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LEAP > SEC Filings for LEAP > Form 10-Q on 2-May-2013All Recent SEC Filings

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Form 10-Q for LEAP WIRELESS INTERNATIONAL INC


2-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations

As used in this report, unless the context suggests otherwise, the terms "we," "our," "ours," "us," and the "Company" refer to Leap Wireless International, Inc., or Leap, and its subsidiaries and consolidated joint ventures, including Cricket Communications, Inc., or Cricket. Unless otherwise specified, information relating to population and potential customers, or POPs, is based on 2013 population estimates provided by Claritas Inc., a market research company.

The following information should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in Part I- Item 1 of this report and the audited consolidated financial statements and notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2012 filed with the Securities and Exchange Commission, or the SEC, on February 25, 2013.

Cautionary Statement Regarding Forward-Looking Statements

Except for the historical information contained herein, this report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements reflect management's current forecast of certain aspects of our future. You can generally identify forward-looking statements by forward-looking words such as "believe," "think," "may," "could," "will," "estimate," "continue," "anticipate," "intend," "seek," "plan," "project," "expect," "should," "would" and similar expressions in this report. Such statements are based on currently available operating, financial and competitive information and are subject to various risks, uncertainties and assumptions that could cause actual results to differ materially from those anticipated in or implied by our forward-looking statements. Such risks, uncertainties and assumptions include, among other things:

• our ability to attract and retain customers in an extremely competitive marketplace;

• our ability to successfully implement product and service plan offerings and execute effectively on our strategic activities;

• the impact of competitors' initiatives and our ability to anticipate and respond to such initiatives;

• changes in economic conditions, including interest rates, consumer credit conditions, consumer debt levels, consumer confidence, unemployment rates, energy and transportation costs and other macro-economic factors that could adversely affect demand for the services we provide;

• our ability to meet significant purchase commitments under agreements we have entered into;

• our ability to refinance our indebtedness under, and comply with the covenants in, any credit agreement, indenture or similar instrument governing our existing indebtedness or any future indebtedness;

• future customer usage of our wireless services, which could exceed our expectations, and our ability to manage or increase network capacity to meet increasing customer demand, in particular demand for data services;

• our ability to offer customers cost-effective 4G Long Term Evolution network technology, or LTE, services;

• our ability to obtain and maintain 3G and 4G roaming and wholesale services from other carriers at cost-effective rates;

• our ability to acquire or obtain access to additional spectrum in the future at a reasonable cost or on a timely basis;

• failure of our network or information technology systems to perform according to expectations and risks associated with the ongoing operation and maintenance of those systems, including our customer billing system;

• our ability to attract, integrate, motivate and retain an experienced workforce, including members of senior management;

• our ability to maintain effective internal control over financial reporting; and

• other factors detailed in "Part II - Item 1A. Risk Factors" below.

All forward-looking statements in this report should be considered in the context of these risk factors. These forward-looking statements speak only as of the filing date of this report, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements. Accordingly, users of this report are cautioned not to place undue reliance on the forward-looking statements.


Overview

Company Overview

We are a wireless communications carrier that offers digital wireless services in the U.S. under the "Cricket®" brand. Our Cricket service offerings provide customers with unlimited nationwide wireless services for a flat rate without requiring a fixed-term contract or a credit check.

Cricket service is offered by Cricket, a wholly-owned subsidiary of Leap. Cricket service is also offered in South Texas by STX Wireless Operations, LLC, or STX Operations, which Cricket controls through a 75.75% membership interest in STX Wireless, LLC, or STX Wireless, the parent company of STX Operations. For more information regarding this joint venture, see "Liquidity and Capital Resources - STX Wireless Joint Venture" below.

As of March 31, 2013, Cricket service was offered in 48 states and the District of Columbia across an extended area covering approximately 292 million POPs. As of March 31, 2013, we had approximately 5.2 million customers, and we owned wireless licenses covering an aggregate of approximately 136.7 million POPs (adjusted to eliminate duplication from overlapping licenses). The combined network footprint in our operating markets covered approximately 96.2 million POPs as of March 31, 2013. The licenses we own provide an average of 23 MHz of spectrum capacity in our operating markets.

In addition to our Cricket network footprint, we have entered into roaming relationships with other wireless carriers that enable us to offer Cricket customers nationwide voice and data roaming services over an extended service area. We recently entered into an agreement with a national carrier for 4G LTE roaming services. In addition, we have also entered into a wholesale agreement, which we use to offer Cricket services in nationwide retailers outside of our current network footprint, and we recently amended that agreement to enable our customers to receive 4G LTE services. These arrangements have enabled us to offer enhanced Cricket products and services, strengthen our retail presence in our existing markets and expand our distribution nationwide. Since originally introducing products in nationwide retailers in September 2011, we have determined to focus our efforts on those retailers that we believe provide the most attractive opportunities for our business. As a result, we reduced our total presence in the nationwide retail channel from approximately 13,000 locations at June 30, 2012 to approximately 5,000 locations at March 31, 2013.

Our business strategy includes our efforts to improve the experience we provide customers so that they choose to remain a Cricket customer for a longer period. As part of these efforts, we are improving our device activation process, the quality of our device portfolio, and the in-store and call center experience we provide for our customers. We are also focused on continually updating our product and service offerings to better meet the needs of current customers and to attract and retain new ones. Product and service offerings we have introduced in recent years include our Muve Music® unlimited music download service, the Lifeline service offerings we have introduced in a number of states, and the third-party device leasing program we introduced in our markets to help customers manage the cost of purchasing a handset. We are also focused on pursuing disciplined investment initiatives and remaining focused on our position as a low-cost provider of wireless telecommunications. We have increased pricing on our devices in an effort to better manage device subsidies and promote the addition of longer-tenured customers. In addition, we have streamlined and reduced our number of dealer locations to attempt to further increase sales activity for more productive locations. We also continue to enhance our network to allow us to provide customers with high-quality service. We are exploring cost-effective ways to deliver LTE services to additional customers in our network footprint, including by deploying facilities-based coverage and by entering into partnerships or joint ventures with other carriers. We have covered approximately 21 million POPs with next-generation LTE network technology and may cover up to an additional approximately 10 million POPs in 2013.

The wireless telecommunications industry is very competitive. In general, we compete with national facilities-based wireless providers and their prepaid affiliates or brands, local and regional carriers, non-facilities-based mobile virtual network operators (or MVNOs), voice-over-internet-protocol (or VoIP) service providers, traditional landline service providers, cable companies and mobile satellite service providers. The evolving competitive landscape negatively impacted our financial and operating results in recent years and we have experienced net customer losses in each of the four most recent quarters. Our ability to remain competitive will depend, in part, on our ability to anticipate and respond to various competitive factors and to keep our costs low. During the third quarter of 2012, we increased pricing on our devices in an effort to better manage our device subsidy and promote the addition of longer-tenured customers, although such changes have also had the effect of decreasing gross customer additions. We also introduced new pricing plans for our service offerings, which included new features such as visual voicemail on certain smartphones, enhanced international calling plans, and supplemental data packages, and we enhanced our Muve Music® service, which is now offered for no additional cost in service plans for our Android-based smartphones. In addition, through a third party we have introduced a device leasing program in our markets to help customers manage the cost of purchasing handsets, and we plan to expand the availability and type of handset financing programs we offer in 2013. The extent to which these initiatives and others we may introduce will positively impact our future financial and operational results will depend upon our continued efforts to enhance the productivity of our distribution channels, continued customer acceptance of our product and service offerings, and


our ability to retain these customers. The evolving competitive landscape may result in more competitive pricing, slower growth, higher costs and increased customer turnover. Any of these results or actions could have a material adverse effect on our business, financial condition and results of operations.

Our customer activity is influenced by seasonal effects related to traditional retail selling periods and other factors that arise in connection with our target customer base. Based on historical results, we generally expect new sales activity to be highest in the first and fourth quarters, although during 2012 we experienced our lowest customer activity during the fourth quarter due, in part, to pricing changes we introduced in the third quarter which reduced the amount of subsidy we provide on devices. Based on historical results, we also generally expect churn to be highest in the third quarter and lowest in the first quarter. Sales activity and churn, however, can be strongly affected by other factors, including changes in service plan pricing, device availability, economic conditions, high unemployment (particularly in the lower-income segment of our customer base) and competitive actions, any of which may either offset or magnify certain seasonal effects. Customer activity can also be strongly affected by promotional and retention efforts that we undertake. For example, from time to time, we lower the price on select smartphones for customers who activate a new line of service and then transfer phone numbers previously used with other carriers. This type of promotion is intended to drive significant, new customer activity for our smartphone handsets and their accompanying higher-priced service plans. We also frequently offer existing customers the opportunity to activate an additional line of voice service on a previously activated Cricket device not currently in service. Customers accepting this offer receive a free first month of service on the additional line of service after paying an activation fee. We also utilize retention programs to encourage existing customers whose service may have been suspended for failure to timely pay to continue service with us for a reduced or free amount. The design, size and duration of our promotional and retention programs vary over time in response to changing market conditions. We believe that our promotional and retention efforts, including those efforts described above, have generally provided and continue to provide important long-term benefits to us, including by helping us attract new customers for our wireless services or by extending the period of time over which customers use our services, thus allowing us to obtain additional revenue from handsets we have already sold. The success of any of these activities depends upon many factors, including the costs that we incur to attract or retain customers and the length of time these customers continue to use our services. Sales activity that would otherwise have been expected based on seasonal trends can also be negatively impacted by factors such as the billing system disruptions we experienced in 2011, promotional and retention efforts not performing as expected at various times in 2012, device quality issues, and the inventory shortages for or unavailability of certain of our strongest-selling devices we have experienced at various times.

Our principal sources of liquidity are our existing unrestricted cash, cash equivalents and short-term investments and cash generated from operations. See "-Liquidity and Capital Resources" below.

Critical Accounting Policies and Estimates

Our discussion and analysis of our results of operations and liquidity and capital resources are based on our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. These principles require us to make estimates and judgments that affect our reported amounts of assets and liabilities, our disclosure of contingent assets and liabilities and our reported amounts of revenues and expenses. On an ongoing basis, we evaluate our estimates and judgments, including those related to revenue recognition and the valuation of deferred tax assets, long-lived assets and indefinite-lived intangible assets. We base our estimates on historical and anticipated results and trends and on various other assumptions that we believe are reasonable under the circumstances, including assumptions as to future events. These estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results may differ from our estimates. Since the filing of our Annual Report on Form 10-K for the year ended December 31, 2012 on February 25, 2013, there have been no significant changes to our critical accounting policies and estimates.



Results of Operations

Operating Items

The following table summarizes operating data for our condensed consolidated
operations for the three months ended March 31, 2013 and 2012 (in thousands,
except percentages):

                                               Three Months Ended March 31,
                                                                                       Change
                                   % of 2013                    % of 2012
                                    Service                      Service
                       2013        Revenues         2012        Revenues       Dollars        Percent

Revenues:
Service revenues   $  684,622                   $  773,998                   $  (89,376 )      (11.5 )%
Equipment revenues    105,236                       51,621                       53,615        103.9  %
Total revenues        789,858                      825,619                      (35,761 )       (4.3 )%
Operating
expenses:
Cost of service       250,858         36.6  %      261,311         33.8  %      (10,453 )       (4.0 )%
Cost of equipment     258,968         37.8  %      247,847         32.0  %       11,121          4.5  %
Selling and
marketing              78,838         11.5  %       95,554         12.3  %      (16,716 )      (17.5 )%
General and
administrative         82,225         12.0  %       89,699         11.6  %       (7,474 )       (8.3 )%
Depreciation and
amortization          152,573         22.3  %      146,543         18.9  %        6,030          4.1  %
Impairments and
other charges             735          0.1  %            -            -  %          735          *
Total operating
expenses              824,197        120.4  %      840,954        108.7  %      (16,757 )       (2.0 )%
Gain (loss) on
sale, exchange or
disposal of

assets, net 4,988 0.7 % (468 ) (0.1 )% 5,456 * Operating loss $ (29,351 ) (4.3 )% $ (15,803 ) (2.0 )% $ (13,548 ) 85.7 %
* Percentage change is not meaningful.

The following table summarizes customer activity for the three months ended March 31, 2013 and 2012:

                                                                           Change
For the Three Months Ended March 31, (1)    2013          2012        Amount     Percent

Gross customer additions                   473,881       859,547    (385,666 )   (44.9 )%
Net customer additions (losses)            (93,037 )     258,060    (351,097 )      *
Weighted-average number of customers     5,213,605     6,025,427    (811,822 )   (13.5 )%
As of March 31,
Total customers                          5,203,747     6,192,073    (988,326 )   (16.0 )%


* Percentage change is not meaningful.



(1) We recognize a gross customer addition for each Cricket Wireless, Cricket Broadband and Cricket PAYGo line of service activated by a customer.


Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

Gross Customer Additions

Gross customer additions for the three months ended March 31, 2013 were 473,881 compared to 859,547 for the corresponding period of the prior year. The 44.9% decrease in the number of gross customer additions was primarily attributable to higher pricing on our entry-level smartphones, continued de-emphasis of our Cricket Broadband service, our narrowed focus on offering our products in fewer nationwide retail locations and the discontinuation of our daily PAYGo product.

Net Customer Additions (Losses)

Net customer losses for the three months ended March 31, 2013 were 93,037 compared to net customer additions of 258,060 for the corresponding period of the prior year. The change was primarily due to the decrease in gross customer additions discussed above and slightly higher churn levels.

Service Revenues

Service revenues decreased $89.4 million, or 11.5%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year. This decrease resulted from a 13.5% decrease in the weighted-average number of customers, partially offset by a 2.7% increase in ARPU.

Equipment Revenues

Equipment revenues increased $53.6 million, or 103.9%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year. This increase resulted primarily from a 197.5% increase in average revenue per device sold due to uptake of our higher-priced devices, partially offset by a 31.5% decrease in the number of devices sold to new and upgrading customers.

Cost of Service

Cost of service decreased $10.5 million, or 4.0%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year. As a percentage of service revenues, such expenses increased to 36.6% from 33.8% in the prior year period. The increase in cost of service as a percentage of service revenues resulted primarily from a 13.5% decrease in the weighted-average number of customers.

Cost of Equipment

Cost of equipment increased $11.1 million, or 4.5%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year. This increase was primarily due to increased uptake of our higher-priced devices, partially offset by a decrease in the number of devices sold to new and upgrading customers discussed above.

Selling and Marketing Expenses

Selling and marketing expenses decreased $16.7 million, or 17.5%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year. As a percentage of service revenues, such expenses decreased to 11.5% from 12.3% in the prior year period. These decreases were largely attributable to our cost management initiatives.

General and Administrative Expenses

General and administrative expenses decreased $7.5 million, or 8.3%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year, primarily due to continued benefits from our cost management initiatives. As a percentage of service revenues, such expenses slightly increased to 12.0% from 11.6% in the prior year period, primarily due to the decrease in service revenues discussed above.

Depreciation and Amortization

Depreciation and amortization expense increased $6.0 million, or 4.1%, for the three months ended March 31, 2013 compared to the corresponding period of the prior year. The increase in depreciation and amortization expense was due primarily to network upgrades which related, in part, to our deployment of next-generation LTE technology.


Impairments and Other Charges

During the three months ended March 31, 2013, we incurred $0.7 million in restructuring charges related to lease exit costs associated with cellular sites that were no longer being developed or utilized and administrative facilities that were no longer being used.

Gain (Loss) on Sale, Exchange or Disposal of Assets, Net

During the three months ended March 31, 2013, we recognized a gain of $6.8 million in connection with the exchange of various spectrum with a subsidiary of T-Mobile USA, Inc., or T-Mobile, and Cellco Partnership dba Verizon Wireless, or Verizon Wireless. For more information regarding this transaction, see the discussion below under "Liquidity and Capital Resources - Capital Expenditures, Significant Acquisitions and Other Transactions." This gain was partially offset by a loss of $1.8 million relating to the disposal of certain property and equipment. During the three months ended March 31, 2012, we recognized a loss of $0.5 million from the disposal of certain property and equipment.

Non-Operating Items

The following table summarizes non-operating data for our condensed consolidated
operations for the three months ended March 31, 2013 and 2012 (in thousands):

                                                     Three Months Ended March 31,
                                                   2013            2012         Change

Equity in net income (loss) of investees, net $    (1,158 )     $     193     $ (1,351 )
Interest income                                        47              29           18
Interest expense                                  (64,725 )       (67,042 )      2,317
Income tax expense                                (14,420 )       (11,711 )     (2,709 )

Three Months Ended March 31, 2013 Compared to Three Months Ended March 31, 2012

Equity in Net Income (Loss) of Investees, Net

Equity in net income (loss) of investees, net reflects our share of net income or losses of regional wireless service providers in which we hold investments.

Interest Expense

Interest expense decreased $2.3 million during the three months ended March 31, 2013 compared to the corresponding period of the prior year. The decrease in interest expense primarily resulted from the refinancing in October 2012 of our $300 million in aggregate principal amount of 10% senior notes due 2015 with the $400 million senior secured B term loan facility under the credit agreement we entered into in October 2012, as amended, or the Credit Agreement, which bears interest at a lower rate.

Income Tax Expense

During the three months ended March 31, 2013, we recorded income tax expense of $14.4 million compared to $11.7 million for the three months ended March 31, 2012. The $2.7 million increase was primarily due to a nonrecurring $2.6 million tax expense associated with the tax deferral of the gain associated with the exchange of various spectrum with T-Mobile and Verizon Wireless, offset in part by a net reduction in deferred tax liabilities associated with our joint ventures.

Unrestricted Subsidiaries

In July 2011, Leap's board of directors designated Cricket Music Holdco, LLC (a wholly-owned subsidiary of Cricket, or Cricket Music) and Cricket Music's wholly-owned subsidiary Muve USA, LLC, or Muve USA, as "Unrestricted Subsidiaries" under the indentures governing our senior notes. Cricket Music, Muve USA and their subsidiaries are also designated as "Unrestricted Subsidiaries" under the Credit Agreement. Cricket Music and Muve USA hold certain hardware, software and intellectual property relating to our Muve Music service. During the three months ended March 31, 2013 and 2012, Cricket Music and Muve USA had no operations or revenues. Therefore, the most significant components of the financial position and results of operations of our


unrestricted subsidiaries were property and equipment and depreciation expense. As of March 31, 2013 and December 31, 2012, property and equipment of our unrestricted subsidiaries was $3.8 million and $4.9 million, respectively. As of March 31, 2013, our unrestricted subsidiaries also had $0.9 million, $0.5 million and $0.5 million of current assets, current liabilities and long-term liabilities, respectively. For each of the three months ended March 31, 2013 and 2012, depreciation expense of our unrestricted subsidiaries was $1.1 million, resulting in a net loss $1.1 million.

Customer Recognition and Disconnect Policies

We recognize a new customer as a gross addition in the month that he or she activates a Cricket service. We recognize a gross customer addition for each . . .

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