ADT Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. INTRODUCTION To obtain a more comprehensive understanding of our financial condition, changes in financial condition, and results of operations, the following discussion and analysis should be read in conjunction with our condensed consolidated financial statements and the related notes included elsewhere in this Quarterly Report on Form 10-Q, as well as our audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the year ended December 31, 2021 (the “2021 Annual Report”), which was filed with the United States (“U.S.”) Securities and Exchange Commission (the “SEC”) on March 1, 2022. The following discussion and analysis contains forward-looking statements about our business, operations, and financial performance based on current plans and estimates that involve risks, uncertainties, and assumptions. Actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause such differences are discussed in the sections of this Quarterly Report on Form 10-Q titled “Cautionary Statements Regarding Forward-Looking Statements” and Item 1A “Risk Factors.” Table of Contents • Overview and Basis of P resentation • Factors Affecting Operating Results • Key Perfor mance Indicators • Results of Operations • Non-GAAP Measures • Liquidity and Capital Resources • Critical Accounting Polici es and Estimates • Cautionary S tate ments Regarding Forward-Looking Statem e nts OVERVIEW AND BASIS OF PRESENTATION Business Overview ADT Inc., together with its wholly-owned subsidiaries (collectively, the “Company,” “we,” “our,” “us,” and “ADT”), is a leading provider of security, interactive, and smart home solutions serving residential, small business, and commercial customers in the U.S. Since the acquisition of Compass Solar Group, LLC (now named ADT Solar LLC) (“ADT Solar”) (the “ADT Solar Acquisition”) in December 2021, we also provide residential solar and energy storage solutions. Our mission is to empower people to protect and connect to what matters most - their families, homes, and businesses - by delivering safe, smart, and sustainable lifestyle-driven solutions through professionally installed, do-it-yourself (“DIY”), and mobile or other digital-based offerings supported by our 24/7 professional monitoring services. Basis of Presentation All financial information presented in this section has been prepared in U.S. dollars in accordance with generally accepted accounting principles in the United States of America (“GAAP”) and includes the accounts of ADT Inc. and its wholly-owned subsidiaries. All intercompany transactions have been eliminated. In addition, we use the equity method of accounting to account for an investment in which we have the ability to exercise significant influence but do not control. We report financial and operating information in the following three segments: • Consumer and Small Business - The Consumer and Small Business (“CSB”) segment primarily includes the sale, installation, servicing, and monitoring of integrated security and automation systems and other related offerings to residential homeowners, small business operators, and other individual consumers, as well as general corporate costs and other income and expense items not included in another segment. 31 • Commercial - The Commercial segment primarily includes the sale, installation, servicing, and monitoring of integrated security and automation systems, fire detection and suppression systems, and other related offerings to larger businesses and/or multi-site operations, which often require more sophisticated integrated solutions, as well as certain dedicated corporate and other costs. • Solar - The Solar segment primarily includes the design and installation of solar and related solutions and services to residential homeowners who purchase solar and energy storage solutions, energy efficiency upgrades, and roofing services, as well as certain dedicated corporate and other costs. Our chief operating decision maker (the “CODM”) uses Adjusted EBITDA, which is considered the segment profit measure, to evaluate segment performance. Our definition of Adjusted EBITDA, a reconciliation of Adjusted EBITDA to net income (loss), and additional information, including a description of the limitations relating to the use of Adjusted EBITDA, are provided under “—Non-GAAP Measures.” Refer to Note 3 “Segment Information” for additional information on the Company’s segments. COVID-19 Pandemic Update During March 2020, the World Health Organization declared the outbreak of a novel coronavirus as a pandemic (the “COVID-19 Pandemic”). While responses have varied by individuals, businesses, and state and local governments, the COVID-19 Pandemic, including recent variants, caused certain notable impacts on general economic conditions, including temporary and permanent closures of many businesses, increased governmental regulations, supply chain disruptions, and changes in consumer spending. To protect our employees and serve our customers, we have implemented and are continuously monitoring and evolving certain measures as necessary, such as (i) detailed protocols for infectious disease safety for employees, (ii) employee daily wellness checks, and (iii) certain work from home actions, including for the majority of our call center professionals. Our response plan has not materially changed from that described in the 2021 Annual Report, and we continue to provide relevant updates to management, employees, and our customers as necessary. We believe our overall recurring revenue and highly variable subscriber acquisition cost model provides a solid financial foundation for strong cash flow generation despite the impact from the COVID-19 Pandemic. We anticipate maintaining sufficient liquidity and capital resources to continue (i) providing essential services, (ii) satisfying our debt requirements, and (iii) having the ability to return capital to our stockholders in the form of a regular quarterly dividend during this challenging macroeconomic environment. We considered the on-going and pervasive economic impact of the COVID-19 Pandemic in our assessment of our financial position, results of operations, and cash flows, as well as certain accounting estimates as of and for the periods presented. However, the evolving and uncertain nature of the COVID-19 Pandemic and its economic impact, as well as the evolving nature of the regulatory environment which may require vaccines or vaccine boosters or other actions that could impact our employee base or impose additional costs on our business, could materially impact our estimates and financial results in future reporting periods. FACTORS AFFECTING OPERATING RESULTS We have been building a strong platform for growth by focusing on improving customer satisfaction, increasing our recurring monthly revenue through customer acquisition, improving customer retention, reducing our revenue payback period, increasing the value of our offerings through new products and services, and increasing the rate at which new customers opt for our interactive services. In December 2021, we expanded into the residential solar market with the closing of the ADT Solar Acquisition. We believe solar is the next logical extension for our offerings, which enhances our ability to offer an integrated safe, smart, and sustainable home experience. As of June 30, 2022, we served approximately 6.7 million security monitoring service subscribers. Generally, a significant upfront investment is required to acquire new customers for our subscriber-based offerings that then provide ongoing and predictable recurring revenue generated from our monitoring and other services. Although the economics of an installation may vary depending on the customer type, acquisition channel, and product offering, we generally achieve revenue break-even in less than two and a half years. 32 In addition, our results are impacted by the mix of transactions under a Company-owned equipment model versus a customer-owned equipment model for our subscriber-based offerings, as there are different accounting treatments applicable to each model. As we continue building our partnership with Google LLC (“Google”), introducing new or enhancing our current offerings, and refining our go-to-market approach, we expect to see a shift toward an increasing proportion of transactions under a customer-owned equipment model (referred to as outright sales), which will impact results in future periods. Our ability to add new customers and grow our businesses also depends on the overall demand for our products and services, which is driven by a number of external factors such as the overall economic conditions in the geographies in which we operate, the price and quality of our products and services compared to those of our competitors, as well as changes in competition such as from the acquisition or disposition of similar businesses by our competitors. The demand for our products and services in our customer channels is also impacted by the following: • Growth in our residential and small business customer base can be influenced by the overall state of the housing market, the perceived threat of crime, the occurrence of significant life events such as the birth of a child or opening of a new business, or the availability of financial incentives such as those provided by insurance carriers. • Growth in our commercial customer base can be influenced by the rate at which new businesses begin operations or existing businesses grow, as well as applicable building codes and insurance policies. • Growth in our solar customer base can be influenced by the availability of certain rebates, tax credits, and other financial incentives, the availability and cost of consumer financing options, and traditional energy prices and grid reliability. We believe advancements in technology, younger generations of consumers, and shifts to de-urbanization have increased consumer interest in smart home offerings and other mobile technology applications; and we have made significant progress toward increasing the variety of our offerings to accommodate these changing interests. In addition, we believe uncertainties around the economic environment and the COVID-19 Pandemic have, in general, increased consumer and business awareness of the need for security. However, we may experience an increase in costs associated with factors such as (i) offering a wider variety of products and services; (ii) providing a greater mix of interactive and smart home solutions; (iii) replacing or upgrading certain system components due to technological advancements or otherwise; (iv) supply chain disruptions; (v) inflationary pressures on costs such as materials, labor, and fuel; and (vi) other changes in prices or terms from our suppliers, vendors, or third-party lenders that provide loan products to our Solar customers. We have implemented certain actions across our business segments such as our virtual service support program (the “Virtual Assistance Program”) in our CSB segment, which we launched in July 2021. The Virtual Assistance Program provides our customers the ability to troubleshoot and resolve certain service issues through a live video stream with our skilled technicians. This provides customers with more options for receiving certain services that best fit their lifestyles while reducing the cost for us to provide these services. Attrition has a direct impact on our financial results, including revenue, operating income, and cash flows. A portion of our customer base can be expected to cancel its service every year as customers may choose not to renew or may terminate their contracts for a variety of reasons, including relocation, cost, loss to competition, or service issues. In addition, customers who do not transition prior to the applicable 3G or Code-Division Multiple Access (“CDMA”) network sunset date, as discussed below, may experience a loss of signal, which could impact attrition in the future. Prior to 2020, new customer additions and our disconnect rates on our residential monitored security customers were typically higher during the second and third calendar quarters of each year relative to the first and fourth quarters due to several factors including the timing of household moves and the overall state of the housing market. We believe the COVID-19 Pandemic affected these seasonal trends beginning in 2020. During 2020, we experienced a lower volume of customer relocations which was followed by a slight increase during 2021 as the number of household moves increased. During 2022, we are beginning to see favorable trends in gross customer revenue attrition as a result of a lower volume of customer relocations. We are currently unable to determine whether there will be any ongoing or further impacts on our seasonality, and we may continue to experience fluctuations in certain trends, such as relocations, in the future. We have not sought or requested government assistance as a result of the COVID-19 Pandemic, but we did experience a favorable cash flow impact during 2020 and other benefits associated with certain income tax and payroll tax provisions of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), including the deferral of remittance of certain 2020 payroll taxes. We paid the majority of the first 50% of the deferred amount during the fourth quarter of 2021, with the remainder due by the end of 2022. The factors described above and elsewhere in this section could have a material adverse effect on our business, financial condition, results of operations, cash flows, and key performance indicators. 33 Other Events and Updates • Radio Conversion Costs - During 2019, we commenced a program to replace the 3G and CDMA cellular equipment used in many of our security systems as a result of the cellular network providers notifying us they will be retiring their 3G and CDMA networks beginning in February 2022. As of the start of the 3G sunset process in February 2022, we had converted substantially all of our remaining 3G customers. For those customers who do not transition prior to or since the completion of the applicable network sunset, the loss of signal to our security systems and certain services we provide may impact our ability to bill and/or collect from these customers in the future. Until the cellular network providers complete the applicable sunset processes, we cannot estimate the impact of the conversion on our attrition rate. We do not expect the remaining radio conversion costs and related incremental revenue to be material. • Google - In July 2020, the Company and Google entered into a Master Supply, Distribution, and Marketing Agreement (the “Google Commercial Agreement”), pursuant to which Google has agreed to supply the Company with certain Google devices as well as certain Google video and analytics services (“Google Devices and Services”) for sale to the Company’s customers. Subject to customary termination rights related to breach and change of control, the Google Commercial Agreement has an initial term of seven years from the date that the Google Devices and Services are successfully integrated into our end-user security and automation platform. Further, subject to certain carve-outs, we have agreed to exclusively sell Google Devices and Services to our customers. In June 2022, we amended the Google Commercial Agreement to extend the date for the launch of the integrated Google Devices and Services until September 30, 2022. If the integrated Google Devices and Services are not launched by September 30, 2022, Google has the contractual right to require us, with certain exceptions, until such integration, to exclusively offer Google Devices and Services without integration for all new professional installations and for existing customers who do not have ADT Pulse or ADT Control interactive services. We have already begun providing Google video services and devices and will continue to do so on a non-integrated basis as we work closely with Google toward an integrated solution. We launched the Google Nest doorbell during the first quarter of 2022, rolled out mesh Wi-Fi during the second quarter of 2022, and launched Google indoor and outdoor cameras in August 2022. The Google Commercial Agreement further specifies each party shall contribute $150 million towards the joint marketing of devices and services; customer acquisition; training of our employees on the sales, installation, customer service, and maintenance of the product and service offerings; and technology updates for products included in such offerings. Each party is required to contribute such funds in three equal tranches, subject to the attainment of certain milestones. • Canopy Investment - In April 2022, we closed on our previously announced transaction with Ford Motor Company (“Ford”) to form a new entity, SNTNL LLC (“Canopy”), which combines ADT’s professional security monitoring and Ford’s AI-driven video camera technology to help customers strengthen security of new and existing vehicles across automotive brands. ADT and Ford expect to invest approximately $100 million collectively during the next three years, of which ADT will contribute 40%. As part of the initial funding at closing, our contribution totaled approximately $11 million. In connection with the investment, we also entered into several commercial agreements (the “Canopy Commercial Agreements”). Refer to Note 5 “Equity Method Investments” for additional information. Updates Related to Existing and Potential Tax Legislation Delayed Effective Dates for Tax Law Changes under the Tax Cuts and Jobs Act Certain changes to U.S. federal tax law included in the Tax Cuts and Jobs Act had a delayed effective date and have taken effect for tax years beginning after December 31, 2021. Under Internal Revenue Code (“IRC”) Section 163(j), the limitation on net business interest expense deductions will no longer be increased by deductions for depreciation, amortization, or depletion. Under IRC Section 174, specified research and experimentation expenditures must now be capitalized and amortized. These items could result in increased taxable income and acceleration of net operating loss utilization, which could impact our tax expense and ultimately, our net income or loss. 34 Potential Federal Tax Legislation The White House released its fiscal year 2023 budget in March 2022, which includes a proposal to raise the corporate tax rate to 28%. If the proposed tax rate increase is passed, the Company would need to revalue its deferred tax liabilities, which could further increase the Company’s effective tax rate. The fiscal year 2023 budget also includes a provision that would reinstate current deductibility for IRC Section 174 research and experimentation expenditures that became subject to capitalization and amortization beginning this year. Potential for Future Valuation Allowance As discussed in our 2021 Annual Report, we had a significant amount of deferred tax assets as of December 31, 2021, against which we take valuation allowances that relate to the uncertainty of our ability to utilize these deferred tax assets in future periods. These valuation allowances were not material in 2021. We review periodically those matters that can influence our decision as to whether or not a valuation allowance is appropriate. Among those matters considered are pending and enacted legislation such as the updates described above. We will consider each quarter whether any developments to such legislation, together with the other factors we consider, require a valuation allowance. We believe that our deferred tax assets for disallowed interest under IRC Section 163(j) will grow meaningfully during 2022 and in subsequent years from their December 31, 2021 level. There is currently significant uncertainty in the matters we consider when determining whether it is appropriate to take additional valuation allowances. While we have not reported any material changes to our valuation allowances as disclosed in our 2021 Annual Report, we may determine to do so in any of the remaining quarters in 2022 or in subsequent years. Any material change to our valuation allowance would materially and adversely affect our operating results and may result in a net loss position for any given period. KEY PERFORMANCE INDICATORS We evaluate our results using certain key performance indicators, including the operating metrics recurring monthly revenue (“RMR”) and gross customer revenue attrition, as well as the non-GAAP measure Adjusted EBITDA. Computations of our key performance indicators may not be comparable to other similarly titled measures reported by other companies. Certain operating metrics are approximated, as there may be variations to reported results due to certain adjustments we might make in connection with the integration over several periods of acquired companies that calculated these metrics differently or periodic reassessments and refinements in the ordinary course of business, including changes due to system conversions or historical methodology differences in legacy systems. Recurring Monthly Revenue RMR is generated by contractual recurring fees for monitoring and other recurring services provided to our customers. We use RMR to evaluate our overall sales, installation, and retention performance. Additionally, we believe the presentation of RMR is useful to investors because it measures the volume of revenue under contract at a given point in time. RMR is also a useful measure for forecasting future revenue performance as the majority of our revenue comes from recurring sources. Gross Customer Revenue Attrition Gross customer revenue attrition is defined as RMR lost as a result of customer attrition, net of dealer charge-backs and reinstated customers, excluding contracts monitored but not owned and DIY customers. Customer sites are considered canceled when all services are terminated. Dealer charge-backs represent customer cancellations charged back to the dealers because the customer canceled service during the charge-back period, which is generally thirteen months. Gross customer revenue attrition is calculated on a trailing twelve-month basis, the numerator of which is the RMR lost during the period due to attrition, net of dealer charge-backs and reinstated customers, and the denominator of which is total annualized RMR based on an average of RMR under contract at the beginning of each month during the period, in each case, excluding contracts monitored but not owned and DIY customers. We use gross customer revenue attrition to evaluate our retention and customer satisfaction performance, as well as evaluate subscriber trends by vintage year. Additionally, we believe the presentation of gross customer revenue attrition is useful to investors as it provides a means to evaluate drivers of customer attrition and the impact of retention initiatives. 35 Adjusted EBITDA We also disclose Adjusted EBITDA, which is a non-GAAP measure. Our definition of Adjusted EBITDA, a reconciliation of Adjusted EBITDA to net income (loss) (the most comparable GAAP measure), and additional information, including a description of the limitations relating to the use of Adjusted EBITDA, are provided under “—Non-GAAP Measures.” RESULTS OF OPERATIONS (in thousands, except as otherwise indicated) Three Months Ended June 30, Six Months Ended June 30, Results of Operations: 2022 2021 $ Change 2022 2021 $ Change Monitoring and related services $ 1,145,792 $ 1,083,520 $ 62,272 $ 2,267,088 $ 2,146,286 $ 120,802 Installation, product, and other 455,238 220,897 234,341 878,689 462,835 415,854 Total revenue 1,601,030 1,304,417 296,613 3,145,777 2,609,121 536,656 Cost of revenue (exclusive of depreciation and amortization shown separately below) 507,813 381,585 126,228 1,017,581 762,751 254,830 Selling, general, and administrative expenses 487,069 445,636 41,433 969,417 895,238 74,179 Depreciation and intangible asset amortization 399,416 474,271 (74,855) 875,539 944,080 (68,541) Merger, restructuring, integration, and other (3,845) 4,804 (8,649) (3,317) 25,311 (28,628) Operating income (loss) 210,577 (1,879) 212,456 286,557 (18,259) 304,816 Interest expense, net (81,651) (166,525) 84,874 (87,958) (214,249) 126,291 Loss on extinguishment of debt — — — — (156) 156 Other income (expense) 1,463 1,533 (70) 2,959 3,336 (377) Income (loss) before income taxes and equity in net earnings (losses) of equity method investee 130,389 (166,871) 297,260 201,558 (229,328) 430,886 Income tax benefit (expense) (37,924) 41,021 (78,945) (57,448) 55,584 (113,032) Income (loss) before equity in net earnings (losses) of equity method investee $ 92,465 $ (125,850) $ 218,315 $ 144,110 $ (173,744) $ 317,854 Equity in net earnings (losses) of equity method investee (948) — (948) (948) — (948) Net income (loss) $ 91,517 $ (125,850) $ 217,367 $ 143,162 $ (173,744) $ 316,906 Key Performance Indicators: (1) RMR $ 368,768 $ 352,428 $ 16,340 $ 368,768 $ 352,428 $ 16,340 Gross customer revenue attrition (percent) 12.7% 13.3% N/A 12.7% 13.3% N/A Adjusted EBITDA (2) $ 597,249 $ 541,865 $ 55,384 $ 1,198,246 $ 1,083,996 $ 114,250 _______________________ (1) Refer to the “Key Performance Indicators” section for the definitions of these key performance indicators. (2) Adjusted EBITDA is a non-GAAP measure. Refer to the “Non-GAAP Measures” section for the definition of this term and a reconciliation to the most comparable GAAP measure. N/A — Not applicable. Monitoring and Related Services Revenue (“M&S Revenue”): Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2022 2021 $ Change 2022 2021 $ Change CSB $ 1,011,442 $ 965,233 $ 46,209 $ 2,004,470 $ 1,916,481 $ 87,989 Commercial 134,350 118,287 16,063 262,618 229,805 32,813 Total M&S Revenue (1) $ 1,145,792 $ 1,083,520 $ 62,272 $ 2,267,088 $ 2,146,286 $ 120,802 _________________ (1) M&S Revenue is not applicable to our Solar segment. Monitoring and related services revenue is primarily comprised of revenue generated from providing recurring monthly monitoring and other services to our customers. 36 The increase in total M&S Revenue for the three and six months ended June 30, 2022 as compared to the prior year periods was primarily attributable to higher recurring revenue in our CSB segment. CSB - For the three and six months ended June 30, 2022, higher recurring revenue was driven by improvements in average pricing as new and existing customers selected higher priced interactive and other services, as well as an increase in the number of active subscribers since the prior year periods primarily due to investments in subscriber growth. Commercial - For the three and six months ended June 30, 2022, higher M&S revenue was driven by an increase in average prices and higher revenue per service call. RMR - Total RMR increased to $369 million as of June 30, 2022 from $352 million as of June 30, 2021. RMR added since the prior year period reflects the impact from improvements in average pricing, as new and existing customers selected higher priced interactive and other services, and our subscriber growth initiatives. Gross Customer Revenue Attrition - Trailing twelve-month gross customer revenue attrition decreased to 12.7% as of June 30, 2022 from 13.3% as of June 30, 2021. The improvement was primarily attributable to a decrease in relocations and fewer voluntary disconnects primarily resulting from customer retention initiatives. Installation, Product, and Other Revenue: Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2022 2021 $ Change 2022 2021 $ Change CSB $ 77,047 $ 57,414 $ 19,633 $ 146,608 $ 144,771 $ 1,837 Commercial 163,136 163,483 (347) 325,045 318,064 6,981 Solar 215,055 — 215,055 407,036 — 407,036 Total installation, product, and other revenue $ 455,238 $ 220,897 $ 234,341 $ 878,689 $ 462,835 $ 415,854 Installation, product, and other revenue is primarily comprised of revenue from the sale and installation of security and solar systems, as well as the amortization of deferred subscriber acquisition revenue. The increase in total installation, product, and other revenue for the three and six months ended June 30, 2022, as compared to the prior year periods, was primarily due to revenue from Solar installations as a result of the ADT Solar Acquisition in December 2021. CSB - For the three and six months ended June 30, 2022, the increase in installation, product, and other revenue reflected additional amortization of deferred subscriber acquisition revenue. For the six months ended June 30, 2022, this was offset by a decrease in installation revenue from a lower volume of outright sales in the first quarter. These changes were primarily a result of our transition to a predominately Company-owned model in the first quarter of 2021. Commercial - For the three and six months ended June 30, 2022, installation, product, and other revenue remained relatively flat, reflecting the impact of supply chain delays. Solar - For the six months ended June 30, 2022, installation, product, and other revenue included a reduction of approximately $30 million in the first quarter of 2022 from the amortization of purchase accounting adjustments. Cost of Revenue: Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2022 2021 $ Change 2022 2021 $ Change CSB $ 171,204 $ 187,766 $ (16,562) $ 342,384 $ 381,137 $ (38,753) Commercial 203,704 193,819 9,885 406,888 381,614 25,274 Solar 132,905 — 132,905 268,309 — 268,309 Total cost of revenue $ 507,813 $ 381,585 $ 126,228 $ 1,017,581 $ 762,751 $ 254,830 Cost of revenue is primarily comprised of costs related to the installation of our security and solar systems, as well as field service and call center costs. 37 The increase in total cost of revenue for the three and six months ended June 30, 2022, as compared to the prior year periods, was primarily due to higher installation costs as a result of the ADT Solar Acquisition in December 2021. CSB - For the three months ended June 30, 2022, CSB field service and call center costs decreased, as compared to the prior year period, primarily as a result of cost savings initiatives such as our Virtual Assistance Program implemented in July 2021, despite rising costs and providing service to a larger number of customers, including a higher mix of interactive services. The decrease for the six months ended June 30, 2022, as compared to the prior year period, is primarily driven by a decrease in installation costs due to a lower volume of outright sales transactions in the first quarter compared to the same period in the prior year as a result of our transition to a predominately Company-owned model, which was completed during March 2021, as well as a decrease in field service and call center costs as described above for the three months ended June 30, 2022. Commercial - For the three and six months ended June 30, 2022, cost of revenue increased, as compared to the prior year periods, primarily due to higher prices on materials, labor, and fuel. Selling, General, and Administrative Expenses (“SG&A”): For the three and six months ended June 30, 2022, the increase in SG&A, as compared to the prior year periods, was primarily driven by: • incremental expenses of approximately $97 million and $173 million, respectively, as a result of the ADT Solar Acquisition in December 2021, and • increases in the provision for credit losses (excluding ADT Solar) of approximately $13 million and $19 million, respectively, primarily in our CSB segment due to lower provision in the prior year as a result of the COVID-19 Pandemic. These increases were partially offset by: • decreases in radio conversion costs of $63 million and $114 million, respectively, primarily due to a decrease in the number of conversions, and • decreases in advertising costs (excluding ADT Solar) of approximately $18 million and $38 million, respectively, primarily due to our efforts to optimize our advertising model in our CSB segment. Depreciation and Intangible Asset Amortization: For the three and six months ended June 30, 2022, the decrease in depreciation and intangible asset amortization, as compared to the prior year periods, was primarily driven by: • a decrease in the amortization of customer relationship intangible assets acquired as part of the acquisition of The ADT Security Corporation in 2016 (the “ADT Acquisition”), partially offset by • increases in the amortization of customer contracts acquired under our authorized dealer program and from other third parties and depreciation of subscriber system assets primarily due to investments in subscriber growth. The majority of the remaining net book value of customer relationship intangible assets acquired in the ADT Acquisition will be amortized during 2022 with the remainder amortized during 2023. Merger, Restructuring, Integration, and Other: During the six months ended June 30, 2021, merger, restructuring, integration, and other primarily included an $18 million impairment charge in CSB due to lower than expected benefits from our developed-technology intangible asset acquired during November 2020. 38 Interest Expense, net: For the three and six months ended June 30, 2022, the decrease in interest expense, net was primarily driven by the unrealized impact on interest rate swap contracts not designated as cash flow hedges primarily due to fluctuations in the forward London Interbank Offered Rate (“LIBOR”). Refer to Note 8 “Derivative Financial Instruments” for additional information. Income Tax Benefit (Expense): 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 state tax rate. Income tax expense for the three months ended June 30, 2022 was $38 million, resulting in an effective tax rate for the period of 29.1%. The effective tax rate primarily represents the federal statutory rate of 21.0%, a state statutory tax rate, net of federal benefits, of 5.5%, and a 3.0% unfavorable impact of prior year return adjustments related to executive compensation, partially offset by a 1.6% favorable impact from the release of a capital loss valuation allowance related to disposal activities. Income tax benefit for the three months ended June 30, 2021 was $41 million, resulting in an effective tax rate for the period of 24.6%. The effective tax rate primarily represents the federal statutory rate of 21.0%, a state statutory tax rate, net of federal benefits, of 2.8%, and a 0.6% favorable impact from prior year tax return adjustments. Income tax expense for the six months ended June 30, 2022 was $57 million, resulting in an effective tax rate for the period of 28.5%. The effective tax rate primarily represents the federal statutory rate of 21.0%, a state statutory tax rate, net of federal benefits, of 5.9%, a 2.0% unfavorable impact of prior year return adjustments related to executive compensation, and a 1.4% unfavorable impact of permanent items, partially offset by a 1.0% favorable impact from the release of a capital loss valuation allowance related to disposal activities. Income tax benefit for the six months ended June 30, 2021 was $56 million, resulting in an effective tax rate for the period of 24.2%. The effective tax rate primarily represents the federal statutory tax rate of 21.0%, a state statutory tax rate, net of federal benefits, of 2.8%, and a 1.0% favorable impact of share-based compensation. NON-GAAP MEASURES To provide investors with additional information in connection with our results as determined in accordance with GAAP, we disclose Adjusted EBITDA as a non-GAAP measure. This measure is not a financial measure calculated in accordance with GAAP, and it should not be considered as a substitute for net income, operating income, or any other measure calculated in accordance with GAAP, and may not be comparable to similarly titled measures reported by other companies. Adjusted EBITDA We believe Adjusted EBITDA is useful to investors to measure the operational strength and performance of our business. We believe the presentation of Adjusted EBITDA is useful as it provides investors additional information about our operating profitability adjusted for certain non-cash items, non-routine items we do not expect to continue at the same level in the future, as well as other items not core to our operations. Further, we believe Adjusted EBITDA provides a meaningful measure of operating profitability because we use it for evaluating our business performance, making budgeting decisions, and comparing our performance against other peer companies using similar measures. We define Adjusted EBITDA as net income or loss adjusted for (i) interest; (ii) taxes; (iii) depreciation and amortization, including depreciation of subscriber system assets and other fixed assets and amortization of dealer and other intangible assets; (iv) amortization of deferred costs and deferred revenue associated with subscriber acquisitions; (v) share-based compensation expense; (vi) merger, restructuring, integration, and other; (vii) losses on extinguishment of debt; (viii) radio conversion costs, net; and (ix) other income/gain or expense/loss items such as impairment charges, financing and consent fees, or acquisition-related adjustments. There are material limitations to using Adjusted EBITDA. Adjusted EBITDA does not take into account certain significant items, including depreciation and amortization, interest, taxes, and other adjustments which directly affect our net income (loss). These limitations are best addressed by considering the economic effects of the excluded items independently and by considering Adjusted EBITDA in conjunction with net income or loss as calculated in accordance with GAAP. 39 The table below reconciles Adjusted EBITDA to net income (loss): Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2022 2021 $ Change 2022 2021 $ Change Net income (loss) $ 91,517 $ (125,850) $ 217,367 $ 143,162 $ (173,744) $ 316,906 Interest expense, net 81,651 166,525 (84,874) 87,958 214,249 (126,291) Income tax expense (benefit) 37,924 (41,021) 78,945 57,448 (55,584) 113,032 Depreciation and intangible asset amortization 399,416 474,271 (74,855) 875,539 944,080 (68,541) Amortization of deferred subscriber acquisition costs 39,050 30,188 8,862 75,989 58,830 17,159 Amortization of deferred subscriber acquisition revenue (58,461) (40,729) (17,732) (111,884) (77,888) (33,996) Share-based compensation expense 16,932 13,587 3,345 32,952 29,606 3,346 Merger, restructuring, integration, and other (3,845) 4,804 (8,649) (3,317) 25,311 (28,628) Loss on extinguishment of debt — — — — 156 (156) Radio conversion costs, net 544 60,635 (60,091) 10,484 119,364 (108,880) Acquisition related adjustments (1) 1,328 (229) 1,557 37,623 (477) 38,100 Other (2) (8,807) (316) (8,491) (7,708) 93 (7,801) Adjusted EBITDA $ 597,249 $ 541,865 $ 55,384 $ 1,198,246 $ 1,083,996 $ 114,250 ________________ (1) During 2022, primarily represents the amortization of the customer backlog intangible asset acquired in the ADT Solar Acquisition, which was fully amortized as of March 2022. (2) During 2022, primarily represents the gain on sale of a business. Adjusted EBITDA in total and by segment was as follows: Three Months Ended June 30, Six Months Ended June 30, (in thousands) 2022 2021 $ Change 2022 2021 $ Change CSB $ 580,701 $ 509,897 $ 70,804 $ 1,141,246 $ 1,029,375 $ 111,871 Commercial 31,363 31,968 (605) 54,993 54,621 372 Solar (14,815) — (14,815) 2,007 — 2,007 Adjusted EBITDA $ 597,249 $ 541,865 $ 55,384 $ 1,198,246 $ 1,083,996 $ 114,250 The explanations below exclude amounts outside of our definition of Adjusted EBITDA, as applicable. The change in total Adjusted EBITDA for the three and six months ended June 30, 2022, as compared to the prior year, was primarily due to the following: • CSB Adjusted EBITDA increased primarily due to an increase in M&S Revenue, as well as decreases in advertising costs and field service and call center costs, partially offset by an increase in the provision for credit losses. • Commercial Adjusted EBITDA remained relatively flat and primarily included an increase in M&S Revenue, offset by an increase in field service and call center costs. In addition, Solar Adjusted EBITDA for the three and six months ended June 30, 2022 includes $11 million of charges associated with the estimated amount of receivables and rebates that are not expected to be collected from a former third-party lender that provided loan products for our Solar customers due to this third-party lender entering a formal insolvency proceeding to effectuate the wind-down of its operations. Refer to the discussions above under “—Results of Operations” for further details. 40 LIQUIDITY AND CAPITAL RESOURCES Liquidity and capital resources primarily consisted of the following: (in thousands) June 30, 2022 Cash and cash equivalents $ 43,609 Availability under First Lien Revolving Credit Facility $ 495,000 Uncommitted available borrowing capacity under Receivables Facility $ 108,362 Carrying amount of total debt outstanding $ 9,842,930 Liquidity We expect our ongoing sources of liquidity to include cash generated from operations, borrowings under our first lien revolving credit facility (the “First Lien Revolving Credit Facility”) and our uncommitted receivables securitization financing agreement (the “Receivables Facility”), and the issuance of equity and/or debt securities as appropriate given market conditions. Our future cash needs are expected to include cash for operating activities, working capital, capital expenditures, strategic investments, periodic principal and interest payments on our debt, and potential dividend payments to our stockholders. In addition, we are closely monitoring the impact of recent inflationary pressures and changes in interest rates on our cash position. We are a highly leveraged company with significant debt service requirements. We may periodically seek to repay, redeem, repurchase, or refinance our indebtedness, or seek to retire or purchase our outstanding securities through cash purchases in the open market, privately negotiated transactions, a 10b5-1 repurchase plan, or otherwise, and any such transactions may involve material amounts. The Company’s notes due 2023 in the outstanding aggregate principal amount of $700 million (the “ADT Notes due 2023”) mature on June 15, 2023 (the “Maturity Date”). As of June 30, 2022, the Company is in the process of seeking financing to replace the ADT Notes due 2023 prior to the Maturity Date. We believe our cash position, borrowing capacity available under our First Lien Revolving Credit Facility and Receivables Facility, and cash provided by operating activities are, and will continue to be, adequate to meet our operational and business needs in the next twelve months, as well as our long-term liquidity needs. Certain of our variable rate debt instruments are based on LIBOR. By June 2023, LIBOR will be replaced with the Secured Overnight Financing Rate (“SOFR”) (the “SOFR Transition Date”), at which point the applicable benchmark for all existing and new issuances under our current debt instruments with a variable rate component will be based on SOFR. Our first lien term loan facility (the “First Lien Term Loan due 2026”) and First Lien Revolving Credit Facility are and will continue to be based on LIBOR until the SOFR Transition Date. However, any future modification, such as a repricing, will require transition to SOFR. Additionally, any new issuances with a variable rate debt component entered into after December 31, 2021 will utilize SOFR per the terms of the credit agreement. As of June 30, 2022, our Receivables Facility is based on SOFR as discussed below. The impact of the transition to SOFR is not expected to be material. Material Cash Requirements There have been no significant changes to our short-term or long-term material cash requirements, or our commitments and contractual obligations from those disclosed in our 2021 Annual Report, except as discussed below: Customer Account Purchases In 2021, we entered into agreements for potential future customer account purchases from two distinct third parties, assuming certain conditions are met, over the course of those agreements. As of June 30, 2022, the remaining commitments for those potential future customer account purchases were not material. Off-Balance Sheet Arrangements During the six months ended June 30, 2022, there have been no material changes to our off-balance sheet arrangements as disclosed in our 2021 Annual Report, except as discussed below: During March 2022, we entered into an unsecured Credit Agreement with Goldman Sachs Mortgage Company, as administrative agent and issuing lender (the “Issuing Lender”), together with other lenders party thereto, pursuant to which we may request the Issuing Lender to issue one or more letters of credit for its own account or the account of its subsidiaries, in an aggregate face amount not to exceed $75 million at any one time. 41 Long-Term Debt There have been no material changes to our long-term debt from those disclosed in our 2021 Annual Report, except as discussed below: First Lien Credit Agreement As of June 30, 2022, we had $80 million in outstanding borrowings under our First Lien Revolving Credit Facility; and during the six months ended June 30, 2022, we borrowed $380 million and repaid $325 million. Receivables Facility As of June 30, 2022, we had an outstanding balance of $292 million under the Receivables Facility; and during the six months ended June 30, 2022, we received proceeds of $140 million and repaid $47 million. In May 2022, we amended the Receivables Facility to change the benchmark rate from 1-month LIBOR to Daily SOFR. In addition, the May 2022 amendment extended the scheduled termination date for the uncommitted revolving period from October 2022 to May 2023, and amended certain other terms to increase the advance rate on pledged collateral. ADT Notes due 2023 As of June 30, 2022, we had an outstanding balance of $700 million under the ADT Notes due 2023 that was classified as a current liability, net of any unamortized discount, in the Condensed Consolidated Balance Sheets. As described above, we are in the process of seeking financing to replace the ADT Notes due 2023 prior to June 15, 2023, which is the maturity date. Debt Covenants As of June 30, 2022, we were in compliance with all financial covenant and other maintenance tests for all our debt obligations. We do not believe there is a material risk of future noncompliance with our financial covenant and other maintenance tests as a result of the COVID-19 Pandemic, or otherwise. Dividends During the six months ended June 30, 2022 and 2021, we declared aggregate dividends of $60 million ($0.035 per share) and $54 million ($0.035 per share) on our Common Stock, respectively, and $4 million ($0.035 per share) on our Class B Common Stock during both periods. On August 4, 2022, we announced a dividend of $0.035 per share to holders of Common Stock and Class B Common Stock of record on September 15, 2022, which will be distributed on October 4, 2022. Cash Flow Analysis Six Months Ended June 30, (in thousands) 2022 2021 $ Change Net cash provided by (used in) operating activities $ 822,636 $ 785,660 $ 36,976 Net cash provided by (used in) investing activities $ (807,440) $ (777,162) $ (30,278) Net cash provided by (used in) financing activities $ 7,073 $ (59,740) $ 66,813 Cash Flows from Operating Activities The increase in cash provided by operating activities was primarily due to: • a decrease in payments related to radio conversion costs, net of the related incremental revenue, of $111 million, and • a decrease in cash interest of $11 million from various refinancing transactions of our long-term debt. These activities were partially offset by: • an increase in payments related to our annual incentive compensation plan of $49 million due to a partial payment in the prior year, and 42 • timing of payments to and receipts from vendors primarily related to accounts payable and inventory. The remainder of the activity related to changes in assets and liabilities due to the volume and timing of other operating cash receipts and payments with respect to when the transactions are reflected in earnings. Refer to the discussions above under “—Results of Operations” for further details. Cash Flows from Investing Activities Cash flows used in investing activities increased primarily due to: • an increase of $39 million in subscriber system assets expenditures as a result of more Company-owned transactions and our growth initiatives, as well as • cash paid of $11 million related to our investment in Canopy during 2022, partially offset by • proceeds of $27 million related to disposal activities during 2022. Cash Flows from Financing Activities During the six months ended June 30, 2022, net cash provided by financing activities primarily consisted of: • net proceeds of $93 million under the Receivables Facility and $55 million under the First Lien Revolving Credit Facility, partially offset by • dividends on common stock of $63 million, as well as • payments related to interest rate swap contracts that included an other-than-insignificant financing element at inception of $25 million. During the six months ended June 30, 2021, net cash used in financing activities primarily consisted of: • dividends on common stock of $58 million, as well as • payments related to interest rate swap contracts that included an other-than-insignificant financing element at inception of $28 million, partially offset by • $55 million of net proceeds under the Receivables Facility. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The accompanying condensed consolidated financial statements are prepared in accordance with GAAP, which requires us to select accounting policies and make estimates that affect amounts reported in the condensed consolidated financial statements and the accompanying notes. Management’s estimates are based on the relevant information available at the end of each period. Actual results could differ materially from these estimates under different assumptions or market conditions. We disclosed our accounting policies and critical accounting estimates in our 2021 Annual Report, which are based on, among other things, estimates and judgments made by management that include inherent risks and uncertainties. Refer to Note 1 “Description of Business and Summary of Significant Accounting Policies” to the condensed consolidated financial statements for further information about recent accounting pronouncements and adoptions. CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains certain information that may constitute “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995 and are made in reliance on the safe harbor protections provided thereunder. While we have specifically identified certain information as being forward-looking in the context of its presentation, we caution you that all statements contained in this report that are not clearly historical in nature, including statements regarding anticipated financial performance; management’s plans and objectives for future operations; our acquisition of ADT Solar and its anticipated impact on our business and financial condition; business prospects; outcomes of regulatory proceedings; market conditions; our ability to successfully respond to the challenges posed by the COVID-19 Pandemic; our strategic partnership and ongoing relationship with Google; the expected timing of product commercialization with Google or any changes thereto; the successful internal development, commercialization, and timing of our next generation platform and innovative offerings; the successful commercialization of our joint venture with Ford; the successful conversion of 43 customers who continue to utilize 3G services; and other matters are forward-looking. Forward-looking statements are contained principally in the sections of this report entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Without limiting the generality of the preceding sentences, any time we use the words “expects,” “intends,” “will,” “anticipates,” “believes,” “confident,” “continue,” “propose,” “seeks,” “could,” “may,” “should,” “estimates,” “forecasts,” “might,” “goals,” “objectives,” “targets,” “planned,” “projects,” and, in each case, their negative or other various or comparable terminology, and similar expressions, we intend to clearly express that the information deals with possible future events and is forward-looking in nature. However, the absence of these words or similar expressions does not mean that a statement is not forward-looking. For ADT, particular uncertainties that could cause our actual results to be materially different than those expressed in our forward-looking statements include, without limitation: • our ability to keep pace with rapid technological changes, including the development of our next-generation platform, and industry changes; • our ability to effectively implement our strategic partnership with or utilize any of the amounts invested in us by Google; • the impact of the COVID-19 pandemic on our employees, our customers, our suppliers and our ability to carry on our normal operations; • the impact of supply chain disruptions; • our ability to maintain and grow our existing customer base; • our ability to sell our products and services or launch new products and services in highly competitive markets, including the home security and automation market, the commercial fire and security markets, and the solar market, and to achieve market acceptance with acceptable margins; • our ability to successfully upgrade obsolete equipment installed at our customers’ premises in an efficient and cost-effective manner; • changes in law, economic and financial conditions, including tax law changes, changes to privacy requirements, changes to telemarketing, email marketing and similar consumer protection laws, interest volatility, and trade tariffs and restrictions applicable to the products we sell; • any material change to the valuation allowances we take with respect to our deferred tax assets; • the impact of potential information technology, cybersecurity or data security breaches; • our dependence on third-party providers, suppliers, and dealers to enable us to produce and distribute our products and services in a cost-effective manner that protects our brand; • our ability to successfully implement an equipment ownership model that best satisfies the needs of our customers and to successfully implement and maintain our receivables securitization financing agreement or similar arrangements; • our ability to successfully pursue alternate business opportunities and strategies; • our ability to integrate various companies we have acquired in an efficient and cost-effective manner; • the amount and timing of our cash flows and earnings, which may be impacted by customer, competitive, supplier and other dynamics and conditions; • our ability to maintain or improve margins through business efficiencies; • and the other factors that are described in this report under the heading “Risk Factors.” Forward-looking statements and information involve risks, uncertainties, and other factors that could cause actual results to differ materially from those expressed or implied in, or reasonably inferred from, such statements, including without limitation, the risks and uncertainties disclosed or referenced under the heading “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q and in Part I, Item 1A in our 2021 Annual Report. Therefore, caution should be taken not to place undue reliance on any such forward-looking statements. Much of the information in this report that looks toward future performance of the Company is based on various factors and important assumptions about future events that may or may not actually occur. As a result, our operations and financial results in the future could differ materially and substantially from those we have discussed in the forward-looking statements included in this Quarterly Report on Form 10-Q. We assume no obligation (and specifically disclaim any such obligation) to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law.