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Edited Transcript of APX Group Holdings Inc earnings conference call or presentation 6-Aug-19 9:00pm GMT

Q2 2019 APX Group Holdings Inc Earnings Call

PROVO Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of APX Group Holdings Inc earnings conference call or presentation Tuesday, August 6, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexander J. Dunn

APX Group Holdings, Inc. - President & Director

* Dale R. Gerard

APX Group Holdings, Inc. - SVP of Finance & Treasurer

* Mark J. Davies

APX Group Holdings, Inc. - CFO

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Conference Call Participants

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* Edwin Tai;DSC Meridian Capital;Partner

* Greggory Price

Barclays Bank PLC, Research Division - Senior Analyst

* Marlane Pereiro

BofA Merrill Lynch, Research Division - Convertible Strategist

* Todd Cranston Morgan

Jefferies LLC, Fixed Income Research - Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the APX Group Holdings Q2 2019 Earnings Conference Call. (Operator Instructions) Thank you.

Dale Gerard, Senior Vice President of Finance and Treasurer, you may begin your conference.

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Dale R. Gerard, APX Group Holdings, Inc. - SVP of Finance & Treasurer [2]

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Thanks, Denise. Good afternoon, everyone. Thank you for joining us this afternoon to discuss our results for the 3-month period ended June 30, 2019. Joining me on the conference call this afternoon are Alex Dunn, APX Group's President; and Mark Davies, APX Group's Chief Financial Officer.

I would like to begin by reminding everyone that the discussion today may contain forward-looking statements, including with regards to the company's future performance and prospects.

Forward-looking statements are inherently subject to risks, uncertainties and assumptions, and are not guarantees of performance. You should not put undue reliance on these statements. You should understand that a number of important factors, including the items discussed in the risk factors in our most recent annual report on Form 10-K/A, such as factors -- such factors may be updated from time to time in our filings with the SEC, which are available on the Investor Relations section of our website, could cause actual results to differ materially from those expressed or implied in our forward-looking statements.

The company undertakes no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

In today's remarks, we'll also refer to certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings release and accompanying presentation or on the financial information page of the Investor Relations portion of our website.

I will now turn the call over to Alex.

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [3]

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Thanks, Dale. Before we get to the prepared materials for this quarter, I'd like to discuss a couple of things. First, I'd like to give an update on the progress of the business, including operations, financials and sales. Second, I'd like to provide some perspective on Vivint's capital structure.

In 2017, we introduced Flex Pay, which lowered the total cost of ownership to our customers and reduced the amount of cash required from our balance sheet to grow the business. In addition, we focused on lowering our cost to create a customer, our general and administrative expenses and our servicing costs while increasing the quality of customer service. All these changes were implemented with an eye towards growing the business in a cash-flow-neutral manner.

We've made a lot of progress with this transformation. The first phase of Flex Pay was introducing a 0% hardware loan to our customers through Citizens Bank in the first quarter of 2017. You may recall that these changes, while overall positive to the company's cash flow, led to a temporary dip in sales productivity as the channels adapted. As soon as the sales channels processed the changes, productivity rebounded, and we had a very strong 2018, with 63% of our new accounts being generated on the Citizens loan and 23% of the new accounts being generated on our retail installment contracts, which are put on our balance sheet.

The second phase of Flex Pay was to integrate a second-look financing partner to reduce the number of retail installment contracts to near 0 in the United States and find a financing partner for our new Canadian customers. This summer, we introduced that second-look financing partner in the United States. While this has been accretive to cash and net subscriber acquisition costs, it has introduced additional changes into the sales process that have required the sales channels to once again adapt.

While our total subscriber base is up 8.2% year-over-year, our new subscriber additions in 2019, so far, are essentially flat with 2018 through the first half of the year. However, as we experienced in 2017, we are already seeing sales productivity rebound and expect a more productive second half.

In addition, we are in discussions with multiple financing partners for our Canadian accounts. While RICs will probably never be at absolute 0, we are in a strong position to get them to the low single digits by year-end.

In addition to driving cash-flow-neutral growth, we have been very focused on reducing expenses and ensuring that they grow at a slower rate than the top line growth each year. In the second quarter of 2018, G&A was 19.3% of our revenue. And in this quarter, G&A is 16.9% of revenue.

Smart Home is complicated. With approximately 14 devices installed per household that use cellular, Wi-Fi, Z-Wave and 345 MHz frequencies to communicate, it is a challenge to provide a reliable experience for the customer. As Smart Home service adoption increased, so did the pressure on our servicing costs. Our operations team is focused on reducing servicing costs and improving service quality. This has been a multiyear project involving our innovation center, IT, the field organization, operations and finance. In a coordinated fashion, we made changes to the hardware, firmware, [tech team] software and standard operating procedures for customer support and our Smart Home Pros. This integrated approach was only possible because of our vertically integrated strategy. This project led to a decrease from our peak of $17.04 of net servicing monthly cost in the first quarter of 2018 to $13.13 monthly net servicing costs during the second quarter of 2019. At the same time, we have significantly improved the quality of service, as evidenced by reducing our average time to install and average time to service by 25% for the 6 months ended June 30, 2019, as compared to the same period in 2018.

All of these changes have led to a business that's been growing at 14% CAGR from 2013 to 2018 with continual improvement in operational cash generation, including Flex Pay, 55% adjusted EBITDA margins in the second quarter of 2019 and a reduction in net subscriber acquisition costs of approximately 50% in the last 3 years.

Lastly, we want to address our capital structure, specifically the senior unsecured bonds that are scheduled to come due in December of 2020. As disclosed in our SEC filings, depending on market conditions and other factors, we opportunistically seek to access the credit and capital markets to refinance or retire our existing indebtedness. For example, in September 2018, we borrowed $810 million under the 2024 Term Loan B and used a portion of the net proceeds from the borrowings under the 2024 Term Loan B to redeem all remaining 2019 notes and to purchase approximately $250.7 million aggregate principal amount of our 2020 notes.

In May 2019, we issued $225 million aggregate principal amount of our 2024 notes. We used the net proceeds from the 2024 notes offering to redeem an additional $225 million aggregate principal amount of our 2020 notes.

Blackstone has been a great partner in the business and has consistently supported our growth and helped us manage our liabilities. We fully expect that we will address our remaining 2020 maturity. Blackstone is actively assisting us currently with finding an appropriate solution for this matter.

I'll now turn the time over to Mark Davies.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [4]

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Thanks, Alex. So I'll walk through the financial slides portion of the presentation.

On Slide #5, we highlight revenue and adjusted EBITDA. For the quarter, we have a 10% revenue growth to $281 million. That's composed primarily of sub increases but also an increase in our average revenue per user per month. Our revenue grew for the 6 months at an 11%, about $56 million year-over-year, again due to sub growth and the average revenue per user increasing. On the EBITDA portion, and we see that for both the quarter and for the 6 months to date, adjusted EBITDA has been scaling quite nicely. This is due to 2 reasons. One is our service costs are down, and we'll talk about that in a moment. And our G&A is also scaling very, very well. We focused on G&A over the last couple of years. From 2018 to 2019, we've actually -- we're $2 million less on G&A in 2019 than we were for this quarter last year. And we've driven our G&A down from 19.3% of revenue last year to 16.9% this year. So nice scaling there. And then on the 6 months to date, we've actually scaled EBITDA at 17% of revenue, and those are the same 2 drivers, service costs and G&A, which equates to about a 5-point increase in adjusted EBITDA. So nice, nice performance on the productivity of the business.

If you look on Page 6, we highlight a few of the portfolio data points. Number one, total subs grew from 1.39 million to 1.51 million or 8% year-over-year. Average monthly revenue per user also increased to $63.35, and that's up, again, year-over-year. And it's been moving up nicely both due to an increase in average monthly revenue per user year-over-year and then on both service fee and an increase on hardware revenues.

On the next slide, Slide 7, we highlight a few points on new subscribers. New subscribers were 111,000 for the 3-month period; 159,000 for the 6-month period. That's flat year-over-year adds, accounting for the exited Best Buy retail volume in 2018. As Alex mentioned, a good portion of that flat performance was due to the changes in Flex Pay. And just like we had in 2017, it takes the sales team a little bit of time to adapt to that new process. And we increased the underwriting requirements of our business in 2019, so we're putting on actually a higher-quality credit customer in this year, which has pushed down volume. One of the -- similar to what we saw in 2017 is the momentum for both of our primary channels, inside sales and direct-to-home. We see momentum in June and moving into July on the adaptability of the sales force, and we're seeing that [total graph] average come up towards the end of this half.

On the right-hand side of this, we've seen this phenomenon over the last couple of years. But we've also -- we've taken another drop down in our RIC percentage. Our RIC mix in the U.S. was 5% in Q2, down from 14% in Q1 and 20% this quarter a year ago. So that helped quite a bit on the net creation cost, which we can talk about on Slide 8.

Two points on Slide 8. One is, service costs have been a continually positive impact for us on both the unit-of-one economics and our earnings in the quarter. We've gone year-over-year from $16.71 down to this quarter at $13.13. This is really due to the work of that integrated platform, the software, the hardware, the install, the service. And with the new software releases last fall, we're seeing continued improvement in both customer service and customer satisfaction. So we've seen with that reduction an increase in our net service margin from 68.6% to 75.2%, which flows directly to EBITDA. So we're really, really pleased with that. And we expect to make further investments in customer service and customer satisfaction, so we'd like to see this trend continue.

On the right-hand side is the acquisition costs I mentioned, and we're down to $1,064 on a net acquisition. That's down $311 year-over-year, and it's actually down $77 quarter-over-quarter as we continue to drive that RIC percentage down.

On Slide #9, we talk a bit about the lifetime value of our customers and the function of a recurring revenue model and how we think about the lifetime value that we put on in the current period. So this year, the last 12 months, we've put on about $1.7 billion of lifetime value. Remember that we introduced this metric last quarter, which is the service revenue -- contracted service revenue times the customer life, plus the product revenue. And given that we are recognizing right now about $1.18 billion of revenue in that last 12 months, we're actually building a nice backlog. And so our backlog year-over-year -- and again, this is just that the revenue we expect to recognize after attrition over the next -- the life of the customer -- has risen from $5.0 billion to $5.7 billion.

If we look at the next page, we look at the lifetime service revenue for a unit of one versus the portfolio on the prior page. This shows that we're generating about $4,408 per customer in service revenue over the course of his life. We use this for really an efficiency metric of our creation cost.

And so on the right-hand side, it shows the multiple between our net creation cost and the amount of service revenue that we derive from that investment. And you can see a nice uptick from 3.1x to 4.1x, a 32% improvement year-over-year as we've driven down net creation and increased the average monthly revenue per user. Some nice hydraulics on both the enterprise and on the unit of one around our lifetime value.

And then finally, on Page 11, our standard attrition slide. Attrition for this quarter on an LTM or last 12-month basis came in at 13.4%. The real reason for this increase, as we've talked about previously, is that this year, we have about 14% -- or the last 12 months, we have about 14% of our subscribers under contract coming up for renewal, where at the same point last year when we were at 11.1%, we only had about 9% coming up for renewal.

So really, this is a confluence of contracts and renewals. And at this point, we don't see any real significant change in our attrition. So with that, we will conclude the prepared presentation and turn it over for any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Todd Morgan from Jefferies.

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Todd Cranston Morgan, Jefferies LLC, Fixed Income Research - Analyst [2]

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Following up on a couple of points. The (inaudible)

(technical difficulty)

Can you hear me?

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Dale R. Gerard, APX Group Holdings, Inc. - SVP of Finance & Treasurer [3]

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Yes, we can hear you. Go ahead, Todd.

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Todd Cranston Morgan, Jefferies LLC, Fixed Income Research - Analyst [4]

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I'm sorry. Anyway, you added slightly fewer subscribers than you did in the year ago period, just in the quarter. I recognize this is a 6-month period, and you -- and certainly, netting off some of the Best Buy guys, it was down a little bit. You -- I would assume, though, and I would be pretty confident that you guys had probably generated leads, at least as many sort of approaches that you did a year ago. So the close rate, if you will, is, I think, that's down, if that's a fair way to think about it. Is there any way you can sort of talk about the dynamic that would cause that, what I think anyway, is perhaps a slightly lower close rate to occur? And kind of what is the -- just a little bit more about how that kind of rebounds as you sort of suggested it might in the upcoming quarters.

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [5]

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Yes. So really, what happened is, as we added the second-look -- so we had Citizens and we had RICs. All of those were 0% financing. And the movement, if you didn't -- if you qualified for financing but didn't qualify for Citizens, it was very seamless moving into the RIC. As we rolled out the second-look provider, we tested this. We did the best right we could, but it was a change. And on some of the second-look accounts, we're charging interest now. And so the biggest change that actually happened was if we had Citizens and RICs this year the same way we did last year, we would be up quite a bit in accounts.

And so it was really a function of 2 things. One, just the changes and the channels having to figure out how to adjust to the changes with our second-look provider and interest, and even how it flowed from essentially a failed Citizens account into a RIC. So that was really one big driver. The other driver is we actually tightened our credit underwriting with everybody, with all of the accounts. And so what's happened is, as we put those changes into place, productivity was down. But essentially, we have really completely rebounded in the last, I would say, 60 days. It's been really good.

And so a big part of that is just kind of, as you can imagine, digesting something, right? It's the -- we call it the pig and the python. It's kind of going through. And once you kind of get it digested, the channels are able to adapt and they recover. The same thing happened -- we saw the same thing happen in 2017. And so we've actually already seen -- like July was really -- a really good month for us in those channels in terms of actually getting back to growth.

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Todd Cranston Morgan, Jefferies LLC, Fixed Income Research - Analyst [6]

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That's great. Two quick cash flow questions, if I could. The first one, I don't know if you mentioned, I apologize if I missed it, the upfront cash you collected at point-of-sale on a gross basis. And secondly, I don't know if you can talk more broadly just about the working capital trends. If I look at operating cash flow for the quarter, year-over-year, it was a little bit down despite EBITDA being up dramatically and so on. If you could talk about that dynamic.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [7]

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Sure. So our -- on a creation cost, we collected about $1,082 per account in Q2. That's -- is that last 12 months?

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [8]

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Yes.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [9]

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That's last 12 months, which netted us out at $1,064 on a net creation cost. So you could actually look at our gross creation cost being the 2 those added together. Last year, our net creation cost was $1,375, and we're up about $300 on collection year-over-year. Most of our cash, kind of cash used during a year, is due to adding new subs. If you were to decompose our cash flow on an annual basis and you look at our revenue less expenses, less service costs, we had positive cash flow. We go negative when we grow. And as we dropped our net creation cost from $1,375 to $1,064, as you mentioned, the use of cash this quarter or this last 6 months is better than it was the last periods. And so there's a -- our kind of stated objective coming into this year, and it's still with us, is that we would like to get to a point where we have a scale and the size of the business, the creation costs continuing to come down, and the way we make investments to get to 0 cash flow for -- in the next X amount of months. And so that's kind of our goal. And around (inaudible).

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Todd Cranston Morgan, Jefferies LLC, Fixed Income Research - Analyst [10]

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Great. Okay. Just a clarification. So in Q1 of 2019, March '19, you said you generated -- you received about $50 million in aggregate point-of-sale proceeds. I was trying to understand what that number might look like for Q2, if you have it.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [11]

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It's -- you (inaudible). Yes, we can get you that number. Probably the best thing to do is follow up with Dale, and he can walk you through that. I don't have it in front of me right now. Because we're on the last 12 months -- yes, we'll -- our creation cost -- our net creation cost is an LTM, and you're asking about a Q2 number in that quarter, and it has to be recalculated, but it can be.

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Operator [12]

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(Operator Instructions) Your next question comes from Greggory Price from Barclays.

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Greggory Price, Barclays Bank PLC, Research Division - Senior Analyst [13]

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First, on the -- I think on the last call, you might have mentioned some new pilots that you're testing out. Was -- I heard you saying that, that was the secular provider? Are there anything -- is there anything else going on that you might be able to update us on since the last call?

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [14]

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We do lots of pilots. And so was there anything in particular or specifically that you're asking about?

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Greggory Price, Barclays Bank PLC, Research Division - Senior Analyst [15]

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Oh, I guess, I think perhaps on the retail front?

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [16]

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Yes. So we definitely have some pilots going on there. And we made adjustments to the model on the retail front from kind of our learnings from Best Buy, where it's generating a lead in the store and then we're following up with the customer in their home and designing a system. We're having a lot of positive and good success in that and figuring out the best way to scale that. But we're still early on in kind of developing that channel.

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Greggory Price, Barclays Bank PLC, Research Division - Senior Analyst [17]

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Understood. And secondly, you mentioned this sponsor and potentially looking to address the 2020s. I guess to the extent that you can talk about it, can you kind of frame out any potential alternatives there that they might be looking at? Or any sort of time frame that we might be able to think about when we might hear something next?

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [18]

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Yes. So I think we can't really talk about the potential structure. You can probably guess what they all are. There's not an unlimited amount of options here. It's either refinancing debt, it's -- or raising some equity to pay debt down. And in terms of timing, I think we are actively -- very actively involved right now in working with various groups to take a look at what those options are. So I would say as soon as we can get something done, so it's definitely not something we're waiting on getting done.

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Greggory Price, Barclays Bank PLC, Research Division - Senior Analyst [19]

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I appreciate that. It's good to hear. And then just lastly for me, on customer capture, just wondering if you can kind of give any color there. And your experience with the attrition rate kind of ticking up, I realize there's some structural issues around that, that might just be specific to the current time period, but kind of what the trends have been there? That's it for me.

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [20]

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Yes. There's nothing structural. Our -- if you take a look at our static kind of pooled attrition curve, it's very similar to what it's always been. And so in terms of like any competitive pressure, we're just not seeing it out there in terms -- any different than -- certainly, we compete every day with lots of companies, but nothing's really changed for us.

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Operator [21]

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Your next question comes from Ed Tai with DSC.

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Edwin Tai;DSC Meridian Capital;Partner, [22]

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Yes. I had some questions around liquidity. I think in your press release, you guys have about $143 million left on the revolver. And I think the last 2 quarters, you drew about $134 million, and I know cash flow is going to improve in the second half, but it just seems like liquidity is a little bit tight here. Just wanted to see if there's any other sources of liquidity that you guys can reach for, asset sales or any other carve-outs that you can utilize.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [23]

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Well, we're where we thought we would be on cash flow. To your point, we -- our working capital is quite high during the summer as we kind of -- as we have inventory sitting on our books. And then we generate cash in the second half. So nothing unusual there. We don't -- we have never used anything else other than our revolver for short-term liquidity and don't have any plans to do that at this point. I think what Alex just talked about with regards to our capital structure, the $455 million which we have left on the 2020s is our first priority. And if you wanted to tack something on that, you could do that. And we would probably do that with a revolver. I think the second thing to keep in mind around all of this is that if you look at our -- and I talked a bit about this. If you look at our EBITDA numbers, we're actually getting to the point where we're delevering on a ratio basis quite nicely. As we grew EBITDA 17% year-over-year for the first half, that gives us more capacity. We think it gives us a better risk profile, and we'll continue to drive that.

So at this point, we don't have any plans to look at something other than recapping the debt, pushing down the leverage ratios, and as we just mentioned, one way or another on the $455 million for the 2020s and seeing if we can pull it together.

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Operator [24]

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Your next question comes from Marlane Pereiro with Bank of America.

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Marlane Pereiro, BofA Merrill Lynch, Research Division - Convertible Strategist [25]

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I was wondering if you still expect attrition to be at 13.1%, 13.2% by year-end. And if Q-o-Q, given it's such a heavy adds quarter, that this could be the peak of where we might see attrition for the year.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [26]

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We're looking at that right now. I think we would be comfortable saying that it'll be in the 13% range. But we add a lot of customers during the summer and each cohort we look at pretty exhaustively to see if there's any differences as we add those new customers this year. I don't -- we're not prepared to provide guidance for Q4 exit on attrition other than that it would be in that 13% range. And then as we go forward into 2020, all of us at the company and I believe our investors will look closely at the cohorts coming due from prior years, and you can kind of triangulate in on a forecast for the year on a cohort basis.

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Marlane Pereiro, BofA Merrill Lynch, Research Division - Convertible Strategist [27]

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Great. And then my second question is, can you confirm or give an idea of what your secured capacity is currently? I know you have that 4x leverage ratio, but just curious about the baskets and that type of thing.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [28]

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Yes, they're all out there on -- all the bond indentures and covenants are out there. And [RIC] -- yes, we know that. Probably the best thing to do is get with Dale again offline. I'm not going to walk you through the various requirements, buckets, carve-outs and those types of things to cover the capacity that we do have at this point on both the secured and unsecured basis.

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Operator [29]

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There are no further questions queued up at this time. I'll turn the call back over to Alex Dunn.

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Alexander J. Dunn, APX Group Holdings, Inc. - President & Director [30]

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Thank you for joining the call today. We appreciate you taking the time.

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Mark J. Davies, APX Group Holdings, Inc. - CFO [31]

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Thanks.

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Operator [32]

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This concludes today's conference call. You may now disconnect.