The ADT Corporation NEUTRAL ZACKS CONSENSUS ESTIMATES (ADT-NYSE) SUMMARY

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1 July 31, 2014 The ADT Corporation Current Recommendation SUMMARY DATA NEUTRAL Prior Recommendation Underperform Date of Last Change 07/31/2013 Current Price (07/30/14) $34.78 Target Price $ Week High $ Week Low $28.08 One-Year Return (%) Beta 1.50 Average Daily Volume (sh) 1,477,451 Shares Outstanding (mil) 174 Market Capitalization ($mil) $5,780 Short Interest Ratio (days) Institutional Ownership (%) 99 Insider Ownership (%) 1 Annual Cash Dividend $0.80 Dividend Yield (%) Yr. Historical Growth Rates Sales (%) 2.9 Earnings Per Share (%) 7.2 Dividend (%) N/A using TTM EPS 18.0 using 2014 Estimate 17.8 using 2015 Estimate 17.0 Zacks Rank *: Short Term 1 3 months outlook 3 - Hold * Definition / Disclosure on last page (ADT-NYSE) SUMMARY ADT reported healthy third quarter fiscal 2014 results with adjusted earnings exceeding the Zacks Consensus Estimate by $0.09. ADT is one of the leading players in the residential and small business security market with a wide array of products, strong brand identity and a well-diversified customer base. ADT expects to further strengthen its position through organic growth across the industry verticals and increased market penetration. However, operating risks regarding high R&D costs for technology-driven products could weigh on the margins moving forward. Moreover, intense competitive pressure and stringent laws and regulations are likely to peg back its profitability to some extent. Nevertheless, we maintain our long-term Neutral recommendation on ADT. Risk Level * Below Avg., Type of Stock Large-Blend Industry Business Info Zacks Industry Rank * 80 out of 267 ZACKS CONSENSUS ESTIMATES Revenue Estimates (In millions of $) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) A 821 A 833 A 846 A 3,309 A A 837 A 849 A 863 E 3,388 E E 881 E 877 E 914 E 3,550 E Earnings Per Share Estimates (EPS is operating earnings before non-recurring items, but including employee stock options expenses) Q1 Q2 Q3 Q4 Year (Dec) (Mar) (Jun) (Sep) (Sep) 2013 $0.44 A $0.41 A $0.53 A $0.46 A $1.84 A 2014 $0.43 A $0.49 A $0.55 A $0.48 E $1.95 E 2015 $0.47 E $0.47 E $0.49 E $0.62 E $2.05 E Projected EPS Growth - Next 5 Years % Zacks Investment Research, All Rights reserved S. Riverside Plaza, Chicago IL 60606

2 OVERVIEW Headquartered in Boca Raton, Florida, The ADT Corporation offers electronic security products along with a wide range of interactive home and business automation and monitoring services for residences and small businesses in the U.S. and Canada. Founded in 1874 as a telegraph delivery company, it has traversed time through a rollercoaster ride, changing its business and ownership across the years before finally getting listed as a standalone company in late On October 1, 2012, ADT was formed as a result of the spin-off of Tyco International Ltd. into three separate publicly traded companies. These included the formation of Tyco International Ltd., which primarily focused on fire protection and electronic security products, installation and services worldwide; The ADT Corporation, which concentrated on residential and small business security installation and services in North America; and Flow Control, which focused on water and fluid solutions, valves and controls, and equipment protection products across the globe. Flow Control later merged with Pentair Inc. to form Pentair Ltd., an industrial growth company that is a global leader in water and fluid solutions, valves and controls, equipment protection and thermal management products. ADT s electronic security and home/business automation solutions primarily include installation and monitoring of residential and small business security and premises automation systems. These products are designed to detect intrusion; control access; react to movement, smoke, carbon monoxide, flooding, temperature and other environmental conditions and hazards; and address personal emergencies, such as injuries, medical emergencies or incapacitation. ADT has a single operating segment. The products and services of the company comprise ADT Pulse interactive home and business solutions, home health services, and monitoring center supported personal emergency response system products and services. The company also provides technical services for the maintenance and installation of upgraded or additional equipment. ADT has a strong balance sheet and a talented management team with more than 6.5 million customers. The company delivers an integrated customer experience by maintaining the industry's largest sales, installation and service field force along with a robust monitoring network. REASONS TO BUY With a wide array of products to cater to a broad spectrum of customer needs, ADT has a strong footprint in the large and growing residential and small business security market. The product portfolio of the company includes some of the most respected, trusted and well-known brands in the industry. As reputation and reliability serve as the two key elements in the decision-making process while purchasing home and small business security and automation services, ADT has a distinct advantage over rivals with its well-recognized and reliable brands. Additionally, ADT continues to add new features and capabilities to its Pulse platform to ensure that the product continues to be the best home security and automation solution in the industry. The depth in product portfolio, strong brand identity and a well-diversified customer base offer an unrivalled competitive advantage to ADT. A bulk of the monitoring and home/business automation services and a large portion of the maintenance services are governed by multi-year contracts with automatic renewal provisions, which generate significant recurring revenue for ADT. This insulates the company from the volatility in the market and enables it to invest for a healthy organic and inorganic growth. Mergers and acquisitions continue to play a pivotal role in ADT s growth over the years. Periodic investments for improvement of the direct sales force and complementary distribution channels should also enable ADT to retain and capture additional market share to fuel its growth engine. Equity Research ADT Page 2

3 ADT believes monitored security and home/business automation services remain under-penetrated in North American households. In addition, rising concerns about crime and security issues (especially by an aging population), increasing customer interest in lifestyle and business productivity, and technology advancements are likely to support the higher penetration of interactive services and home/business automation. As such, the company envisions significant growth potential and intends to capitalize on this opportunity by leveraging on its efficient operating model and lower technology costs over time. These would then enable the company to considerably reduce the cost of basic installation and services, thereby making it affordable for a wider market acceptance by a larger portion of households and businesses. We remain encouraged with such inherent growth prospects of the company. REASONS TO SELL ADT faces significant pricing pressure and competition as the security alarm industry is highly fragmented due to low barriers to entry. The company witnesses significant competitive pricing pressures on installation, monitoring and service fees. In addition, cable and telecommunications companies are also eroding its market share by expanding into the monitored security alarm industry and bundling their existing offerings with monitored security services. As such, ADT has to continually invest in R&D and similar other value drivers that act as a hedge against tough competition. This increases its operating costs and reduces its profitability to some extent. The operations of the company are subject to various federal, state, provincial and local laws and regulations in the U.S. and Canada in such areas as consumer protection, occupational licensing, environmental protection, labor and employment, tax and other laws and regulations. In addition, most states and provinces in which ADT operates have licensing laws directed specifically toward the security services industry. Increased government regulation escalates costs and restricts operations, somewhat impairing the long-term growth of its business. The company s business strategy hinges on acquiring companies and making investments that complement its existing businesses. These acquisitions entail huge integration costs which often become a drag on the profitability of the company. Furthermore, ADT incurs significant upfront investments for expanding its customer base, including direct material and labor costs to install security and home/business automation systems, indirect sales costs, marketing costs and administrative costs related to installation activities. The economics of the installation business also varies depending on the customer acquisition channel. Consequently, ADT s long-term profitability is dependent on long customer tenure and minimal customer attrition. However customer attrition rate has remained steady over the recent quarters despite some solid customer retention activities, which therefore remains a concern for the company. Equity Research ADT Page 3

4 RECENT NEWS ADT Comfortably Beats on Q3 Adjusted Earnings, Revenues Up June 30, 2014 ADT s third quarter fiscal 2014 GAAP net income declined to $82 million or $0.47 per share from $113 million or $0.52 per share in the year-ago quarter. The year-over-year decrease in earnings is primarily due to high operating costs during the reported quarter associated with being a standalone public company. Excluding non-recurring items, adjusted net income stood at $97 million or $0.55 per share in the reported quarter, versus $116 million or $0.53 per share in the year-ago quarter. Although adjusted net income declined year over year, it increased on a per share basis due to lower number of outstanding shares during the reported quarter. The quarterly adjusted earnings exceeded the Zacks Consensus Estimate by $0.09. Quarter Details Revenues for the quarter increased 1.9% year over year to $849 million and perfectly matched the Zacks Consensus Estimate. Recurring revenues of $785 million, which accounted for 92.5% of total revenue in the reported quarter, was up 2.7% compared with the year-earlier period. Recurring revenue growth was largely driven by an increase in average revenue per customer, which was up 3.9% year over year to $ ADT closed the quarter with 6.4 million customer accounts. Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) decreased 9.3% to $388 million in the reported quarter from $428 million in the prior-year period. However, EBITDA before special items improved 4.4% to $452 million. Adjusted EBITDA margins improved 120 basis points to 53.2% due to productivity improvements and cost efficiencies. In its earnings release, ADT provided key insights in some of the initiatives it has taken to accelerate growth, improve cost efficiencies, and optimize capital structure. In order to capture a greater pie in the market, the company invested heavily in its ADT Pulse platform and launched several new products. ADT Pulse take rates climbed to 49% of customer additions, up from 28% in the year-earlier quarter. During the quarter, ADT aimed to reduce customer attrition by initiating tighter credit screening policies, implementing resale efforts and customer loyalty programs. Revenue attrition improved 30 basis points to 13.9% on a sequential basis, while unit attrition in residential and small business channels was up 20 basis points sequentially to 13.5% due to relocations associated with the housing recovery and non-pay customers. The company also expanded its dealer network and forged a 5-year renewal contract with its largest dealer Defender Direct to drive new growth initiatives. In order to reduce subscriber acquisition costs, ADT implemented new technology and installation procedures and optimized lead management, sales conversion and marketing activities across all channels. The company also collaborated with location-based services and family networking technology provider Life360 to add a new dimension to its expanding portfolio. The partnership between the two leading players in their respective categories aims to develop innovative co-branded mobile security applications to provide greater safety and security services to families. In order to facilitate mutual bonding and trust in the business relationship, ADT has decided to take a minority interest in Life360 by investing $25 million. Both the companies are expected to work in unison to develop a new mobile application that will offer personal security solutions for on-the-go families. The upcoming mobile app will enable users to have a direct access to ADT s round-the-clock monitoring centers that can connect them to police, fire and emergency medical responders. Equity Research ADT Page 4

5 Subsequent to the quarter end, ADT closed the acquisition of Reliance Protectron, Inc. one of the largest security monitoring and installation companies in Canada. With the deal, ADT has strengthened its Canadian presence to better serve over 800,000 local customers with the best of products and solutions along with superior customer service in the security industry. In addition, the strategic buy will offer a steady revenue stream to ADT as Protectron reportedly has higher levels of customer retention than other major players in North America. Post-acquisition, the Canadian firm will continue to use the Protectron brand under ADT ownership. Balance Sheet and Cash Flow Cash and cash equivalents at quarter end were $250 million, while long-term debt aggregated $4,725 million. Subsequent to the quarter end, ADT borrowed $375 million from the revolving credit facility to fund the Protectron acquisition. Cash from operating activities totaled $1,165 million for the nine months of fiscal 2014 compared with $1,273 million in the prior-year period. Free cash flow before special items decreased 40.6% to $98 million in the quarter. ADT repurchased 2.6 million of its shares for $79 million during the reported quarter under its $3 billion share repurchase program. Since the beginning of fiscal 2014, the company has repurchased 35 million shares for $1.4 billion. Equity Research ADT Page 5

6 VALUATION ADT s current trailing 12-month earnings multiple is 18.0x, compared with the 27.8x average for the peer group and 18.1x for the S&P 500. Over the last five years, shares of ADT have traded in the range of 15.7x to 28.6x trailing 12-month earnings. The stock is trading at a discount to its peers, based on the forward estimated earnings. We maintain our long-term Neutral recommendation on the stock as we anticipate it to perform in line with the broader market. Our target price of $37.00, based on 19.0x fiscal 2014 earnings estimate, factors in this view. Key Indicators F1 F2 Est. 5-Yr EPS Gr% P/CF 5-Yr High 5-Yr Low The ADT Corporation (ADT) Industry Average S&P McGraw Hill Financial, Inc. (MHFI) Nielsen Holdings N.V. (NLSN) IHS Inc. (IHS) Verisk Analytics, Inc. (VRSK) TTM is trailing 12 months; F1 is 2014 and F2 is 2015, CF is operating cash flow P/B Last Qtr. P/B 5-Yr High P/B 5-Yr Low ROE D/E Last Qtr. Div Yield Last Qtr. EV/EBITDA The ADT Corporation (ADT) Industry Average S&P Equity Research ADT Page 6

7 Earnings Surprise and Estimate Revision History Equity Research ADT Page 7

8 DISCLOSURES & DEFINITIONS The analysts contributing to this report do not hold any shares of ADT. The EPS and revenue forecasts are the Zacks Consensus estimates. Additionally, the analysts contributing to this report certify that the views expressed herein accurately reflect the analysts personal views as to the subject securities and issuers. Zacks certifies that no part of the analysts compensation was, is, or will be, directly or indirectly, related to the specific recommendation or views expressed by the analyst in the report. Additional information on the securities mentioned in this report is available upon request. This report is based on data obtained from sources we believe to be reliable, but is not guaranteed as to accuracy and does not purport to be complete. Because of individual objectives, the report should not be construed as advice designed to meet the particular investment needs of any investor. Any opinions expressed herein are subject to change. This report is not to be construed as an offer or the solicitation of an offer to buy or sell the securities herein mentioned. Zacks or its officers, employees or customers may have a position long or short in the securities mentioned and buy or sell the securities from time to time. Zacks uses the following rating system for the securities it covers. Outperform- Zacks expects that the subject company will outperform the broader U.S. equity market over the next six to twelve months. Neutral- Zacks expects that the company will perform in line with the broader U.S. equity market over the next six to twelve months. Underperform- Zacks expects the company will under perform the broader U.S. Equity market over the next six to twelve months. The current distribution of Zacks Ratings is as follows on the 1109 companies covered: Outperform %, Neutral %, Underperform 5.0%. Data is as of midnight on the business day immediately prior to this publication. Our recommendation for each stock is closely linked to the Zacks Rank, which results from a proprietary quantitative model using trends in earnings estimate revisions. This model is proven most effective for judging the timeliness of a stock over the next 1 to 3 months. The model assigns each stock a rank from 1 through 5. Zacks Rank 1 = Strong Buy. Zacks Rank 2 = Buy. Zacks Rank 3 = Hold. Zacks Rank 4 = Sell. Zacks Rank 5 = Strong Sell. We also provide a Zacks Industry Rank for each company which provides an idea of the near-term attractiveness of a company s industry group. We have 264 industry groups in total. Thus, the Zacks Industry Rank is a number between 1 and 264. In terms of investment attractiveness, the higher the rank the better. Historically, the top half of the industries has outperformed the general market. In determining Risk Level, we rely on a proprietary quantitative model that divides the entire universe of stocks into five groups, based on each stock s historical price volatility. The first group has stocks with the lowest values and are deemed Low Risk, while the 5 th group has the highest values and are designated High Risk. Designations of Below-Average Risk, Average Risk, and Above-Average Risk correspond to the second, third, and fourth groups of stocks, respectively. Analyst: Supriyo Bose Lead Analyst: Supriyo Bose QCA: Supriyo Bose Reasons for Update: 3Q14 Earnings Equity Research ADT Page 8