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Edited Transcript of VVNT.N earnings conference call or presentation 7-May-20 9:30pm GMT

Q1 2020 Vivint Smart Home Inc Earnings Call

May 9, 2020 (Thomson StreetEvents) -- Edited Transcript of Vivint Smart Home Inc earnings conference call or presentation Thursday, May 7, 2020 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Dale R. Gerard

APX Group Holdings, Inc. - CFO

* Nate Stubbs

APX Group Holdings, Inc. - VP of IR

* Scott R. Hardy

APX Group Holdings, Inc. - COO

* Todd R. Pedersen

APX Group Holdings, Inc. - Co-Founder, CEO & Director

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Conference Call Participants

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* Edward Paul Mally

Imperial Capital, LLC, Research Division - MD & Head of Institutional Research

* Kunal Madhukar

Deutsche Bank AG, Research Division - Research Associate

* Michael Fisher

Evercore ISI Institutional Equities, Research Division - Research Analyst

* Roderick B. Hall

Goldman Sachs Group Inc., Research Division - MD

* Shweta R. Khajuria

RBC Capital Markets, Research Division - Assistant VP

* Todd Cranston Morgan

Jefferies LLC, Fixed Income Research - Analyst

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Presentation

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Operator [1]

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Welcome to the Vivint Smart Home First Quarter 2020 Earnings Call. (Operator Instructions)

I would now like to hand the conference over to your speaker today, Nate Stubbs, VP, Investor Relations. Thank you. Please go ahead, sir.

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Nate Stubbs, APX Group Holdings, Inc. - VP of IR [2]

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Good afternoon, everyone. Thank you for joining us this afternoon to discuss the results of Vivint Smart Home and APX Group Holdings for the 3-month period ended March 31, 2020.

On today's call, we will be presenting the results for Vivint Smart Home. In the press release we issued today as well as the accompanying presentation, we also provide tables with reconciliations for the results of APX Group Holdings.

Joining me on the conference call this afternoon are Todd Pedersen, Vivint Smart Home's Chief Executive Officer; Dale R. Gerard, Vivint's CFO; and Scott Hardy, Vivint's COO.

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 our annual report on Form 10-K for the fiscal year ended December 31, 2019, and in our quarterly report on Form 10-Q for the quarterly period ended March 31, 2020, as 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 will also refer to certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures for historical periods to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings release and accompanying presentation which are available on the Investor Relations section of our website or on the financial information page of the Investor Relations portion of our website.

I will now turn the call over to Todd.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [3]

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Thanks, Nate, and good afternoon to everyone joining the call.

I hope everyone is staying safe in the current environment. And today, we will cover 3 main topics: discuss our financial and operating results for the first quarter, review our customer engagement and the performance of our platform during this difficult time, and highlight key elements of our business and actions we've taken that give us confidence in our performance for the remainder of 2020 and beyond.

We've had a great start to 2020, and we are pleased to see significant improvements in our key metrics year-over-year. Revenue in total subscribers continue to grow, and EBITDA margins continue to expand despite the challenges related to the current environment. Dale will provide more specifics on the financials during his remarks as well as share updated thoughts about our full year 2020 performance.

The remainder of my commentary will focus on the Vivint Smart Home story in the context of COVID-19. Why our customers value our services even more during difficult and uncertain times like these, why we think our financial model is built to withstand the current environment, what proactive operational measures we have taken to protect our employees, our customers and our business and how we plan to get back up to speed with our direct owned sales teams.

Our services qualify is essential under the guidelines issued by the U.S. Department of Homeland Security. In a time when we're asked to stay at home for an extended period, there's no better time to have a comprehensive smart home system. Vivint Smart Home provides essential services to nearly 1.6 million customers across North America. Vivint services include life-saving and life-protecting 24/7 professional monitoring for emergency situations such as medical, fire, carbon monoxide and burglary alerts. Our vertically integrated model includes dedicated customer care and monitoring teams to ensure that we respond to these alerts from our customers within seconds. Our cloud platform and proprietary technology also allows customers to seamlessly manage and protect their homes, whether they're sheltering in place or away. Vivint takes care of our customers and their families while providing the peace of mind that people demand during times of heightened awareness, anxiety, crime and uncertainty.

We've been securing and creating smart homes for over 20 years. So I can tell you from experience that Vivint has a history of exhibiting strength and resiliency through challenging economic times. For example, we only witnessed a slight increase in customer attrition in 2008 and 2009 during the global financial crisis. Although the current pandemic poses a unique set of societal problems compared to then, we are confident that our customers will continue to value home security and smart home technology. In fact, a case can be made for pent-up demand forming as a result of this crisis.

We have long believed the total addressable market for smart home presents a massive opportunity, and in the not-so-distant future, the vast majority of the 150 million homes in North America will be running on a comprehensive smart home operating system. We believe Vivint is the best-positioned provider to take advantage should demand accelerate in this way. We are confident in our value proposition because it has been proven over 2 decades.

Today, we have over 21 million connected devices on the Vivint Smart Home proprietary cloud-based platform, and we are uniquely qualified to help our customers deal with the current environment across the various smart home devices we support. From door locks, cameras, security monitoring, thermostats, lighting controls, smart speakers and many other connected devices. All of these innovative products are designed to work together seamlessly through our elegant platform that homeowners can control from their in-home touchscreen hub, through a single app on their phone or other devices or by simply using their voice. Even prior to the current health and economic crisis, we already had the industry-leading engagement on our smart home operating system, with over 13 interactions a day on average and over 1.4 billion daily events being processed on our cloud platform.

During the current pandemic, our platform has continued to seamlessly handle all daily interactions as our customers have relied even more on their smart home systems for various and often evolving use cases. Some of these use cases are very intuitive, such as our next-generation doorbell camera that intelligently detects packages and actively helps protect them from porch pirates. With more than 1 million packages that are still on -- go missing from porches every day, our newest doorbell camera helps provide homeowners with peace of mind by helping to prevent crime before it happens. Other use cases have become increasingly important while we've been sheltering in place, such as using indoor smart cameras to keep a watchful eye on elderly parents while social distancing or to make sure kids are doing their homework during the sudden era of distance learning. Customers are relying even more on smart smoke detectors as more home cooking takes place. And they are recognizing the value of our AI-powered outdoor cameras that recognizes potential lurkers and can sound an alert to scare way potential thieves. Whatever it may be, our customers have been more reliant on the various smart devices that we professionally installed for them in these ways and more. And they continue to lean on our nationwide team of dedicated smart home employees for a more urgent interaction such as real-time security monitoring or to get help in the event of medical emergency. The bottom line is that frequent engagement in the Vivint system is a very good indicator for us, and it's happening across our customer base during this pandemic.

Although our value proposition is clear and we fully expect that our current customers will continue to make the most of what their Vivint system offers them, we also acknowledge that our ability to capitalize on any near-term demand for new smart home systems is limited, particularly in light of state sheltering in place, coupled with our own decision to pause all direct-to-home sales in mid-March. Overall uncertainty at the macro level remains at historic highs, and we are closely monitoring how that continues to impact the credit markets and unemployment rates.

There are very real risks that the world could be hit with additional waves of the virus, causing more social and economic disruption before a reliable vaccine is ready for widespread use. Fortunately, we benefit from a highly predictable and recurring revenue model, in which roughly 90% of our expected revenue for 2020 was under contract at the beginning of the year. Vivint has also implemented a number of operational changes and safety procedures to continue to protect the health and well-being of our employees while still providing the exceptional service levels our customers have come to rely on. All of these considerations give us great confidence in our ability to weather the current economic environment.

To give you a sense for the actions we've taken, we have transitioned our highly nimble workforce, including all corporate employees and more than 1,500 of our customer care professionals, to effective work-from-home environments, where they continue to provide uninterrupted customer service and maintain our high-quality standards. We are maintaining our geographically dispersed central monitoring stations to provide 24/7 professional monitoring services for all emergencies.

Furthermore, we are now conducting daily fitness-for-duty assessments for all customer-facing employees, which includes a temperature and symptoms check. We are contacting customers before a visit to determine if anyone in the home is experiencing signs of illness or has been exposed to COVID-19, and rescheduling appointments when necessary. We are closely following CDC guidelines for social distancing and hand-washing, including cleaning workspaces and surfaces and not shaking hands with customers. And of course, we're using protective sanitary equipment during service visits such as disposable gloves, masks and hand sanitizer.

We have implemented detailed business continuity plans intended to ensure the health, safety and well-being of our customers, employees and communities, and to protect the financial and operational strength of the company. Dale has more of the details that he'll share during his remarks around these efforts. But rest assured that we're remaining judicious around overhead spend, budgets, projects and everything else related to our goal of getting to cash flow neutral. That philosophy has not changed as a result of the pandemic, and we are tracking ahead of our previously stated timeline of 18 to 24 months.

Moving now to our plans to resume direct-to-home sales, which account for about 50% of our new subscriber adds. Our sales teams are ready to hit the ground running, and they have received extensive training on proper interactions with customers in light of the current environment. The key gating factor is that we must follow individual state guidelines in ramping our sales teams across the country. At this point, many states have reopened, and we estimate that our direct-to-home sales teams are operating at about 70% of their full capacity. In time and assuming no further major setbacks from COVID-19, we're optimistic that the upcoming summer sales period will proceed.

While all of this is happening, our priority remains to take all appropriate steps to protect the health, well-being of our employees and customers. Our other sales channel, national inside sales, which onboards nearly half of all new accounts in a normal environment, has continued to operate without material interruption throughout the pandemic. While we anticipate eventually reaching a full deployment of our direct-to-home sales channel in the U.S. over the next few weeks, in Canada, because of the lack of consumer financing options and that each account sold there historically has required a significant cash investment by the company, Vivint will no longer originate new customers through the direct-to-home channel. We will continue to sell smart homes through our national inside sales channel. Furthermore, we remain committed to our customers in Canada, and we'll continue to operate there with dedicated support and services.

We anticipate that funding the vast majority of our new customers via the Vivint Flex Pay program will continue to be a key driver in our strategy of profitable subscriber growth. Our external customer financing partners have expressed their commitment to maintaining their current underwriting standards of new smart home customers through the current economic downturn. We believe that we are widening our lead over the competition in enabling customers to easily finance a full smart home experience while also dramatically improving Vivint's unit economics and the company's cash flow dynamics.

I will now turn the call over to Dale to go through specifics of our first quarter results as well as to provide our updated thoughts on the remainder of fiscal 2020.

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [4]

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Thanks, Todd. I'll walk through the financial slide portion of the presentation that we posted today in conjunction with our earnings release.

On Slide 8, we highlight our revenue, adjusted EBITDA and covenant adjusted EBITDA for the quarter. For first quarter 2020, revenue grew by 9.8% to $303.2 million. The growth in revenue is attributable to a 7.1% increase in total subscribers as well as a 2.3% increase in the average monthly revenue per user. In the center of Slide 8, adjusted EBITDA has scaled nicely for the first quarter. The primary drivers were lower net service costs and continued scaling of our general and administrative expenses. For the quarter, we are proud to have scaled adjusted EBITDA margins by 570 basis points to 44.5% of revenue compared to 38.8% in the first quarter of 2019.

Meanwhile, covenant adjusted EBITDA, which is a calculation used for our debt covenants, scaled by 840 basis points to 62.6% of revenue compared to 54.2% in the first quarter of 2019.

As you look on Slide 9, we highlight a few data points for the subscriber portfolio, which were strong across the board. Total subscribers at quarter-end grew from 1.45 million to 1.55 million or 7.1%. Average monthly revenue per user, or AMRU, also increased to $65.27, up 2.3% year-over-year. AMRU has been moving up nicely due to recognition of deferred revenue and effective cross-selling of new products, such as our newest generation of outdoor and doorbell cameras.

On the next slide, Slide 10, we highlight a few points on new subscribers. New subscriber originations were 50,053 for the first quarter, which is strong considering that direct-to-home sales were paused in mid-March. We continue to refine and improve the underwriting requirements of our business, decreasing the number of retail installment contracts or RICs. We saw favorable year-over-year trends in subscriber financing mix during the first quarter, highlighted by a 53% reduction in the number of subscribers financed through retail installment contracts. By shifting a greater proportion of our subscribers away from RICs and towards our third-party financing partners and pay in full, we are able to reduce our net subscriber acquisition cost and improve our cash flow dynamics. As we look to the future, we will be focused on delivering a true smart home experience to millions of homes in a profitable and cash neutral way.

Moving to Slide 11, we will cover our net service cost per subscriber and net subscriber acquisition cost per new subscriber. The reduction in net service cost continued to be a significant driver of our earnings improvement during the first quarter of 2020. We continued our trend of year-over-year improvements in net service cost per subscriber, moving from $17.04 in the first quarter of 2018 to $13.83 in the first quarter of 2019, and now to $11.76 in the most recent quarter, a $5.28 improvement versus 2018. This represents the lowest service cost per subscriber in the last 5 years by a significant margin and demonstrates the advantage of Vivint's vertically integrated smart home cloud platform, which encompasses the software, the hardware, the installation and ongoing customer support.

As we continue to make improvements in all of these areas, we're seeing continued positive trends in both the cost of service and customer satisfaction. The result is that our net service margin continued its increasing trend, moving from 68.6% in the first quarter of 2018 to 74% in the first quarter of 2019 and now to 77% in the most recent quarter. These efforts largely explain the improvement seen in our adjusted EBITDA.

On the right-hand side of Slide 11, we highlight our average net subscriber acquisition cost in the last 12-month period. For the first quarter ended March 31, 2020, net subscriber acquisition cost per new subscriber decreased to $960. That's 16% lower year-over-year as we continue to drive down the number of new subscribers that are financed on a Vivint retail installment contract and shift to a higher mix of customers utilizing our financing partners or paying in full for the purchase of their smart home products.

During the quarter, we also benefited from pricing leverage on the point-of-sale purchase and installation of equipment. Before the recent pandemic hit, we had already put in place a number of cost-reduction initiatives that were completed during the first quarter and that are expected to meaningfully reduce G&A and overhead costs by streamlining operations, focusing engineering and innovation and driving better customer satisfaction. In addition to these actions and because analyzing how we can operate more efficiently is a continuous exercise of Vivint, we initiated another round of cost-cutting post COVID-19 to further reduce our discretionary spend.

Slide 12 covers the lifetime value of our customers and the benefits of a reoccurring revenue model. In the last 12 months, we've added approximately $1.75 billion of lifetime value. We continue to see nice backlog numbers, which, as a reminder, represent revenue adjusted for attrition that we expect to recognize over the lifetime of a customer. Backlog at quarter end was $5.73 billion, up 9% compared to $5.24 billion a year ago.

Slide 13 depicts our typical subscriber walk that illustrates the changes in total subscribers at quarter end. As expected, our attrition has trended higher than our historical averages given the higher percentage of customers that are in the end of term lifecycle phase.

Our attrition dynamics are driven by 2 primary factors. First, the rate of attrition for a customer cohort changes as it progresses through different phases of the life cycle. We define these phases as interim, end of term and post initial term. Each phase carries with it a corresponding expected attrition rate, with attrition at its highest during the end-of-term phase. As we have shared in past earnings calls, the cohort attrition curves remain fairly steady. The second factor that affects attrition is the percent of total customers in each stage of the life cycle. The percent of customers in the end-of-term phase rose in 2019 and will stay elevated in 2020 before falling again in 2021.

In the first quarter, attrition trended slightly higher sequentially by 20 basis points to 14.1%. This remains higher than our long-term trend for attrition, but is in line with our expectations given the higher percentage of customers that are in the end-of-term phase.

Now we know there's a lot of curiosity out there regarding how we think our attrition curve may change as a result of the pandemic. Echoing Todd's commentary about our past experiences through severe economic downturns as well as propensity for customers to focus inward and prioritize home security during times of crisis, at this point, we have no reason to think the same structural curve that we've discussed previously won't continue to hold, with a life cycle impact that I spoke about being the primary driver. As a case in point, our portfolio has performed slightly better than expectations in terms of attrition and other leading indicators through the end of April.

That's a good segue into Slide 14, where we address our business activity in the interim period since our first quarter ended in March. The key takeaway on the sales front is that we continue to see robust demand for our products and services, and we have continued to acquire new Vivint Smart Home customers, primarily via our national inside sales team, despite the challenges posed by COVID-19.

On the cost side of the equation, we have curtailed discretionary spending to preserve cash and improve our highly variable cost structure. And as a result of these actions, some of which were initiated as normal course prior to COVID-19, we have achieved greater than $30 million in annualized fixed cost reductions. We have also fully drawn down on our revolving credit facility as a precautionary measure to increase our cash position, which stood at $305 million as of April 30, and preserved liquidity and flexibility in light of current uncertainty in the global financial markets resulting from the COVID-19 pandemic. Overall, we remain on track to achieve our goals regarding cash use and are aiming to get to cash flow neutral ahead of our previously stated 18- to 24-month time frame.

Finally, moving to our financial outlook for the year on Slide 15. I'll first share some of the fundamental characteristics of our financial model. Over 95% of our revenue is reoccurring, which provides long-term visibility and predictability to our business. Most of our new subscribers that finance their smart home systems choose to enter into 5-year contracts and remain on the platform for approximately 8 years driving significant lifetime margin dollars. Our strong unit economics and scale has contributed to our ability to drive significant adjusted EBITDA improvement. That said, most companies have been impacted by the COVID-19 pandemic. And although we believe our reoccurring model makes us resilient to the full impact of the pandemic, it will affect our outcome for the year.

In terms of revised guidance, we expect to end 2020 with 1.55 million to 1.62 million total subscribers. Our estimate for 2020 revenue is $1.2 billion to $1.25 billion versus previous guidance of $1.25 billion to $1.29 billion. And finally, we are reaffirming our previous 2020 adjusted EBITDA guidance of between $525 million and $535 million.

Operator, please open the line for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Rod Hall with Goldman Sachs.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [2]

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And nice job here in the midst of this turmoil. I wanted to -- I guess I wanted to start with the subs growth guidance. You reduced that growth expectation by quite a bit in percentage terms, not by much in terms of absolute number of subs, but I wonder what assumptions you're making on distribution there. Are you thinking that all of the distribution now, from now until the end of the year is going to be from inside sales? Or do you think at some point, you'll be able to get back out again? Or just what kind of assumption is built into that in terms of selling motion?

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [3]

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This is Todd Pedersen speaking. Thanks for the compliment, by the way, on the quarter, we were super happy with it.

So it is -- it's a result of our direct-to-home program being put on pause, which was about mid-March. Obviously, like anyone else, we're trying to be respectful around the states being shut down. And here's the update on that. We've -- we have relaunched that program. We are -- by this weekend, we feel like we'll be about 70% of what we normally would be from a sales rep perspective. There are still states that are not open to do business on the door-to-door program. We kind of -- we're making some adjustments on where they might change as far as markets go. So that -- so the number of subscribers is a result of that. The thing I would say, though, is the places that we have deployed. And it's early, still, but the receptivity and the per-rep average, if we look at it on a daily basis on a per-rep basis is very strong.

So we're trying to -- we're optimistic because we are having great interactions with consumers. We've adjusted the process on how we sell in the neighborhoods and not going in people's homes if they don't feel comfortable with that. And trying to kind of practice social distancing, but we're optimistic by trying to make sure that we're conservative on the projection side.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [4]

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Okay. Yes, that's great. Because I figured maybe people will just -- even though the sales force is operating, people wouldn't want them in their house and things like that, so that's good.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [5]

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It's actually just -- I want to be clear on this. They've -- it's been amazing how welcoming people are. Again, we're wearing masks, gloves, keeping our distance. They can actually e-sign to a cell phone or a tablet, so not to interact directly with the customer, not to go into their homes, but the productivity per rep is really good. So the receptivity from consumers and the demands for our product and services at this time is quite amazing. So...

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [6]

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Okay. Thanks, Todd. And then if I can follow-up on that. I -- your guidance now still implies EBITDA margin at least that's improving this year over last. And I see the big improvement in net service cost per sub, which seems like it's driving the nice margin improvement. Are you guys assuming that -- I guess you're assuming that can continue along through the year, is that correct? Are we interpreting that the right way, the guidance?

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Scott R. Hardy, APX Group Holdings, Inc. - COO [7]

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Yes, Rod, this is Scott. As we've shared, we continue to see impressive gains on service costs, and that's a function of the vertically integrated business model that Todd talked about, having the integrated software platform, the hardware, the diagnostic tools, controlling the installation process, that's really helped us drive some significant improvements, both on the cost side and, importantly, on the customer satisfaction side.

That said, historically, our service costs have been seasonally lower in Q1. Our service costs tend to be highest in the early months of a customer's life cycle. So given the seasonality of how we generally put new customers on, particularly in the summer, we tend to see service costs increase in the back half of the year. So while we're really encouraged by the current trends on service costs and the Q1 results, we wouldn't anticipate a sustained full year results at that level.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [8]

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I want to add something to that. This is -- it's super important to cite this. We've been reporting publicly for about 7 years now. And if people go back a few years back -- and again, without public shareholders, we had debt holders. Our service costs several years back was north of $18 per subscriber per month, which, by the way, the business still worked at that level. But the -- our decision to build out and own a proprietary technology stack, the operating system, the firmware, the hardware, the hardware development, again, like Scott mentioned, the diagnostic tools, this is an incredible and important moat we've created and the capability that we have as a company to continue to enhance and tweak these -- all of these functions of business to continue to improve the service cost. But really, really important is the delivery of the products and the service to customers. So customer satisfaction is way up. This is not we reduce cost and our service levels are worse, this is our service levels are as good as they've ever been. So we're incredibly pleased with these results. Scott is being a bit modest.

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Roderick B. Hall, Goldman Sachs Group Inc., Research Division - MD [9]

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I was just curious what drives that EBITDA margin expansion then in the guide. Is it something else or is it probably service cost?

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [10]

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So this is Dale. So it's going to be some service costs for sure, Rod. And then I think as we said in the prepared remarks, we've done a lot of going through our cost structure, we had taking out costs, so we feel really good about -- we'll see that in the back half of the year. We did a lot of that in the first quarter, some of that early April. And so that $30 million we talked about, we'll see -- on an annualized basis, we'll see some of that throughout the next 9 months or 8 months of 2020. So it's really kind of holding the -- seeing the revenue come in, in terms of the subscribers and then servicing costs and then taking that out of cost. And it's not only on the G&A and the service side, but we also took out overhead costs. And I think you saw that in the fact that our net subscriber cost was $960. Some of that is upfront, but we're also attacking expense overhead within the sales process.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [11]

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Look, there is the reality. We have -- we're now starting to get the benefit of all the investments we've made in the technology stack, and we're getting operational efficiencies there. But even from a corporate side, because of the tools and technologies and our ability to deliver, and we're able to bring back some of those costs and get operational efficiencies from a corporate perspective also. So we're super pleased with all of this. And this is all -- this process, and you all noticed, we started this before COVID hit, so this is just a continuation of what we're already focused on.

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Operator [12]

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Your next question comes from the line of Amit Daryanani with Evercore.

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Michael Fisher, Evercore ISI Institutional Equities, Research Division - Research Analyst [13]

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This is Michael Fisher on for Amit. I wanted to get into -- you mentioned the cash flow-neutral target is tracking ahead of the initial 18 to 24 months. Can you talk about maybe any of the drivers or what's kind of shifted since you initially put that target out that's maybe enabling some upside?

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [14]

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Yes. So there's -- it's multiple fronts. Obviously, the net subscriber acquisition cost is something that we focused on. You've seen a gain there. You're going to see continued improvement there. We've -- I think we show a reduction in RICs from last year to this year of about 50%. You're going to see that improve. In fact, it's going to be one of the biggest gains that you'll see from the company. So really important. We're trying to make sure that we're financing these product sales off-balance sheet.

We -- and again, mentioned that we're now not onboarding new customers from the direct-to-home side in Canada, which we -- we have never found a partner to provide the consumer financing. So those subscribers were all again on-boarded on balance sheet. They were great subscribers, great credit scores, but there was a large amount of cash usage. We are still servicing the customer base up there, and they are our customers, but the exchange rate and the lack of consumer financing available there, we've chosen to halt that. Now we are still onboarding customers that call in and/or are referred into the company, so we have full capability of installation and service up there.

And then just a plan of production in expenses and cost and reducing some budgets and eliminating projects here and there. So we're just really fine-tuning the way we operate this business. We intend, just so everyone knows, to take some of those savings, cash savings, and start to focus on growing and building the brand, telling the story. We have an incredible story to tell. We have an incredible technology and service that we can deliver to consumers, which is in very high demand right now, especially in this period of time. And just the quality of product and the design and the delivery of the services has now come to a point where like, okay, it's time to really focus on growing this business as we take advantage of this large market that we're part of.

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Michael Fisher, Evercore ISI Institutional Equities, Research Division - Research Analyst [15]

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Okay. And then just to dig a little bit on the permanent fixed cost savings of $30 million, is that mostly -- again, is that service cost savings as well flowing through? Or the drivers there? And then the $20 million in restructuring expense, is that part of the initiative to generate the cost savings?

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [16]

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Yes. So we'll kind of break those down. The $20 million really relates around the changes in personnel and cost reductions that we did at the beginning of March. So we kind of -- we'd actually talked about on the fourth quarter call from 2019 and put out, and so that's really what is included in that restructuring charge there. It's -- some of it's severance and most of -- half of it or so is related to stock-based comp, which was -- as we -- those people left and their equity -- kind of their treatment of their equity changed. And then the other cost -- as Todd said, we really focused on cost, whether it's in servicing. And again, really focusing on overhead and making sure that we have the right infrastructure, the right cost structure and that we're spending money in the areas that really provide either servicing customers or they're providing growth. And so as we think about service, how do we think about our leadership, our structure there, level -- kind of tiers, leaders in the field, people that are in the corporate -- on the servicing side. And then on the G&A -- and innovation, the same thing. It's like, hey, there's a lots of products and lots of different things we can go do, but let's focus in on what we really think the customers want that can drive that kind of next-gen of products.

And so it's really across all areas of the company. It's not just one area. And we've actually -- I would say for 2020, we've actually taken actions that are greater than the $30 million, but some of those will -- that will come back most likely in 2021, such as -- not -- we've discontinued any type of merit increases for '20. We've actually stopped matching the 401(k). So we've taken some actions. Again, we want to be ahead of it. We think that -- and we've done a lot of these in early April to make sure that we're in a good position to weather any kind of storm that comes at us here. But some of those will come back next year. But the $30 million is what we think of permanently is not coming back in the budgets and different things that we've been doing.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [17]

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And the $30 million, to be clear, is not part of the service cost reduction. It's separate.

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [18]

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Yes.

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Scott R. Hardy, APX Group Holdings, Inc. - COO [19]

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So you'll see some of it in the subscriber acquisition cost and a lot of it in the G&A.

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Operator [20]

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Your next question comes from the line of Edward Mally with Imperial Capital.

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Edward Paul Mally, Imperial Capital, LLC, Research Division - MD & Head of Institutional Research [21]

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Just to go back to the attrition trends, away from where you are in the customer contract life cycle, have you seen over the last couple of months any changes in those trends with reduced relocations, for example, or changes in the drivers of attrition? That's my first question.

And then second question, just to clarify on the revolver draw. You noted that it was fully drawn with $305 million of cash on the balance sheet at the end of April. Does the $305 million represent the full revolver draw or was it a higher amount drawn on the revolver?

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Scott R. Hardy, APX Group Holdings, Inc. - COO [22]

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Thanks, Edward. This is Scott. I'll tackle the attrition question and then turn it over to Dale to address the question about the revolver draw.

On attrition, certainly given the economic impact of the COVID virus, this is something that we're paying very close attention to. We're monitoring consumer credit and unemployment trends and candidly feel fortunate that we have a majority of our customer base that consists of homeowners that have a credit score of over 700.

So as Dale shared, our Q1 attrition was in line with expectations, slightly better than what we've planned. It reflects really the value that we think consumers see in the services we're providing, particularly in times of uncertainty like this. Q1 was up over Q4 by about 20 basis points. That's a function of, as we've shared in the past, cohort-level attrition and then the percent of customers that are coming out of term. That percent has been going up. But overall, we're actually performing slightly better than we would have expected in Q1.

Todd shared, and I think Dale did as well, we have a history of strength and resiliency during economic downturns. We saw that in 2008 and 2009, and through April and even the first week of May. And we're seeing indicators in terms of notices of cancellation in terms of number of customers that are going into our collection process that are tracking normal and in line with our expectations, which suggests an ongoing resiliency of the business model.

We've always had a forbearance program for customers that are in some form of financial distress, and that's where we will defer payment for a period of months and then extend their contract by a meaningful amount. We did see during the last 6 weeks, a modest and temporary increase in the number of customers that we are proactively calling in and asking for payment forbearance. That peaked really in late March and early April. But as of last week, the number of customers asking for forbearance was coming back into line with our historical run rates. Overall, during that period, it's well under 1% of our customer base that has done that. So we're feeling, at this point, that there's no real change to how we're seeing attrition for 2020.

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [23]

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Thanks, Scott. And then in terms of the revolver. So the revolving credit facility, we get the -- amended that in mid-February when we did some refinancing efforts. So the revolver has a total capacity of $350 million. Less LCs, there's about $334 million that's outstanding that we've drawn. And we have $305 million in cash as of April 30. And thankfully, today, we're still sitting on about $305 million of cash. So we really brought that revolver down.

I mean, I was around, when last time there was these kind of disruptions in the market, so we brought that down as really -- in case there was some disruption in the financial markets. And we could -- we're able -- and we didn't need it to draw it. We weren't able to, so we -- in the abundance of consciousness, we drew down on that revolver, again, as sitting in cash on our balance sheet. And like I said, we drew down -- total revolver outstanding drawdowns is $334 million and we're sitting on $300 million in cash, which you'll see when the Q comes out that we used about $30 million in operating cash flow for the first quarter.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [24]

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And again, I think this was asked earlier, but we have given projections of getting cash flow neutral in 18 to 24 months. We are incredibly focused on trying to accomplish cash flow neutrality this year. There are factors that still remain with can we roll out our entire program? Will it last? Do states get shut back down? But what I would say is, it's our primary factor. I think just through some of the numbers Dale's thrown out now, we're doing substantially better than last year and are pleased with where we're sitting right now, and I think we'll do a good job towards getting near that level this year.

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Operator [25]

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(Operator Instructions) Your next question comes from the line of Shweta Khajuria with RBC Capital Markets.

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Shweta R. Khajuria, RBC Capital Markets, Research Division - Assistant VP [26]

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Going back to the resiliency of the business model. Could you please talk about potentially worst-case scenarios should the economy enter into a deeper recession worse than, let's say, 2008, 2009? The beauty of subscription model is that it provides great resiliency, and the average life of the subscriber here is pretty long. So could you please talk about how you think about the worst-case scenario And the resiliency of the business model?

And then the second question is on the strength in overall e-commerce, so how -- have you changed? And I'm sorry if you covered this already, but have you changed the strategic sort of focus towards the strength in e-commerce and that as a channel, given that in the in-person sales channel is paused for now?

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [27]

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Sure. Thanks for the questions. I'm going to answer the first part of that.

So knowing that unemployment rates are continuing to rise, we do understand that there's risk to some of our subscribers losing their jobs, not having the ability to pay as of yet. And I think we're kind of in the middle of it, but not at the end of it. We have not -- if you're hearing our numbers here, we are not -- we have not yet been affected by that. In fact, we've seen slight improvements on all of the metrics in our business. And this is a product and service that provides safety and peace of mind. And with -- and this is really important. With the differentiation, with the platform that we've developed with camera technology and the software we have around our doorbell camera and packaged theft-detection deterrents, our outdoor cameras with the lurker alerts, just enhancing what we deliver, the demand is higher, whether it be someone who doesn't have anything at this point or that does have our services. And so it doesn't mean that we're completely protected from a continued downside scenario from a macroeconomic perspective, but we're in a very good position compared to most companies and most industries.

We're deemed an essential service from states for a reason. It's essential to customers. And really, depending on what their circumstances are with family or be it pets or children or elderly parents that need to be cared and provided for and watched over. So we were -- in fact, we're very proud of the fact that we deliver such incredible services, especially nowadays.

But from a company perspective, here's what I would say, we've taken a lot of time and been very surgical about looking at additional potential downsides and continued economic downturn, how we manage the business, how we manage costs in the field and otherwise, how we spend, budgets, prioritization of projects that we have. There are things that we can pull back on more. There's obviously overhead that can be either reallocated or readjusted to adjust to the current economic environment. So I would say we -- this management team has a very organized and detailed and structured plan in the event that the economic downturn worsens and starts to affect us. And that will either be through attrition or lack of demand from the consumers, which we're not seeing any -- either of those at this point. It doesn't mean that we can't or won't, but at this point we have not seen that. Again, Scott mentioned a slight increase in the deferment program -- or deferral program, but that's back in line. It was slight and momentary. So we're -- again, we're watching on a daily basis every important metric that there is that you can watch in that regard. So...

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Scott R. Hardy, APX Group Holdings, Inc. - COO [28]

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Yes, from an e-commerce perspective, Shweta, certainly our 2 primary go-to-market channels are direct-to-home and inside sales, and we are testing and constantly piloting other forms of channel distribution to get to market. E-commerce is one of those. I think, certainly, we'll see a continued trend accelerated by the COVID virus towards the e-commerce. And so that's an area we continue to test into, to evaluate. It's not really built into our forecast at this point, and so it's all upside for us as we're able to find the right bit and drive acquisition through those types of channels.

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Operator [29]

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Our next question comes from the line of Kunal Madhukar with Deutsche Bank.

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Kunal Madhukar, Deutsche Bank AG, Research Division - Research Associate [30]

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A couple, if I may. One, with regard to the guide, especially on like subscriber gross adds. What are the assumptions that are going into the guide, especially in terms of how much do you think the direct-to-home can kind of get? How much do you think the national inside sales can kind of get? And how does that change -- and especially in light of -- we may be headed into a new normal, which we don't even know what it could look like. And so what happens if we have to be in a social distancing kind of an environment for the rest of the year?

And then with regard to the financing on the upfront equipment, maybe you haven't seen it until now, maybe credit is still easy. What happens in an environment where credit becomes tougher? And do you think -- how do you think that could potentially impact the subscriber growth for the rest of the year?

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [31]

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Yes. So on the first part of the question -- this is Todd. We don't break out the numbers to the specific channels, but this is what I would tell you. From an inside sales perspective, demand has been up over kind of our expected run rate in that channel. We -- obviously, we mentioned we've put on pause the direct-to-home program. Not all of the states -- as you all know, not all of the states are open for any type of business, let alone someone going into neighborhoods and into homes. We've made -- well, what I can say is this. In the markets that we're in, in the states that are opened up, productivity per sales rep is up, which again speaks to the demand and the interest that people have in the services that we deliver -- we do deliver.

And from a social distancing perspective, we've adjusted -- from an engagement perspective, social distancing perspective. And then also tools perspective, we've changed how we interact and engage with the consumer if needs be. In fact, some customers, we will not engage them directly. We will keep our social distance, and they will ask why won't we enter their home? But we are not entering homes unless people ask us to. And we obviously have done the physical checks on our sales force and our installation force every morning, making sure they have no signs of the virus, and then also asking the appropriate question to the family or home owner that we're entering into.

But even with the change in environment and how we engage with consumers, which also includes the ability to do video -- we've all learned this. The ability to do a sales call over video, we have that capability, too, now like anyone else does in this situation. We've adjusted, and the performance is very good.

Now the question would be, and this is the -- we pulled back on our gross subscriber adds because we did pause the direct-to-home program and there are states that still are not open yet. So that would be the difference in the number. But as far as productivity goes and engagement goes -- and if this is the new norm, we're okay with that because we can accomplish what we need to accomplish with -- just keep -- continue to have social distancing and that type of thing. So we feel very confident in that regard. On the credit side, Dale is going to talk about that.

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [32]

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Yes. Just one more. So I think, again, we don't give out guidance in terms of by channel, but I think what you could take Todd's -- what Todd's saying is on the direct-to-home, whatever you have in your model for the full year, assume that we don't have very much for April because that channel was paused. That was pause kind of mid-March. So you could kind of say from mid-March until right now we're just starting to ramp back up. And as Todd said, we're probably about 70% of where we would normally be at this point in terms of reps out on the doors. So if you can kind of think through that as you remodel that.

In terms of financing, again, we stay in very, very close contact with our 2 consumer financing partners. We have a primary and a secondary financing partner. We've not seen anything at this point. It's something -- it's one of those metrics, I guess, as Todd said, we watch every day and every morning. Early in the morning I get the report and I look at those to see what was the -- what declines were we seeing yesterday, what were the reasons for declines on financing, what approval rates were, all the different things by channel. And so again, we're in contact with these partners. They're very committed to the program. They still are open for business and looking to put on new business.

And so we're watching this, but we think that we have really good partners to partner with us here. And our customers -- as Todd said, a lot of these customers -- the demand for the products there and customers, their FICO score and their financial situation is still allowing them to continue to purchase this and get finance more of the product.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [33]

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And look, anyone that's in the financial world that's lending money, whether it be a corporation or an individual or consumer, they're going to lend into a space or an industry where they're going to get a consistent return. And if you look at our -- the financials and the numbers and you think about the forbearance on our customers, as it stands right now, numbers are trending really well as expected or slightly better than that. And so we believe that as long as our customer base is paying their bill and the demand is there so they can onboard more financing under on to the platform, we're in good position. Again, like Dale said, we're in communication with Citizens constantly, and they've been a great partner. And by the way, they partner up with some other really large-scale companies that also depend on that financing. So as it stands today, we feel great.

Now if that changed and the -- Citizens went away, we do have a secondary financing partner. There are others out there we are not engaged with physically. But from a conversation perspective, there are others we're having conversations with. If it all went away, and that may be the question you're asking, we would have -- we'd slow down growth. But as it stands today in this current -- and cut back costs, and there are other measures that we would take as a business. But as it stands right now, we feel like we're in a good position. So...

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Kunal Madhukar, Deutsche Bank AG, Research Division - Research Associate [34]

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That's very helpful. Thanks, Todd. Thanks, Dale. A quick follow-up on the ARPU, the service ARPU. That declined precipitously on a year-over-year basis versus the declines that we've been seeing previously. What happened there?

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [35]

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Yes. Again, this goes back to how we've talked about the pricing model and Flex Pay model, where ARPU -- and a little bit -- Todd talked about this a little bit in the fourth quarter call. We're actually looking -- as we continue to drive cash -- to cash flow neutral goal here, we're pushing -- we're starting to leverage pricing upfront on some of the products and some of the sales at the point of sale. And what you're seeing, a little bit of that is that we're giving -- our ARPU is coming down a little bit. Our service ARPU is coming in a little bit as the customers are paying more for the equipment and financing more.

When you look at it out-of-pocket for a customer, it's still in that mid-$70-a-month range. $72 to $75 a month, the customer is paying. It's just that that bill now is split a little bit differently and a little bit more going to the finance partners, which, by the way, we get all that cash upfront. So the economics on that customer and the return on that capital is much better for us. And so that's what you're seeing, and you're seeing that kind of flow through.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [36]

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So this is very, very important. You mentioned the word precipitous. It's actually -- this is actually a good thing. We've talked about our objective to get to cash flow neutrality. This is one of those levers. Our old model -- and if you look at some of the other models in consumer finance -- or consumer-facing businesses, our old model was, we got all $75, but we had to finance that entire SAC on our balance sheet. Now we're having the consumer finance more of the hardware upfront. We're getting that cash upfront. And it's one of the drivers that's getting us towards cash flow neutrality. So it's -- we're very, very pleased with the results. And I think everyone on this phone call will feel the same when we kind of finish up the year and we see the results of that.

And so there's no reduction in demand for services. In fact, it's the opposite. There's an increasing demand for the hardware and services. We're just using finance as a lever to not have to go back to the debt work. So we're very pleased with this result.

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Operator [37]

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Your next question comes from the line of Todd Morgan with Jefferies.

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Todd Cranston Morgan, Jefferies LLC, Fixed Income Research - Analyst [38]

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I guess, I must say, I think you guys are doing a pretty amazing job here. If I'm looking at this, you added 50,000 gross subscribers in the first quarter this year when there was clearly issues. That was a couple of thousand more than you had a year ago, and in before that. So that's pretty strong. It looks like, if I'm doing some quick math, that you think for the full year that the gross adds might be maybe 50,000 or so less than they were in 2019.

Is it -- I mean, can I kind of simplistically extrapolate out and say the net subscriber acquisition costs, that's probably close to $100 million of cash outlays that you would potentially avoid? Is it fair to think of things in that way? And I think you did say you might roll some of that back into sort of brand enhancement. But I mean, that's a big difference in the cash uses, if I'm thinking about that right. Is that fair?

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [39]

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Yes, I think the cash uses, I mean, if you looked at -- we're still putting out about $1,000 on a sub. So if you say we're going to do less than 50,000 subs despite close to the $50 million of cash saving, $50 million to $60 million, but I think you're exactly right. That is a large cash savings if we're not able to do that. And then to the brand question, I think, Todd will give you what -- whether we reinvest that money into brand.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [40]

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Yes. So I mean, look, we are interested -- we know that the services we deliver are very differentiated and special, and people that have them are raving fans. And it's getting better and better with technology advancements, and there are innovation centers developing enhancements in the software and the firmware and the deployment. We're just getting better at it.

So we are laying out plans to begin to brand and market the business and services. Because frankly, a lot of people just don't even know who Vivint is, and we've got 1.5 million subscribers. And so we intend to tell that story. Now we are not going to do that until we're confident that we have [excess] -- beyond -- I'd say, we're not going to do that until we're cash flow positive. We're not going to spend our debt to start a big marketing and demand-gen program. You're not going to see that. But we are feeling confident enough about the plans that we have laid out in the upcoming months. And we need to prep for that, think about that, think about how to tell the story, integrate that into our kind of ongoing financials and investment. So we hope to do it, intend to do it, but we will not do it until we have excess cash beyond neutrality.

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Todd Cranston Morgan, Jefferies LLC, Fixed Income Research - Analyst [41]

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Okay, great. And then just is there any change in the way you're sort of thinking about or processing sort of the second-look customers that you're signing up now? Are there more or less of those? Are you doing anything differently?

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Dale R. Gerard, APX Group Holdings, Inc. - CFO [42]

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Yes, no. It's -- we rolled out the -- Fortiva as our second financing partner, rolled those out in April of 2019. That is still the same as it's always been. They're kind of taking a look at anything that doesn't kind of get financed by Citizens, and rightly closes down to them. So really no change in that process at all.

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Operator [43]

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There are no further questions at this time. I will turn the call back to management for closing remarks.

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Todd R. Pedersen, APX Group Holdings, Inc. - Co-Founder, CEO & Director [44]

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We appreciate everyone getting on the call. I know some people had a bit of a difficult time getting on. Thanks for the patience with that.

Again, management is incredibly pleased with Q1 performance. Although it's been a bit of a hectic last few months for us and other companies and individuals across the world, we felt like we've responded quickly and decisively. And we look forward to a very good 2020 year, and you can expect us to deliver on the numbers. Thank you.

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Operator [45]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.