a Canada perspective, again, I'm pleased with the progress. We've brought in Andrea Martin at the beginning of this calendar year. Andrea has put together a really strong leadership team, leveraging some great talent from Protectron, leveraging some talent from ADT. We actually took a sales leader out of the U.S. and moved him up there.

We've also brought in some great talent from externally, including some people who had – from some pretty big name companies with strong recurring revenue experience. I think we're starting to see the momentum build there. I think the employee engagement is improving pretty significantly.

We've retooled the dealer program, and Andrea and her team had their Dealer Conference a few weeks ago. And the feedback from the dealers were they're very pleased with the changes we're making in the program. So, all the indicators are very positive. We're sharing best practices between the business, and I think you'll see momentum in 2016.

And I think that will accelerate in 2017 and beyond..

Okay. Thank you..

Great. Thanks, Jeff..

Our next question comes from Shlomo Rosenbaum with Stifel. Your line is open..

This is Adam Parrington in for Shlomo. Why did the subscriber base decline by about 31,000 subscribers sequentially? I mean, gross additions were roughly flat year-on-year. Attrition was better. Re-sales were up 21% year-on-year, but the base still declined. I was curious if you can provide any color on that..

Yeah. I mean, I guess the simple answer, Adam, is we lost more customers than we gained. Although from a – but when you look at the year-over-year improvements, attrition improved pretty dramatically. And when you look at – and gross adds were about flat with last year. So, yeah, the simple math is that we lost more than we gained.

At the same time, we're making good progress on both of those. Those metrics continue to converge. When you look at for the year, our net losses were down about 50% on a year-over-year basis.

So, we feel like we're building momentum for that crossover point, and we're continuing to target getting to gross – or, excuse me, net add positive in the foreseeable future..

I mean, I could add to that as well. We indicated that third and fourth quarter were the hardest quarters, fourth quarter in particular is where you have the highest amount of relocations because of the summer months.

But as we talk about quality growth and things, I mean, we started to implement not only the – fully implement the 10-year screening which we've talked about, but also some of the customer changes emanating from the data analytic reviews that Naren mentioned earlier. And I think we definitely are targeting that subscriber growth.

But we're going to do it the right way with the right terms, and we're not going to chase sales by chasing customers at a year from now or two years from now won't be customers. Because we're both trying to get subscriber growth and cash flow growth. I think it's important we remain disciplined as we go for both of those goals..

And what were the radio conversion costs that you expect to be next year? You mentioned about 500,000 subscribers left, (51:41) cost in terms of dollars?.

We've been indicating it, it's about $200, maybe a little bit less depending on the week. Some of those will be upgraded, so we would put that as a cost of upgrade because that will be – if they sign a new contract for three years. So we indicated somewhere in the $85 million to $100 million range just to complete the program.

I'm not saying that's all next year, we have five quarters to do that. But, again, the more we upgrade, less the charge would be. We'll upgrade them to Pulse, and they'll sign another three-year contract, et cetera. So, I think the mix has something to do with the ultimate costs.

But it's been running, if you look at the math and the numbers I gave you, we spent $55 million this year for 270,000 customers where some were upgraded. So, it's about $200 a house..

Okay, great. All right. Thank you. Appreciate the time..

Thanks, Adam..

Our next question comes from Ronnie Weiss with Credit Suisse. Your line is open..

Hey. Good morning, guys..

Good morning..

Just want to touch on kind of the M&A pipeline.

Just kind of what you're seeing out there and if it's not as robust as it has been in the past, should we expect more share repurchases going into 2016 over 2015?.

Yeah. I'll talk about that. I mean, the pipeline is interesting. We're seeing that there is a decent amount of consolidation interest, people who are – that's in the markets. But I think there's still pretty high expectation for. One of the reasons we have – again, everything with us is remaining disciplined. So, we look at a lot of things.

As you can see this year we have not done much in the way of consolidation and tuck unders because the pricing needs to be right. There's been a couple of transactions in the space. And a lot of the businesses or people would say, if I can get to this price, I'll sell; if I can't, I won't.

And so, I think we have a pretty good pipeline of business that we're interested in. And we think it is an opportunity for us, for sure. But again, as we said, it needs to be at the right price. To us, some of these things we're looking at because of small- to medium-size opportunities it's just really a third way to acquire customers.

Some are even asset deals. They're not even business acquisitions. We are mostly buying accounts with a couple of salespeople. So, I got to look at it relative to what my dealers and/or my direct team can deliver and make sure that the return metrics are there. So, we remain optimistic with that channel.

I think it's not likely I think we remain one of the larger buyers out there. So, if someone wants to sell, we'd be the ones who could make that. But I think, at this day, when I compare that to where my stock trades at, sub 40 RMR, it's why we believe that the best buy in security is our own stock..

Got it.

And then just quickly, have you guys ever quantified the synergies on Protectron for 2016? And just how big of a benefit is that going to be towards your guidance and the EBITDA?.

I mean, when we originally did the deal, we indicated the $10 million to $15 million range. And I think we're very confident with that number. As Naren mentioned, the management team is in place. We've gotten some of that clearly, but 2016 will be an acceleration of that.

And some of the larger opportunities do require some integration of systems and things. A lot of that work is underway as we speak. So, I think by the end of 2016, we'll be at the run rate of what we're looking for.

It doesn't mean we're going to be realizing it all in 2016, but to start to integrate the two billing systems and some of the customer systems is going to require certainly some – a significant amount of work up in Canada. I think they have a great plan to do that.

So, I think you can look in the kind of possibly in the higher end of that range of $10 million to $15 million..

Yeah. I think we got to keep in mind when we do a deal like that, we look at everything on a cash basis. So, that $10 million to $15 million would be cash improvements similar to what we spend. Some of that will show up in SAC rather than in the P&L, so all of that doesn't flow through in EBITDA. Some of it will show up in SAC and cash improvements..

Got it. Thanks, guys..

Great. And Stephanie, we're going to take questions from two more people. And if we can, let's just keep it to one question a piece if possible so we can get the last two one in..

Certainly. Our next question comes from Jeffrey Sprague with Vertical Research. Your line is open..

Thank you. Good morning..

Good morning..

I guess I will keep it to one just multipart question. I was just actually hoping to get a little bit more color on some of the underlying dynamics within Pulse.

Kind of bringing the year to a close here what percent of Pulse customers were automation customers, is the Pulse attrition rate still tracking to that roughly kind of 30% better than kind of historical attrition now that you've got maybe what four or five years of history now of Pulse customers? And also just kind of part of that I was wondering it obviously makes sense to kind of try to attract higher quality customers on any day in any business but does that focus in any way indicate that some of the experience on the early Pulse customers hasn't been quite as good as you thought? And so there's a further level of scrutiny and screening around Pulse specifically? Sorry for the multipart but thank you..

All right, Jeff. So, first, starting on the automation side. I think it's north of 40% of our new Pulse customers are coming with automation. So, that's on the new side.

When you look at it from a base perspective, I expect that it's higher than that from a base perspective, again, because it's got better retention, and over time, if we are losing Pulse customers, we would be losing more non-automation customers. The attrition rate, again, continues to be very good.

I would refer back to some of the data we shared in our Investor Day, and things are continuing to hold there. As far as the quality growth piece, Jeff, again, I think what's happening is, our ability to segment the data and segment customers better through our analytics is what's helping us just be a little bit more surgical than our approach.

I think when you look at the economics on a portfolio basis, they've always been very good. We've talked about what the IRRs are. What now we can do is we can surgically remove some of those less-attractive customers within a tranche, and focus on the more attractive customers.

So again, while we are walking away from some business, it will help not just our operating metrics, but it will help the overall profitability and free cash flow for the company. And we know how important that is to our shareholders and we want to make sure that we're using every penny wisely for them..

Thank you..

Thanks, Jeff. Operator we'll take our last question..

Our final question comes from Jane Zhao with Morgan Stanley. Your line is open..

Thanks guys for fitting me in.

So just quickly Naren you talk about the potential to generate $500 million annual free cash flow closing remarks, I wonder should we see this as a five-year target or do you have a timeline for that?.

Yeah. I think we said over the next several years, but I would say it's in that – that reflected back three years and I'm looking forward three years. So, I'd say in that three- to five-year range..

Okay. Great.

Can I maybe squeeze in one more quickly? I just wonder if you guys can maybe break out your current attrition by the non-payable entry and the relocation bucket as you have done in the past?.

Yeah. Why don't we – Jane, we'll get back to you on that, just so we can pull up those details. I don't know if we have it handy or if you want to....

Yeah. Sure. Definitely. Thanks..

Okay. Thanks. We can give you a call back on that – rather, Mike, unless you have some....

I mean, I don't think it changed much since you've seen in the Analyst Day. So, I would expect that the Analyst Day would be your best – your best view of that for right now, Jane..

Okay. Cool. We can follow up offline. Thanks, guys..

Perfect. Thanks, Jane..

All right. Great. Well, again, thank you all for joining the call. Again, we're excited with our performance, and we continue to be very excited about the future for our business and we look forward to our next quarterly update..

Thank you. Ladies and gentlemen, that does conclude today's conference. You may all disconnect. And, everyone, have a great day..