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ADT > SEC Filings for ADT > Form 10-Q on 1-May-2013All Recent SEC Filings

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Form 10-Q for ADT CORP


1-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Introduction
The following discussion should be read in conjunction with our Condensed, Consolidated and Combined Financial Statements and the notes thereto, which are included in Item 1 of this Quarterly Report on Form 10-Q, as well as our Annual Report on Form 10-K for the fiscal year ended September 28, 2012, which was filed with the U.S. Securities and Exchange Commission ("SEC") on November 27, 2012 (the "2012 Form 10-K"). This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including but not limited to those provided in Item 1A. Risk Factors and under the heading "Cautionary Statement Regarding Forward-Looking Statements" below. The Condensed, Consolidated and Combined Financial Statements include our combined operations, assets and liabilities and have been prepared in accordance with generally accepted accounting principles in the United States of America ("GAAP"). As part of a plan to separate into three independent companies, on or prior to September 28, 2012, Tyco transferred the equity interests of the entities that held all of the assets and liabilities of its residential and small business security business in the United States and Canada to ADT (the "Separation"). Our Condensed and Consolidated Balance Sheets as of March 29, 2013 and September 28, 2012 reflect the consolidated financial position of ADT and its subsidiaries as an independent publicly-traded company. Additionally, our Condensed, Consolidated and Combined Statements of Operations and Comprehensive Income for the quarter and six months ended March 29, 2013, as well as the Condensed, Consolidated and Combined Statement of Cash Flows for the six months ended March 29, 2013 reflect ADT's operations and cash flows as a standalone company. Prior to the Separation on September 28, 2012, our financial position, results of operations and cash flows consisted of Tyco's residential and small business security business in the United States, Canada and certain U.S. territories and were derived from Tyco's historical accounting records and presented on a carve-out basis. As such, our Condensed, Consolidated and Combined Statements of Operations and Comprehensive Income for the quarter and six months ended March 30, 2012 and our Condensed, Consolidated and Combined Statement of Cash Flows for the six months ended March 30, 2012 consist of the combined results of operations of the ADT North American Residential Security Business of Tyco.
We conduct business through our operating entities and report financial and operating information in one reportable segment. We have a 52- or 53-week fiscal year that ends on the last Friday in September. Both fiscal year 2013 and fiscal year 2012 are 52-week years.
Business Overview
ADT is a leading provider of electronic security, interactive home and business automation and related monitoring services. We currently serve more than six million customers, making us the largest company of our kind in both the United States and Canada.
Our subscriber-based business requires significant upfront costs to generate new customers, which in turn provide predictable recurring revenue generated from monthly monitoring fees. In any period, our business results will be impacted by a number of factors including: customer additions, costs associated with adding new customers, average revenue per customer, costs related to providing services to customers and customer tenure. We manage our business to optimize these key factors. We focus on investing wisely in each of our customer acquisition channels to grow our account base in a cost effective manner and generate positive future cash flows and attractive margins. We also focus on "Creating Customers for Life" by maintaining consistently high levels of customer satisfaction, which increases customer tenure and improves profitability. Key Performance Measures
We operate our business with the goal of retaining customers for long periods of time in order to recoup our initial investment in new customers, achieving cash flow break-even in approximately three years. We generate substantial recurring net operating cash flow from our customer base. In evaluating our results, we review the following key performance indicators:
Customer Growth. Growth of our customer base is crucial to drive our recurring customer revenue as well as to leverage costs of operations. To grow our customer base, we market our electronic security and home/business automation systems and services through national television advertisements, Internet advertising and also through a direct sales force and an authorized dealer network. The key customer metrics that we use to track customer growth are gross customer additions and ending customers. Gross customer additions are new monitored customers installed or acquired during the period.


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Customer Attrition Rate. Our economic model is highly dependent on customer retention. Success in retaining customers is driven in part by our discipline in accepting new customers with favorable characteristics and by providing high quality equipment, installation, monitoring and customer service. We evaluate our customer retention based upon the recurring revenue lost resulting from customer attrition, net of dealer charge-backs and re-sales. Dealer charge-backs represent customer cancellations charged back to the dealers because the customer cancelled service during the initial period of the contract, generally 12 to 15 months. Re-sales are inactive customer sites that are returned to active service during the period. The attrition rate is a 52 week trailing ratio, the numerator of which is the annualized recurring revenue lost during the period due to attrition and the denominator of which is total annualized recurring revenue based on an average of recurring revenue under contract at the beginning of each month during the period.
Recurring Customer Revenue. Recurring customer revenue is generated by contractual monthly recurring fees for monitoring and other recurring services provided to our customers. Our other revenue consists of revenue associated with sale of equipment, deferred revenue related to upfront installations fees, non-routine repair and maintenance services and customer termination charges. Average Revenue per Customer. Average revenue per customer measures the average amount of recurring revenue per customer per month, and is calculated based on the recurring revenue under contract at the end of the period, divided by the total number of customers under contract at the end of the period. Cost to Serve Expenses. Cost to serve expenses represent the cost of providing services to our customers reflected in our Condensed, Consolidated and Combined Statements of Operations and include costs associated with service calls for customers who have maintenance contracts, costs of monitoring, call center customer service and guard response, partnership commissions and continuing equity programs, bad debt expense and general and administrative expenses. Recurring customer revenue less cost to serve expenses represents our recurring revenue margin.
Gross Subscriber Acquisition Cost Expenses. Gross subscriber acquisition cost expenses represent the cost of acquiring new customers reflected in our Condensed, Consolidated and Combined Statements of Operations and include advertising, marketing, and both direct and indirect selling costs for all new accounts as well as sales commissions and installation equipment and labor costs.
Earnings before interest, taxes, depreciation and amortization ("EBITDA"). EBITDA is a non-GAAP measure reflecting net income adjusted for interest, taxes and certain non-cash items which include depreciation of subscriber system assets and other fixed assets, amortization of deferred costs and deferred revenue associated with customer acquisitions, and amortization of dealer and other intangible assets. We believe EBITDA is useful to provide investors with information about operating profits, adjusted for significant non-cash items, generated from the existing customer base. A reconciliation of EBITDA to net income (the most comparable GAAP measure) is provided under "-Results of Operations-Non-GAAP Measures."
Free Cash Flow ("FCF"). FCF is a non-GAAP measure that our management employs to measure cash that is free from any significant existing obligation and is available to service debt and make investments. The difference between net cash provided by operating activities (the most comparable GAAP measure) and FCF is cash outlays for capital expenditures, subscriber system assets, dealer generated customer accounts and bulk account purchases. A reconciliation of FCF to net cash provided by operating activities is provided under "-Results of Operations-Non- GAAP Measures."


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Results of Operations
Quarter Ended March 29, 2013 Compared with Quarter Ended March 30, 2012
                                                      For the Quarters Ended
(in millions, except as otherwise indicated)    March 29, 2013       March 30, 2012
Recurring customer revenue                     $          756       $          720
Other revenue                                              65                   87
     Total revenue                                        821                  807
Operating income                                          174                  186
Interest expense, net                                     (30 )                (22 )
Other income                                               16                    -
Income tax expense                                        (53 )                (59 )
     Net income                                $          107       $          105

Key Performance Indicators:
    Ending number of customers (thousands)              6,471                6,432
    Gross customer additions (thousands)                  303                  291
    Customer attrition rate (percent)                    13.9 %               13.2 %
    Average revenue per customer (dollars)     $        39.66       $        37.98
    Cost to serve expenses                     $          257       $          230
    Gross subscriber acquisition cost expenses $          113       $          140
    EBITDA                                     $          419       $          399

As mentioned above, we manage our business to optimize a number of factors including: customer additions, costs associated with adding new customers, average revenue per customer, costs related to providing services to customers and customer tenure. In order to understand how these key factors impact our Condensed, Consolidated and Combined Statements of Operations, we consider the following components of our expenses: cost to serve expenses, gross subscriber acquisition cost expenses and depreciation and amortization. The following tables reflect the location of these costs in our Condensed, Consolidated and Combined Statements of Operations for the quarters ended March 29, 2013 and March 30, 2012:

                                              For the Quarter Ended March 29, 2013
                                                       Selling, general and
                                                          administrative
(in millions)                        Cost of revenue         expenses             Total
Cost to serve expenses               $          97     $              160     $        257
Gross subscriber acquisition cost
expenses                                        15                     98              113
Depreciation and amortization                  219                     43              262
Other                                           10                      -               10
    Total                            $         341     $              301     $        642


                                              For the Quarter Ended March 30, 2012
                                                       Selling, general and
                                                          administrative
(in millions)                        Cost of revenue         expenses             Total
Cost to serve expenses               $          89     $              141     $        230
Gross subscriber acquisition cost
expenses                                        46                     94              140
Depreciation and amortization                  206                     37              243
Other                                            8                      -                8
    Total                            $         349     $              272     $        621


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Revenue
Revenue of $821 million increased by $14 million, or 1.7%, for the quarter ended March 29, 2013 as compared with the quarter ended March 30, 2012, as a result of growth in recurring customer revenue, which increased by $36 million, or 5.0%. The majority of this increase was related to higher average revenue per customer. The increase in recurring customer revenue was partially offset by a reduction of $22 million, or 25.3%, in other revenue due to the mix shift toward more ADT-owned systems rather than outright system sales, increasing deferred revenue and reducing current period installation revenue.
Average revenue per customer increased by $1.68, or 4.4%, as of March 29, 2013 compared with March 30, 2012. This increase was primarily due to price escalations on our existing customer base and the addition of new customers at higher rates, including increased take rates on ADT Pulse, as well as the impact of existing customers upgrading to ADT Pulse and other higher priced offerings. Gross customer additions rose by 12,000, or 4.1%, for the quarter ended March 29, 2013 as compared with the quarter ended March 30, 2012, as a result of higher levels of dealer generated customer accounts and bulk account purchases. Net of attrition, our ending number of customers grew by 39,000, or 0.6%, from March 30, 2012 to March 29, 2013. Although our annualized customer attrition as of March 29, 2013 was 13.9% compared with 13.2% as of March 30, 2012, attrition was relatively flat to December 28, 2012, increasing only 10 basis points as a result of relocations. We continue to focus on delivering high quality services and our disciplined customer selection process in order to limit customer attrition.
Operating Income
Operating income of $174 million decreased by $12 million, or 6.5%, for the quarter ended March 29, 2013 as compared with the quarter ended March 30, 2012. Operating margin was 21.2% for the quarter ended March 29, 2013 compared with 23.0% for the quarter ended March 30, 2012. Operating expenses for the quarter ended March 29, 2013, which included $5 million of non-recurring costs related to the Separation, totaled $647 million, up 4.2% or $26 million as compared with the quarter ended March 30, 2012. The increase in operating expenses includes $19 million in higher depreciation and amortization expense related to our subscriber system assets and dealer generated accounts. This increase primarily reflects the impact of increased take rates on higher cost offerings, including ADT Pulse, as well as the mix shift toward more ADT owned systems and overall account growth. Cost to serve expenses totaled $257 million for the quarter ended March 29, 2013 as compared to $230 million for the quarter ended March 30, 2012. Cost to serve expenses for the quarter ended March 30, 2012 include integration costs related to the acquisition of Broadview Security of $5 million and approximately $1 million in reversals of previously recorded restructuring related expenses. After considering these items, cost to serve expenses increased by approximately $31 million for the quarter ended March 29, 2013 as compared with the quarter ended March 30, 2012. This increase was primarily a result of higher corporate costs and dis-synergies associated with the separation of our business from the commercial security business of Tyco and increased customer service expenses, driven by account growth and investments to improve customer retention. The overall increase in operating expenses was partially offset by a $27 million reduction in gross subscriber acquisition cost expenses. This decrease resulted from the deferral of a higher proportion of upfront installation costs associated with the mix shift toward more ADT-owned systems.
Interest Expense, net
Interest expense was $30 million for the quarter ended March 29, 2013 compared with $22 million for the quarter ended March 30, 2012. Interest expense for the quarter ended March 29, 2013 is comprised primarily of interest on our long-term debt, which reflects an increase in borrowings related to the issuance of $700 million in notes during January 2013. Interest expense for the quarter ended March 30, 2012 includes allocated interest expense related to Tyco's external debt of $21 million.
Other Income
During the quarter ended March 29, 2013, the Company recorded $16 million of other income, which is comprised primarily of $15 million of non-taxable income recorded pursuant to the tax sharing agreement entered into in conjunction with the Separation. See Note 9 to the Condensed, Consolidated and Combined Financial Statements for more information.
Income Tax Expense
Income tax expense of $53 million decreased $6 million for the quarter ended March 29, 2013 as compared with the quarter ended March 30, 2012, while the effective tax rate fell to 33.1% from 36.0%. The effective tax rate reflects the favorable impact resulting from non-taxable other income of $15 million. See Note 9 to the Condensed, Consolidated and Combined Financial Statements for more information on other income. The effective tax rate can vary from period to period due to permanent tax adjustments, discrete items such as the settlement of income tax audits and changes in tax laws, as well as recurring factors such as changes in the overall effective state tax rate.


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Six Months Ended March 29, 2013 Compared to Six Months Ended March 30, 2012

                                                      For the Six Months Ended
(in millions, except as otherwise indicated)    March 29, 2013       March 30, 2012
Recurring customer revenue                     $        1,500       $         1,428
Other revenue                                             130                   174
     Total revenue                                      1,630                 1,602
Operating income                                          360                   362
Interest expense, net                                     (54 )                 (44 )
Other income                                               22                     -
Income tax expense                                       (116 )                (120 )
     Net income                                $          212       $           198

Summary Cash Flow Data:
     Net cash provided by operating activities            812                   709
     Net cash used in investing activities               (599 )                (507 )
     Net cash used in financing activities                (27 )                (177 )

Key Performance Indicators:
    Ending number of customers (thousands)              6,471                 6,432
    Gross customer additions (thousands)                  560                   586
    Customer attrition rate (percent)                    13.9 %                13.2 %
    Average revenue per customer (dollars)     $        39.66       $         37.98
    Cost to serve expenses                     $          498       $           469
    Gross subscriber acquisition cost expenses $          224       $           274
    EBITDA                                     $          836       $           785
    FCF                                        $          230       $           202

The following tables reflect the location of cost to serve expenses, gross subscriber acquisition cost expenses and depreciation and amortization in our Condensed, Consolidated and Combined Statements of Operations for the six months ended March 29, 2013 and March 30, 2012:

                                            For the Six Months Ended March 29, 2013
                                                       Selling, general and
                                                          administrative
(in millions)                        Cost of revenue         expenses             Total
Cost to serve expenses               $         195     $              303     $       498
Gross subscriber acquisition cost
expenses                                        28                    196             224
Depreciation and amortization                  436                     83             519
Other                                           18                      -              18
    Total                            $         677     $              582     $     1,259


                                            For the Six Months Ended March 30, 2012
                                                       Selling, general and
                                                          administrative
(in millions)                        Cost of revenue         expenses             Total
Cost to serve expenses               $         179     $              290     $       469
Gross subscriber acquisition cost
expenses                                        91                    183             274
Depreciation and amortization                  409                     73             482
Other                                           15                      -              15
    Total                            $         694     $              546     $     1,240


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Revenue
Revenue of $1.6 billion increased by $28 million, or 1.7%, during the six months ended March 29, 2013 as compared to the six months ended March 30, 2012, as a result of growth in recurring customer revenue, which increased by $72 million, or 5.0%. The majority of this increase was related to higher average revenue per customer. The increase in recurring customer revenue was partially offset by a reduction of $44 million, or 25.3%, in other revenue due to the mix shift toward more ADT-owned systems rather than outright system sales, increasing deferred revenue and reducing current period installation revenue.
Average revenue per customer for the six months ended March 29, 2013 increased by $1.68, or 4.4%, compared to the six months ended March 30, 2012. This increase was primarily due to price escalations on our existing customer base and the addition of new customers at higher rates, including increased take rates on ADT Pulse, as well as the impact of existing customers upgrading to ADT Pulse and other higher priced offerings.
Gross customer additions fell by 26,000, or 4.4%, during the six months ended March 29, 2013 as compared to the six months ended March 30, 2012, as a result of lower dealer channel production as well as the impact of Hurricane Sandy. Net of attrition, our ending number of customers grew by 39,000, or 0.6%, from March 30, 2012 to March 29, 2013. Although our annualized customer attrition as of March 29, 2013 was 13.9% compared with 13.2% as of March 30, 2012, attrition was relatively flat to December 28, 2012, increasing only 10 basis points as a result of relocations. We continue to focus on delivering high quality services and our disciplined customer selection process in order to limit customer attrition.
Operating Income
Operating income of $360 million decreased by $2 million, or 0.6%, for the six months ended March 29, 2013 as compared to the six months ended March 30, 2012. Operating margin was 22.1% for the six months ended March 29, 2013 compared with 22.6% for the six months ended March 30, 2012. Operating expenses for the six months ended March 29, 2013, which included $11 million of non-recurring costs related to the Separation, totaled $1.3 billion, up 2.4% or $30 million as compared to the six months ended March 30, 2012. The increase in operating expenses includes $37 million in higher depreciation and amortization expense related to our subscriber system assets and dealer generated accounts. Cost to serve expenses totaled $498 million for the six months ended March 29, 2013 as compared to $469 million for the six months ended March 30, 2012. Cost to serve expenses for the six months ended March 30, 2012 include integration costs related to the acquisition of Broadview Security of $10 million and restructuring related expenses of approximately $1 million. After considering these items, cost to serve expenses increased by approximately $40 million for the six months ended March 29, 2013 as compared to the six months ended March 30, 2012. This increase was primarily a result of higher corporate costs and dis-synergies associated with the separation of our business from the commercial security business of Tyco as well as increased customer service and maintenance expenses driven by account growth and investments to improve customer retention. The overall increase in operating expenses was partially offset by a $50 million reduction in gross subscriber acquisition cost expenses. This decrease resulted from the deferral of a higher proportion of upfront installation costs associated with the mix shift toward more ADT-owned systems. Interest Expense, net
Interest expense was $54 million for the six months ended March 29, 2013 compared with $44 million for the six months ended March 30, 2012. Interest expense for the six months ended March 29, 2013 is comprised primarily of interest on our long-term debt, which reflects an increase in borrowings related to the issuance of $700 million in notes during January 2013. Interest expense for the six months ended March 30, 2012 includes allocated interest expense related to Tyco's external debt of $42 million. Other Income
During the six months ended March 29, 2013, the Company recorded $22 million of other income, which is comprised primarily of $21 million of non-taxable income recorded pursuant to the tax sharing agreement entered into in conjunction with the Separation. See Note 9 to the Condensed, Consolidated and Combined Financial Statements for more information.
Income Tax Expense
Income tax expense of $116 million decreased $4 million for the six months ended March 29, 2013 as compared to the six months ended March 30, 2012, while the effective tax rate fell to 35.4% from 37.7%. The effective tax rate reflects the favorable impact resulting from $21 million in non-taxable other income, partially offset by the impact of a discrete charge of $6 million due to a California legislative change enacted on November 6, 2012. See Note 9 to the Condensed, Consolidated and Combined Financial Statements for more information on other income. The effective tax rate can vary from period to period due to permanent tax adjustments, discrete items such as the settlement of income tax audits and changes in tax laws, as well as recurring factors such as changes in the overall effective state tax rate.


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Non-GAAP Measures
In an effort to provide investors with additional information regarding our results as determined by GAAP, we also disclose non-GAAP measures which . . .

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