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T-Mobile US, Inc. 10-K 2007 Documents found in this filing:
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
For the fiscal year ended December 31, 2006
OR
For the transition period from to
Commission File No. 000-50869
MetroPCS Communications, Inc.
(Exact name of registrant as specified in its charter)
Registrant’s telephone number, including area code: (214) 265-2550
Securities registered pursuant to Section 12(b) of the Act:
None Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $0.0001 per share Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of
the Securities Act.
o
Yes
þ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act.
o
Yes þ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
MetroPCS Communications, Inc. Yes o No þ
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge,
in definitive proxy or information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K.
þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in
Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act): Yes o No
þ
The aggregate market value of voting stock held by non-affiliates of the registrants is not
determinable as such shares were privately placed and there is no public market for such shares.
157,135,815 shares of MetroPCS Communications, Inc. common stock were outstanding as of
March 30, 2007.
MetroPCS Communications, Inc.
Index to Form 10-K
-i-
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CAUTIONARY STATEMENT
REGARDING FORWARD-LOOKING STATEMENTS
Any statements made in this annual report that are not statements of historical fact,
including statements about our beliefs and expectations, are forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995, as amended, and should be
evaluated as such. Forward-looking statements include information concerning possible or assumed
future results of operations, including descriptions of our business strategies and plans. These
statements often include words such as “anticipate,” “expect,” “suggests,” “plan,” “believe,”
“intend,” “estimates,” “targets,” “projects,” “should,” “may,” “will,” and other similar
expressions. These forward-looking statements are contained throughout this report, including the
“Business,” “Regulation,” “Risk Factors,” and “Management’s Discussion and Analysis of Financial
Conditions and Results of Operations.” We base these statements on our current expectations,
plans, projections, and assumptions that we have made in light of our experience in the industry,
as well as our perceptions of historical trends, current conditions, expected future developments
and other factors we believe are appropriate under the circumstances. As you read and consider
this annual report, you should understand that these statements are not guarantees of future
performance or results. The forward-looking statements are subject to and involve risks,
uncertainties and assumptions, and many of these risks are beyond our ability to control or
predict. Because of these risks, uncertainties and assumptions, you should not place undue
reliance on these forward-looking statements. Although we believe that these forward-looking
statements are based on reasonable assumptions at the time they are made, you should be aware that
many factors could affect our actual financial results or results of operations and could cause
actual results to differ materially from those expressed in the forward-looking statements.
Factors that may materially affect such forward-looking statements and projections include:
All future written and oral forward-looking statements attributable to us or persons acting on
our behalf are expressly qualified in their entirety by our cautionary statements. We do not
intend to release publicly any
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revisions to any forward-looking statements or projections to reflect events or circumstances
in the future or to reflect the occurrence of unanticipated events, except as required by law.
MARKET AND OTHER DATA
Market data and other statistical information used throughout this report are based on
independent industry publications, government publications, reports by market research firms and
other published independent sources. Some data is also based on our good faith estimates, which we
derive from our review of internal surveys and independent sources, including information provided
to us by the U.S. Census Bureau. Although we believe these sources are reliable, we have not
independently verified the information. By including such market data and information, we do not
undertake a duty to provide such data in the future or to update such data when such data is
updated.
This report contains trademarks, service marks and trade names of companies and organizations
other than us. MetroPCS® and other trademarks are registered trademarks of MetroPCS Wireless,
Inc., a wholly-owned subsidiary, and certain of our other subsidiaries.
In this annual report on Form 10-K, unless the context indicates otherwise, references to
“MetroPCS,” “MetroPCS Communications,” “our Company,” “the Company,” “we,” “our,” “ours” and “us”
refer to MetroPCS Communications, Inc., a Delaware corporation, and its wholly-owned subsidiaries.
PART I
Item 1. Business
Recent Events
On January 4, 2007, we filed a registration statement for an initial public offering of our
common stock. We expect to consummate the offering during the second quarter of 2007. We have
applied to have our common stock listed on the New York Stock Exchange under the symbol “PCS”
effective upon the consummation of our currently pending initial public offering.
On March 14, 2007, our board of directors approved a 3 for 1 stock split in the form of a
stock dividend. Shareholders of record on March 14, 2007 received a stock dividend of two
additional shares of common stock for each share of common stock they own. Except as otherwise
noted, all information contained in this report gives effect to the 3 for 1 stock split.
General
We offer wireless broadband personal communication services, or PCS, on a no long-term
contract, flat rate, unlimited usage basis in selected major metropolitan markets in the United
States. Since we launched our wireless service in 2002 we have been among the fastest growing
wireless broadband PCS providers in the United States as measured by growth in subscribers and
revenues. We reached one million customers in January 2004, 1.5 million customers in February
2005, two million customers in February 2006, 2.5 million customers in August 2006 and three
million customers in January, 2007. We launched our service initially in 2002 in the Miami,
Atlanta, Sacramento and San Francisco metropolitan areas, which we refer to as our Core Markets and
which currently comprise our Core Markets segment. Beginning in the second half of 2004, we began
to strategically acquire licenses in new geographic areas that share certain key characteristics
with our existing Core Markets. These new geographic areas, which we refer to as our Expansion
Markets and which currently comprise our Expansion Markets segment, include the Tampa/Sarasota,
Dallas/Ft. Worth and Detroit metropolitan areas, as well as the Los Angeles and Orlando
metropolitan areas and portions of northern Florida, which were acquired by Royal Street
Communications, LLC, or Royal Street Communications. We currently offer our services in the
greater San Francisco, Miami, Tampa/Sarasota/Orlando, Atlanta, Sacramento, Dallas-Ft. Worth, and
Detroit metropolitan areas, which include a total licensed population of approximately 43 million.
We launched service in the Miami, Atlanta and Sacramento metropolitan areas in the first quarter of
2002; in San Francisco in September 2002; in Tampa-Sarasota in October 2005; in Dallas-Fort Worth
in March 2006; in Detroit in April 2006; and, through a wholesale arrangement with Royal Street
Communications and Royal Street Communications with its wholly-owned operating and license
subsidiaries, or Royal Street, in Orlando and portions of northern Florida in November 2006. In
2005,
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Royal Street Communications, a company in which we own a non-controlling 85% limited
liability company
member interest, but only elect two of the five members of the management committee, was
granted licenses by the Federal Communications Commission (“FCC”) for the Los Angeles basic trading
area and various basic trading areas throughout northern Florida. Royal Street is in the process
of building infrastructure in Los Angeles and expects to commence commercial service in the second
or third quarter of 2007. We have a wholesale arrangement that will allow us to sell
MetroPCS-branded service to the public on up to 85% of the service capacity provided by the Royal
Street systems.
Our wireless services target a mass market which we believe is largely underserved by
traditional wireless carriers. Our service, branded under the “MetroPCS” name, allows customers to
place unlimited local calls from within our service area, and to receive unlimited calls from any
area while in our local service areas under simple and affordable flat monthly rate plans starting
at $30 per month. For an additional $5 to $20 per month, our customers may select a service plan
that offers additional services, such as the ability to place unlimited long distance calls from
within our service area to any number in the continental United States, or unlimited voicemail,
caller ID, call waiting, text messaging, mobile Internet browsing, push e-mail and picture and
multimedia messaging. For additional fees, we also provide international long distance and text
messaging, ringtones, ring back tones, downloads, games and content applications, unlimited
directory assistance and other value-added services. Our customers also have access, on a prepaid
basis, to nationwide roaming. Our rate plans differentiate our service from the more complex plans
and long-term contracts required by most other traditional wireless carriers. Our customers pay
for our service in advance, eliminating any customer-related credit exposure.
As of December 31, 2006, our customers in all metropolitan areas averaged approximately 2,000
minutes of use per month, compared to approximately 875 minutes per month for customers of the
national wireless carriers. We believe that average monthly usage by our customers also exceeds
the average monthly usage for typical wireline customers. Average usage by our customers indicates
that a substantial number of our customers use our services as their primary telecommunications
service, and our customer surveys indicate that a significant number of our customers use us as
their primary or sole telecommunications service provider.
Business Strategy
We believe the following components of our business strategy provide the foundation for
our continued rapid growth:
Continue to Target Underserved Customer Segments in our Markets. We target a mass market
which we believe is largely underserved by traditional wireless carriers. We believe that our
rapid growth to over 3.0 million customers since our initial service launch in 2002 demonstrates
the substantial demand in the United States for our innovative wireless services. We believe our
rapid adoption rates and customer mix indicate that our service is expanding the overall size of
the wireless market and better meeting the needs of many existing wireless users. Our average
monthly usage by our customers for all markets is approximately 2,000 minutes per month, and our
recent customer surveys indicate that over 80% of our customers use us as their primary phone
service and that over 50% of our customers have eliminated their traditional landline phone
service. Approximately 65% of our customers are first time wireless users, while the balance have
switched to our service from another wireless carrier.
Offer Affordable, Fixed Price Unlimited Service Plans With No Long-Term Service Contract
Requirement. We plan to continue to offer our fixed price, unlimited wireless service plans, which
we believe represent an attractive and differentiated offering to a large segment of the
population. Our service is designed to provide mobile functionality while eliminating the gap
between traditional wireless and wireline pricing. We believe this stimulates the demand for our
wireless service, contributes to the continuing growth of our subscriber base and will increase the
overall wireless adoption levels in our markets.
Remain One of the Lowest Cost Wireless Service Providers in the United States. We believe our
operating strategy, network design and high relative population density in our markets have enabled
us to become, and will enable us to continue to be, one of the lowest cost providers of wireless
broadband PCS services in the United States. We also believe our rapidly increasing scale will
allow us to continue to drive our per-customer operating costs down in the future. In addition, we
will seek to maintain operating costs per customer that are substantially below the operating costs
of our national wireless broadband PCS competitors. We believe our industry leading cost position
provides us and will continue to provide us with a sustainable competitive advantage.
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Expand into Attractive Markets. We have been successful in acquiring or gaining access to
spectrum in a number of new metropolitan areas which share the high relative population density and
customer characteristics of
our Core Markets. We believe our early experience in Tampa/Sarasota, Dallas/Ft. Worth and
Detroit, where, as of December 31, 2006, we have added approximately 640,000 new subscribers since
the launch of service, demonstrates our ability to successfully expand our service into new
metropolitan areas.
Company History
General Wireless, Inc., or GWI, was formed in 1994 for the purpose of bidding on, acquiring
and operating broadband PCS licenses as a very small business under the FCC’s designated entity
rules. In 1995, GWI formed GW1, Inc. as a wholly-owned subsidiary, and shortly afterwards changed
GW1, Inc.’s name to GWI PCS, Inc., or GWI PCS. In 1996, GWI PCS participated in the FCC’s C-Block
auctions of broadband PCS spectrum licenses and was declared the high bidder on licenses for the
Miami, Atlanta, Sacramento and San Francisco metropolitan areas. In 1999, GWI PCS changed its name
to MetroPCS Wireless, Inc., or MetroPCS Wireless, and GWI changed its name to MetroPCS, Inc.
In March 2004, MetroPCS, Inc. formed MetroPCS Communications as a wholly-owned subsidiary of
MetroPCS, Inc. and in July 2004 a wholly-owned subsidiary of MetroPCS Communications, Inc., MPCS
Holdco Merger Sub, Inc., merged into MetroPCS, Inc. and MetroPCS, Inc. was the surviving
corporation. As a result of this merger, MetroPCS, Inc. became a wholly-owned subsidiary of
MetroPCS Communications, Inc. In August 2006, MetroPCS Communications, Inc. formed MetroPCS V,
Inc., as a wholly-owned subsidiary which indirectly, through a series of no longer existing
wholly-owned subsidiaries, held all of the common stock of MetroPCS Wireless.
In November 2006, as part of the restructuring associated with the issuance by MetroPCS
Wireless of 9 1/4% senior notes and the senior secured credit facility, MetroPCS, Inc. was merged
into MetroPCS Wireless, with MetroPCS Wireless surviving, and MetroPCS V, Inc. was renamed
MetroPCS, Inc. MetroPCS Wireless’ business constitutes substantially all of the business of
MetroPCS Communications, Inc. and its wholly- owned subsidiary, and parent of MetroPCS Wireless,
MetroPCS, Inc. (formerly known as MetroPCS V, Inc.), and we continue to conduct business under the
MetroPCS brand.
Products and Services
Voice Services. We provide affordable, reliable, high-quality wireless broadband PCS services
through the service pricing plans detailed in the chart below. All service plans are
“paid-in-advance” and do not require a long-term contract. Our lowest priced $30 per month service
plan allows our customers to place unlimited local calls but without the ability to add additional
features. For an additional $5 to $20 per month, a subscriber may select a service plan which
provides more flexibility and options such as nationwide long distance calling, unlimited text
messaging (domestic and international), voicemail, caller ID, call waiting, picture and multimedia
messaging, mobile Internet browsing, push e-mail, data and other a la carte options on a prepaid
basis. Our most popular service plans currently are our unlimited $40 and $45 rate plans which
offer unlimited local and long distance calling, text and picture messaging, enhanced voice mail,
caller ID, call waiting and 3-way calling. As of December 31, 2006, over 85% of our customers had
selected either our $40 or $45 service plans. On February 22, 2007 we introduced our new $50
service plan which includes unlimited mobile Internet browsing and push e-mail in addition to the
services included in our $45 service plan. It is too early to judge the impact that this new
service plan will have on our current service plan mix.
MetroPCS Service Plans
Our local outbound calling areas extend in most cases beyond the boundaries of our actual
license area. For example, customers in our San Francisco and Sacramento markets may place
unlimited local calls while inside our service area to areas throughout the majority of northern
California without incurring toll charges. Our wireline competitors generally would impose toll
charges for calls within this area, while our service treats these as local calls.
Customers who travel outside of our coverage area may roam onto other wireless networks in two
ways. First, a customer may purchase service directly from a manual roaming provider in that area
by providing the provider with a credit card number, which allows that provider to bill the
customer directly for any roaming charges. If the customer chooses this option, we incur no costs,
nor do we receive any revenues. Second, a customer may
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subscribe to our nationwide roaming
service, branded as “TravelTalk,” under which we provide voice roaming service through agreements
with other wireless carriers. We launched our TravelTalk roaming service on a prepaid basis in
April 2006. Under this option, the customer makes a deposit in a prepaid account and may access
our
nationwide roaming service when traveling outside our local service area. We incur costs for
providing, and earn revenue from, this nationwide roaming service in excess of our costs. Due to
charges imposed by our roaming suppliers, our nationwide roaming service is not cost effective for
customers who travel frequently outside our local service area, but the ability to roam nationwide
on a prepaid basis expands the market to those customers that may find occasional roaming
beneficial.
Data Services. Our data services include:
Custom Calling Features. We offer other custom calling features, including caller ID, call
waiting, three-way calling, distinctive ringtones, ring back tones and voicemail.
Advanced Handsets. We sell a variety of handsets manufactured by nationally recognized
handset manufacturers for use on our network, including models that provide color screens, camera
phones and other features facilitating digital data. All of the handsets we offer are CDMA 1XRTT
compliant and are capable of providing the location data mandated by the FCC’s wireless E-911 rules
and regulations.
Core and Expansion Markets
Our strategy has been to offer our services in major metropolitan markets and their
surrounding areas, which we refer to as clusters. Within our Core Markets we operate three separate
clusters, which include Georgia (Atlanta), South Florida (Miami) and Northern California (San
Francisco and Sacramento). We initially launched our service in South Florida, Georgia and the
Sacramento area of Northern California in the first quarter of 2002 and launched the San Francisco
metropolitan area in September of 2002. These Core Market clusters have a licensed population of
approximately 26 million of which our networks currently cover approximately 22 million. Our Core
Market clusters have an average population density of 271 people per square mile, compared to the
national average of 84, enjoy average annualized population growth of 1.8% compared to the national
average of 1.1% and have a median household income of $53,000 compared to a national average of
$47,000.
Beginning in the second half of 2004, we began to acquire licenses opportunistically for new
markets that shared characteristics similar to our existing Core Markets. In addition to these
acquisitions, we also entered into agreements with Royal Street, a company in which we own a
non-controlling 85% limited liability company member interest, which was granted broadband PCS
licenses by the FCC in December 2005 following FCC Auction 58. For a discussion of Royal Street and
Auction 58, please see “— Auction 58 and Royal Street.” We have a wholesale agreement with Royal
Street that allows us to purchase up to 85% of Royal Street’s service capacity and sell it on a
retail basis under the MetroPCS brand in geographic areas where Royal Street was granted FCC
licenses. Our Expansion Markets include Tampa/Sarasota/Orlando, Dallas/Ft. Worth, Detroit, portions
of Northern Florida, which are geographically complementary to our South Florida cluster, as well
as Los Angeles, which is geographically complementary to our Northern California cluster. Within
our Expansion Markets we operate or will operate four new separate clusters: Northern and Central
Florida, Dallas/Ft. Worth, Detroit and Southern California. As of November 2006, we had launched
our service in all of our major Expansion Markets except for Los Angeles, which we expect to launch
in the second or third quarter of 2007 through our wholesale arrangement with Royal Street. Our
Expansion Markets have a licensed population of approximately 40 million, of which our networks
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currently cover approximately 16 million people in the geographic areas we have launched to date,
including our operations in Orlando and portions of northern Florida. Together, our Core and
Expansion Markets have average population density of 339 people per square mile, compared to the
national average of 84, enjoy average annualized
population growth of 1.7% compared to the national average of 1.1% and have a median household
income of $50,000 compared to a national average of $47,000. We believe all of these Expansion
Markets are particularly attractive because of their high population densities, attractive customer
demographics, high historical and projected population growth rates, favorable business climates
and long commuting times relative to national averages.
The table below provides a metropolitan area by metropolitan area overview of our Core and
Expansion Markets (excluding Auction 66 Markets) including the FCC basic trading area (BTA)
identification number, the number of people, or POPs, the POP density, the annualized POP growth
rate, the spectrum depth and each metropolitan area’s actual or expected launch date. For our
Expansion Markets we have noted whether we are the FCC license holder in each metropolitan area or
if we will provide our services in that metropolitan area through our agreements with Royal Street,
which holds the license. It should also be noted that all of the licensed spectrum in our Core and
Expansion Markets is in the 1900 MHz PCS band and that the metropolitan area classifications in the
table below conform to the FCC’s basic trading area (BTA) geographic areas for PCS spectrum.
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Auction 66 Markets
At the conclusion of FCC Auction 66 in September 2006, we were declared the high bidder on
eight additional FCC licenses for total aggregate winning bids of approximately $1.4 billion, and,
in November 2006, we were granted all eight of these licenses. The spectrum licenses granted as a
result of Auction 66 are in the advanced wireless services, or AWS, band which includes the 1710 to
1755 MHz frequencies as well as the 2110 to 2155 MHz frequencies. These frequency ranges are near
the PCS band in which we operate our Core and Expansion Markets, and we believe this spectrum to
have similar technical properties to the PCS spectrum we are currently licensed to operate. We can
offer the same PCS services on these AWS licenses as we offer on our other PCS spectrum and can
offer additional advanced services. The AWS licenses awarded by the FCC in Auction 66 were divided
into geographic areas which are different from the geographic areas associated with PCS licenses.
The map below describes the geographic coverage of our Auction 66 licenses and shows the
relationship between these new AWS licenses and our existing Core and Expansion Markets.
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Our Auction 66 licenses cover a total unique population of approximately 117 million. New
expansion opportunities in geographic areas outside of our Core and Expansion Markets represent
approximately 69 million of the total covered population of our Auction 66 Markets, as described in
the chart below. Our expansion opportunities as a result of Auction 66 cover six of the top 25
metropolitan market areas in the United States, including the entire east coast corridor from
Philadelphia to Boston, including New York City, as well as the entire states of New York,
Connecticut and Massachusetts. Together our east coast expansion opportunities cover a geographic
area of approximately 50 million people. In the Western United States our new expansion
opportunities cover a geographic area of approximately 19 million people, including the San Diego,
Portland, Seattle and Las Vegas metropolitan areas.
The balance of our Auction 66 Markets, which covers a population of approximately 48 million,
supplements or expands the geographic boundaries of our existing operations in Dallas/Ft. Worth,
Detroit, San
Francisco and Sacramento, and Royal Street’s license area in Los Angeles. Given our
performance in the Core and Expansion Markets to date, we expect this additional spectrum to
provide us with enhanced operating flexibility, reduced capital expenditure requirements in
existing licensed areas and an expanded service area relative to our position prior to Auction 66.
We intend to focus our build-out strategy in our new Auction 66 Markets initially on licenses with
a total population of approximately 40 million in major metropolitan areas which we believe offer
us the opportunity to achieve financial results similar to our existing Core and Expansion Markets,
with a primary focus on the New York, Philadelphia, Boston and Las Vegas metropolitan areas. Of the
approximately 40 million total population, we are targeting launch of operations with an initial
population of approximately 30 to 32 million by late 2008 or early 2009.
Source: FCC Auction 66 Website
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The New York EA overlaps that portion of the Northeast REA surrounding the greater New
York metropolitan area. The Las Vegas EA also overlaps that portion of the West REA that also
covers Las Vegas. As a result, we have 20 MHz of spectrum in these metropolitan areas which we
believe will facilitate a more efficient rollout and allow us to more effectively scale our
operations.
There are incumbent governmental and non-governmental users in the AWS band. The relocation of
incumbent governmental users will be funded by the proceeds of Auction 66, although certain
governmental users will not be required to relocate. The non-governmental incumbent licensees will
need to be relocated pursuant to the FCC’s approved spectrum relocation order, which may require us
to pay for their relocation expenses which we currently estimate to be approximately $40 to $60
million, and which requires voluntary negotiation for the first three years before the commercial
incumbents are subject to mandatory relocation.
Auction 58 and Royal Street
In January 2005, the FCC conducted Auction 58 for wireless broadband PCS spectrum. Auction 58
was the first significant FCC auction for wireless broadband PCS spectrum since Auction 35 in 2001.
Auction 58, like other major auctions conducted by the FCC, was designed to allow small businesses,
very small businesses and other so called designated entities, or DEs, to acquire spectrum and
construct wireless networks to promote competition with existing carriers. To that end, the FCC
designated certain blocks of wireless broadband PCS spectrum for which only DEs could apply.
Qualified DEs were able to bid on these restricted or “closed” licenses which were not available to
other bidders who did not qualify as DEs. In addition, very small business DEs were permitted to
apply for and bid on “open” licenses with a bidding credit of 25% of the gross bid price. We
entered into a cooperative arrangement with an unaffiliated very small business entrepreneur and
invested in Royal Street, a DE that qualified to bid on “closed” licenses and was eligible for the
25% bidding credit on “open” licenses. We own a non-controlling 85% limited liability company
member interest in Royal Street Communications and may elect only two of the five members to Royal
Street Communication’s management committee, which has the full power to direct the management of
Royal Street. C9 Wireless, LLC, or C9, has control over the operations of Royal Street because it
has the right to elect three of the five members of Royal Street Communication’s management
committee. C9 has the right to put all or part of its ownership interest in Royal Street
Communications to us, but due to regulatory restrictions, we have no corresponding right to call
C9’s ownership interest in Royal Street Communications. The put right has been structured so that
its exercise will not adversely affect Royal Street’s continued eligibility as a very small
business designated entity during periods where such eligibility is required. If C9 exercises its
put right, we will be required to pay a fixed return on C9’s invested capital in Royal Street
Communications, which fixed return diminishes annually beginning in the sixth year following the
grant of Royal Street’s FCC licenses. These put rights expire in June 2012.
Auction 58 was completed in February 2005, and Royal Street Communications made its final
payment to the FCC for the licenses it won in Auction 58 in March 2005. In December 2005, Royal
Street Communications was granted the following licenses on which it was the high bidder at the
conclusion of Auction 58: Los Angeles, California; and Orlando, Jacksonville, Lakeland-Winter
Haven, Melbourne-Titusville and Gainesville, Florida basic trading areas.
Royal Street holds all of the Auction 58 licenses through its wholly-owned subsidiaries and
has entered into certain cooperative agreements with us relating to the financing, design,
construction and operation of the networks. The Royal Street agreements are based on a “wholesale
model” in which Royal Street plans to sell up to 85% of its engineered service capacity on a
wholesale basis to us, which we in turn will market on a retail basis under the MetroPCS-brand to
our customers within the covered area. In addition, the Royal Street agreements contemplate that
MetroPCS, at Royal Street’s request and at all times subject to Royal Street’s direction and
control, will build-out the networks, provide information to Royal Street relating to the budgets
and business plans as well as arrange for administrative, clerical, accounting, credit, collection,
operational, engineering, maintenance, repair, and technical services. We do not own or control the
Royal Street licenses. However, pursuant to contractual arrangements with Royal Street, we have
access, via the wholesale arrangement, to as much as 85% of the engineered service capacity of
Royal Street’s network with the remaining 15% reserved by Royal Street to sell to other parties.
Also, pursuant to another of the Royal Street agreements, upon Royal Street’s request, we will
provide financing for the acquisition and build-out of licenses won in Auction 58. As of
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December
31, 2006 the maximum amount that Royal Street may borrow from us under the loan agreement is
approximately $500 million. As of December 31, 2006 Royal Street has borrowed $394 million from us
under the loan agreement, approximately $294 million of which was used for the acquisition of new
licenses. In March 2007, Royal Street borrowed an additional $70 million from us under the loan
agreement. Interest accrues under the loan agreement at a rate equal to 11% per annum, compounded
quarterly. Royal Street has commenced repayment of that portion of the loans related to the Orlando
and Lakeland-Winter Haven markets. The proceeds from this loan are to be used by Royal Street to
make payments for the licenses won in Auction 58, to finance the build-out and operation of the
Royal Street network infrastructure, and to make payments under the loan until Royal Street has
positive free cash flow.
License Term
All of the broadband PCS licenses held by us and by Royal Street have an initial term of ten
years after the initial grant date (which varies by license, but the initial San Francisco,
Sacramento, Miami and Atlanta licenses were granted in January 1997), and, subject to applicable
conditions, may be renewed at the end of their terms. The AWS licenses granted in Auction 66 have
an initial term of fifteen years after the initial grant of the license. Each FCC license is
essential to our and Royal Street’s ability to operate and conduct our and Royal Street’s business
in the area covered by that license. We continue to file renewal applications for our broadband PCS
licenses as the windows to file renewal applications open. One application has been granted and one
application is currently pending for those licenses that expire in April 2007 and the FCC has
granted all of the renewal applications for those licenses that expired in January 2007. For a
discussion of general licensing requirements, please see “— General Licensing Requirements and
Broadband Spectrum Allocations.”
Distribution and Marketing
We offer our products and services under the “MetroPCS” brand indirectly through approximately
2,000 independent retail outlets and directly to our customers through 95 Company-operated retail
stores. Our indirect distribution outlets include a range of local, regional and national mass
market retailers and specialty stores. A significant portion of our gross customer additions have
been added through our indirect distribution outlets and for the twelve months ended December 31,
2006, 84% of our gross customer additions were through indirect channels. We have over 2,000
locations where customers can make their monthly payments, and many of these locations also serve
as distribution points for our products and services. Our cost to distribute through direct and
indirect channels is substantially similar, and we believe our mix of indirect and direct
distribution allows us to reach the largest number of potential customers in our markets at a low
relative cost. We plan to increase our number of indirect distribution outlets and Company-operated
stores in both Core and Expansion Markets and in new markets acquired in the future, such as the
Auction 66 Markets.
We advertise locally to develop our brand and support our indirect and direct distribution
channels. We advertise primarily through local radio, cable, television, outdoor and local print
media. In addition, we believe we have benefited from a significant number of word-of-mouth
customer referrals.
Customer Care, Billing and Support Systems
We use several outsourcing solutions to efficiently deliver quality service and support to our
customers as part of our strategy of establishing and maintaining our leadership position as a low
cost telecommunications provider while ensuring high customer satisfaction levels. We outsource
some or all of the following back office and support functions to nationally recognized third-party
providers:
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Network Operations
We believe we were the first U.S. wireless broadband PCS carrier to have 100% of our customers
on a CDMA 1XRTT network. We began building our network in 2001, shortly after other CDMA carriers
began upgrading their networks to 1XRTT. As a result, we believe we deployed our network with third
generation capabilities at a much lower cost than incurred by other carriers who were forced to
undergo a technology migration to deploy second generation CDMA networks. Since all of our handsets
are CDMA 1XRTT compliant, we receive the full capacity and quality benefits provided by CDMA 1XRTT
across our entire network and customer base.
As of December 31, 2006, our network consists of 11 switches at eight switching centers and
3,397 operating cell sites. A switching center serves several purposes, including routing calls,
managing call handoffs, managing access to the public telephone network and providing access to
voicemail and other value-added services. Currently, almost all of our cell sites are co-located,
meaning our equipment is located on leased facilities that are owned by third parties retaining the
right to lease the facilities to additional carriers. Our switching centers and national operations
center provide around-the-clock monitoring of our network base stations and switches.
Our switches connect to the public telephone network through fiber rings leased from
third-parties, which facilitate the first leg of originating and terminating traffic between our
equipment and local exchange and long distance carriers. We have negotiated interconnection
agreements with relevant local exchange carriers in our service areas.
We use third-party providers for long distance services and the majority of the backhaul
services. Backhaul services are the telecommunications services that we use to carry traffic to and
from our cell sites and our switching facilities.
Network Technology
Wireless digital signal transmission is accomplished by using various forms of frequency
management technology, or “air interface protocols.” The FCC has not mandated a universal air
interface protocol for wireless broadband PCS systems; rather, wireless broadband PCS systems in
the United States operate under one of three dominant principle air interface protocols: CDMA; time
division multiple access, or TDMA; or global system for mobile communications, or GSM. All three
air interface protocols are incompatible with each other. Accordingly, a customer of a system that
utilizes CDMA technology is unable to use a CDMA handset when traveling in an area not served by a
CDMA-based wireless carrier, unless the customer carries a dual-band/dual-mode handset that permits
the customer to use the alternate wireless system in that area. In addition, certain carriers also
restrict customers from changing the programming of their phones to be used on other carriers’
networks using the same air interface protocol.
We believe 10 MHz of spectrum to be sufficient to begin service in metropolitan areas using
technology that divides the base station coverage area served by a transmitter receiver into three
parts or “sectors” (segments of the circle representing the base station’s broadcast area).
However, in metropolitan areas with only 10 MHz of spectrum we have a network design capable of
subdividing the service area into six parts or sectors and to deploy these six-sector cells in
selected, high-demand areas. This will increase the capacity of the wireless base stations in these
markets by doubling the number of sectors over which a base station’s antennas can handle calls
simultaneously. Our vendors have informed us that cell sites using six sectors have been in
operation for many years in the U.S., and we have obtained actual performance data on cell sites
that have been operational for multiple years.
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We and Royal Street have commercially deployed
six-sector cell sites in certain geographic areas in 2006, and we anticipate that Royal Street will
deploy this technology in Los Angeles in 2007.
We believe that CDMA technology uses spectrum more efficiently than any alternative commonly
used wireless technology in 10 MHz. We also intend to buy EVRC-B, or 4G vocoder, handsets when
available. 4G vocoder handsets allow for greater capacity in the network. We believe these
handsets will be available in 2007. We currently intend to further enhance network capacity by
upgrading our networks with EV-DO Revision A with Voice-Over-Internet-Protocol, or VoIP, which we
anticipate will be available in 2008. When combined with six-sector technology, it is our
expectation that new 4G vocoder and EV-DO Revision A with VoIP will more than double the effective
available spectrum relative to three-sector, 1XRTT technology. Thus, we believe 10 MHz of spectrum
has the effective capacity of 20 MHz using today’s technologies. We anticipate that spectral
efficiency will continue to improve over the next several years, allowing us to keep up with the
increased usage of third-generation services.
As a result of Auction 66, we were granted licenses for additional spectrum in some of these
metropolitan areas. We acquired this spectrum because the price of the spectrum was attractive when
considering the additional cost that would have been incurred to employ the technologies described
above to more fully utilize the existing 10 MHz. In many cases, our Auction 66 spectrum will allow
us to enlarge our existing geographic service area, which we believe will further enhance the
attractiveness of our services.
Our decision to use CDMA is based on several key advantages over other digital protocols,
including the following:
Higher network capacity. Cellular technology capitalizes on reusing discrete amounts of
spectrum at a cell site that can be used at another cell site in the system. We believe, based on
studies by CDMA handset manufacturers, that our implementation of CDMA digital technology will
eventually provide approximately seven to ten times the system capacity of analog technology and
approximately three times the system capacity of TDMA and GSM systems, resulting in significant
operating and cost efficiencies. Additionally, we believe that CDMA technology provides network
capacity and call quality that is superior to other wireless technologies.
Longer handset battery life. While a digital handset using any of the three digital air
interface protocols has a substantially longer battery life than an analog cellular handset, CDMA
handsets can provide even longer periods between battery recharges than other commonly deployed
digital PCS technologies.
Fewer dropped calls. CDMA systems transfer calls throughout the CDMA network using a “soft
hand-off,” which connects a mobile customer’s call with a new base station while maintaining a
connection with the base station currently in use, and “hard hand-off,” which disconnects the call
from the current base station when it connects to another base station. CDMA networks monitor the
quality of the transmission received by multiple neighbor base stations simultaneously to select
the best transmission path and to ensure that the call is not disconnected in one base station
unless replaced by a stronger signal from another. Analog, TDMA and GSM networks only use a hard
hand-off and disconnect the call from the current base station as it connects with a new one
without any simultaneous connection to both base stations. Since CDMA allows for both hard and
soft hand-off, it results in fewer dropped calls compared to other wireless technologies.
Simplified frequency planning. TDMA and GSM service providers spend considerable time and
money on frequency planning because they must reuse frequencies to maximize network capacity. CDMA
technology allows reuse of the same subset of allocated frequencies in every cell, substantially
reducing the need for costly frequency planning.
Efficient migration path. CDMA 1XRTT technology can be upgraded easily and cost-effectively
for enhanced voice and data capabilities. The technology requires relatively low incremental
investment for each step along the migration path with relatively modest incremental capital
investment levels as demand for more robust data services or additional capacity develops.
Privacy and security. CDMA uses technology that requires accurate time and code phase
knowledge to decode, increasing privacy and security.
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Competition
We compete directly in each of our metropolitan areas with other wireless service providers,
with wireline companies and increasingly with cable companies by providing a wireless alternative
to traditional wireline service. The wireless industry is dominated by national carriers, such as
Cingular Wireless, Verizon Wireless, Sprint Nextel and T-Mobile and their prepaid affiliates or
brands, which have an estimated 84% of the national wireless market share as measured by number of
subscribers, according to the Federal Communications Commission’s Annual Report and Analysis of
Competitive Market Conditions with Respect to Commercial Mobile Services, FCC 06-142, released
September 29, 2006. National carriers typically offer post-paid plans that require long-term
contracts and credit checks or deposits. Over the past few years, the wireless industry has seen an
emergence of several new competitors that provide either pay-as-you-go or prepaid wireless
services. Some of these competitors, such as Virgin Mobile USA, Amp’d Mobile and Tracfone, are
non-facility based mobile virtual network operators, or MVNOs, that contract with wireless network
operators to provide a separately branded wireless service. These MVNOs typically also charge by
the minute rather than offering flat-rate unlimited service plans. In addition, several large
satellite companies, computer companies and Internet search and portal companies have indicated an
interest in establishing next generation wireless networks and VoIP providers have indicated that
they may offer wireless services over a Wi-Fi/Cellular network to compete directly with us. Some
companies, such as Leap Wireless d/b/a Cricket and Sure West Wireless, are regional carriers with
unlimited fixed-rate service plans similar to ours. Thus, we compete with both the national
carriers, the prepaid, pay-as-you-go service providers and in some cases regional and local
carriers, and may face additional competition from new entrants with substantial resources in the
future. We believe that competition for subscribers among wireless communications providers is
based mostly on price, service area, services and features, call quality and customer service. The
wireline industry is also dominated by large incumbent carriers, such as AT&T, Verizon, and
BellSouth, and competitive local exchange or Voice-Over-Internet-Protocol, or VoIP, service
providers, such as Vonage, McLeod USA, and XO Communications. The cable industry is also dominated
by large carriers such as Time Warner Cable, Comcast and Cox Communications. These cable companies
formed a joint venture along with Sprint Nextel and Bright House Networks called SpectrumCo LLC, or
SpectrumCo, which bid on and acquired 20 MHz of AWS spectrum in a number of major metropolitan
areas throughout the United States, including all of the major metropolitan areas which comprise
our Core, Expansion and Auction 66 Markets.
Sprint Nextel recently announced that it will offer an unlimited local calling plan under its
Boost brand in certain of the geographic areas in which we offer service. In response, in certain
of our markets we have added additional features to our existing service plans. Currently, in our
San Francisco, Sacramento, and Dallas/Ft. Worth metropolitan areas we have added to the $35 service
plan unlimited long distance in the continental United States, to the $40 service plan unlimited
short message and multimedia message services, and to the $45 service plan unlimited mobile
Internet browsing and international short message service. As competition develops, we may offer
similar service plans in our other metropolitan areas, we may add additional features or
services to our existing service plans, or make other changes to our service plans.
Many of our wireless, wireline and cable competitors’ resources are substantially greater, and
their market shares are larger, than ours, which may affect our ability to compete successfully.
Additionally, many of our wireless competitors offer larger coverage areas or nationwide calling
plans that do not give rise to additional roaming charges, and the competitive pressures of the
wireless communications industry have led them to offer service plans with growing bundles of
minutes of use at lower per minute prices or price plans with unlimited nights and weekends. Our
competitors’ plans could adversely affect our ability to maintain our pricing, market penetration,
growth and customer retention. In addition, large national wireless carriers have been reluctant to
enter into roaming agreements at attractive rates with smaller and regional carriers like us, which
limits our ability to serve certain market segments. Moreover, the FCC is pursuing policies making
additional spectrum for wireless services available in each of our markets, which may increase the
number of our wireless competitors and enhance our wireless competitors’ ability to offer
additional plans and services. Further, since many of our competitors are large companies, they can
require handset manufacturers to provide the newest handsets exclusively to them. Our competitors
also can afford to heavily subsidize the price of the subscriber’s handset because they require
long term contracts. These advantages may detract from our ability to attract customers from
certain market segments.
We also compete with companies using other communications technologies, including paging,
digital two-way paging, enhanced specialized mobile radio, domestic and global mobile satellite
service, and wireline telecommunications services. We also may face competition from providers of
an emerging technology known as Worldwide Interoperability for Microwave Access, or WiMax, which is
capable of supporting wireless
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transmissions suitable for mobility applications. Also, certain
mobile satellite providers recently have received authority to offer ancillary terrestrial service
and a coalition of companies which includes DIRECTV Group, EchoStar, Google, Inc., Intel Corp. and
Yahoo! has indicated its desire to establish next generation wireless networks and technologies in
the 700 MHz band. These technologies may have advantages over our technology that customers may
ultimately find more attractive. Additionally, we may compete in the future with companies that
offer new technologies and market other services we do not offer or may not be available with our
network technology, from our vendors or within our spectrum. Some of our competitors do or may
bundle these other services together with their wireless communications service, which customers
may find more attractive. Energy companies, utility companies, satellite companies and cable
operators also are expanding their services to offer telecommunications services.
In the future, we may also face competition from mobile satellite service, or MSS, providers,
as well as from resellers of these services. The FCC has granted to some MSS providers, and may
grant others, the flexibility to deploy an ancillary terrestrial component to their satellite
services. This added flexibility may enhance MSS providers’ ability to offer more competitive
mobile services. In addition, we also may face competition from providers of WiMax, which is
capable of supporting wireless transmissions suitable for mobility applications, using exclusively
licensed or unlicensed spectrum.
Seasonality
Net customer additions are typically strongest in the first and fourth calendar quarters
of the year. Softening of sales and increased churn in the second and third calendar quarters of
the year usually combine to result in fewer net customer additions during the second and third
calendar quarters. The following table sets forth our net subscriber additions and total
subscribers from the first quarter of 2004 through the fourth quarter of 2006.
MetroPCS Subscriber Statistics
Inflation
We do not believe that inflation has had a material effect on our operations.
Employees
As of December 31, 2006, we had 2,046 employees. We believe our relationship with our
employees is good. None of our employees is covered by a collective bargaining agreement or
represented by an employee union.
Regulation
The government regulates the wireless telecommunications industry extensively at both the
federal level and, to varying degrees, at the state and local levels. Administrative rulemakings,
legislation and judicial proceedings can affect this government regulation and may be significant
to us. In recent years, the regulation of the communications industry has been in a state of flux
as Congress, the FCC, state legislatures and state regulators have passed laws and promulgated
policies to foster greater competition in telecommunications markets.
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Federal Regulation
Wireless telecommunications systems and services are subject to extensive federal regulation
under the Communications Act of 1934, as amended, or the Communications Act, and the implementing
regulations adopted thereunder by the FCC. These regulations and associated policies govern, among
other things, applications for and renewals of licenses to construct and operate wireless
communications systems, ownership of wireless licenses and the transfer of control or assignment of
such licenses, the ongoing technical, operational and service requirements under which wireless
licensees must operate, the rates, terms and conditions of service, the protection and use of
customer information, roaming policies, the provision of certain services, such as E-911, and the
interconnection of communications networks.
General Licensing Requirements and Broadband Spectrum Allocations
The FCC awards certain broadband PCS licenses for geographic service areas called Major
Trading Areas, or MTAs, and other broadband PCS licenses for Basic Trading Areas, or BTAs, defined
by Rand McNally & Company. Under the broadband PCS licensing plan, the United States and its
possessions and territories are divided into 493 BTAs, all of which are included within 51 MTAs.
The FCC allocates 120 MHz of radio spectrum in the 1.9 GHz band for licensed broadband PCS. The FCC
divided the 120 MHz of spectrum into two 30 MHz blocks, known as the A- and B-Blocks, licensed for
each of the 51 MTAs, one 30 MHz block, known as the C-Block, licensed for each of the 493 BTAs, and
three 10 MHz blocks, known as the D-, E- and F-Blocks, licensed for each of the 493 BTAs, for a
total of more than 2,000 licenses. Each broadband PCS license authorizes operation on one of six
frequency blocks allocated for broadband PCS. However, licensees are given the flexibility to
partition their service areas and to disaggregate their spectrum into smaller areas or spectrum
blocks with the approval of the FCC. The FCC also awarded two cellular licenses on a metropolitan
statistical area, or MSA, and rural service area, or RSA,
basis with 25 MHz of spectrum for each license. There are 306 MSAs and 428 RSAs in the United
States. Licensees of cellular spectrum can offer PCS services in competition with broadband PCS
licensees. Many of our competitors utilize a combination of cellular and broadband PCS spectrum to
provide their services.
In 2005, the FCC allocated an additional 90 MHz of spectrum to be used for AWS. Each AWS
license authorizes operation on one of six frequency blocks. The FCC divided the 90 MHz of spectrum
into two 10 MHz and one 20 MHz blocks licensed for each of 12 designated regional economic area
groupings, or REAG, one 10 MHz and one 20 MHz block licensed for each of 176 designated economic
areas, or EA, licenses, and a 20 MHz block licensed for each of 734 designated metropolitan
statistical area/rural service area basis. The economic areas are geographic areas defined by the
Regional Economic Analysis Division of the Bureau of Economic Analysis, U.S. Department of
Commerce. Regional economic areas are collections of economic areas. Metropolitan statistical areas
and rural service areas are defined by the Office of Management and Budget and the FCC,
respectively. Licensees of AWS spectrum can offer PCS and cellular services in competition with
broadband PCS and cellular licensees. The FCC auctioned the AWS spectrum in a single multiple round
auction which commenced on August 9, 2006. In November 2006, the FCC granted us 10 MHz REAG
licenses in the Northeast and West, and 10 MHz EA licenses in New York, Detroit-Ann Arbor,
Dallas/Ft. Worth, Las Vegas, Grand Rapids-Muskegon-Holland, Michigan, and Shreveport-Bossier City,
Louisiana. See “Business— Ownership Restrictions.”
The FCC sets construction benchmarks for broadband PCS and AWS licenses. All broadband PCS
licensees, holding licenses originally granted as 30 MHz licenses, must construct facilities to
provide service covering one-third of their service area’s population within five years, and
two-thirds of the population within ten years, of their initial license grant date. All broadband
PCS licensees holding licenses which originally were granted as, or disaggregated to become, 10 MHz
and 15 MHz licenses must construct facilities to provide service to 25% of the license area within
five years of their initial license grant date, or make a showing of substantial service. While the
FCC has granted limited extensions to and waivers of these requirements, licensees failing to meet
these coverage requirements generally must forfeit their license. Either we or the previous
licensee for each of our broadband PCS licenses has satisfied the applicable five-year coverage
requirement for our licenses and the ten-year requirement for those licenses with license terms
expiring in January 2007. All AWS licensees will be required to construct facilities to provide
substantial service by the end of the initial 15-year license term.
The FCC generally grants broadband PCS licenses for ten-year terms that are renewable upon
application to the FCC. AWS licenses are granted for an initial 15-year term and then are renewable
for successive ten-year terms. Our initial PCS license terms ended in January 2007 and we have
filed renewal applications for additional ten-year terms. All of these applications for our initial
PCS licenses have been granted. We also are filing renewal
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applications for our other PCS licenses
as the filing windows open and in some instances our applications already have been granted while
others are still pending or waiting for the filing window to open. Our initial AWS license terms
end in November 2021. The FCC may deny our broadband PCS and AWS license renewal applications for
cause after appropriate notice and hearing. The FCC will award a renewal expectancy to us for our
broadband PCS licenses if we meet specific past performance standards. To receive a renewal
expectancy for our broadband PCS licenses, we must show that we have provided substantial service
during our past license term, and have substantially complied with applicable FCC rules and
policies and the Communications Act. The FCC defines substantial service as service which is sound,
favorable and substantially above a mediocre service level only minimally warranting renewal. If we
receive a renewal expectancy, it is very likely that the FCC will renew our existing broadband PCS
licenses. If we do not receive a renewal expectancy, the FCC may accept competing applications for
the license renewal period, subject to a comparative hearing, and may award the broadband PCS
license for the next term to another entity. We believe we will be eligible for a renewal
expectancy for our broadband PCS licenses that will be renewed in the near term, but cannot be
certain because the applicable FCC standards are not precisely defined.
The FCC may deny applications for FCC licenses, and in extreme cases revoke FCC licenses, if
it finds a licensee lacks the requisite qualifications to be a licensee. In making this
determination, the FCC considers any adverse findings against the licensee or applicant in a
judicial or administrative proceeding involving felonies, possession or sale of illegal drugs,
fraud, antitrust violations or unfair competition, employment discrimination, misrepresentations to
the FCC or other government agencies, or serious violations of the Communications Act or FCC
regulations. We believe there are no activities and no judicial or administrative proceedings
involving us that would warrant such a finding by the FCC.
The FCC also has other broadband wireless spectrum allocation proceedings in process. In 2004,
the FCC sought comment on service rules for an additional 20 MHz of AWS spectrum in the 1915-1920
MHz, 1995-2000
MHz, 2020-2025 MHz and 2175-2180 MHz bands and has indicated that it intends to initiate a
further proceeding with regard to an additional 20 MHz of AWS spectrum in the 2155-2175 MHz band in
the future. These proposed allocations present certain unique spectrum clearing and interference
issues, and we cannot predict with any certainty the likely timing of these proposed allocations. A
company has also filed an application for 20 MHz of this spectrum to be licensed on an exclusive
basis without an auction, which the FCC put on public notice on March 9, 2007. The FCC also has
allocated an additional 60 MHz of wireless broadband spectrum in the 700 MHz band and the FCC is
now required by statute to commence auctioning this spectrum no later than January of 2008. On
August 10, 2006, the FCC issued a Notice of Proposed Rulemaking seeking comment on possible changes
to the 700 MHz band plan, including possible changes in the service area sizes for the 60 MHz of as
yet unauctioned 700 MHz spectrum. We are participating in this proceeding and advocating a greater
number of smaller license areas, but cannot predict the likely outcome or whether it will benefit
or adversely affect us. On September 8, 2006, the FCC also sought comment on the existing licenses
in the 700 MHz spectrum and the disposition of the 700 MHz spectrum returned by Nextel
Communications. Furthermore, in December 2006, the FCC sought comment on the possible
implementation of a nationwide broadband interoperable network in the 700 MHz band allocated for
public safety use, which also could be used by commercial service providers on a secondary basis.
Transfer and Assignment of PCS Licenses
The Communications Act requires prior FCC approval for assignments or transfers of control of
any license or construction permit, with limited exceptions. The FCC may prohibit or impose
conditions on assignments and transfers of control of licenses. We have managed to secure the
requisite approval of the FCC to a variety of assignment and transfer proposals without undue
delay. Although we cannot assure you that the FCC will approve or act in a timely fashion on any of
our future requests to approve assignment or transfer of control applications, we have no reason to
believe the FCC will not approve or grant such requests or applications in due course. Because an
FCC license is necessary to lawfully provide wireless broadband service, FCC disapproval of any
such request would adversely affect our business plans.
The FCC allows FCC licenses and service areas to be subdivided geographically or by bandwidth,
with each divided license covering a smaller service area and/or less spectrum. Any such division
is subject to FCC approval, which cannot be guaranteed. In addition, in May 2003, the FCC adopted a
Report and Order to facilitate development of a secondary market for unused or underused wireless
spectrum by imposing less restrictive standards on transferring and leasing of spectrum to third
parties. These policies provide us with alternative means to obtain additional spectrum or dispose
of excess spectrum, subject to FCC approval and applicable FCC
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conditions. These alternatives also
allow our competitors to obtain additional spectrum or new competitors to enter our markets.
Ownership Restrictions
Before January 1, 2003, the FCC rules imposed a “spectrum cap” limiting to 55 MHz the amount
of commercial mobile radio service, or CMRS, spectrum an entity could hold in a major market. The
FCC now has eliminated the spectrum cap for CMRS in favor of a case-by-case review of transactions
raising CMRS spectrum concentration issues. Previously decided cases under the case-by-case
approach indicate that the FCC will screen a transaction for competitive concerns if 70 MHz of
cellular and broadband PCS spectrum in a single market is attributable to a party or affiliated
group, or if there is a material change in the post-transaction market share concentrations as
measured by the Herfindahl-Hirschman Index. The 70 MHz benchmark may change over time as more and
more broadband spectrum is made available, and its applicability to AWS or 700 MHz spectrum is
unclear. By eliminating a spectrum cap for CMRS in favor of a more flexible analysis, we believe
the FCC’s changes will increase wireless operators’ ability to attract capital and make investments
in other wireless operators. We also believe that these changes allow our competitors to make
additional acquisitions of spectrum and further consolidate the industry.
The FCC rules initially established specific ownership requirements for broadband PCS licenses
obtained in the C- and F-Block auctions, which are known as the entrepreneur’s block auctions. We
were subject to these requirements until recently because our licenses were obtained in the C-Block
auction. When we acquired our C-Block broadband PCS licenses, the FCC’s rules for the C-Block
auction permitted entities to exclude the gross revenues and assets of non-attributable investors
in determining eligibility as a DE and small business, so long as the licensee employed one of two
control group structural options. We elected to meet the 25% control group option which required
that, during the first ten years of the initial license term (which for us would have ended on
January 27, 2007), a licensee have an established group of investors meeting the requirements for
the C-Block auctions,
holding at least 50.1% of the voting interests of the licensee, possessing actual and legal
control of both the control group and the licensee, and electing or appointing a majority of the
licensee’s board of directors. In addition, those qualifying investors were required to hold no
less than a specified percentage of the equity. After the first three years of the license term
(which for us ended January 27, 2000), the qualifying investors must collectively retain at least
10% of the licensee’s equity interests. The 10% equity interest could be held in the form of
options, provided the options were exercisable at any time, solely at the holder’s discretion, at
an exercise price less than or equal to the current market value of the underlying shares on the
short-form auction application filing date or, for options issued later, the options’ issue date.
Finally, under the 25% control group option, no investor or group of affiliated investors in the
control group was permitted to hold over 25% of the licensee’s overall equity during the initial
license term.
In August 2000, the FCC revised its control group requirements as they applied to DE
licensees. The revised rules apply a control test that obligates the eligible very small business
members of a DE licensee to maintain de facto (actual) and de jure (legal) control of the business.
Because we had taken advantage of installment payments at the time we purchased the licenses in the
C-Block auction, we were still required to comply with the control group requirements. In May 2005,
we paid off the remaining installments we owed to the FCC on all of the licenses we acquired in the
C-Block auction. In addition, none of the license acquisitions made by us after the C-Block auction
required that we qualify as a DE. As a consequence, upon repayment of the installments to the FCC,
we were no longer subject to the FCC rules and regulations pertaining to unjust enrichment or
installment financing. Based on this change of circumstances, we were no longer required to
maintain our previous status as an eligible DE or to abide by the ownership restrictions applicable
to DEs under the 25% control group option. In August 2005, we filed administrative updates with the
FCC with respect to all of our FCC licenses, which served to notify the FCC and all interested
parties of this change of circumstances. Effective as of December 31, 2005, MetroPCS
Communications, Inc.’s Class A Common Stock was converted into our common stock and the built-in
control structures required to maintain our DE status were terminated with the consent of the FCC.
Royal Street is a DE which must meet and continue to abide by the FCC’s DE requirements,
including the revised control group requirements. The FCC rules provide that if a license is
transferred to a non-eligible entity, an entity which qualifies for a lesser credit on open
licenses, or the DE ceases to be qualified, the licensee may lose all closed licenses which are not
constructed, and may be required to refund to the FCC a portion of the bidding credit received for
all open licenses, based on a five-year straight-line basis and might lose its closed licenses or
be required to pay an unjust enrichment payment on the closed licenses. In Auction 58, Royal Street
received a bidding credit equal to approximately $94 million. If Royal Street were found to no
longer qualify as a DE, it would be
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required to repay the FCC the amount of the bidding credit on a
five-year straight-line basis. Any closed licenses which are transferred prior to the five-year
anniversary may also be subject to an unjust enrichment payment. Royal Street also is party to
certain grandfathered arrangements with us that cannot be extended to new or additional licenses
due to recent changes in the DE rules. For this reason, the ability of Royal Street to own or
control additional licenses in the future will be inhibited absent significant changes in the
business relationship with us.
Specifically, in April 2006, the FCC adopted a Second Report and Order and Second Further
Notice of Proposed Rulemaking relating to its DE program. This Order was clarified by the FCC in
its June 2006 Order on Reconsideration of the Second Report and Order, which largely upheld the
rules established in the Second Report and Order but clarified that the FCC’s revised unjust
enrichment rules would only apply to licenses initially granted after April 25, 2006 (the Second
Report and Order, as clarified by the Order on Reconsideration, is referred to herein as the DE
Order). First, the FCC found that an entity that enters into an impermissible material relationship
will be ineligible for award of designed entity benefits and subject to unjust enrichment on a
license-by-license basis. The FCC concluded that any arrangement whereby a DE leases or resells
more than fifty percent of the capacity of its spectrum or network to third parties is an
impermissible material relationship and will render the licensee ineligible for any DE benefits,
including bidding credits, installment payments, and, as applicable, set-asides, and will subject
the DE to unjust enrichment payments on a license-by-license basis. Second, the FCC found that any
entity which has a spectrum leasing or resale arrangement (including wholesale arrangements) with
an applicant for more than 25% of the applicant’s total spectrum capacity on a license-by-license
basis will be considered to have an attributable interest in the applicant. Based on these revised
rules, Royal Street will not be able to enter into the same relationship it currently has with us
for any future FCC auctions and receive DE benefits, including bidding credits. In addition, Royal
Street will not be able to acquire any additional DE licenses in the future, and resell services to
us on those licenses on the same basis as the existing arrangements, without making itself
ineligible for DE benefits. The FCC, however, grandfathered otherwise impermissible material
relationships for existing licenses that were entered into or filed with the FCC before the release
date of the FCC order.
Third, the FCC has revised the DE unjust enrichment rules to provide that a licensee which
seeks to assign or transfer control of the license, enter into an otherwise impermissible material
relationship, or otherwise loses its eligibility for a bidding credit for any reason, will be
required to reimburse the FCC for any bidding credits received as follows: if the DE loses its
eligibility or seeks to assign or transfer control of the license, the DE will have to reimburse
the FCC for 100% of the bidding credit plus interest if such loss, assignment or transfer occurs
within the first five years of the license term; 75% if during the sixth and seventh year of the
license term; 50% if during the eighth and ninth of the license term; and 25% in the tenth year. In
addition, to the extent that a DE enters into an impermissible material relationship, seeks to
assign or transfer control of the license, or otherwise loses its eligibility for a bidding credit
for any reason prior to the filing of the notification informing the FCC that the construction
requirements applicable at the end of the license term have been met, the DE must reimburse the FCC
for 100% of the bidding credit plus interest. In its June 2006 Order on Reconsideration of the
Second Report and Order, the FCC clarified its rules to state that its changes to the DE unjust
enrichment rules would only apply to licenses initially issued after April 25, 2006. Licenses
issued prior to April 25, 2006, including those granted to Royal Street from Auction 58, would be
subject to the five-year unjust enrichment rules previously in effect. Likewise, the requirement
that the FCC be reimbursed for the entire bidding credit amount owed if a DE loses its eligibility
for a bidding credit prior to the filing of the notifications informing the FCC that the
construction requirements applicable at the end of the license term have been met applies only to
those licenses that are initially granted on or after April 25, 2006. Fourth, the FCC has adopted
rules requiring a DE to seek approval for any event in which it is involved that might affect its
ongoing eligibility, such as entry into an impermissible material relationship, even if the event
would not have triggered a reporting requirement under the FCC’s existing rules. In connection with
this rule change, the FCC now requires DEs to file annual reports with the FCC listing and
summarizing all agreements and arrangements that relate to eligibility for designated entity
benefits. Fifth, the FCC indicated that it will step up its audit program of DEs and has stated
that it will audit the eligibility of every DE that wins a license in the AWS auction at least once
during the initial license term. Sixth, these changes will all be effective with respect to all
applications filed with the FCC that occur after the effective date of the FCC’s revised rules,
including the AWS auction.
Several interested parties filed a Petition for Expedited Reconsideration and a Motion for
Expedited Stay Pending Reconsideration or Judicial Review of the DE Order. The Petitions challenged
the DE Order on both substantive and procedural grounds. Among other claims, the Petitions
contested the FCC’s effort to apply the revised rules to applications for the AWS auction and to
apply the revised unjust enrichment payment schedule to existing DE arrangements. In the Motion for
Stay, the petitioners requested that the FCC also stay the effectiveness of the rule changes, and
stay the commencement of the AWS auction which commenced on June 29, 2006 and all
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associated
pre-AWS auction deadlines. The FCC did not grant the stay, and the petitioners sought a court stay.
On June 7, 2006, the petitioners filed an appeal of the DE Order with the Court of Appeals for the
Third Circuit and sought an emergency stay of the DE Order. On June 29, 2006, the Court issued a
decision denying the emergency stay motion. The parties to the appeal recently filed briefs in this
case. The court has issued an order for oral argument, but has not yet set a date for oral
argument. We are unable at this time to predict the likely outcome of the appeals and unable to
predict the impact on the Auction. We also are unable to predict whether the litigation will result
in any changes to the DE Order or to the DE program, and, if there are changes, whether or not any
such changes will be beneficial or detrimental to our interests. However, the relief sought by the
petitioners includes overturning the results of Auction 66. If the petitioners are ultimately
successful in getting this relief, any licenses granted to us as a result of Auction 66 would be
revoked. Our payments to the FCC for the licenses would be refunded, but without interest. If our
licenses are revoked we will have been required to pay interest to our lenders on the money paid to
the FCC for the AWS licenses, but would not receive interest. The interest expense, which could be
substantial, may affect our results of operations and the loss of the Auction 66 licenses could
affect our future prospects.
In connection with the changes to the DE rules, the FCC also adopted in April 2006 a Second
Further Notice of Proposed Rulemaking seeking comment on whether additional restrictions should be
adopted in its DE program relating to, among other things:
There can be no assurance what additional changes, if any, to the DE program may be adopted as
a result of this rulemaking. Based on the FCC’s latest rulings, we do not expect any future changes
in the DE rules to be applied retroactively to Royal Street, but we cannot give any assurance that
the FCC will not give any new rules retroactive effect. If additional changes are made to the
program that are applied to the current arrangements between Royal Street, C9 Wireless and us, it
could have a material adverse effect on our and Royal Street’s operations and financial
performance.
The Communications Act includes provisions authorizing the FCC to restrict ownership levels in
us by foreign nationals or their representatives, a foreign government or its representative or any
corporation organized under the laws of a foreign country. The law permits indirect foreign
ownership of as much as 25% of our equity without the need for any action by the FCC. If the FCC
determines it is in the best interest of the general public, the FCC may revoke licenses or require
an ownership restructuring if our foreign ownership exceeds the statutory 25% benchmark. However,
the FCC generally permits additional indirect foreign ownership in excess of the statutory 25%
benchmark particularly if that interest is held by an entity or entities from World Trade
Organization member countries. For investors from countries that are not members of the World Trade
Organization, the FCC determines if the home country extends reciprocal treatment, called
“equivalent competitive opportunities,” to United States entities. If these opportunities do not
exist, the FCC may not permit such foreign investment beyond the 25% benchmark. We have adopted
internal procedures to assess the nature and extent of our foreign ownership, and we believe that
the indirect ownership of our equity by foreign entities is below the benchmarks established by the
Communications Act. If we have foreign ownership in excess of the limits, we have the right to
acquire the portion of the foreign investment which places us over the foreign ownership
restriction. Nevertheless, these foreign ownership restrictions could affect our ability to attract
additional equity financing and complying with the restrictions could increase our cost of
operations.
General Regulatory Obligations
The Communications Act and the FCC’s rules impose a number of requirements upon wireless
broadband PCS, and in many instances AWS, licensees. These requirements, summarized below, could
increase our costs of doing business.
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Federal legislation enacted in 1993 requires the FCC to reduce the disparities in the
regulatory treatment of similar mobile services, such as cellular, PCS and Enhanced Specialized
Mobile Radio, or ESMR, services. Under this regulatory structure, our wireless broadband PCS and
AWS services are classified as CMRS. The FCC regulates providers of CMRS services as common
carriers, which subjects us to many requirements under the Communications Act and FCC rules and
regulations. The FCC, however, has exempted CMRS offerings from some typical common carrier
regulations, such as tariff and interstate certification filings, which allows us to respond more
quickly to competition in the marketplace. The 1993 federal legislation also preempted state rate
and entry regulation of CMRS providers.
The FCC permits cellular, broadband PCS, AWS, paging and ESMR licensees to offer fixed
services on a co-primary basis along with mobile services. This rule may facilitate the provision
of wireless local loop service by CMRS licensees using wireless links to provide local telephone
service. The extent of lawful state regulation of such wireless local loop service is undetermined.
While we do not presently have a fixed service offering, our network can accommodate such a
service. We continue to evaluate our service offerings, which may include a fixed service plan at
some point in the future.
The spectrum allocated for broadband PCS was utilized previously by fixed microwave systems.
To foster the orderly clearing of the spectrum, the FCC adopted a transition and cost sharing plan
pursuant to which incumbent microwave users could be reimbursed for relocating out of the band and
the costs of relocation were shared by the broadband PCS licensees benefiting from the relocation.
Under the FCC regulations, DEs were able to pay microwave reimbursed clearing obligations through
installment payments. We incurred various microwave relocation obligations pursuant to this
transition plan. The transition and cost sharing plans expired in April 2005, at which time
remaining microwave incumbents in the broadband PCS spectrum remained obligated to relocate to
different spectrum but assumed responsibility for their costs to relocate to alternate spectrum. We
have fulfilled all of the relocation obligations (and related payments) directly incurred in our
broadband PCS markets. As of December 31, 2006, we had no obligations related to our PCS licenses
payable to other carriers under cost sharing plans for microwave relocation in our markets. As a
result of the offer to purchase made by Madison Dearborn Capital Partners IV, L.P. and certain
affiliates of TA Associates, Inc. in 2005, we ceased being a DE have paid off
all remaining microwave clearing obligations to other carriers. This process has taken longer
than we anticipated which could give rise to an objection by a carrier to which microwave clearing
payments are due.
In addition, spectrum allocated for AWS currently is utilized by a variety of categories of
commercial and governmental users. To foster the orderly clearing of the spectrum, the FCC adopted
a transition and cost sharing plan pursuant to which incumbent non-governmental users could be
reimbursed for relocating out of the band and the costs of relocation would be shared by AWS
licensees benefiting from the relocation. The FCC has established a plan where the AWS licensee and
the incumbent non-governmental user are to negotiate voluntarily for three years and then, if no
agreement has been reached, the incumbent licensee is subject to mandatory relocation where the AWS
licensee can force the incumbent non-governmental licensee to relocate at the AWS licensee’s
expense. The spectrum allocated for AWS currently is utilized also by governmental users. The FCC
rules provide that a portion of the money raised in Auction 66 will be used to reimburse the
relocation costs of governmental users from the AWS band. However, not all governmental users are
obligated to relocate. We estimate the costs we may incur to relocate the incumbent licensees in
the areas where we have been granted AWS licenses in Auction 66 to be approximately $40 to $60
million, and the time it will take to clear the AWS spectrum in markets where we acquired licenses
is uncertain.
We are obligated to pay certain annual regulatory fees and assessments to support FCC wireless
industry regulation, as well as fees supporting federal universal service programs, number
portability, regional database costs, centralized telephone numbering administration,
telecommunications relay service for the hearing-impaired and application filing fees. These fees
are subject to increase by the FCC periodically.
The FCC requires CMRS providers to implement basic 911 and enhanced, or E-911, emergency
services. Our obligation to implement these services is incurred in stages on a market-by-market
basis as local emergency service providers request E-911 services. These services allow state and
local emergency service providers to better identify and locate callers using wireless services,
including callers using special devices for the hearing impaired. We have constructed facilities to
implement these capabilities in markets where we have had requests and are in the process of
constructing facilities in the markets we launched recently. The FCC also has rules that require
us, because we employ a handset-based location technology, to ensure that specified percentages of
the handsets in service on the system be location capable. As of December 31, 2005, 95% of our
handsets were required to be
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location-capable and we met this requirement. Failure to maintain
compliance with the FCC’s E-911 requirements can subject us to significant penalties. The extent
to which we must deploy E-911 services affects our capital spending obligations. In 1999, the FCC
amended its rules to no longer require compensation by the state to carriers for E-911 costs and to
expand the circumstances under which wireless carriers may be required to offer E-911 services to
the public safety agencies. States in which we do business may limit or eliminate our ability to
recover our E-911 costs. Federal legislation enacted in 1999 may limit our liability for
uncompleted 911 calls to a similar level to wireline carriers in our markets.
Federal law requires CMRS carriers to provide law enforcement agencies with support for lawful
wiretaps. Federal law also requires compliance with wiretap-related record-keeping and
personnel-related obligations. Complying with these E-911 and law enforcement wiretap requirements
may require systems upgrades creating additional capital obligations for us and additional
personnel, a process which may cost us additional expense which we may not be able to recover. Our
customer base may be subject to a greater percentage of law enforcement requests than those of
other carriers and that the resulting expenses incurred by us to cooperate with law enforcement are
proportionately greater.
Because the availability of telephone numbers is dwindling, the FCC has adopted number pooling
rules that govern how telephone numbers are allocated. Number pooling is mandatory inside the
wireline rate centers where we have drawn numbers and that are located in counties included in the
top 100 metropolitan statistical areas, or MSAs, as defined by FCC rules. We have implemented
number pooling and support pooled number roaming in all of our markets which are included in the
top 100 MSAs. The FCC also has authorized states to start limited numbering administration to
supplement federal requirements and some of the states where we provide service have been
authorized by the FCC to start limiting numbering administration.
In addition, the FCC has ordered all telecommunications carriers, including CMRS carriers, to
provide telephone number portability enabling subscribers to keep their telephone numbers when they
change telecommunications carriers, whether wireless to wireless or, in some instances, wireline to
wireless, and vice versa. Under these local number portability rules, a CMRS carrier located in one
of the top 100 MSAs must have the technology in place to allow its customers to keep their
telephone numbers when they switch to a new carrier. Outside of the top 100 MSAs, CMRS carriers receiving a request to allow end users to keep
their telephone numbers must be capable of doing so within six months of the request or within six
months of November 24, 2003, whichever is later. In addition, all CMRS carriers are required to
support nationwide roaming for customers retaining their numbers. We currently support number
portability in all of our markets.
FCC rules provide that all local exchange carriers must, upon request, enter into mutual or
reciprocal compensation arrangements with CMRS carriers for the exchange of local traffic, under
which each carrier compensates the other for terminated local traffic originating on the
compensating carrier’s network. Local traffic is defined for purposes of the reciprocal
compensation arrangement between local exchange carriers and CMRS carriers as intra-MTA traffic,
and thus the FCC’s reciprocal compensation rules apply to any local traffic originated by a CMRS
carrier and terminated by a local exchange carrier within the same MTA and vice versa, even if such
traffic is interexchange. While these rules provide that local exchange carriers may not charge
CMRS carriers for facilities used by CMRS carriers to terminate local exchange carriers’ traffic,
local exchange carriers may charge CMRS carriers for facilities used to transport and terminate
CMRS traffic and for facilities used for transit purposes to carry CMRS carrier traffic to a third
carrier. FCC rules also provide that, on the CMRS carrier’s request, incumbent local exchange
carriers must exchange local traffic with CMRS carriers at rates based on the FCC’s costing rules;
rates are set by state public utility commissions applying the FCC’s rules. The rules governing
CMRS interconnection are under review by the FCC in a rulemaking proceeding, and we cannot be
certain whether or not there will be material changes in the applicable rules, and if there are
changes, whether they will be beneficial or detrimental to us.
Before 2005, some local exchange carriers claimed a right by filing a state tariff to impose
unilateral charges on CMRS carriers for the termination of CMRS carriers’ traffic on the local
exchange carrier’s network, often at above-cost rates. In 2005, the FCC issued a Report and Order
holding that, on a going forward basis, no local exchange carrier was permitted to unilaterally
impose tariffed rates for the termination of a CMRS carrier’s traffic. This Report and Order
imposed on CMRS carriers an obligation to engage in voluntary negotiation and arbitration with
incumbent local exchange carriers similar to those imposed on the incumbent local exchange carriers
pursuant to Section 252 of the Communications Act. Further, the FCC found that its prior rules did
not preclude incumbent local exchange carriers from imposing unilateral charges pursuant to tariff
for the period prior to
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the effective date of the Report and Order. Finally, the Report and Order
found that, once an incumbent local exchange carrier requested negotiation of an interconnection
arrangement, both carriers are obligated to begin paying the FCC’s default rates for all traffic
exchanged after the request for negotiation. Several CMRS carriers and incumbent local exchange
carriers have appealed the Report and Order and we have sought clarification on certain aspects of
the Report and Order. In the meantime, a number of local exchange carriers and incumbent local
exchange carriers have demanded that we pay bills for traffic exchanged in the past and we are
evaluating those demands. We may pay some portion of these amounts, which may be material. Also, a
number of local exchange carriers have requested that we enter into negotiations for
interconnection agreements and, as a result of such negotiations, we may be obligated to pay
amounts to settle prior claims and on a going forward basis, and such amounts may be material.
Also, other local exchange companies have threatened to sue us if agreements governing termination
compensation are not reached. We generally have been successful in negotiating arrangements with
carriers with whom we exchange traffic; however, our business could be adversely affected if the
rates some carriers charge us for terminating our customers’ traffic ultimately prove to be higher
than anticipated. In one case, a complaint has been filed by a CLEC against us before the FCC
claiming a right to terminating compensation payments on a going forward basis and going backward
basis at a rate that we consider to be excessive. We are vigorously defending against the
complaint, but cannot predict the outcome at this time. An adverse outcome could be material.
The FCC has adopted rules requiring interstate communications carriers, including CMRS
carriers, to “make an equitable and non-discriminatory contribution” to a Universal Service Fund,
or USF, that reimburses communications carriers providing basic communications services to users
receiving services at subsidized rates. We have made these FCC-required payments. The FCC recently
started a rulemaking proceeding to solicit public comment on ways of reforming both how it assesses
carrier USF contributions and how carriers may recover their costs from customers and some of the
proposals may cause the amount of USF contributions required from us and our customer to increase.
Effective April 1, 2003, the FCC prospectively forbade carriers from recovering administrative
costs related to administering the required universal service assessments from customers as USF
charges. The FCC’s rules require carriers’ USF recovery charges to customers not exceed the
assessment rate the carrier pays times the proportion of interstate telecommunications revenue on
the bill. We are currently in compliance with these requirements.
Wireless broadband carriers may be designated as Eligible Telecommunications Carriers, or
ETCs, and may receive universal service support for providing service to customers using wireless
service in high cost areas. Other wireless broadband carriers operating in states where we operate
have obtained or applied for ETC status. Such other carriers’ receipt of universal service support
funds may affect our competitive status in a particular market by allowing our competitors to offer
service at a lower rate. We may decide in the future to apply for this designation in certain
qualifying high cost areas where we provide wireless services. If we are approved, these payments
would be an additional revenue source that we could use to support the services we provide in high
cost areas.
CMRS carriers are exempt from the obligation to provide equal access to interstate long
distance carriers. However, the FCC has the authority to impose rules requiring unblocked access
through carrier identification codes or 800/888 numbers to long distance carriers so CMRS customers
are not denied access to their chosen long distance carrier, if the FCC determines the public
interest so requires. Our customers have access to alternative long distance carriers using
toll-free numbers.
FCC rules also impose restrictions on a telecommunications carrier’s use of customer
proprietary network information, or CPNI, without prior customer approval, including restrictions
on the use of information related to a customer’s location. The FCC recently began an
investigation into whether CMRS carriers are properly protecting the CPNI of their customers
against unauthorized disclosure to third parties. In February 2006, the FCC requested that all
CMRS carriers provide a certificate from an officer of the CMRS carrier based on personal knowledge
that the CMRS carrier was in compliance with all CPNI rules. We have provided such a certificate.
The FCC also has proposed substantial fines on certain wireless carriers for their failure to
comply with the FCC’s CPNI rules. We believe that our current practices are consistent with
existing FCC rules on CPNI, and do not foresee new costs or limitations on our existing practices
as a result of the current FCC rules in that area. However, in February 2006, the FCC also adopted
a notice of proposed rulemaking seeking comment on a variety of issues related to customer privacy,
including what additional security measures may be warranted to protect a customer’s CPNI. Congress
and state legislators also are in the process of enacting legislation which addresses the use and
protection of CPNI which may impact our obligations. For example, Congress recently enacted the
Telephone Records and Privacy Protection
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Act of 2006, which imposes criminal penalties upon persons
who purchase without a customer’s consent, or use fraud to gain unauthorized access to, telephone
records. The FCC’s proposed rules, if adopted or modified, and the recent and pending legislation
(if enacted) may require us to change how we protect our customer’s CPNI and could require us to
incur additional costs or change our business practices or processes, which costs and changes may
be material.
Telecommunications carriers are required to make their services accessible to persons with
disabilities. These FCC rules generally require service providers to offer equipment and services
accessible to and usable by persons with disabilities, if readily achievable, and to comply with
FCC-mandated complaint/grievance procedures. These rules are largely untested and are subject to
interpretation through the FCC’s complaint process. While these rules principally focus on the
manufacturer of the equipment, we could have costly new requirements imposed on us and, if we were
found to have violated the rules, be subject to fines, which fines could be material. As a related
matter, on July 10, 2003, the FCC issued an order requiring digital wireless phone manufacturers
and wireless service providers (including us) to take steps ensuring the availability of hearing
aid compatible digital wireless phones. Specifically, the FCC mandated that non-Tier 1 CMRS
carriers, such as us, are required under the FCC’s current rules to offer to its customers at least
two wireless digital phones for each air interface used by it that meet the FCC hearing
aid-compatibility requirements. We currently are in compliance with these requirements. By February
18, 2008, half of the digital wireless handsets that we offer for each air interface must meet the
FCC’s hearing aid-compatibility requirements. Since there has been consolidation in the digital
wireless handset manufacturers industry, we may have difficulty securing the necessary handsets in
order to meet the FCC’s requirements. In addition, since we are required to offer these hearing
aid-compatible wireless phones for each air interface we provide, this requirement may limit our
ability to offer services using new air interfaces other than CDMA 1XRTT, may limit the number of
handsets we can offer, or may increase the costs of handsets for those new air interfaces. Further,
to the extent that the costs of such handsets are more than non-hearing aid-compatible digital
wireless handsets, it may decrease demand for our services, decrease the number of wireless phones
we can offer to our customers, or increase our selling costs if we choose to subsidize the cost of
the hearing aid-compatible handsets.
The FCC has determined that long distance or interexchange service offerings from CMRS
providers are subject to Communications Act rate averaging and rate integration requirements. Rate
averaging requires us to average our intrastate long distance CMRS rates between rural and high
cost areas and urban areas. The FCC has
delayed implementation of rate integration requirements for wide area rate plans pending
further reconsideration of its rules, and has also delayed a requirement that CMRS carriers
integrate their rates among CMRS affiliates. Other aspects of the FCC’s rules have been vacated by
the United States Court of Appeals for the District of Columbia Circuit, and are subject to further
consideration by the FCC. There is a pending proceeding for the FCC to determine how integration
requirements apply to CMRS offerings, including single rate plans. Our pricing flexibility is
reduced to the extent we offer services subject to these requirements, and we cannot assure you
that the FCC will decline imposing these requirements on us.
Antenna structures used by us and other wireless providers are subject to FCC rules
implementing the National Environmental Policy Act and the National Historic Preservation Act.
Under these rules, construction cannot begin on any structure that may significantly affect the
human environment or that may affect historic properties until the wireless provider has filed an
environmental assessment with and obtained approval from the FCC. Processing of environmental
assessments can delay construction of antenna facilities, particularly if the FCC determines that
additional information is required or if community opposition arises. In addition, several
environmental groups have unsuccessfully requested changes to the FCC’s environmental processing
rules, challenged specific environmental assessments as failing statutory requirements and sought
to have the FCC conduct a comprehensive assessment of antenna tower construction environmental
effects. The FCC also is considering the impact that communications facilities, including wireless
towers and antennas, may have on migratory birds. In August of 2003, the FCC initiated a rulemaking
proceeding seeking information on whether rule changes should be adopted to reduce the risk of
migratory bird collisions with commercial towers. The FCC released a Notice of Proposed Rulemaking
in this proceeding on November 7, 2006, in which the FCC tentatively concludes that
medium-intensity white strobe lights should be considered the preferred system in place of red
obstruction lighting systems to the maximum extent possible without compromising safety. The FCC
also seeks comments on the possible adoption of various other measures that might serve to mitigate
the impact of communications towers on migratory birds. In the meantime, there are a variety of
federal and state court actions in which citizen and environmental groups have sought to deny tower
approvals based upon potential adverse impacts to migratory birds.
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Although we use antenna
structures that are owned and maintained by third parties, the results of these FCC and court
proceedings could have an impact on our efforts to secure access to particular towers, or the costs
of access.
The location and construction of PCS antennas, base stations and towers also are subject to
FCC and Federal Aviation Administration regulations, federal, state and local environmental
regulation, and state and local zoning, land use and other regulation. Before we can put a system
into commercial operation, we, or the tower owner in the case of leased sites, must obtain all
necessary zoning and building permit approvals for the cell site and microwave tower locations. The
time needed to obtain necessary zoning approvals and state permits varies from market to market and
state to state and, in some cases, may materially delay our ability to provide service. Variations
also exist in local zoning processes. Further, certain municipalities impose severe restrictions
and limitations on the placement of wireless facilities which may impede our ability to provide
service in that area. In 2002, the Board of Supervisors for the City and County of San Francisco,
or the City of San Francisco, denied certain applications to construct three sites in the City of
San Francisco. The City of San Francisco claimed that additional facilities were not necessary
because adequate services are available from other wireless carriers. In July 2002, we filed suit
against the City of San Francisco and its Board of Supervisors based on their denial of our
applications. The trial was conducted in late March 2006 and early April 2006. In June 2006, the
court found in favor of the City of San Francisco and denied our applications. The court clarified
that a gap in coverage existed, but that we had not used the least restrictive means to provide
service in the area. None of the parties to the proceeding have appealed and the time to bring an
appeal has expired. A failure or inability to obtain necessary zoning approvals or state permits,
or to satisfy environmental rules may make construction impossible or infeasible on a particular
site, might adversely affect our network design, increase our network design costs, require us to
use more costly alternative technologies, such as distributed antenna systems, reduce the service
provided to our customers, and affect our ability to attract and retain customers.
In 2004, the FCC initiated a proceeding to update and modernize its systems for distributing
emergency broadcast alerts. Television stations, radio broadcasters and cable systems currently are
required to maintain emergency broadcast equipment capable of retransmitting emergency messages
received from a federal agency. As part of its attempts to modernize the emergency alert system,
the FCC in its proceeding is addressing the feasibility of requiring wireless providers, such as
us, to distribute emergency information through wireless networks. Unlike broadcast and cable
networks, however, our infrastructure and protocols — like those of all other similarly-situated
wireless broadband CMRS carriers — are optimized for the delivery of individual messages on a
point-to-point basis, and not for delivery of messages on a point-to-multipoint basis, such as all
subscribers within a defined geographic area. While multiple proposals have been discussed in the
FCC proceeding, including limited proposals
to use existing short messaging service capabilities on a short-term basis, the FCC has not
yet ruled and therefore we are not able to assess the short- and long-term costs of meeting any
future FCC requirements to provide emergency and alert service, should the FCC adopt such
requirements. Adoption of such requirements, however, could require new components within our
network and transmission infrastructure and also require consumers to purchase new handsets.
Congress recently passed the Warning, Alert, and Response Network Act as part of the Security and
Accountability For Every Port Act of 2006. In this Act, which was recently signed into law,
Congress provided for the establishment, within 60 days of enactment, of an advisory committee to
provide recommendations to the FCC regarding technical standards and protocols under which electing
commercial mobile radio service, or CMRS, providers may offer subscribers the capability of
receiving emergency alerts. The FCC is required to complete a proceeding to adopt relevant
technical standards, protocols, procedures, and other technical requirements based on the
recommendations of such Advisory Committee necessary to enable alerting capability for CMRS
providers that voluntarily elect to transmit emergency alert. Under the Act, a CMRS carrier can
elect not to participate in providing such alerting capability. If a CMRS carrier elects to
participate, the carrier may not charge separately for the alerting capability and the CMRS
carrier’s liability related to, or any harm resulting from, the transmission of, or failure to
transmit, an emergency alert is limited. The FCC is obligated to complete its rulemaking
implementing such rules within a relatively short period of time after receiving the
recommendations from the advisory committee. Until the FCC promulgates rules, we do not know if
they will adopt such requirements, and if it does, what their impact will be on our infrastructure
and service.
The FCC historically has required that CMRS providers permit customers of other carriers to
roam “manually” on their networks, for example, by supplying a credit card number, provided that
the roaming customer’s handset is technically capable of accessing the roamed-on network. The FCC
recently initiated a notice of proposed rulemaking seeking comments
on whether automatic roaming services are considered common carrier services, whether CMRS carriers have an obligation to offer
automatic roaming services to other carriers, whether carriers have an obligation to provide
non-voice roaming services, and what rates a carrier may charge for roaming
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services. The FCC
previously initiated roaming proceedings on similar issues but failed to resolve these issues.
Roaming rights are important to us because we have a limited service area and must rely on other
carriers in order to offer roaming outside our existing service areas. We have commented in this
proceeding in support of an FCC rule requiring carriers to honor requests for automatic roaming at
reasonable, non-discriminatory rates. However, we cannot predict the likely outcome of this
proceeding or the likely timing of an FCC ruling. If the FCC decides not to require automatic
roaming at reasonable non-discriminatory rates, or limits roaming to voice services only, we may
have difficulty attracting and retaining certain groups of customers which could have an adverse
impact on our business.
In September of 2004, the FCC issued a Report and Order and Further Notice of Proposed
Rulemaking and adopted several measures designed to increase carrier flexibility, reduce regulatory
costs and to promote access to capital and spectrum for entities seeking to provide or improve
wireless service to rural areas, including the relaxation of the FCC rule that prohibited a carrier
from having any interest in both the Block A and Block B cellular licenses in a common market.
These rule changes create potential opportunities for us if we seek to extend our service to rural
markets, but also could benefit our competitors.
On November 20, 2006, the Copyright Office of the Library of Congress, or the Copyright
Office, released the final rules in its triennial review of the exemptions to the prohibition on
circumvention of copyright protection systems for access control technologies, or Triennial Review,
contained in the Digital Millennium Copyright Act, or DMCA. In 1998, Congress enacted the DMCA,
which among other things amended the United States Copyright Act to add a section prohibiting the
circumvention of technological measures employed to protect a copyrighted work, or access control.
In addition, the Copyright Office has the authority to exempt certain activities which otherwise
might be prohibited by that section for a period of three years when users are (or in the next
three years are likely to be) adversely affected by the prohibition in their ability to make
noninfringing uses of a class of copyrighted work. Many carriers, including us, routinely place
software locks on their wireless handsets which prevent a customer from using a wireless handset
sold by one carrier on another carrier’s system. In its Triennial Review, the Copyright Office
determined that these software locks on wireless handsets are access controls which adversely
affect the ability of consumers to make noninfringing use of the software on their wireless
handsets. As a result, the Copyright Office found that a person could circumvent such software
locks and other firmware that enable wireless handsets to connect to a wireless telephone network
when such circumvention is accomplished for the sole purpose of lawfully connecting the wireless
handset to another wireless telephone network. A wireless carrier has filed suit in the United
States District Court in Florida to reverse the Copyright Office’s decision. This exemption is
effective from November 27, 2006 through October 27, 2009 unless extended by the Copyright Office.
This ruling, if upheld, could allow customers to use their wireless handsets on the networks
of other carriers. Since many of our competitors generally subsidize their wireless handsets
substantially more than we do, customers of our competitors may find it attractive to bring their
phones to us for activation. This may result in us experiencing lower costs to add customers. This
ruling may also allow our customers who are dissatisfied with our service to utilize the services
of our competitors without having to purchase a new wireless handset. The ability of our customers
to leave our service and use their wireless handsets to receive a competitor’s service may have an
adverse material impact on our business. In addition, since our subsidy for handsets to our
distribution partners is incurred in advance, we may experience higher distribution costs resulting
from wireless handsets not being activated or maintained on our network, which costs may be
material.
In a February 20, 2007, filing, a provider of VoIP services asked the FCC to issue a
declaratory ruling that would give wireless customers the right to utilize any device of their
choice to access a wireless network as long as the devise did not cause interference or network
degradation. This so-called “Carterfone Rule” is opposed by many wireless companies and the
principal wireless industry association, but may be considered by the FCC. The proponent also
requested that the FCC initiate proceedings to determine whether the practices of wireless carriers
comport with the Carterfone Rule.
On March 23, 2007, the FCC released a declaratory ruling finding that wireless broadband
Internet access service is an information service under the Communications Act of 1934, as amended,
or the Communications Act. In addition, the FCC found that the transmission component of wireless
broadband Internet access service is telecommunications and that the offering of a
telecommunications transmission component as part of a functionally integrated Internet access
service offering is not a telecommunications service under the Communications Act. Further, the
FCC found that mobile wireless broadband Internet access service is not a “commercial mobile
service” under Section 332 of the Act. Finally, the FCC defined broadband Internet access for this
purpose as service at
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speeds in excess of 200 kbps in at least one direction. This ruling
eliminates any common carrier obligations with respect to the provision of mobile wireless
broadband Internet access services and could have a material impact on our ability to negotiate
roaming agreements with other wireless carriers which include the provision of mobile wireless
broadband Internet access services while roaming on the other carrier’s network. In addition, this
ruling could allow our competitors and us greater flexibility in the pricing and terms and
conditions of this service.
State, Local and Other Regulation
The Communications Act preempts state or local regulation of market entry or rates charged by
any CMRS provider. As a result, we are free to establish rates and offer new products and services
with minimum state regulation. However, states may continue regulating “other terms and conditions”
of wireless service, and certain states where we operate maintain additional oversight
jurisdiction, primarily focusing upon consumer protection issues and resolution of customer
complaints. In addition, several state authorities have initiated actions or investigations of
various wireless carrier practices. The outcome of these proceedings is uncertain and could require
us to change our marketing practices, ultimately increasing state regulatory authority over the
wireless industry. State and local governments also may manage public rights of way and can require
fair and reasonable compensation from telecommunications carriers, including CMRS providers, for
the use of such rights of any, so long as the government publicly discloses such compensation.
A dispute exists between the FCC and certain state public utility commission advocates as to
whether the FCC’s preemptive rights over rates allows the FCC to prevent states from prohibiting
the use of separate line items on wireless bills for charges that are not mandated by federal,
state or local law. The FCC ruled in 2005 that states were preempted from requiring or prohibiting
the use of non-misleading line items on wireless bills. In 2006, the United States Court of Appeals
for the Eleventh Circuit vacated the FCC decision. A similar case is currently pending before the
United States Court of Appeals for the Ninth Circuit. Several parties have announced an intention
to seek review of the issues in the U.S. Supreme Court. The outcome of these cases, which we are
unable to predict at this time, could affect the extent to which our CMRS services are subject to
state regulations that may cause us to incur additional costs.
The California Public Utilities Commission, or CPUC, in early 2006 adopted consumer protection
rules replacing an earlier consumer bill of rights. The new consumer bill of rights applies to
“telecommunications services” subject to the CPUC’s jurisdiction — they do not replace and only
supplement existing requirements that carriers have under federal and state law, tariffs, other
orders and decisions of the FCC or the CPUC, and FCC requirements. The consumer bill of rights
establishes seven rights (freedom of choice, disclosure, privacy, public participation and
enforcement, accurate bills and dispute resolution, nondiscrimination, and public safety) and also
includes rules on CPUC staff requests for information; worker identification; E-911 access;
slamming rules (e.g., change of a subscriber’s telecommunications service without authorization)
with some modifications to existing slamming rules; and new cramming rules (e.g., placement of
unauthorized charges on a telecommunications bill) that apply to all charges on a telephone bill
(and eliminates the interim opt-in rules for non-communications relating services). The cramming
rules generally reiterate requirements that already exist under the law with some additions. The
consumer bill of rights does not create a private right of action or liability that would not exist
absent the rules. We have reviewed the consumer bill of rights and believe that we are in
compliance.
We cannot give any assurance that the consumer bill of rights will not cause us to spend
additional funds or complicate our marketing and sales programs which may have a material adverse
impact on our operations in California. We cannot assure you that any state or local regulatory
requirements currently applicable to our systems will not be changed in the future or that
regulatory requirements will not be adopted in those states and localities which currently have
none. Such changes could impose new obligations on us that would adversely affect our operating
results.
Future Regulation
From time to time, federal or state legislators propose legislation and federal or state
regulators propose regulations that could affect us, either beneficially or adversely. We cannot
assure you that federal or state governments will not enact legislation or that the FCC or other
federal or state regulator will not adopt regulations or take other action that might adversely
affect us. Changes such as the FCC allocating additional radio spectrum for services competing with
our business or granting existing licensees of other services flexibility to offer mobile wireless
services could adversely affect our operating results.
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Item 1A. Risk Factors
Risks Related to Our Business
Our business strategy may not succeed in the long term.
A major element of our business strategy is to offer consumers a service that allows them to
make unlimited local calls and, depending on the service plan selected, long distance calls, from
within our service area and to receive unlimited calls from any area for a flat monthly rate
without entering into a long-term service contract. This is a relatively new approach to marketing
wireless services and it may not prove to be successful in the long term or deployable in
geographic areas we have acquired but not launched or geographic areas we may acquire in the
future. Some companies that have offered this type of service in the past have not been successful.
From time to time, we evaluate our service offerings and the demands of our target customers and
may amend, change, discontinue or adjust our service offerings or trial new service offerings as a
result. These service offerings may not be successful or prove to be profitable.
We have limited operating history and have launched service in a limited number of metropolitan
areas. Accordingly, our performance to date may not be indicative of our future results or our
performance in future markets we launch.
We began offering service in the first quarter of 2002, and we had no revenues before that
time. Consequently, we have a limited operating and financial history upon which to evaluate our
financial performance, business plan execution and ability to succeed in the future. You should
consider our prospects in light of the risks, expenses and difficulties we may encounter, including
those frequently encountered by new companies competing in rapidly evolving and highly competitive
markets. If we are unable to execute our plans and grow our business, our financial results will be
adversely affected. Our business strategy involves expanding into new geographic areas beyond our
Core Markets and these geographic areas may present competitive challenges different from those
encountered in our Core Markets. Our financial performance in new geographic areas, including our
Expansion Markets and Auction 66 Markets, may not be as positive as our Core Markets.
We face intense competition from other wireless and wireline communications providers, and
potential new entrants, which could adversely affect our operating results and hinder our ability
to grow.
We compete directly in each of our markets with (i) other facilities-based wireless providers,
such as Verizon Wireless, Cingular Wireless, Sprint Nextel, and T-Mobile and their prepaid
affiliates or brands, (ii) non-
facilities based mobile virtual network operators, or MVNOs, such as Virgin Mobile USA and
Amp’d Mobile, (iii) incumbent local exchange carriers, such as AT&T and Verizon, as a mobile
alternative to traditional landline service and (iv) competitive local exchange carriers or
Voice-Over-Internet-Protocol, or VoIP, service providers, such as Vonage, Time Warner, Comcast,
McLeod USA, Clearwire and XO Communications, as a mobile alternative to wired service. We also may
face competition from providers of an emerging technology known as Worldwide Interoperability for
Microwave Access, or WiMax, which is capable of supporting wireless transmissions suitable for
mobility applications. Also, certain mobile satellite providers recently have received authority to
offer ancillary terrestrial service and a coalition of companies which includes DIRECTV Group,
EchoStar, Google, Inc., Intel Corp. and Yahoo! has indicated its desire to establish next
generation wireless networks and technologies in the 700 MHz band. In addition, VoIP service
providers have indicated that they may offer wireless services over a Wi-Fi/Cellular network to
complete directly with us for the provisioning of wireless services. Many major cable television
service providers, including Comcast, Time Warner Cable, Cox Communications and Bright House
Networks, also have indicated their intention to offer suites of service, including wireless
service, often referred to as the “Quadruple Play,” and are actively pursuing the acquisition of
spectrum or leasing access to spectrum to implement those plans. These cable companies formed a
joint venture along with Sprint Nextel called SpectrumCo LLC, or SpectrumCo, which bid on and
acquired 20 MHz of advanced wireless service, or AWS, spectrum in a number of major metropolitan
areas throughout the United States, including all of the major metropolitan areas which comprise
our Core, Expansion and Auction 66 Markets. Many of our current and prospective competitors are, or
are affiliated with, major companies that have substantially greater financial, technical,
personnel and marketing resources than we have (including spectrum holdings, brands and
intellectual property) and larger market share than we have, which may affect our ability to
compete successfully. These competitors often have greater name and brand recognition and
established relationships with a larger base of current and potential customers and, accordingly,
we may not be able to compete successfully. In some markets, we also compete with local or regional
carriers, such as
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Leap Wireless International, or Leap Wireless, and Sure West Wireless, some of
whom have or may develop fixed-rate unlimited service plans similar to ours.
Sprint Nextel recently announced that it will offer an unlimited local calling plan under its
Boost brand in certain of the geographic areas in which we offer service. In response, in certain
of our markets we have added additional features to our existing service plans. Currently, in our
San Francisco, Sacramento, and Dallas/Ft. Worth metropolitan areas we have added to the $35 service
plan unlimited long distance in the continental United States, to the $40 service plan unlimited
short message and multimedia message services, and to the $45 service plan unlimited mobile
Internet browsing and international short message service. The Sprint Nextel calling plans may
increase our churn and decrease demand for our services in those metropolitan areas where they
offer their unlimited local calling plan. In addition, as a result of the changes in our service
plans, we may experience lower revenues, lower ARPU and lower Adjusted EBITDA in the affected
metropolitan areas. If Sprint Nextel expands its unlimited local calling plan into other
metropolitan areas or if other carriers institute similar service plans, we may make similar
changes to our service plans in our other metropolitan areas, add additional features or services
to our existing service plans, or make other changes to our service plans, all of which could have
a material adverse impact on our future financial results.
We expect that increased competition will result in more competitive pricing, slower growth
and increased churn of our customer base. Our ability to compete will depend, in part, on our
ability to anticipate and respond to various competitive factors and to keep our costs low. The
competitive pressures of the wireless telecommunications industry have caused, and may continue to
cause, other carriers to offer service plans with increasingly large bundles of minutes of use at
increasingly lower prices and rate plans with unlimited nights and weekends. These competitive
plans could adversely affect our ability to maintain our pricing and market penetration and
maintain and grow our customer base.
We may face additional competition from new entrants in the wireless marketplace, many of whom may
have significantly more resources than we do.
Certain new entrants with significant financial resources participated in Auction 66 and were
designated as the high bidder on spectrum rights in geographic areas served by us. For example,
SpectrumCo acquired 20 MHz of spectrum in all of the metropolitan areas which comprise our Core,
Expansion and Auction 66 Markets. In addition, Leap Wireless offers fixed-rate unlimited service
plans similar to ours and acquired spectrum which overlaps some of the metropolitan areas we serve
or plan to serve. These licenses could be used to provide services directly competitive with our
services.
The auction and licensing of new spectrum, including the spectrum recently auctioned by the
FCC in Auction 66, may result in new competitors and/or allow existing competitors to acquire
additional spectrum, which could allow them to offer services that we may not technologically or
cost effectively be able to offer with the licenses we hold or to which we have access. The FCC has
already designated an additional 60 MHz of spectrum in the 700 MHz band which may be used to offer
services competitive with the services we offer or plan to offer. Furthermore, the FCC may pursue
policies designed to make available additional spectrum for the provision of wireless services in
each of our metropolitan areas, which may increase the number of wireless competitors and enhance
the ability of our wireless competitors to offer additional plans and services that we may be
unable to successfully compete against.
Some of our competitors have technological or operating capabilities that we may not be able to
successfully compete with in our existing markets or any new markets we may launch.
Some of the carriers we compete against provide wireless services using cellular frequencies
in the 800 MHz band. These frequencies enjoy propagation advantages over the PCS frequencies we
use, which may cause us to have to spend more capital than our competitors in certain areas to
cover the same area. In addition, the FCC plans to auction additional spectrum in the 700 MHz band
which will have similar characteristics to the 800 MHz cellular frequencies. Many of the wireless
carriers against whom we compete have service area footprints substantially larger than our
footprint. In addition, certain of our competitors are able to offer their customers roaming
services over larger geographic areas and at rates lower than the rates we can offer. Our ability
to replicate these roaming service offerings at rates which will make us, or allow us to be,
competitive is uncertain at this time.
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Certain carriers we compete against, or may compete against in the future, are multi-faceted
telecommunications service providers which, in addition to providing wireless services, are
affiliated with companies that provide local wireline, long distance, satellite television,
Internet, media, content, cable television and/or other services. These carriers are capable of
bundling their wireless services with other telecommunications services and other services in a
package of services that we may not be able to duplicate at competitive prices.
We also compete with companies that use other communications technologies, including paging
and digital two-way paging, enhanced specialized mobile radio and domestic and global mobile
satellite service. These technologies may have certain advantages over the technology we use and
may ultimately be more attractive to our existing and potential customers. We may compete in the
future with companies that offer new technologies and market other services that we do not offer or
may not be able to offer. Some of our competitors do or may offer these other services together
with their wireless communications service, which may make their services more attractive to
customers. Energy companies and utility companies are also expanding their services to offer
communications services.
In addition, we compete with companies that take advantage of the unlicensed spectrum that the
FCC is increasingly allocating for use. Certain technical standards are being prepared, including
Worldwide Interoperability for Microwave Access, or WiMax, which may allow carriers to offer
services competitive with ours in the unlicensed spectrum. The users of this unlicensed spectrum do
not have the exclusive use of licensed spectrum, but they also are not subject to the same
regulatory requirements that we are and, therefore, may have certain advantages over us.
We may face increased competition from other fixed rate unlimited plan competitors in our existing
and new markets.
We currently overlap with Leap Wireless and Sure West Wireless, who are fixed-rate unlimited
service plan wireless carriers providing service in the Sacramento, Modesto and Merced, California
basic trading areas. In Auction 66, the FCC auctioned 90 MHz of spectrum in each geographic area of
the United States including the areas in which we currently hold or have access to licenses. Leap
Wireless also acquired licenses in or has been announced as the high bidder in Auction 66 in some
of the same geographic areas in which we currently hold or have access to licenses or in which we
were granted licenses as a result of Auction 66. In addition to Leap Wireless, other licensees who
have PCS spectrum or acquired spectrum in Auction 66 also may decide to offer fixed-rate unlimited
wireless service offerings. In addition, Sprint Nextel recently announced that it is launching an
unlimited local calling plan under its Boost brand in certain of the markets in which we offer
service. Other national wireless carriers may also decide in the future to offer fixed-rate
unlimited wireless service offerings. In addition, we may not be able to launch fixed-rate
unlimited service plans ahead of our competition in our new markets. As a result, we may
experience lower growth in such areas, may experience higher churn, may change our service plans in
affected
markets and may incur higher costs to acquire customers, which may materially and adversely
affect our financial performance in the future.
A patent infringement suit has been filed against us by Leap Wireless which could have a material
adverse effect on our business or results of operations.
On June 14, 2006, Leap Wireless and Cricket Communications, Inc., or collectively Leap, filed
suit against us in the United States District Court for the Eastern District of Texas, Marshall
Division, Civil Action No. 2-06CV-240-TJW and amended on June 16, 2006, for infringement of U.S.
Patent No. 6,813,497 “Method for Providing Wireless Communication Services and Network and System
for Delivering of Same,” or the ’497 Patent, issued to Leap. The complaint seeks both injunctive
relief and monetary damages for our alleged infringement of such patent.
If Leap is successful in its claim for injunctive relief, we could be enjoined from operating
our business in the manner we operate currently, which could require us to redesign our current
networks, to expend additional capital to change certain of our technologies and operating
practices, or could prevent us from offering some or all of our services using some or all of our
existing systems. In addition, if Leap is successful in its claim for monetary damage, we could be
forced to pay Leap substantial damages for past infringement and/or ongoing royalties on a portion
of our revenues, which could materially adversely impact our financial performance. If Leap
prevails in its action, it could have a material adverse effect on our business, financial
condition and results of operations. Moreover, the actions may consume valuable management time,
may be very costly to defend and may distract management attention away from our business.
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The Department of Justice has informally stated that it would carefully scrutinize any statement by
us in support of any future efforts by us to acquire divestiture assets and as a result we may have
difficulty acquiring spectrum in the future.
We acquired the PCS spectrum for the Dallas/Ft. Worth and Detroit Expansion Markets from
Cingular Wireless as a result of a consent decree entered into between Cingular Wireless, AT&T
Wireless and the United States Department of Justice, or the DOJ. When we acquired the spectrum, we
had certain expectations which were communicated to the DOJ about how we would use the spectrum,
including expectations about constructing a combined 1XRTT/EV-DO network on the spectrum capable of
supporting data services. Although we have constructed a combined 1XRTT/EV-DO network in those
markets, we expected to be able to support our services as demand increased by upgrading the
networks to a EV-DO Revision A with VoIP when available. Based upon our discussions at the time
with our network vendor, we anticipated that these upgrades would be available in 2006.
As a result of a delay in the availability of EV-DO Revision A with VoIP, we contacted the DOJ
in September 2006 to inform them that we had determined that it was necessary for us to redeploy
the EV-DO network assets at certain cell sites in those markets to 1XRTT in order to serve our
existing customers. The DOJ responded with an informal letter, which the Company received in
November 2006, expressing concern over our use of the spectrum and requesting certain information
regarding our construction of our network facilities in these markets, our use of EV-DO, and the
services we are providing in the Dallas/Ft. Worth and Detroit Expansion Markets. We have responded
to the initial DOJ request and subsequent follow-up requests. On March 23, 2007, the DOJ sent us a
letter in which they did not request any further information from us but stated that the DOJ would
carefully scrutinize any statement by us in support of any future efforts by us to acquire
divestiture assets. This may make it more difficult for us to acquire any spectrum in the future
which may be available as a result of a divesture required by the DOJ. This also does not preclude
the DOJ from taking any further action against the Company. We cannot predict at this time whether
the DOJ will pursue this matter any further and, if they do, what actions they may take or what the
outcome may be.
If we experience a higher rate of customer turnover than we have forecasted, our costs could
increase and our revenues could decline, which would reduce our profits.
Our average monthly rate of customer turnover, or churn, for the year ended December 31, 2006
was approximately 4.6%. A higher rate of churn could reduce our revenues and increase our marketing
costs to attract the replacement customers required to sustain our business plan, which could
reduce our profit margin. In addition, we may not be able to replace customers who leave our
service profitably or at all. Our rate of customer churn may be affected by several factors,
including the following:
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Unlike many of our competitors, we do not require our customers to enter into long-term
service contracts. As a result, our customers have the ability to cancel their service at any time
without penalty, and we therefore expect our churn rate to be higher than other wireless carriers.
In addition, customers could elect to switch to another carrier that has service offerings based on
newer network technology. We cannot assure you that our strategies to address customer churn will
be successful. If we experience a high rate of wireless customer churn, seek to prevent significant
customer churn, or fail to replace lost customers, our revenues could decline and our costs could
increase which could have a material adverse effect on our business, financial condition and
operating results.
We may not have access to all the funding necessary to build and operate our Auction 66 Markets.
The proceeds from the sale of the senior notes and our borrowings under our senior secured
credit facility did not include the funds necessary to construct, launch and operate our Auction 66
Markets. In addition to the proceeds from our initial public offering, we will need to generate
significant excess free cash flow, which is defined as Adjusted EBITDA less capital expenditures,
from our operations in our Core and Expansion Markets in order to construct and operate the Auction
66 Markets in the near term or at all. See “Management Discussion and Analysis of Financial
Condition and Results of Operations —Liquidity and Capital Resources.” If we are unable to fund the
build-out of our Auction 66 Markets with the proceeds from our initial public offering and excess
internally generated cash flows, we may be forced to seek additional debt financing or delay our
construction. The covenants under our senior secured credit facility and the indenture covering the
notes may prevent us from incurring additional debt to fund the construction and operation of the
Auction 66 Markets, or may prevent us from securing such funds on suitable terms or in accordance
with our preferred construction timetable. Accordingly, we may be required to continue to pay
interest on the secured debt and the senior notes for our Auction 66 Market licenses without the
ability to generate any revenue from our Auction 66 Markets.
We may not achieve the customer penetration levels in our Core and Expansion Markets that we
currently believe are possible with our business model.
Our ability to achieve the customer penetration levels that we currently believe are possible
with our business model in our Core and Expansion Markets is subject to a number of risks,
including:
If we are unable to achieve the aggregate levels of customer penetration that we currently
believe are possible with our business model in our Core and Expansion Markets, our ability to
continue to grow our customer base and revenues at the rates we currently expect may be limited.
Any failure to achieve the penetration levels we currently believe are possible may have a material
adverse impact on our future financial results and operations. Furthermore, any inability to
increase our overall level of market penetration in our Core and Expansion Markets, as well as any
inability to achieve similar customer penetration levels in other markets we launch in the future,
could adversely impact the market price of our stock.
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We may be subject to claims of infringement regarding telecommunications technologies that are
protected by patents and other intellectual property rights.
Telecommunications technologies are protected by a wide array of patents and other
intellectual property rights. As a result, third parties may assert infringement claims against us
from time to time based on our general business operations, the equipment, software or services we
use or provide, or the specific operation of our wireless networks. We generally have
indemnification agreements with the manufacturers, licensors and suppliers who provide us with the
equipment, software and technology that we use in our business to protect us against possible
infringement claims, but we cannot guarantee that we will be fully protected against all losses
associated with an infringement claim. Moreover, we may be subject to claims that products,
software and services provided by different vendors which we combine to offer our services may
infringe the rights of third parties and we may not have any indemnification protection from our
vendors for these claims. Further, we have been, and may be, subject to further claims that certain
business processes we use may infringe the rights of third parties, and we may have no
indemnification rights from any of our vendors or suppliers. Whether or not an infringement claim
is valid or successful, it could adversely affect our business by diverting management’s attention,
involving us in costly and time-consuming litigation, requiring us to enter into royalty or
licensing agreements (which may not be available on acceptable terms, or at all), require us to pay
royalties for prior periods, or requiring us to redesign our business operations, processes or
systems to avoid claims of infringement. If a claim is found to be valid or if we cannot
successfully negotiate a required royalty or license agreement, it could disrupt our business,
prevent us from offering certain services and cause us to incur losses of customers or revenues,
any or all of which could be material and could adversely affect our business, financial
performance, operating results and the market price of our stock.
The wireless industry is experiencing rapid technological change, and we may lose customers if we
fail to keep up with these changes.
The wireless telecommunications industry is experiencing significant technological change. Our
continued success will depend, in part, on our ability to anticipate or adapt to technological
changes and to offer, on a timely basis, services that meet customer demands. We cannot assure you
that we will obtain access to new technology on a timely basis, on satisfactory terms, or that we
will have adequate spectrum to offer new services or implement new technologies. This could have a
material adverse effect on our business, financial condition and operating results. For us to keep
pace with these technological changes and remain competitive, we must continue to make significant
capital expenditures to our networks and to acquire additional spectrum. Customer acceptance of the
services that we offer will continually be affected by technology-based differences in our product
and service offerings and those offered by our competitors.
The wireless telecommunications industry has been, and we believe will continue to be,
characterized by several trends, including the following:
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We expect competition to intensify as a result of new competitors, allocation of additional
spectrum and relaxation of existing policies, and the development of new technologies, products and
services. For instance, we currently do not offer certain of the high speed data applications
offered by our competitors. In addition, push-to-talk has become popular as it allows subscribers
to save time on dialing or connecting to a network and some of the companies that compete with us
in our wireless markets offer push-to-talk. We do not offer our customers a push-to-talk service.
As demand for this service continues to grow, and if we do not offer these technologies, we may
have difficulty attracting and retaining subscribers, which will have an adverse effect on our
business. In addition, other service providers have announced plans to develop a WiFi or WiMax
enabled handset. Such a handset would permit subscribers to communicate using voice and data
services with their handset using VoIP technology in any area equipped with a wireless Internet
connection, or hot spot, potentially allowing more carriers to offer larger bundles of minutes
while retaining low prices and the ability to offer attractive roaming rates. The number of hot
spots in the U.S. is growing rapidly, with some major cities and urban areas being covered
entirely. The availability of VoIP or another alternative technology to our competitor’s
subscribers could increase their ability to offer competing rate plans, which would have an adverse
effect on our ability to attract and retain customers.
We and Royal Street may incur significant costs in our build-out and launch of new markets and we
may incur operating losses in those markets for an undetermined period of time.
We and Royal Street have invested and expect to continue to invest a significant amount of
capital to build systems that will adequately cover our Expansion Markets, and we and Royal Street
will incur operating losses in each of these markets for an undetermined period of time. We also
anticipate having to spend and invest a significant amount of capital to build systems and operate
networks in the Auction 66 Markets.
Our and Royal Street’s network capacities in our existing and new markets may be insufficient to
meet customer demand or to offer new services that our competitors may be able to offer.
We and Royal Street have licenses for only 10 MHz of spectrum in certain of our markets, which
is significantly less than most of the wireless carriers with whom we and Royal Street compete.
This limited spectrum may require Royal Street and us to secure more cell sites to provide
equivalent service (including data services based on EV-DO technology), spend greater capital
compared to Royal Street’s and our competitors, to deploy more expensive network equipment, such as
six-sector antennas and EV-DO Revision A with VoIP, sooner than our competitors, or make us more
dependent on improvements in handsets, such as EVRC-B or 4G capable handsets. Royal Street’s and
our limited spectrum may also limit Royal Street’s and our ability to support our growth plans
without additional technology improvements and/or spectrum, and may make Royal Street and us more
reliant on technology advances than our competitors. There is no guarantee we and Royal Street can
secure adequate tower
sites or additional spectrum, or that expected technology improvements will be available to
support Royal Street’s and our business requirements or that the cost of such technology
improvements will allow Royal Street and us to remain competitive with other carriers. Competitive
carriers in these markets also may take steps prior to Royal Street and us launching service to try
to attract Royal Street’s and our target customers. There also is no guarantee that the operations
in the Royal Street metropolitan areas, which are based on a wholesale model, will be profitable or
successful. Most national wireless carriers have greater spectrum capacity than we do that can be
used to support third generation, or 3G, and fourth generation, or 4G, services. These national
wireless carriers are currently investing substantial sums of capital to deploy the necessary
capital equipment to deliver 3G enhanced services. We and Royal Street have access to less spectrum
than certain major competitive carriers in most of our and Royal Street’s markets. Our limited
spectrum may make it difficult for us and Royal Street to simultaneously support our voice services
and 3G/4G services. In addition, we and Royal Street may have to invest additional capital and/or
acquire additional spectrum to support the delivery of 3G/4G services. There is no guarantee that
we or Royal Street will be able to provide 3G/4G services on existing licensed spectrum, or will
have access to either the spectrum or capital, necessary to provide competitive 3G/4G services in
our metropolitan areas, or that our vendors will provide the necessary equipment and software in a
timely manner. Moreover, Royal Street’s and our deployment of 3G/4G services requires technology
improvements which may not occur or may be too costly for Royal Street and us to compete.
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We are dependent on certain network technology improvements which may not occur, or may be
materially delayed.
The adequacy of our spectrum to serve our customers in markets where we have access to only 10
MHz of spectrum is dependent upon certain recent and ongoing technology improvements, such as EV-DO
Revision A with VoIP, 4G vocoders, and intelligent antennas. Further, there can be no assurance
that (1) the additional technology improvements will be developed by our existing infrastructure
provider, (2) such improvements will be delivered when needed, (3) the prices for such improvements
will be cost-effective, or (4) the technology improvements will deliver our projected network
efficiency improvements. If projected or anticipated technology improvements are not achieved, or
are not achieved in the timeframes we need such improvements, we and Royal Street may not have
adequate spectrum in certain metropolitan areas, which may limit our ability to grow our customer
base, may inhibit our ability to achieve additional economies of scale, may limit our ability to
offer new services offered by our competitors, may require us to spend considerably more capital
and incur more operating expenses than our competitors with more spectrum, and may force us to
purchase additional spectrum at a potentially material cost. If our network infrastructure vendor
does not supply such improvements or materially delays the delivery of such improvements and other
network equipment manufacturers are able to develop such technology, we may be at a material
competitive disadvantage to our competitors and we may be required to change network infrastructure
vendors, the cost of which could be material.
We may be unable to acquire additional spectrum in the future at a reasonable cost.
Because we offer unlimited calling services for a fixed fee, our customers tend, on average,
to use our services more than the customers of other wireless carriers. We believe that the average
amount of use our customers generate may continue to rise. We intend to meet this demand by
utilizing spectrum-efficient state-of-the-art technologies, such as six-sector cell site
technology, EV-DO Revision A with VoIP, 4G vocoders and intelligent antennas. Nevertheless, in the
future we may need to acquire additional spectrum in order to maintain our grade of service and to
meet increasing customer demands. However, we cannot be sure that additional spectrum will be made
available by the FCC for commercial uses on a timely basis or that we will be able to acquire
additional spectrum at a reasonable cost. For example, there have been recent calls for
reallocating spectrum previously slated for commercial mobile uses to public safety uses in order
to enable first responders to establish an interoperable nationwide broadband network. If the
additional spectrum is unavailable when needed or unavailable at a reasonable cost, we could lose
customers or revenues, which could be material, and our ability to grow our customer base may be
materially adversely affected.
Substantially all of our network infrastructure equipment is manufactured or provided by a single
infrastructure vendor and any failure by that vendor could result in a material adverse effect on
us.
We have entered into a general purchase agreement with an initial term of three years,
effective as of June 6, 2005, with Lucent Technologies, Inc., or Lucent, now known as Alcatel
Lucent, as our network infrastructure supplier of PCS CDMA system products and services, including
without limitation, wireless base stations, switches, power, cable and transmission equipment and
services. The agreement does not cover the spectrum we recently
acquired in Auction 66. The agreement provides for both exclusive and non-exclusive pricing
for PCS CDMA products and the agreement may be renewed at our option on an annual basis for three
additional years after its initial three-year term concludes. Substantially all of our PCS network
infrastructure equipment is manufactured or provided by Alcatel Lucent. A substantial portion of
the equipment manufactured or provided by Alcatel Lucent is proprietary, which means that equipment
and software from other manufacturers may not work with Alcatel Lucent’s equipment and software, or
may require the expenditure of additional capital, which may be material. If Alcatel Lucent ceases
to develop, or substantially delays development of, new products or support existing equipment and
software, we may be required to spend significant amounts of money to replace such equipment and
software, may not be able to offer new products or service, and may not be able to compete
effectively in our markets. If we fail to continue purchasing our PCS CDMA products exclusively
from Alcatel Lucent, we may have to pay certain liquidated damages based on the difference in
prices between exclusive and non-exclusive prices, which may be material to us.
Our network infrastructure vendor has merged, which could have a material adverse effect on us.
Lucent announced on April 2, 2006 that it had entered into a definitive merger agreement with
Alcatel, and the shareholders of each company approved the merger. Alcatel and Lucent announced on
November 30, 2006 the
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completion of the merger and the companies began doing business on December
1, 2006 as “Alcatel Lucent.” There can be no assurance that the combined entity will continue to
produce and support the products and services that we currently purchase from Alcatel Lucent. In
addition, the combined entity may delay or cease developing or supplying products or services
necessary to our business. If Alcatel Lucent delays or ceases to produce products or services
necessary to our business and we are unable to secure replacement products and services on
reasonable terms and conditions, our business could be materially adversely affected.
Our network infrastructure vendor may change where it manufactures equipment necessary for our
network which could have a material adverse effect on us.
As a result of its ongoing operations, Alcatel Lucent may move the manufacturing of some of
its products from its existing facilities in one country to another manufacturing facility located
in another country and that process may accelerate with the completion of its merger. To the extent
that products are manufactured outside the current facilities, we may experience delays in
receiving products from Alcatel Lucent and the quality of the products we receive may suffer. These
delays and quality problems could cause us to experience problems in increasing capacity of our
existing systems, expanding our service areas, and the construction of new markets. If these delays
or quality problems occur, they could have a material adverse effect on our ability to meet our
business plan and our business operations and finances may be materially adversely affected.
No equipment or handsets are currently available for the AWS spectrum and such equipment or
handsets may not be developed in a timely manner.
The
AWS spectrum requires modified or new equipment and handsets which are not
currently available. We do not manufacture or develop our own equipment or handsets and are
dependent on third party manufacturers to design, develop and manufacture such equipment. If
equipment or handsets are not available when we need them, we may not be able to develop the
Auction 66 Markets. We may, therefore, be forced to pay interest on our indebtedness which we used
to fund the purchase of the licenses in Auction 66, without realizing any revenues from our Auction
66 Markets.
If we are unable to manage our planned growth effectively, our costs could increase and our level
of service could be adversely affected.
We have experienced rapid growth and development in a relatively short period of time and
expect to continue to experience substantial growth in the future. The management of rapid growth
will require, among other things, continued development of our financial and management controls
and management information systems. Historically, we have failed to adequately implement financial
controls and management systems.
We publicly acknowledged deficiencies in our financial reporting as early as August 2004, and
controls and systems designed to address these deficiencies are not yet fully implemented. The
costs of implementing these controls and systems will affect the near-term financial results of the
business and the lack of these controls and systems may materially adversely affect our ability to
access the capital markets.
Our expected growth also will require stringent control of costs, diligent management of our
network infrastructure and our growth, increased capital requirements, increased costs associated
with marketing activities, the ability to attract and retain qualified management, technical and
sales personnel and the training and management of new personnel. Our growth will challenge the
capacity and abilities of existing employees and future employees at all levels of our business.
Failure to successfully manage our expected growth and development could have a material adverse
effect on our business, increase our costs and adversely affect our level of service. Additionally,
the costs of acquiring new customers could adversely affect our near-term profitability.
We have identified material weaknesses in our internal control over financial reporting in the
past. We will incur significant time and expense enhancing, documenting, testing and certifying our
internal control over financial reporting and our business may be adversely affected if we have
other material weaknesses or significant deficiencies in our internal control over financial
reporting in the future.
In connection with the preparation of our quarterly financial statements for the three months
ended June 30, 2004, we determined that previously disclosed financial statements for the three
months ended March 31, 2004 understated service revenues and net income. Additionally, in
connection with their evaluation of our disclosure
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controls and procedures with respect to the
filing in May 2006 of our Annual Report on Form 10-K for the year ended December 31, 2004, our
chief executive officer and chief financial officer concluded that certain material weaknesses in
our internal controls over financial reporting existed as of December 31, 2004. The material
weaknesses related to deficiencies in our information technology and accounting control
environments, insufficient “tone at the top,” deficiencies in our accounting for income taxes, and
a lack of automation in our revenue reporting process. In connection with their review of our
material weaknesses, our management and audit committee concluded that our previously reported
consolidated financial statements for the years ended December 31, 2002 and 2003 should be restated
to correct accounting errors resulting from these material weaknesses.
We have identified, developed and implemented a number of measures to strengthen our internal
control over financial reporting and address the material weaknesses that we identified in 2004.
Although there were no reported material weaknesses in our internal controls over financial
reporting as of December 31, 2006, our management did identify significant deficiencies relating to
the accrual of equipment and services and the accounting for distributed antenna system agreements.
There can be no assurance that we will not have significant deficiencies in the future or that
such conditions will not rise to the level of a material weakness. The existence of one or more
material weaknesses or significant deficiencies could result in errors in our financial statements
or delays in the filing of our periodic reports required by the SEC. Any failure by us to timely
file our periodic reports could result in a breach of the indenture covering the senior notes and
our secured credit facility, potentially accelerating payment under both agreements. We may not
have the ability to pay, or borrow any amounts necessary to pay, any accelerated payment due under
the secured credit facility or the indenture covering the senior notes. We may also incur
substantial costs and resources to rectify any internal control deficiencies.
As a public company we will incur significant legal, accounting, insurance and other expenses.
The Sarbanes-Oxley Act of 2002, as well as compliance with other SEC and exchange listing rules,
will increase our legal and financial compliance costs and make some activities more time-consuming
and costly. Furthermore, as a public company, SEC rules require that our chief executive officer
and chief financial officer periodically certify the existence and effectiveness of our internal
control over financial reporting. Our independent registered public accounting firm will be
required, beginning with our Annual Report on Form 10-K for our fiscal year ending on December 31,
2007, to attest to our assessment of our internal control over financial reporting.
During the course of our testing, we may identify deficiencies that would have to be
remediated to satisfy the SEC rules for certification of our internal control over financial
reporting. As a consequence, we may have to disclose in periodic reports we file with the SEC
significant deficiencies or material weaknesses in our system of internal controls. The existence
of a material weakness would preclude management from concluding that our internal control over
financial reporting is effective, and would preclude our independent auditors from issuing an
unqualified opinion that our internal control over financial reporting is effective. If we cannot
produce reliable financial reports, we may be in breach of the indenture covering the senior notes
and our secured credit facility, potentially accelerating payment under both agreements. In
addition, disclosures of this type in our SEC reports could cause investors to lose confidence in
our financial reporting and may negatively affect the trading price of our common stock. Moreover,
effective internal controls are necessary to produce reliable financial reports and to prevent
fraud. If we have deficiencies in our disclosure controls and procedures or internal control over
financial reporting it may negatively impact our business, results of operations and reputation.
Because we may have issued stock options and shares of common stock in violation of federal and
state securities laws and some of our stockholders and option holders may have a right of
rescission, we intend to make a rescission offer to certain holders of shares of our common stock
and options to purchase shares of our common stock.
Certain options to purchase our common stock granted since January 2004 and certain shares
issued upon exercise of options granted during this period may not have been exempt from the
registration and qualification requirements of the Securities Act of 1933 or under the securities
laws of a few states. As of December 31, 2006, we granted to employees and former employees options
to purchase approximately 2,148,000 shares of our common stock, of which approximately 1,959,000
options remain outstanding with a weighted average exercise price per option of $6.28. We issued
these options and shares of common stock in reliance on Rule 701 under the Securities Act of 1933.
However, we may not have been entitled to rely on Rule 701 because (1) during certain periods we
exceeded certain thresholds in the rule and may not have delivered to our option holders the
financial and other information required to be delivered by Rule 701; and (2) during certain
periods in 2004 and 2006 we were subject to, or should have been subject to, the periodic reporting
requirements under the Securities Exchange Act of 1934.
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As a result, certain holders of options and
shares acquired from us may have a right to require us to repurchase those securities if we are
found to be in violation of federal or state securities laws.
In order to address these issues, we intend to make a rescission offer to the holders of
options to purchase approximately 1,959,000 shares of our common stock as soon as practicable after
the completion of our initial public offering. We will be making this offer to approximately 525 of
our current and former employees. If the rescission offer is accepted by all persons to whom it is
made, we could be required to make aggregate payments of up to approximately $2.6 million. This
amount reflects a purchase price equal to the price paid by the holder for each share of common
stock that is the subject of the rescission offer and a purchase price equal to 20% of the
aggregate exercise price for each option that is the subject of the rescission offer. It is
possible that an option holder could argue that the purchase price for the options does not
represent an adequate remedy for the issuance of the option in violation of applicable securities
laws, and a court may find that we are required to pay a greater amount for the options.
There can be no assurance that the SEC or state regulatory bodies will not take the position
that any rescission offers should extend to all holders of options or stock acquired upon exercise
of options granted during the relevant periods. The Securities Act of 1933 also does not provide
that a rescission offer will extinguish a holder’s right to rescind the grant of an option or the
issuance of shares that were not registered or exempt from the registration requirements under the
Securities Act of 1933. Consequently, should any recipients of our rescission offer reject the
offer, expressly or impliedly, we may remain liable under the Securities Act of 1933 for the
purchase price of the options and shares that are subject to the rescission offer.
We failed to register our stock options under the Securities Exchange Act of 1934 and, as a result,
we may face potential claims under federal and state securities laws.
As of December 31, 2005, options granted under our 1995 option plan and our 2004 equity
incentive plan were held by more than 500 holders. As a result, we were required to file a
registration statement registering the stock options pursuant to Section 12(g) of the Securities
Exchange Act of 1934 no later than April 30, 2006. We failed to file a registration statement
within the required time period.
If we had filed a registration statement pursuant to Section 12(g) as required, we would have
become subject to the periodic reporting requirements of Section 13 of the Securities Exchange Act
of 1934 upon the effectiveness of that registration statement. We have not filed any periodic
reports, including quarterly reports on Form 10-Q and periodic reports on Form 8-K during the
period since April 30, 2006, which is the latest date upon which we were required to file a
registration statement.
Our failure to file the periodic reports we would have been required to file had we registered
our common stock pursuant to Section 12(g) could give rise to potential claims by present or former
stockholders based on the theory that such holders were harmed by the absence of such public
reports. In addition to any claims by present or former stockholders, we could be subject to
administrative and/or civil actions by the SEC. If any such claim or action is asserted, we could
incur significant expenses and divert management’s attention in defending them.
Our failure to timely file a registration statement under the Securities Exchange Act of 1934, may
mean that we may not be able to timely meet our periodic reporting requirements as a public
company.
As a publicly-traded company, we are now required to file periodic reports with the SEC
containing our financial statements within a specified period following the completion of quarterly
and annual periods. In 2006, we failed to file a registration statement under the Securities
Exchange Act of 1934 within the time period required by Section 12(g) of such act as a result of
our failure to have in place procedures to inform us that we were required to file a registration
statement. Our failure to timely file that registration statement may mean that we may not have all
of the controls and procedures in place to ensure compliance with all of the rules and requirements
applicable to public companies. Any failure by us to file our periodic reports with the SEC in a
timely manner could harm our reputation and reduce the trading price of our common stock.
A significant portion of our revenue is derived from geographic areas susceptible to natural and
other disasters.
Our markets in California, Texas and Florida contribute a substantial amount of revenue,
operating cash flows, and net income to our operations. These same states, however, have a history
of natural disasters which may
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adversely affect our operations in those states. The severity and
frequency of certain of these natural disasters, such as hurricanes, are projected to increase over
the next several years. In addition, the major metropolitan areas in which we operate, or plan to
operate, could be the target of terrorist attacks. These events may cause our networks to cease
operating for a substantial period of time while we reconstruct them and our competitors may be
less affected by such natural disasters or terrorist attacks. If our networks cease operating for
any substantial period of time, we may lose revenue and customers, and may have difficulty
attracting new customers in the future, which could materially adversely affect our operations.
Although we have business interruption insurance which we believe is adequate, we cannot provide
any assurance that the insurance will cover all losses we may experience as a result of a natural
disaster or terrorist attack or that the insurance carrier will be solvent.
Our substantial indebtedness could adversely affect our financial health.
We have now, and will continue to have, a significant amount of debt. As of December 31, 2006,
we had $2.6 billion of outstanding indebtedness under the senior secured credit facility and the
senior notes. Our substantial amount of debt could have important material adverse consequences to
us. For example, it could:
In addition, a substantial portion of our debt, including borrowings under our senior secured
credit facility, bears interest at variable rates. Although we have entered into a transaction to
hedge some of our interest rate risk, if market interest rates increase, variable-rate debt will
create higher debt service requirements, which could adversely affect our cash flow. While we have
and may in the future enter into agreements limiting our exposure to higher interest rates, any
such agreements may not offer complete protection from this risk and any portions not subject to
such agreements would have full exposure to higher interest rates. We estimate the interest expense
and principal repayments on our debt for the 12 months ending December 31, 2007 to be approximately
$228.1 million.
Despite current indebtedness levels, we will be able to incur substantially more debt. This could
further exacerbate the risks associated with our leverage.
We will be able to incur additional debt in the future despite our current level of
indebtedness. The terms of the senior secured credit facility and the indenture governing the
senior notes will allow us to incur substantial amounts of additional debt, subject to certain
limitations. There are no restrictions on our or any of our future unrestricted subsidiaries’
ability to incur additional indebtedness. If new debt is added to our current debt levels, the
related risks we could face would be magnified.
To service our debt, we will require a significant amount of cash, which may not be available to
us.
Our ability to make payments on, or repay or refinance, our debt and to fund planned capital
expenditures and operating losses associated with the Expansion Markets and the Auction 66 Markets,
will depend largely upon receipt of proceeds from our initial public offering and our future
operating performance. Our future performance is subject to certain general economic, financial,
competitive, legislative, regulatory and other factors that are beyond our control. In addition,
our ability to borrow funds in the future to make payments on our debt will depend on the
satisfaction of the covenants in our senior secured credit facility, the indenture covering the
senior notes and our
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other debt agreements and other agreements we may enter into in the future.
Specifically, we will need to maintain specified financial ratios and satisfy financial condition
tests. We cannot assure you that our business will generate sufficient cash flow from operations
or that future borrowings will be available to us under our senior secured credit facility or from
other sources in an amount sufficient to enable us to pay interest or principal on our debt,
including the senior notes, or to fund our other liquidity needs.
The terms of our debt place restrictions on certain of our subsidiaries which may limit our
operating flexibility.
The indenture governing the senior notes and the senior secured credit facility impose
material operating and financial restrictions on MetroPCS Wireless and certain of its subsidiaries.
These restrictions, subject in certain cases to ordinary course of business and other exceptions,
may limit MetroPCS Wireless’ and our ability to engage in some transactions, including the
following:
In addition, although MetroPCS Communications and its unrestricted subsidiaries have the
ability to incur new indebtedness, the indenture governing the senior notes and the senior secured
credit facility impose restrictions on the ability of MetroPCS Wireless and some of our other
subsidiaries to incur additional debt. Because substantially all of our current operations are
conducted through MetroPCS Wireless and the other subsidiaries that are subject to these
restrictions, our operating flexibility may be limited.
Under the senior secured credit facility, MetroPCS Wireless is also subject to financial
maintenance covenants with respect to its senior secured leverage and in certain circumstances
total maximum consolidated leverage and certain minimum fixed charge coverage ratios.
These restrictions could limit MetroPCS Wireless’ and our ability to obtain debt financing,
repurchase stock, refinance or pay principal on our outstanding debt, complete acquisitions for
cash or debt or react to changes in our operating environment. Any future debt that we incur may
contain similar or more restrictive covenants.
Our success depends on our ability to attract and retain qualified management and other personnel.
Our business is managed by a small number of key executive officers. The loss of one or more
of these persons could disrupt our ability to react quickly to business developments and changes in
market conditions, which could harm our financial results. As of April 1, 2007, none of our key
executives has an employment contract, so any of our key executive officers may leave at any time
subject to forfeiture of any unpaid performance awards and any unvested stock options. In
addition, upon any change in control, all unvested stock options will vest which may make it
difficult for anyone to acquire us. We believe that our future success will also depend in large
part on our continued ability to attract and retain highly qualified executive, technical and
management personnel. We believe competition for highly qualified management, technical and sales
personnel is intense, and there can be no assurance that we will retain our key management,
technical and sales employees or that we will be successful in attracting,
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assimilating or
retaining other highly qualified management, technical and sales personnel in the future sufficient
to support our continued growth. We have occasionally experienced difficulty in recruiting
qualified personnel and there can be no assurance that we will not experience such difficulties in
the future. Our inability to attract or retain highly qualified executive, technical and
management personnel could materially and adversely affect our business operations and financial
performance.
We rely on third-party suppliers to provide our customers and us with equipment, software and
services that are integral to our business, and any significant disruption in our relationship with
these vendors could increase our cost and affect our operating efficiencies.
We have entered into agreements with third-party suppliers to provide equipment and software
for our network and services required for our operations, such as customer care and billing and
payment processing. Sophisticated information and billing systems are vital to our ability to
monitor and control costs, bill customers, process customer orders, provide customer service and
achieve operating efficiencies. We currently rely on internal systems and third-party vendors to
provide all of our information and processing systems. Some of our billing, customer service and
management information systems have been developed by third-parties and may not perform as
anticipated. If these suppliers experience interruptions or other problems delivering these
products or services on a timely basis or at all, it may cause us to have difficulty providing
services to or billing our customers, developing and deploying new services and/or upgrading,
maintaining, improving our networks, or generating accurate or timely financial reports and
information. If alternative suppliers and vendors become necessary, we may not be able to obtain
satisfactory and timely replacement services on economically attractive terms, or at all. Some of
these agreements may be terminated upon relatively short notice. The loss, termination or
expiration of these contracts or our inability to renew them or negotiate contracts with other
providers at comparable rates could harm our business. Our reliance on others to provide essential
services on our behalf also gives us less control over the efficiency, timeliness and quality of
these services. In addition, our plans for developing and implementing our information and billing
systems rely to some extent on the design, development and delivery of products and services by
third-party vendors. Our right to use these systems is dependent on license agreements with
third-party vendors. Since we rely on third-party vendors to provide some of these services, any
switch or disruption by our vendors could be costly and affect operating efficiencies.
If we lose the right to install our equipment on wireless cell sites, or are unable to renew
expiring leases for wireless cell sites on favorable terms or at all, our business and operating
results could be adversely impacted.
Our base stations are installed on leased cell site facilities. A significant portion of these
cell sites are leased from a small number of large cell site companies under master agreements
governing the general terms of our use of that company’s cell sites. If a master agreement with one
of these cell site companies were to terminate, the cell site company were to experience severe
financial difficulties or file for bankruptcy or if one of these cell site companies were unable to
support our use of its cell sites, we would have to find new sites or rebuild the affected portion
of our network. In addition, the concentration of our cell site leases with a limited number of
cell site companies could adversely affect our operating results and financial condition if we are
unable to renew our expiring leases with these cell site companies either on terms comparable to
those we have today or at all.
In addition, the tower industry has continued to consolidate. If any of the companies from
which we lease towers or distributed antenna systems, or DAS systems, were to consolidate with
other tower or DAS systems
companies, they may have the ability to raise prices which could materially affect our
profitability. If any of the cell site leasing companies or DAS system providers with which we do
business were to experience severe financial difficulties, or file for bankruptcy protection, our
ability to use cell sites leased from that company could be adversely affected. If a material
number of cell sites were no longer available for our use, our financial condition and operating
results could be adversely affected.
We may be unable to obtain the roaming and other services we need from other carriers to remain
competitive.
Many of our competitors have regional or national networks which enable them to offer
automatic roaming and long distance telephone services to their subscribers at a lower cost than we
can offer. We do not have a national network, and we must pay fees to other carriers who provide
roaming services and who carry long distance calls made by our subscribers. We currently have
roaming agreements with several other carriers which allow our customers to roam on those carriers’
network. The roaming agreements, however, do not cover all geographic areas where our customers may
seek service when they travel, generally cover voice but not data services, and at least one
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such
agreement may be terminated on relatively short notice. In addition, we believe the rates charged
by the carriers to us in some instances are higher than the rates they charge to certain other
roaming partners. The FCC recently initiated a Notice of Proposed Rulemaking seeking comments on
whether automatic roaming services are considered common carrier services, whether carriers have an
obligation to offer automatic roaming services to other carriers, whether carriers have an
obligation to provide non-voice automatic roaming services, and what rates a carrier may charge for
roaming services. We are unable to predict with any certainty the likely outcome of this
proceeding. The FCC previously has initiated roaming proceedings to address similar issues but
repeatedly has failed to resolve these issues. Our current and future customers may desire that we
offer automatic roaming services when they travel outside the areas we serve which we may be unable
to obtain or provide cost effectively. If we are unable to obtain roaming agreements at reasonable
rates, then we may be unable to effectively compete and may lose customers and revenues.
A recent ruling from the Copyright Office of the Library of Congress may have an adverse effect on
our distribution strategy.
The Copyright Office of the Library of Congress, or the Copyright Office, recently released
final rules on its triennial review of the exemptions to certain provisions of the Digital
Millennium Copyright Act, or DMCA. A section of the DMCA prohibits anyone other than a copyright
owner from circumventing technological measures employed to protect a copyrighted work, or access
control. In addition, the DMCA provides that the Copyright Office may exempt certain activities
which otherwise might be prohibited by that section of the DMCA for a period of three years when
users are (or in the next three years are likely to be) adversely affected by the prohibition on
their ability to make noninfringing uses of a class of copyrighted work. Many carriers, including
us, routinely place software locks on wireless handsets, which prevent a customer from using a
wireless handset sold by one carrier on another carrier’s system. In its triennial review, the
Copyright Office determined that these software locks on wireless handsets are access controls
which adversely affect the ability of consumers to make noninfringing use of the software on their
wireless handsets. As a result, the Copyright Office found that a person could circumvent such
software locks and other firmware that enable wireless handsets to connect to a wireless telephone
network when such circumvention is accomplished for the sole purpose of lawfully connecting the
wireless handset to another wireless telephone network. A wireless carrier has filed suit in the
United States District Court in Florida to reverse the Copyright Office’s decision. This exemption
is effective from November 27, 2006 through October 27, 2009 unless extended by the Copyright
Office.
This ruling, if upheld, could allow our customers to use their wireless handsets on networks
of other carriers. This ruling may also allow our customers who are dissatisfied with our service
to utilize the services of our competitors without having to purchase a new handset. The ability of
our customers to leave our service and use their wireless handsets on other carriers’ networks may
have an adverse material impact on our business. In addition, since we provide a subsidy for
handsets to our distribution partners that is incurred in advance, we may experience higher
distribution costs resulting from wireless handsets not being activated or maintained on our
network, which costs may be material.
We may incur higher than anticipated intercarrier compensation costs, which could increase our
costs and reduce our profit margin.
When our customers use our service to call customers of other carriers, we generally are
required to pay the carrier that serves the called party and any intermediary or transit carrier
for the use of their network. Similarly,
when a customer of another carrier calls one of our customers, that carrier generally is
required to pay us for the use of our network. While we generally have been successful in
negotiating agreements with other carriers that establish acceptable compensation arrangements,
some carriers have claimed a right to unilaterally impose charges on us that we consider to be
unreasonably high. The FCC has determined that certain unilateral termination charges imposed prior
to April 2005 may be appropriate. We have requested clarification of this order. We cannot assure
you that the FCC will rule in our favor. An adverse ruling or FCC inaction could result in some
carriers successfully collecting such fees from us, which could increase our costs and affect our
financial performance. In the meantime, certain carriers are threatening to pursue or have
initiated claims against us for termination payments and the likely outcome of these claims is
uncertain. A finding by the FCC that we are liable for additional terminating compensation payments
could subject us to additional claims by other carriers. In addition, certain transit carriers have
taken the position that they can charge “market” rates for transit services, which may in some
instances be significantly higher than our current rates. We may be obligated to pay these higher
rates and/or purchase services from others or engage in direct connection, which may result in
higher costs which could materially affect our costs and financial results.
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Concerns about whether wireless telephones pose health and safety risks may lead to the adoption of
new regulations, to lawsuits and to a decrease in demand for our services, which could increase our
costs and reduce our revenues.
Media reports and some studies have suggested that radio frequency emissions from wireless
handsets are linked to various health concerns, including cancer, or interfere with various
electronic medical devices, including hearing aids and pacemakers. Additional studies have been
undertaken to determine whether the suggestions from those reports and studies are accurate. In
addition, lawsuits have been filed against other participants in the wireless industry alleging
various adverse health consequences as a result of wireless phone usage. While many of these
lawsuits have been dismissed on various grounds, including a lack of scientific evidence linking
wireless handsets with such adverse health consequences, future lawsuits could be filed based on
new evidence or in different jurisdictions. If any such suits do succeed, or if plaintiffs are
successful in negotiating settlements, it is likely additional suits would be filed. Additionally,
certain states in which we offer or may offer service have passed or may pass legislation seeking
to require that all wireless telephones include an earpiece that would enable the use of wireless
telephones without holding them against the user’s head. While it is not possible to predict
whether any additional states in which we conduct business will pass similar legislation, such
legislation could increase the cost of our wireless handsets and other operating expenses.
If consumers’ health concerns over radio frequency emissions increase, consumers may be
discouraged from using wireless handsets, and regulators may impose restrictions or increased
requirements on the location and operation of cell sites or the use or design of wireless
telephones. Such new restrictions or requirements could expose wireless providers to further
litigation, which, even if not successful, may be costly to defend, or could increase our cost of
handsets and equipment. In addition, compliance with such new requirements, and the associated
costs, could adversely affect our business. The actual or perceived risk of radio frequency
emissions could also adversely affect us through a reduction in customers or a reduction in the
availability of financing in the future. In addition to health concerns, safety concerns have been
raised with respect to the use of wireless handsets while driving. Certain states and
municipalities in which we provide service or plan to provide service have passed laws prohibiting
the use of wireless phones while driving or requiring the use of wireless headsets. If additional
state and local governments in areas where we conduct business adopt regulations restricting the
use of wireless handsets while driving, we could have reduced demand for our services.
A system failure could cause delays or interruptions of service, which could cause us to lose
customers.
To be successful, we must provide our customers reliable service. Some of the risks to our
network and infrastructure which may prevent us from providing reliable service include:
Network disruptions may cause interruptions in service or reduced capacity for customers,
either of which could cause us to lose customers and incur expenses. Further, our costs to replace
or repair the network may be substantial, thus causing our costs to provide service to increase. We
may also experience higher churn as our competitors systems may not experience similar problems.
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Unauthorized use of, or interference with, our network could disrupt service and increase our
costs.
We may incur costs associated with the unauthorized use of our network including
administrative and capital costs associated with detecting, monitoring and reducing the incidence
of fraud. Fraudulent use of our network may impact interconnection and long distance costs,
capacity costs, administrative costs, fraud prevention costs and payments to other carriers for
fraudulent roaming. Such increased costs could have a material adverse impact on our financial
results.
Security breaches related to our physical facilities, computer networks, and informational
databases may cause harm to our business and reputation and result in a loss of customers.
Our physical facilities and information systems may be vulnerable to physical break-ins,
computer viruses, theft, attacks by hackers, or similar disruptive problems. If hackers gain
improper access to our databases, they may be able to steal, publish, delete or modify confidential
personal information concerning our subscribers. In addition, misuse of our customer information
could result in more substantial harm perpetrated by third-parties. This could damage our business
and reputation and result in a loss of customers.
Risks Related to Legal and Regulatory Matters
We are dependent on our FCC licenses, and our ability to provide service to our customers and
generate revenues could be harmed by adverse regulatory action or changes to existing laws or
rules.
The FCC regulates most aspects of our business, including the licensing, construction,
modification, operation, use, ownership, control, sale, roaming arrangements and interconnection
arrangements of wireless communications systems, as do some state and local regulatory agencies. We
can make no assurances that the FCC or the state and local agencies having jurisdiction over our
business will not adopt regulations or take other actions that would adversely affect our business
by imposing new costs or requiring changes in our current or planned operations, or that the
Communications Act, from which the FCC obtains its authority, will not be amended in a manner
materially adverse to us.
Taken together or individually, new or changed regulatory requirements affecting any or all of
the wireless, local, and long distance industries may harm our business and restrict the manner in
which we operate our business. The enactment of new adverse legislation, regulation or regulatory
requirements may slow our growth and have a material adverse effect upon our business, results of
operations and financial condition. We cannot assure you that changes in current or future
regulations adopted by the FCC or state regulators, or other legislative, administrative or
judicial initiatives relating to the communications industry, will not have a material adverse
effect on our business, results of operations and financial condition. In addition, pending
congressional legislative efforts to reform the Communications Act may cause major industry and
regulatory changes that are difficult to predict and which may have material adverse consequences
to us.
Some of our principal assets are our FCC licenses which we use to provide our services. The
loss of any of these licenses could have a material adverse effect on our business. Our FCC
licenses are subject to revocation if the FCC finds we are not in compliance with its rules or the
Communications Act’s requirements. We also could be subject to fines and forfeitures for such
non-compliance, which could adversely affect our business. For example,
absent a waiver, failure to comply with the FCC’s Enhanced-911, or E-911, requirements,
privacy rules, lighting and painting regulations, employment regulations, Customer Proprietary
Network Information, or CPNI, protection rules, hearing aid-compatibility rules, number portability
requirements, law enforcement cooperation, rate averaging or other existing or new regulatory
mandates could subject us to significant penalties or a revocation of our FCC licenses, which could
have a material adverse effect on our business, results of operations and financial condition. In
addition, a failure to comply with these requirements or the FCC’s construction requirements could
result in revocation of the licenses and/or fines and forfeitures, any of which could have an
adverse effect on our business.
The structure of the transaction with Royal Street creates several risks because we do not control
Royal Street and do not own or control the licenses it holds.
We have agreements with Royal Street that are intended to allow us to actively participate in
the development of the Royal Street licenses and networks, and we have the right to acquire on a
wholesale basis 85% of the services provided by the Royal Street systems and to resell these
services on a retail basis under our brand in
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accordance with applicable laws and regulations.
There are, nonetheless, risks inherent in the fact that we do not own or control Royal Street or
the Royal Street licenses. C9 Wireless, LLC, or C9, an unaffiliated third party, has the ability to
put all or part of its ownership interest in Royal Street Communications to us, but, due to
regulatory restrictions, we have no corresponding right to call C9’s ownership interest in Royal
Street Communications. We can give no assurance that C9 will exercise its put rights or, if it
does, when such exercise may occur. Further, these put rights expire in June 2012. Subject to
certain non-controlling investor protections in Royal Street Communication’s limited liability
company agreement, C9 also has control over the operations of Royal Street because it has the right
to elect three of the five members of Royal Street Communication’s management committee, which has
the full power to direct the management of Royal Street. The FCC’s rules also restrict our ability
to acquire or control Royal Street licenses during the period that Royal Street must maintain its
eligibility as a very small business designated entity, or DE, which is currently through December
2010. Thus, we cannot be certain that the Royal Street licenses will be developed in a manner fully
consistent with our business plan or that C9 will act in ways that benefit us.
Royal Street acquired certain of its PCS licenses as a DE entitled to a 25% discount. As a
result, Royal Street received a bidding credit equal to approximately $94 million for its PCS
licenses. If Royal Street is found to have lost its status as a DE it would be required to repay
the FCC the amount of the bidding credit on a five-year straight-line basis beginning on the grant
date of the license. If Royal Street were required to pay this amount, it could have a material
adverse effect on us due to our non-controlling 85% limited liability company member interest in
Royal Street. In addition, if Royal Street is found to have lost its status as a DE, it could lose
some or all of the licenses only available to DEs, which includes most of its licenses in Florida.
If Royal Street lost those licenses, it could have a material adverse effect on us because we would
lose access to the Orlando metropolitan area and certain portions of northern Florida.
Certain recent regulatory developments pertaining to the DE program indicate that the FCC
plans to be proactive in assuring that DEs abide by the FCC’s control requirements. The FCC has the
right to audit the compliance of DEs with FCC rules governing their operations, and there have been
recent indications that it intends to exercise that authority. In addition, the Royal Street
business plan may become so closely aligned with our business plan that there is a risk the FCC may
find Royal Street to have relinquished control over its licenses in violation of FCC requirements.
If the FCC were to determine that Royal Street has failed to exercise the requisite control over
its licenses, the result could be the loss of closed licenses, which are licenses that the FCC only
offered to qualified DEs, the loss of bidding credits, which effectively lowered the purchase price
for the open licenses, and fines and forfeitures, which amounts may be material.
In making the changes to the DE rules, the FCC concluded that certain relationships between a
DE licensee and its investors would in the future be deemed impermissible material relationships
based on a new FCC view that these relationships, by their very nature, are generally inconsistent
with an applicant’s or licensee’s ability to achieve or maintain designated entity eligibility and
inconsistent with Congress’ legislative intent. The FCC cited wholesale service arrangements as an
example of an impermissible material relationship, but indicated that previously approved
arrangements of this nature would be allowed to continue. While the FCC has grandfathered the
existing arrangements between Royal Street and us, there can be no assurance that any changes that
may be required of those arrangements in the future will not cause the FCC to determine that the
changes would trigger the loss of DE eligibility for Royal Street and require the reimbursement of
the bidding credits received by Royal Street and loss of any licenses covering geographic areas
which are not sufficiently constructed that were available initially only to DEs. Further, the FCC
has opened a Notice of Further Proposed Rulemaking seeking to determine what additional
changes, if any, may be required or appropriate to its DE program. There can be no assurance
that these changes will not be applied to the current arrangements between Royal Street and us. Any
of these results could be materially adverse to our business.
We may not be able to continue to offer our services if the FCC does not renew our licenses when
they expire.
Our current PCS licenses began to expire in January 2007. We have filed applications to renew
our PCS licenses for additional ten-year periods by filing renewal applications with the FCC as
soon as the filing windows were opened. A number of the renewal applications have been granted,
including all of the licenses that expired in January 2007. The remainder of the applications are
currently pending or the filing window has not yet opened. Renewal applications are subject to FCC
review and potentially public comment to ensure that licensees meet their licensing requirements
and comply with other applicable FCC mandates. If we fail to file for renewal of any particular
license at the appropriate time or fail to meet any regulatory requirements for renewal, including
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construction and substantial service requirements, we could be denied a license renewal and,
accordingly, our ability to continue to provide service in the geographic area covered by such
license would be adversely affected. In addition, many of our licenses are subject to interim or
final construction requirements. While we or the prior licensee have met the five-year construction
benchmark, there is no guarantee that the FCC will find our construction sufficient to meet the
applicable construction requirement, in which case the FCC could terminate our license and our
ability to continue to provide service in that license area would be adversely affected. For some
of our PCS licenses, we also have a 10 year construction obligation and for our AWS licenses we
have a 15 year construction obligation. For all PCS and AWS licenses the FCC requires that a
licensee provide substantial service in order to receive a renewal expectancy. There is no
guarantee that the FCC will find our or the prior licensees’ system construction to meet any
ten-year build-out requirement or construction requirements for renewal. Additionally, while
incumbent licensees may enjoy a certain renewal expectancy if they provide substantial service,
there is no guarantee that the FCC will conclude that we are providing substantial service, that we
are entitled to a renewal expectancy, or will renew all or any of our licenses, or that the FCC
will not grant the renewal with conditions that could materially and adversely affect our business.
Failure to have our licenses renewed would materially and adversely affect our business.
The value of our licenses may drop in the future as a result of volatility in the marketplace and
the sale of additional spectrum by the FCC.
The market value of FCC licenses has been subject to significant volatility in the past and
Congress has mandated that the FCC bring an additional substantial amount of spectrum to the market
by auction in the next several years. The likely impact of these future auctions on license values
is uncertain. For example, Congress has mandated that the FCC auction 60 MHz of spectrum in the 700
MHz band in early 2008 and another 40 MHz of AWS spectrum is in the process of being assigned for
wireless broadband services and is expected to be auctioned in the future by the FCC. There can be
no assurance of the market value of our FCC licenses or that the market value of our FCC licenses
will not be volatile in the future. If the value of our licenses were to decline significantly, we
could be forced to record non-cash impairment charges which could impact our ability to borrow
additional funds. A significant impairment loss could have a material adverse effect on our
operating income and on the carrying value of our licenses on our balance sheet.
The FCC may license additional spectrum which may not be appropriate for or available to us or
which may allow new competitors to enter our markets.
The FCC periodically makes additional spectrum available for wireless use. For instance, the
FCC recently allocated and auctioned an additional 90 MHz of spectrum for AWS. The AWS band plan
made some licenses available in small (Metropolitan Statistical Area (MSA) and Rural Service Area
(RSA)) license areas, although the predominant amount of spectrum remains allocated on a regional
basis in combinations of 10 MHz and 20 MHz spectrum blocks. This band plan tended to favor large
incumbent carriers with nationwide footprints and presented challenges for us in acquiring
additional spectrum. The FCC also has allocated an additional 40 MHz of spectrum devoted to AWS. It
is in the process of considering the channel assignment policies for 20 MHz of this spectrum and
has indicated that it will initiate a further proceeding with regard to the remaining 20 MHz in the
future. The FCC also is in the process of taking comments on the appropriate geographic license
areas and channel blocks for an additional 60 MHz of spectrum in the 700 MHz band. Specifically, on
August 10, 2006, the FCC issued a Notice of Proposed Rulemaking seeking comment on possible changes
to the 700 MHz band plan, including possible changes in the service area and channel block sizes
for the 60 MHz of as yet unauctioned 700 MHz spectrum. We, along with other small, regional and
rural carriers, filed comments advocating changes to the current 700 MHz bandplan to
create a greater number of licenses with smaller spectrum blocks and geographic area sizes.
Several national wireless carriers support the current plan and other interested parties have made
band plan and licensing proposals that differ from ours by favoring larger license areas, larger
license blocks and the use of combinatorial bidding, which we do not favor, to enable applicants to
more easily assemble a nationwide foot print. In addition, one commenter advocates reassigning 30
MHz of the 700 MHz band which now is slated for commercial broadband use, to public safety use to
create a nationwide, interoperable broadband network that public safety users can access on a
priority basis. Another commenter advocates allocating 10 MHz of the 700 MHz band, which now is
slated for commercial broadband use, on a nationwide basis, in accordance with specific public
safety rules that would force the licensee to fund the construction of a nationwide broadband
infrastructure, offer service only on a wholesale basis, and provide public safety with priority
access to the 10 MHz of spectrum during emergencies. In September 2006, the FCC also sought comment
on proposals to increase the flexibility of guard band licensees in the 700 MHz spectrum.
Furthermore, in December 2006, the FCC sought comment on the possible implementation of a
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nationwide broadband interoperable network in the 700 MHz band allocated for public safety use,
which also could be used by commercial service providers on a secondary basis. We cannot predict
the likely outcome of those proceedings or whether they will benefit or adversely affect us.
There are a series of risks associated with any new allocation of broadband spectrum by the
FCC. First, there is no assurance that the spectrum made available by the FCC will be appropriate
for or complementary to our business plan and system requirements. Second, depending upon the
quantity, nature and cost of the new spectrum, it is possible that we will not be granted any of
the new spectrum and, therefore, we may have difficulty in providing new services. This could
adversely affect the valuation of the licenses we already hold. Third, we may be unable to purchase
additional spectrum or the prices paid for such spectrum may negatively affect our ability to be
competitive in the market. Fourth, new spectrum may allow new competitors to enter our markets and
impact our ability to grow our business and compete effectively in our market. Fifth, new spectrum
may be sold at prices lower than we paid at past auctions or in private transactions, thus
adversely affecting the value of our existing assets. Sixth, the clearing obligations for existing
licensees on new spectrum may take longer or cost more than anticipated. Seventh, our competitors
may be able to use this new spectrum to provide products and services that we cannot provide using
our existing spectrum. Eighth, there can be no assurance that our competitors will not use certain
FCC programs, such as its designated entity program or the proposed nationwide interoperable
networks for public safety use, to purchase or acquire spectrum at materially lower prices than
what we are required to pay. Any of these risks, if they occur, may have a material adverse effect
on our business.
We are subject to numerous surcharges and fees from federal, state and local governments, and the
applicability and amount of these fees is subject to great uncertainty and may prove to be material
to our financial results.
Telecommunications providers pay a variety of surcharges and fees on their gross revenues from
interstate and intrastate services. Interstate surcharges include federal Universal Service Fund
fees and common carrier regulatory fees. In addition, state regulators and local governments impose
surcharges, taxes and fees on our services and the applicability of these surcharges and fees to
our services is uncertain in many cases and jurisdictions may argue as to whether we have correctly
assessed and remitted those monies. The division of our services between interstate services and
intrastate services is a matter of interpretation and may in the future be contested by the FCC or
state authorities. In addition, periodic revisions by state and federal regulators may increase the
surcharges and fees we currently pay. The Federal government and many states apply
transaction-based taxes to sales of our products and services and to our purchases of
telecommunications services from various carriers. It is possible that our transaction based tax
liabilities could change in the future. We may or may not be able to recover some or all of those
taxes from our customers and the amount of taxes may deter demand for our services.
Spectrum for which we have been granted licenses as a result of AWS Auction 66 is subject to
certain legal challenges, which may ultimately result in the FCC revoking our licenses.
We have paid the full purchase price of approximately $1.4 billion to the FCC for the licenses
we were granted as a result of Auction 66, even though there are ongoing uncertainties regarding
some aspects of the final auction rules. In April 2006, the FCC adopted an Order relating to its DE
program, or the DE Order. This Order was modified by the FCC in an Order on Reconsideration which
largely upheld the revised DE rules but clarified that the FCC’s revised unjust enrichment rules
would only apply to licenses initially granted after April 25, 2006. Several interested parties
filed an appeal in the U.S. Court of Appeals for the Third Circuit on June 7, 2006, of the DE
Order. The appeal challenges the DE Order on both substantive and procedural grounds. Among other
claims, the petitions contest the FCC’s effort to apply the revised rules to applications for the
AWS Auction 66 and seeks to overturn the results of Auction 66. We are unable at this time to
predict the likely outcome of the court action. We also are
unable to predict the likelihood that the litigation will result in any changes to the DE
Order or to the DE program, and, if there are changes, whether or not any such changes will be
beneficial or detrimental to our interests. If the court overturns the results of Auction 66, there
may be a delay in us receiving a refund of our payments. Further, the FCC may appeal any decision
overturning Auction 66 and not refund any amounts paid until the appeal is final. In such instance,
we may be forced to pay interest on the payments made to the FCC without receiving any interest on
such payments from the FCC. If the results of Auction 66 were overturned and we receive a refund,
the delay in the return of our money and the loss of any amounts spent to develop the licenses in
the interim may affect our financial results and the loss of the licenses may affect our business
plan. Additionally, such refund would be without interest. In the meantime we would have been
obligated to pay interest to our lenders on the amounts we advanced to the FCC during the interim
period and such interest amounts may be material.
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We may be delayed in starting operations in the Auction 66 Markets because the incumbent licensees
may have unreasonable demands for relocation or may refuse to relocate.
The spectrum allocated for AWS currently is utilized by a variety of categories of existing
licensees (Broadband Radio Service, Fixed Service) as well as governmental users. The FCC rules
provide that a portion of the money raised in Auction 66 will be used to reimburse the relocation
costs of certain governmental users from the AWS band. However, not all governmental users are
obligated to relocate. To foster the relocation of non-governmental incumbent licensees, the FCC
also adopted a transition and cost sharing plan under which incumbent users can be reimbursed for
relocating out of the AWS band with the costs of relocation being shared by AWS licensees
benefiting from the relocation. The FCC has established rules requiring the new AWS licensee and
the non-governmental incumbent user to negotiate voluntarily for up to three years before the
non-governmental incumbent licensee is subject to mandatory relocation.
We are not able to determine with any certainty the costs we may incur to relocate the
non-governmental incumbent licenses in the Auction 66 Markets or the time it will take to clear the
AWS spectrum in those areas.
If any federal government users refuse to relocate out of the AWS band in a metropolitan area
where we have been granted a license, we may be delayed or prevented from serving certain
geographic areas or customers within the metropolitan area and such inability may have a material
adverse effect on our financial performance, and our future prospects. In addition, if any of the
incumbent users refuse to voluntarily relocate, we may be delayed in using the AWS spectrum granted
to us and such delay may have a material adverse effect on our ability to serve the metropolitan
areas, our financial performance, and our future prospects.
The FCC may adopt rules requiring new point-to-multipoint emergency alert capabilities that would
require us to make costly investments in new network equipment and consumer handsets.
In 2004, the FCC initiated a proceeding to update and modernize its systems for distributing
emergency broadcast alerts. Television stations, radio broadcasters and cable systems currently are
required to maintain emergency broadcast equipment capable of retransmitting emergency messages
received from a federal agency. As part of its attempts to modernize the emergency alert system,
the FCC in its proceeding is addressing the feasibility of requiring wireless providers, such as
us, to distribute emergency information through our wireless networks. Unlike broadcast and cable
networks, however, our infrastructure and protocols — like those of all other similarly-situated
wireless broadband PCS carriers — are optimized for the delivery of individual messages on a
point-to-point basis, and not for delivery of messages on a point-to-multipoint basis, such as all
subscribers within a defined geographic area. While multiple proposals have been discussed in the
FCC proceeding, including limited proposals to use existing SMS capabilities on a short-term basis,
the FCC has not yet ruled and therefore we are not able to assess the short- and long-term costs of
meeting any future FCC requirements to provide emergency and alert service, should the FCC adopt
such requirements. Congress recently passed the Warning, Alert, and Response Network Act, or the
Act, which was signed into law. In the Act, Congress provided for the establishment, within 60 days
of enactment, of an advisory committee to provide recommendations to the FCC on, and the FCC is
required to complete a proceeding to adopt, relevant technical standards, protocols, procedures and
other technical requirements based on such recommendations necessary to enable alerting capability
for commercial mobile radio service, or CMRS, providers that voluntarily elect to transmit
emergency alerts. Under the Act, a CMRS carrier can elect not to participate in providing such
alerting capability. If a CMRS carrier elects to participate, the carrier may not charge separately
for the alerting capability and the CMRS carrier’s liability related to or any harm resulting from
the transmission of, or failure to transmit, an emergency is limited. Within a relatively short
period of time after receiving the recommendations from the advisory committee, the FCC is
obligated to complete its rulemaking implementing such rules. Adoption of such requirements,
however, could require us to purchase new or additional
equipment and may also require consumers to purchase new handsets. Until the FCC rules, we do
not know if it will adopt such requirements, and if it does, what their impact will be on our
network and service.
FCC approval for the sale of our stock, if required, may not be forthcoming or may result in
adverse conditions to the business or to the holders of our stock.
If the sale of our stock would cause a change in control of us under the Communications Act of
1934, as amended and the FCC’s rules, regulations or policies promulgated thereunder, the prior
approval of the FCC would be required prior to any such sale. There can be no assurance that, at
the time the sale is contemplated, the FCC would grant such an approval, or that the FCC would
grant such an approval without adverse conditions.
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General Matters
We are currently controlled by a limited number of stockholders, and their interests may be
different from yours.
A significant portion of the voting power of our capital stock is concentrated in the hands of
a few shareholders who also are either members of our board of directors or can appoint directors
to the board. M/C Venture Partners, Accel Partners, TA Associates, Madison Dearborn Partners, and
Mr. Roger D. Linquist, our President, Chief Executive Officer, and Chairman of the Board, all can
appoint members to our board of directors and these stockholders, along with the holders of our
Series D Preferred Stock as a class, elect a majority of our directors. In addition, all of our
directors collectively own or control in excess of 50% of the voting power of the shares of our
capital stock on an as-converted basis. Stockholders holding over 10% of the voting power also
hold collectively in excess of 38% of the voting power of our capital stock. These stockholders
will have the ability to significantly influence whether required consents can be obtained and thus
influence our ability to enter into significant corporate transactions and these stockholders may
have different interests than the other holders of our common stock.
Ownership of shares of our common stock, Series D Preferred Stock and/or Series E Preferred Stock
is an illiquid investment.
Although we have filed a registration statement for an initial public offering of our common
stock and have applied to list our stock on the New York Stock Exchange upon completion of the
offering, there is currently no established trading market for the shares of our common stock,
Series D Preferred Stock and Series E Preferred Stock. There can be no assurance that our initial
public offering will be successful or that a trading market will develop. Holders of shares of
common stock and preferred stock are subject to the transfer limitations contained in the Second
Amended and Restated Stockholders Agreement, dated August 30, 2005, as amended, by and between us
and certain of our stockholders, including, among other things, co-sale rights of other
stockholders. The co-sale rights make it less likely that a stockholder desiring to sell his, her
or its equity interest will be able to sell any amount of its investment in excess of the
percentage ownership of us held by such stockholder. As such, a continuing investment in the
shares of common stock and/or preferred stock may result in a lack of liquidity with respect to
such stock for an indefinite period of time.
Our stockholder rights plan could prevent a change in control of our Company in instances in which
some stockholders may believe a change in control is in their best interests.
In connection with our planned initial public offering, our board of directors has approved
entering into a rights agreement that establishes our stockholder rights plan, or Rights Plan.
Pursuant to the Rights Plan, we will issue to our stockholders one preferred stock purchase right
for each outstanding share of our common stock as of March 27, 2007. Each right, when exercisable,
will entitle its holder to purchase from us a unit consisting of one one-thousandth of a share of
series A junior participating preferred stock at a purchase price to be determined by our board of
directors at the time the Rights Plan was adopted. Our Rights Plan is intended to protect
stockholders in the event of an unfair or coercive offer to acquire our Company and to provide our
board of directors with adequate time to evaluate unsolicited offers. The Rights Plan may have
anti-takeover effects. The Rights Plan will cause substantial dilution to a person or group that
attempts to acquire us on terms that our board of directors does not believe are in our best
interests and those of our stockholders and may discourage, delay or prevent a merger or
acquisition that stockholders may consider favorable, including transactions in which stockholders
might otherwise receive a premium for their shares.
Conflicts of interest may arise because some of our directors are principals of our stockholders,
and we have
waived our rights to certain corporate opportunities.
Our board of directors includes representatives from Accel Partners, TA Associates, Madison
Dearborn Capital Partners and M/C Venture Partners. Those stockholders and their respective
affiliates may invest in entities that directly or indirectly compete with us or companies in which
they are currently invested may already compete with us. As a result of these relationships, when
conflicts between the interests of those stockholders or their respective affiliates and the
interests of our other stockholders arise, these directors may not be disinterested. Under Delaware
law, transactions that we enter into in which a director or officer has a conflict of interest are
generally permissible so long as (1) the material facts relating to the director’s or officer’s
relationship or interest as to the transaction are
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disclosed to our board of directors and a
majority of our disinterested directors approves the transaction, (2) the material facts relating
to the director’s or officer’s relationship or interest as to the transaction are disclosed to our
stockholders and a majority of our disinterested stockholders approves the transaction, or (3) the
transaction is otherwise fair to us. Also, pursuant to the terms of our certificate of
incorporation, our non-employee directors, including the representatives from Accel Partners, TA
Associates, Madison Dearborn Capital Partners and M/C Venture Partners, are not required to offer
us any corporate opportunity of which they become aware and could take any such opportunity for
themselves or offer it to other companies in which they have an investment, unless such opportunity
is expressly offered to them in their capacity as a director of our Company.
Item 1B.
Unresolved Staff Comments
None.
Item 2. Properties
We currently maintain our executive offices in Dallas, Texas, and regional offices in Alameda,
California; Sunrise, Florida; Norcross, Georgia; Folsom, California; Plano, Texas; Livonia,
Michigan; Irvine, California; Tampa, Florida; and Orlando, Florida. As of December 31, 2006, we
also operated 95 retail stores throughout our metropolitan areas. All of our regional offices,
switch sites, retail stores and virtually all of our cell site facilities are leased from
unaffiliated third parties. We believe these properties, which are being used for their intended
purposes, are adequate and well-maintained.
Item 3. Legal Proceedings
On June 14, 2006, Leap Wireless International, Inc. and Cricket Communications, Inc., or
collectively Leap, filed suit against us in the United States District Court for the Eastern
District of Texas, Marshall Division, Civil Action No. 2-06CV-240-TJW and amended on June 16, 2006,
for infringement of U.S. Patent No. 6,813,497 “Method for Providing Wireless Communication Services
and Network and System for Delivering of Same,” or the ’497 Patent, issued to Leap. The complaint
seeks both injunctive relief and monetary damages for our alleged infringement of such patent. On
August 3, 2006, we (i) answered the complaint, (ii) raised a number of affirmative defenses, and
(iii) together with two related entities, counterclaimed against Leap and several related entities
and certain current and former employees of Leap and certain of its related entities, including
Leap’s CEO. We have also tendered Leap’s claims to the manufacturer of our network infrastructure
equipment for indemnity and defense. In our counterclaims, we claim that we do not infringe any
valid or enforceable claim of the ’497 Patent. Certain of the Leap defendants, including its CEO,
answered our counterclaims on October 13, 2006. In its answer, Leap and its CEO denied our
allegations and asserted affirmative defenses to our counterclaims. In connection with denying a
motion to dismiss by certain individual defendants, the court concluded that our claims against
those defendants were compulsory counterclaims. The court has set April 3, 2007 as the date for a
scheduling conference at which time the Court will set the date for the Claim Construction hearing
and trial. We plan to vigorously defend against Leap’s claims relating to the ’497 Patent.
If Leap were successful in its claim for injunctive relief, we could be enjoined from
operating our business in the manner we currently operate, which could require us to expend
additional capital to change certain of our technologies and operating practices, or could prevent
us from offering some or all of our services using some or all of our existing systems. In
addition, if Leap were successful in its claim for monetary damage, we could be forced to pay Leap
substantial damages for past infringement and/or ongoing royalties on a portion of our revenues,
which could materially adversely impact our financial performance.
On August 15, 2006, we filed a separate action in the California Superior Court, Stanislaus
County, Case No. 382780, against Leap and others for unfair competition, misappropriation of trade
secrets, interference with contracts, breach of contract, intentional interference with prospective
business advantage, and trespass. In this suit we seek monetary and punitive damages and injunctive
relief. Defendants responded to our complaint by filing demurrers on or about January 5, 2007
requesting that the Court dismiss the complaint. On February 1, 2007, the Court granted the
demurrers in part and granted us leave to amend the complaint. We filed a First Amended
Complaint on February 27, 2007. Defendant’s response to the First Amended Complaint is due
March 28, 2007. We intend to vigorously prosecute this complaint.
On September 22, 2006, Royal Street filed a separate action in the United States District
Court for the Middle District of Florida, Tampa Division, Civil Action No. 8:06-CV-01754-T-23TBM,
seeking a declaratory judgment that Leap’s ’497 Patent is invalid and not being infringed upon by
Royal Street. Leap responded to Royal Street’s complaint by filing a motion to dismiss Royal
Street’s complaint for lack of subject matter jurisdiction or, in the alternative, that the action
be transferred to the United States District Court for the Eastern District of Texas, Marshall
Division where Leap has brought suit against us under the same patent. Royal Street has responded
to this motion. The Court has set a trial date in October 2008.
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In addition, we are involved in litigation from time to time, including litigation regarding
intellectual property claims, that we consider to be in the normal course of business. We are not
currently party to any other pending legal proceedings that we believe would, individually or in
the aggregate, have a material adverse effect on our financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
In December 2006, we submitted
to our stockholders an amendment to our 2004 Equity Incentive Compensation Plan to increase the number of shares
available for issuance to 18,600,000 and to make certain other changes.
On December 13, 2006, we received approval of the amendment by written consent of greater than a majority of our stockholders.
PART II
Item 5. Market Price for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
There is no established public trading market for our common equity.
As of December 31, 2006, we had 157,052,097 shares of common stock outstanding held by
approximately 181 stockholders of record.
We have never paid or declared any regular dividends on our common stock and do not intend to
declare or pay regular dividends on our common stock in the foreseeable future. The terms of our
senior secured credit facility restrict our ability to declare or pay dividends. We generally
intend to retain the future earnings, if any, to invest in our business. Subject to Delaware law,
our board of directors will determine the payment of future dividends on our common stock, if any,
and the amount of any dividends in light of:
Equity Compensation Plan Information
The following table provides information as of December 31, 2006 with respect to shares of
MetroPCS Communications’ common stock issuable under our equity compensation plans.
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Non-Employee Director Remuneration Plan
Non-employee members of our board of directors are eligible to participate in our non-employee
director remuneration plan under which such directors may receive compensation for serving on the
board of directors. This compensation includes annual retainers, board meeting fees, committee
paid event fees, initial stock grants and annual stock grants. See Item 11, “Compensation of
Directors” for further information regarding this plan.
Recent Sales of Unregistered Securities
Set forth below is a listing of all sales of securities by MetroPCS Communications during the
past three years not registered under the Securities Act:
Series E Convertible Preferred Stock. In September 2005, MetroPCS Communications issued
500,000 shares of Series E Preferred Stock of MetroPCS Communications, to Madison Dearborn and TA
Associates for an aggregate sales price of $50,000,000 pursuant to a Stock Purchase Agreement dated
August 30, 2005 (“Series E Purchase Agreement”). This transaction was undertaken in reliance upon
the accredited investors’ exemption from registration afforded by Rule 506 of Regulation D (“Rule
506”) of the Securities Act. We believe that other exemptions may also exist for this transaction.
Each share of Series E Preferred Stock accrues dividends from the date of issuance at a rate of 6%
per year on the liquidation value of $100 per share. Each share of Series E Preferred Stock will
be converted into common stock upon (i) the completion of a Qualifying Public Offering, (as defined
in the Second Amended and Restated Stockholders Agreement), (ii) the common stock trading (or, in
the case of a merger or consolidation of MetroPCS Communications with another company, other than
as a sale or change of control of MetroPCS Communications, the shares received in such merger or
consolidation having traded immediately prior to such merger or consolidation) on a national
securities exchange for a period of 30 consecutive trading dates above a price implying a market
valuation of the Series D Preferred Stock over twice the Series D Preferred Stock initial purchase
price, or (iii) the date specified by the holders of
662/3% of the Series E Preferred Stock. The
Series E Preferred Stock is convertible into common stock at $9.00 per share, which per share
amount is subject to adjustment in accordance with the terms of the Second Amended and Restated
Articles of Incorporation of MetroPCS Communications. If not previously converted, MetroPCS
Communications is required to redeem all outstanding shares of Series E Preferred Stock on July 17,
2015, at the liquidation preference of $100 per share plus accrued but unpaid dividends.
In October 2005, in connection with the purchase of the Series E Preferred Stock, Madison
Dearborn and TA Associates conducted a Tender Offer in which they purchased Series D Preferred
Stock and common stock representing, together with their Series E Preferred Stock, approximately
34% of the common stock on a fully diluted basis at the time of purchase.
Series D Convertible Preferred Stock. Between July 2000 and January 2004, MetroPCS issued
3,500,993 shares of Series D Preferred Stock, par value $0.0001 per share, of MetroPCS (“MetroPCS
Series D Preferred Stock”), in multiple closings, for an aggregate sales price of $350,099,300.
These transactions relied on the accredited investors’ exemption from registration requirements
afforded by Rule 506. We believe that other exemptions may also exist for these transactions. In
2004, each share of MetroPCS Series D Preferred Stock was converted into Series D Preferred Stock.
Each share of Series D Preferred Stock will be converted into common stock upon (i) the completion
of a Qualifying Public Offering, (as defined in the Second Amended and Restated Stockholders
Agreement), (ii) the common stock trades (or, in the case of a merger or consolidation of MetroPCS
Communications with another company, other than as a sale or change of control of MetroPCS
Communications,
the shares received in such merger or consolidation having traded immediately prior to such
merger or consolidation) on a national securities exchange for a period of 30 consecutive trading
dates above a price that implies a market valuation of the Series D Preferred Stock in excess of
twice the initial purchase price of the Series D Preferred Stock, or (iii) the date specified by
the holders of
662/3% of the Series D Preferred Stock. The Series D Preferred Stock is convertible
into common stock at $3.13 per share, which per share amount is subject to adjustment under the
terms of the Second Amended and Restated Articles of Incorporation of MetroPCS Communications. If
not previously converted, MetroPCS Communications is required to redeem all outstanding shares of
Series D Preferred Stock on July 17, 2015, at the liquidation preference of $100 per share plus
accrued but unpaid dividends.
MetroPCS Restructuring Transaction. In connection with its formation, MetroPCS
Communications, Inc., or MetroPCS Communications, issued 300 shares of its common stock to
MetroPCS, Inc. on March 10, 2004 for an
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aggregate purchase price of $1,000. The transaction was
deemed exempt from Securities Act registration under Section 4(2) of the Securities Act as a
transaction by an issuer not involving any public offering. In April 2004, in connection with the
abandoned initial public offering, MetroPCS, Inc., MetroPCS Communications, and MPCS Holdco Merger
Sub, Inc., a wholly owned subsidiary of MetroPCS Communications (“Merger Sub”), entered into an
Agreement and Plan of Merger in which Merger Sub and MetroPCS, Inc. agreed to merge with MetroPCS,
Inc. as the surviving corporation. On the effective date of the merger, which was in July 2004,
each share of Class A common stock of MetroPCS, Inc., par value $0.0001 per share, was
automatically converted into one share of Class A common stock, par value $0.0001 per share, of
MetroPCS Communications; each share of Class C common stock of MetroPCS, Inc., par value $0.0001
per share, (including each share of Class B non-voting common stock of MetroPCS, Inc. that was
converted into Class C common stock of MetroPCS, Inc. in April 2004) was automatically converted
into one share of Class C common stock, par value $0.0001 per share, of MetroPCS Communications;
and each share of Series D Preferred Stock of MetroPCS, Inc. was automatically converted into one
share of Series D Preferred Stock of MetroPCS Communications. In addition, each option to purchase
MetroPCS, Inc. Class C common stock (including each option to purchase MetroPCS, Inc. Class B
non-voting common stock that was converted into an option to purchase MetroPCS, Inc. Class C common
stock in April 2004) was assumed by MetroPCS Communications, and if and when exercisable, shall be
exercised for common stock in MetroPCS Communications. Further, each warrant outstanding to obtain
Class C common stock (including each warrant to purchase MetroPCS, Inc. Class B non-voting common
stock that was converted into a warrant to purchase MetroPCS, Inc. Class C common stock) in
MetroPCS, Inc. was assumed by MetroPCS Communications and, if and when exercisable, shall be
exercised for the same class of common stock in MetroPCS Communications. In April 2004, each share
of Class B non-voting common stock in MetroPCS, Inc. was converted into one share of Class C common
stock in MetroPCS, Inc. Concurrent with the conversion, MetroPCS, Inc. increased the number of
Class C common stock shares to 300,000,000 and decreased the authorized number of Class B common
stock shares to zero. On July 23, 2004 the Class C common stock of MetroPCS Communications was
renamed common stock. These transactions are exempt from registration under Section 4(2) of the
Securities Act as a transaction by an issuer not involving any public offering.
Exchange of Common Stock. When MetroPCS, Inc. emerged from bankruptcy in October 1998, its
Fifth Amended and Restated Certificate of Incorporation included a provision prohibiting the
issuance of non-voting equity securities pursuant to our bankruptcy plan of reorganization and
Section 1123(a)(6) of the Bankruptcy Code. After its emergence from bankruptcy, MetroPCS, Inc.
issued shares of Class B non-voting common stock, which had been authorized by its certificate of
incorporation in effect prior to the bankruptcy filing. The Class B common stock had no voting
rights except as required by law. MetroPCS, Inc.’s board of directors has indicated that the
continued inclusion of the prohibition on the issuance of non-voting equity securities after
MetroPCS, Inc.’s emergence from bankruptcy was a mistake, and on August 30, 2005, MetroPCS filed a
certificate of correction to remove this prohibition. In addition, MetroPCS, Inc.’s Seventh
Amended and Restated Certificate of Incorporation retroactively rescinds any prohibition on the
issuance of the non-voting equity securities and ratifies the authorization and issuance of the
Class B common stock by MetroPCS, Inc.
In April 2004, all of the shares of Class B non-voting common stock, par value $0.0001 per
share, of MetroPCS, Inc. (“Class B Common Stock”) converted into shares of Class C common stock of
MetroPCS, Inc.. In order to resolve any uncertainty regarding the validity of the common stock
ultimately received in the conversion of Class B Common Stock, MetroPCS Communications entered into
an exchange agreement with Madison Dearborn and TA Associates in August 2005 to exchange all the
common stock, which had been issued in connection with the conversion of Class B Common Stock, that
Madison Dearborn and TA Associates acquired as a result of their recent offer to purchase, along
with all claims relating to the possible invalidity of the issuance of the Class B Common Stock for
an equivalent number of shares of MetroPCS Communications common stock. In addition, in December
2005, we initiated an offer to exchange any remaining MetroPCS Communications common stock
ultimately received in connection with the conversion of Class B Common Stock, along with any
claims relating to the possible invalidity of the issuance of the Class B Common Stock, for an
equivalent number of shares of MetroPCS Communications common stock. As a result, all shares of
MetroPCS Communications common stock which were ultimately received in connection with the
conversion of Class B Common Stock, along with all claims relating to the possible invalidity of
the issuance of the Class B Common Stock, have been exchanged for new shares of MetroPCS
Communications common stock. The transaction was deemed exempt from Securities Act registration
under Section 4(2) of the Securities Act as a transaction by an issuer not involving any public
offering.
Equity Incentive Plans. Since January 1, 2004 through December 31, 2006, our employees have
purchased 24,436,032 shares of MetroPCS Communications common stock through the exercise of
outstanding options under
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the 1995 Plan for an aggregate sales price of approximately $9.8 million.
Since January 1, 2004 through December 31, 2006, our employees have purchased 17,892 shares of
MetroPCS Communications common stock through the exercise of outstanding options under our 2004
Equity Incentive Compensation Plan, as amended, or the 2004 Plan, for an aggregate sales price of
approximately $0.1 million. These transactions were undertaken in reliance upon exemptions from
Securities Act registration requirements afforded by Rule 701, Rule 506 and Section 4(2) of the
Securities Act, except that we have determined that the issuance of options to purchase 1,959,296
shares of MetroPCS Communications common stock under the 1995 Plan and 2004 Plan since January 1,
2004 may not have been exempt from registration or qualification requirements under federal or
state securities laws. Consequently, certain of these options and shares of MetroPCS Communications
common stock may have been issued in violation of federal or state securities laws and may be
subject to rescission. We intend to make a rescission offer as soon as practicable after the
effective date of this offering to holders of any outstanding options and shares subject to
rescission. If the rescission offer is accepted by all offerees, we could be required to make an
aggregate payment of up to approximately $2.6 million.
Director Remuneration Plan. Non-employee members of our board of directors are eligible to
participate in our non-employee director remuneration plan under which such directors may receive
compensation for serving on the board of directors. This compensation includes annual retainers,
board meeting fees, committee paid event fees, initial stock grants and annual stock grants.
Non-employee directors are eligible to receive an initial grant of 120,000 options to purchase
MetroPCS Communications common stock plus an additional 30,000 or 9,000 options to purchase
MetroPCS Communications common stock if the member serves as the chairman of the audit committee or
any of the other committees, respectively. Non-employee directors are also eligible to receive an
annual grant of 30,000 options to purchase MetroPCS Communications common stock plus an additional
15,000 or 6,000 options to purchase MetroPCS Communications common stock if the member serves as
the chairman of the audit committee or the other committees, respectively. In addition,
non-employee directors may elect to receive their annual retainer in the form of MetroPCS
Communications common stock. If such election is made, the non-employee director is eligible to
receive the number of shares of MetroPCS Communications common stock that is equal to (a) the
portion of the annual retainer received in MetroPCS Communications common stock divided by the fair
market value of the MetroPCS Communications common stock at the time the annual retainer is paid
(b) times three. Since the inception of the plan, non-employee directors have been granted
1,066,131 options to purchase MetroPCS Communications common stock and 97,596 of those options have
been exercised. Shares of MetroPCS Communications common stock granted under the non-employee
director remuneration plan were granted in reliance upon Rule 506 of the Securities Act and options
were granted in reliance upon Rule 701 and/or Rule 506 of the Securities Act. We believe other
exemptions may also be available.
Issuer Purchases of Equity Securities
We did not repurchase any equity securities during the period covered by this report.
Item 6. Selected Financial Data
The following tables set forth selected consolidated financial data. We derived our selected
consolidated financial data as of and for the years ended December 31, 2006, 2005 and 2004 from our
consolidated financial statements, which were audited by Deloitte & Touche LLP. We derived our
selected consolidated financial data as of and for the years ended December 31, 2003 and 2002 from
our consolidated financial statements. The historical selected financial data may not be
indicative of future performance and should be read in conjunction with “Managements Discussion and
Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this report.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Company Overview
Except as expressly stated, the financial condition and results of operations discussed
throughout Management’s Discussion and Analysis of Financial Condition and Results of Operations
are those of MetroPCS Communications, Inc. and its consolidated subsidiaries.
We are a wireless telecommunications carrier that currently offers wireless broadband personal
communication services, or PCS, primarily in the greater Atlanta, Dallas/Ft. Worth, Detroit, Miami,
San Francisco, Sacramento and Tampa/Sarasota/Orlando metropolitan areas. We launched service in the
greater Atlanta, Miami and
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Sacramento metropolitan areas in the first quarter of 2002; in San
Francisco in September 2002; in Tampa/Sarasota in October 2005; in Dallas/Ft. Worth in March 2006;
in Detroit in April 2006; and Orlando in November 2006. In 2005, Royal Street Communications, LLC
or Royal Street Communications, a company in which we own 85% of the limited liability company
member interests and with which we have a wholesale arrangement allowing us to sell
MetroPCS-branded services to the public, was granted licenses by the Federal Communications
Commission, or FCC, in Los Angeles and various metropolitan areas throughout northern Florida.
Royal Street is in the process of constructing its network infrastructure in its licensed
metropolitan areas. We commenced commercial services in Orlando and certain portions of northern
Florida in November 2006 and we expect to begin offering services in Los Angeles in the second or
third quarter of 2007 through our arrangements with Royal Street Communications.
As a result of the significant growth we have experienced since we launched operations, our
results of operations to date are not necessarily indicative of the results that can be expected in
future periods. Moreover, we expect that our number of customers will continue to increase, which
will continue to contribute to increases in our revenues and operating expenses. In November 2006,
we were granted advanced wireless services, or AWS, licenses covering a total unique population of
approximately 117 million for an aggregate purchase price of approximately $1.4 billion.
Approximately 69 million of the total licensed population associated with our Auction 66 licenses
represents expansion opportunities in geographic areas outside of our Core and Expansion Markets,
which we refer to as our Auction 66 Markets. These new expansion opportunities in our Auction 66
Markets cover six of the 25 largest metropolitan areas in the United States. The balance of our
Auction 66 Markets, which cover a population of approximately 48 million, supplements or expands
the geographic boundaries of our existing operations in Dallas/Ft. Worth, Detroit, Los Angeles, San
Francisco and Sacramento. We currently plan to focus on building out approximately 40 million of
the total population in our Auction 66 Markets with a primary focus on the New York, Philadelphia,
Boston and Las Vegas metropolitan areas. Of the approximate 40 million total population, we are
targeting launch of operations with an initial covered population of approximately 30 to 32 million
by late 2008 or early 2009. Total estimated capital expenditures to the launch of these operations
are expected to be between $18 and $20 per covered population, which equates to a total capital
investment of approximately $550 million to $650 million. Total estimated expenditures, including
capital expenditures, to become free cash flow positive, defined as Adjusted EBITDA less capital
expenditures, is expected to be approximately $29 to $30 per covered population, which equates to
$875 million to $1.0 billion based on an estimated initial covered population of approximately 30
to 32 million. We believe that our existing cash, cash equivalents and short-term investments,
proceeds from our currently pending initial public offering, and our anticipated cash flows from
operations will be sufficient to fully fund this planned expansion.
We sell products and services to customers through our Company-owned retail stores as well as
indirectly through relationships with independent retailers. We offer service which allows our
customers to place unlimited
local calls from within our local service area and to receive unlimited calls from any area
while in our local service area, through flat rate monthly plans starting at $30 per month. For an
additional $5 to $20 per month, our customers may select a service plan that offers additional
services, such as unlimited nationwide long distance service, voicemail, caller ID, call waiting,
text messaging, mobile Internet browsing, push e-mail and picture and multimedia messaging. We
offer flat rate monthly plans at $30, $35, $40, $45 and $50 as fully described under “Business —
MetroPCS Service Plans.” All of these plans require payment in advance for one month of service. If
no payment is made in advance for the following month of service, service is discontinued at the
end of the month that was paid for by the customer. For additional fees, we also provide
international long distance and text messaging, ringtones, games and content applications,
unlimited directory assistance, ring back tones, nationwide roaming and other value-added services.
As of December 31, 2006, over 85% of our customers have selected either our $40 or $45 rate plans.
Our flat rate plans differentiate our service from the more complex plans and long-term contract
requirements of traditional wireless carriers. In addition the above products and services are
offered by us in the Royal Street markets. Our arrangements with Royal Street are based on a
wholesale model under which we purchase network capacity from Royal Street to allow us to offer our
standard products and services in the Royal Street markets to MetroPCS customers under the MetroPCS
brand name.
Critical Accounting Policies and Estimates
The following discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in accordance with
accounting principles generally accepted in the United States of America, or GAAP. You should read
this discussion and analysis in conjunction with our consolidated financial statements and the
related notes thereto contained elsewhere in this report. The preparation of these consolidated
financial statements in conformity with GAAP requires us to make estimates and assumptions that
affect the reported amounts of certain assets, liabilities, revenues and expenses, and related
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disclosure of contingent assets and liabilities at the date of the financial statements. We base
our estimates on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the results of which form the basis for making judgments about
the carrying values of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect our more significant judgments
and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
Our wireless services are provided on a month-to-month basis and are paid in advance. We
recognize revenues from wireless services as they are rendered. Amounts received in advance are
recorded as deferred revenue. Suspending service for non-payment is known as hotlining. We do not
recognize revenue on hotlined customers.
Revenues and related costs from the sale of accessories are recognized at the point of sale.
The cost of handsets sold to indirect retailers are included in deferred charges until they are
sold to and activated by customers. Amounts billed to indirect retailers for handsets are recorded
as accounts receivable and deferred revenue upon shipment by us and are recognized as equipment
revenues when service is activated by customers.
Our customers have the right to return handsets within a specified time or after a certain
amount of use, whichever occurs first. We record an estimate for returns as contra-revenue at the
time of recognizing revenue. Our assessment of estimated returns is based on historical return
rates. If our customers’ actual returns are not consistent with our estimates of their returns,
revenues may be different than initially recorded.
Effective July 1, 2003, we adopted Emerging Issues Task Force (“EITF”) No. 00-21, “Accounting
for Revenue Arrangements with Multiple Deliverables,” (“EITF No. 00-21”), which is being applied on
a prospective basis. EITF No. 00-21 also supersedes certain guidance set forth in U.S. Securities
and Exchange Commission Staff Accounting Bulletin Number 101, “Revenue Recognition in Financial
Statements,” (“SAB 101”). SAB 101 was amended in December 2003 by Staff Accounting Bulletin Number
104, “Revenue Recognition.” The consensus addresses the accounting for arrangements that involve
the delivery or performance of multiple products, services and/or rights to use assets. Revenue
arrangements with multiple deliverables are divided into separate units of accounting and the
consideration received is allocated among the separate units of accounting based on their relative
fair values.
We determined that the sale of wireless services through our direct and indirect sales
channels with an accompanying handset constitutes revenue arrangements with multiple deliverables.
Upon adoption of EITF No. 00-21, we began dividing these arrangements into separate units of
accounting, and allocating the consideration between the handset and the wireless service based on
their relative fair values. Consideration received for the handset is recognized as equipment
revenue when the handset is delivered and accepted by the customer. Consideration received for the
wireless service is recognized as service revenues when earned.
Allowance for Uncollectible Accounts Receivable
We maintain allowances for uncollectible accounts for estimated losses resulting from the
inability of our independent retailers to pay for equipment purchases and for amounts estimated to
be uncollectible for intercarrier compensation. We estimate allowances for uncollectible accounts
from independent retailers based on the length of time the receivables are past due, the current
business environment and our historical experience. If the financial condition of a material
portion of our independent retailers were to deteriorate, resulting in an impairment of their
ability to make payments, additional allowances may be required. In circumstances where we are
aware of a specific carrier’s inability to meet its financial obligations to us, we record a
specific allowances for intercarrier compensation against amounts due, to reduce the net recognized
receivable to the amount we reasonably believe will be collected. Total allowance for uncollectible
accounts receivable as of December 31, 2006 was approximately 7% of the total amount of gross
accounts receivable.
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Inventories
We write down our inventory for estimated obsolescence or unmarketable inventory equal to the
difference between the cost of inventory and the estimated market value or replacement cost based
upon assumptions about future demand and market conditions. Total inventory reserves for
obsolescent and unmarketable inventory were not significant as of December 31, 2006. If actual
market conditions are less favorable than those projected, additional inventory write-downs may be
required.
Deferred Income Tax Asset and Other Tax Reserves
We assess our deferred tax asset and record a valuation allowance, when necessary, to reduce
our deferred tax asset to the amount that is more likely than not to be realized. We have
considered future taxable income, taxable temporary differences and ongoing prudent and feasible
tax planning strategies in assessing the need for the valuation allowance. Should we determine that
we would not be able to realize all or part of our net deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to earnings in the period we made that
determination.
We establish reserves when, despite our belief that our tax returns are fully supportable, we
believe that certain positions may be challenged and ultimately modified. We adjust the reserves in
light of changing facts and circumstances. Our effective tax rate includes the impact of income tax
related reserve positions and changes to income tax reserves that we consider appropriate. A number
of years may elapse before a particular matter for which we have established a reserve is finally
resolved. Unfavorable settlement of any particular issue may require the use of cash or a reduction
in our net operating loss carryforwards. Favorable resolution would be recognized as a reduction to
the effective rate in the year of resolution. Tax reserves as of December 31, 2006 were $23.9
million of which $4.4 million and $19.5 million are presented on the consolidated balance sheet in
accounts payable and accrued expenses and other long-term liabilities, respectively.
Property and Equipment
Depreciation on property and equipment is applied using the straight-line method over the
estimated useful lives of the assets once the assets are placed in service, which are ten years for
network infrastructure assets including capitalized interest, three to seven years for office
equipment, which includes computer equipment, three to seven years for furniture and fixtures and
five years for vehicles. Leasehold improvements are amortized over the shorter of the remaining
term of the lease and any renewal periods reasonably assured or the estimated useful life of the
improvement. The estimated life of property and equipment is based on historical experience with
similar assets, as well as taking into account anticipated technological or other changes. If
technological changes were to occur more rapidly than anticipated or in a different form than
anticipated, the useful lives assigned to these assets may need to be shortened, resulting in the
recognition of increased depreciation expense in future periods. Likewise, if the anticipated
technological or other changes occur more slowly than anticipated, the life of the assets could be
extended based on the life assigned to new assets added to property and equipment. This could
result in a reduction of depreciation expense in future periods.
We assess the impairment of long-lived assets whenever events or changes in circumstances
indicate the carrying value may not be recoverable. Factors we consider important that could
trigger an impairment review include significant underperformance relative to historical or
projected future operating results or significant changes in the manner of use of the assets or in
the strategy for our overall business. The carrying amount of a long-lived asset is not recoverable
if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual
disposition of the asset. When we determine that the carrying value of a long-lived asset is not
recoverable, we measure any impairment based upon a projected discounted cash flow method using a
discount rate we determine to be commensurate with the risk involved and would be recorded as a
reduction in the carrying value of the related asset and charged to results of operations. If
actual results are not consistent with our assumptions and estimates, we may be exposed to an
additional impairment charge associated with long-lived assets. The carrying value of property and
equipment was approximately $1.3 billion as of December 31, 2006.
FCC Licenses and Microwave Relocation Costs
We operate broadband PCS networks under licenses granted by the FCC for a particular
geographic area on spectrum allocated by the FCC for broadband PCS services. In addition, in
November 2006, we acquired a number
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of AWS licenses which can be used to provide services
comparable to the PCS services provided by us, and other
advanced wireless services. The PCS licenses included the obligation to relocate existing
fixed microwave users of our licensed spectrum if our spectrum interfered with their systems and/or
reimburse other carriers (according to FCC rules) that relocated prior users if the relocation
benefits our system. Additionally, we incurred costs related to microwave relocation in
constructing our PCS network. The PCS and AWS licenses and microwave relocation costs are recorded
at cost. Although FCC licenses are issued with a stated term, ten years in the case of PCS licenses
and fifteen years in the case of AWS licenses, the renewal of PCS and AWS licenses is generally a
routine matter without substantial cost and we have determined that no legal, regulatory,
contractual, competitive, economic, or other factors currently exist that limit the useful life of
our PCS and AWS licenses. The carrying value of FCC licenses and microwave relocation costs was
approximately $2.1 billion as of December 31, 2006.
Our primary indefinite-lived intangible assets are our FCC licenses. Based on the requirements
of Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and other Intangible
Assets,” (“SFAS No. 142”) we test investments in our FCC licenses for impairment annually or more
frequently if events or changes in circumstances indicate that the carrying value of our FCC
licenses might be impaired. We perform our annual FCC license impairment test as of each September
30th. The impairment test consists of a comparison of the estimated fair value with the carrying
value. We estimate the fair value of our FCC licenses using a discounted cash flow model. Cash flow
projections and assumptions, although subject to a degree of uncertainty, are based on a
combination of our historical performance and trends, our business plans and management’s estimate
of future performance, giving consideration to existing and anticipated competitive economic
conditions. Other assumptions include our weighted average cost of capital and long-term rate of
growth for our business. We believe that our estimates are consistent with assumptions that
marketplace participants would use to estimate fair value. We corroborate our determination of fair
value of the FCC licenses, using the discounted cash flow approach described above, with other
market-based valuation metrics. Furthermore, we segregate our FCC licenses by regional clusters for
the purpose of performing the impairment test because each geographical region is unique. An
impairment loss would be recorded as a reduction in the carrying value of the related
indefinite-lived intangible asset and charged to results of operations. Historically, we have not
experienced significant negative variations between our assumptions and estimates when compared to
actual results. However, if actual results are not consistent with our assumptions and estimates,
we may be required to record to an impairment charge associated with indefinite-lived intangible
assets. Although we do not expect our estimates or assumptions to change significantly in the
future, the use of different estimates or assumptions within our discounted cash flow model when
determining the fair value of our FCC licenses or using a methodology other than a discounted cash
flow model could result in different values for our FCC licenses and may affect any related
impairment charge. The most significant assumptions within our discounted cash flow model are the
discount rate, our projected growth rate and management’s future business plans. A change in
management’s future business plans or disposition of one or more FCC licenses could result in the
requirement to test certain other FCC licenses. If any legal, regulatory, contractual, competitive,
economic or other factors were to limit the useful lives of our indefinite-lived FCC licenses, we
would be required to test these intangible assets for impairment in accordance with SFAS No. 142
and amortize the intangible asset over its remaining useful life.
For the license impairment test performed as of December 31, 2006, the fair value of the FCC
licenses was in excess of its carrying value. A 10% change in the estimated fair value of the FCC
licenses would not have impacted the results of our annual license impairment test.
Share-Based Payments
We account for share-based awards exchanged for employee services in accordance with SFAS No.
123(R), “Share-Based Payment,” (“SFAS No. 123(R)”). Under SFAS No. 123(R), share-based compensation
cost is measured at the grant date, based on the estimated fair value of the award, and is
recognized as expense over the employee’s requisite service period. We adopted SFAS No. 123(R) on
January 1, 2006. Prior to 2006, we recognized stock-based compensation expense for employee
share-based awards based on their intrinsic value on the date of grant pursuant to Accounting
Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”)
and followed the disclosure requirements of SFAS No. 148, “Accounting for Stock-Based Compensation
— Transition and Disclosure,” (“SFAS No. 148”), which amends the disclosure requirements of SFAS
No. 123, “Accounting for Stock-Based Compensation,” (“SFAS No. 123”).
We adopted SFAS No. 123(R) using the modified prospective transition method. Under the
modified prospective transition method, prior periods are not revised for comparative purposes. The
valuation provisions of
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SFAS No. 123(R) apply to new awards and to awards that are outstanding on
the effective date and subsequently modified or cancelled. Compensation expense, net of estimated
forfeitures, for awards outstanding at the effective
date is recognized over the remaining service period using the compensation cost calculated
under SFAS No. 123 in prior periods.
We have granted nonqualified stock options. Most of our stock option awards include a service
condition that relates only to vesting. The stock option awards generally vest in one to four years
from the grant date. Compensation expense is amortized on a straight-line basis over the requisite
service period for the entire award, which is generally the maximum vesting period of the award.
The determination of the fair value of stock options using an option-pricing model is affected
by our common stock valuation as well as assumptions regarding a number of complex and subjective
variables. The methods used to determine these variables are generally similar to the methods used
prior to 2006 for purposes of our pro forma information under SFAS No. 148. Factors that our Board
of Directors considers in determining the fair market value of our common stock, include the
recommendation of our finance and planning committee and of management based on certain data,
including discounted cash flow analysis, comparable company analysis and comparable transaction
analysis, as well as contemporaneous valuation reports. The volatility assumption is based on a
combination of the historical volatility of our common stock and the volatilities of similar
companies over a period of time equal to the expected term of the stock options. The volatilities
of similar companies are used in conjunction with our historical volatility because of the lack of
sufficient relevant history equal to the expected term. The expected term of employee stock options
represents the weighted-average period the stock options are expected to remain outstanding. The
expected term assumption is estimated based primarily on the stock options’ vesting terms and
remaining contractual life and employees’ expected exercise and post-vesting employment termination
behavior. The risk-free interest rate assumption is based upon observed interest rates on the grant
date appropriate for the term of the employee stock options. The dividend yield assumption is based
on the expectation of no future dividend payouts by us.
As share-based compensation expense under SFAS No. 123(R) is based on awards ultimately
expected to vest, it is reduced for estimated forfeitures. SFAS No. 123(R) requires forfeitures to
be estimated at the time of grant and revised, if necessary, in subsequent periods if actual
forfeitures differ from those estimates. We recorded stock-based compensation expense of
approximately $14.5 million for the year ended December 31, 2006.
The value of the options is determined by using a Black-Scholes pricing model that includes
the following variables: 1) exercise price of the instrument, 2) fair market value of the
underlying stock on date of grant, 3) expected life, 4) estimated volatility and 5) the risk-free
interest rate. The Company utilized the following weighted-average assumptions in estimating the
fair value of the options grants for the years ended December 31, 2006 and 2005:
The Black-Scholes model requires the use of subjective assumptions including expectations
of future dividends and stock price volatility. Such assumptions are only used for making the
required fair value estimate and should not be considered as indicators of future dividend policy
or stock price appreciation. Because changes in the subjective assumptions can materially affect
the fair value estimate, and because employee stock options have characteristics significantly
different from those of traded options, the use of the Black-Scholes option pricing model may not
provide a reliable estimate of the fair value of employee stock options.
During the years ended December 31, 2005 and 2006, the following awards were granted under the
Company’s Option Plans:
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Compensation expense is recognized over the requisite service period for the entire
award, which is generally the maximum vesting period of the award.
Valuation of Common Stock
Significant Factors, Assumptions, and Methodologies Used in Determining the Fair Value of our
Common Stock.
The determination of the fair value of our common stock requires us to make judgments that are
complex and inherently subjective. Factors that our Board of Directors considers in determining the
fair market value of our common stock include the recommendation of our finance and planning
committee and of management based on certain data, including discounted cash flow analysis,
comparable company analysis and comparable transaction analysis, as well as contemporaneous
valuation reports. When determining the fair value of our common stock, we follow the guidance
prescribed by the American Institute of Certified Public Accountants in its practice aid,
“Valuation of Privately-Held-Company Equity Securities Issued as Compensation,” (the “Practice
Aid”).
According to the Practice Aid, quoted market prices in active markets are the best evidence of
fair value of a security and should be used as the basis for the measurement of fair value, if
available. Since quoted market prices for our securities are not available, the estimate of fair
value should be based on the best information available, including prices for similar securities
and the results of using other valuation techniques. Privately held enterprises or shareholders
sometimes engage in arm’s-length cash transactions with unrelated parties for the issuance or sale
of their equity securities, and the cash exchanged in such a transaction is, under certain
conditions, an observable price that serves the same purpose as a quoted market price. Those
conditions are (a) the equity securities in the transaction are the same securities as those with
the fair value determination is being made, and (b) the transaction is a current transaction
between willing parties. To the extent that arm’s-length cash transactions were available, we
utilized those transactions to determine the fair value of our common stock. When arm’s-length
transactions as described above were not available, then we utilized other valuation techniques
based on a number of methodologies and analyses, including:
Sales of our common stock in arm’s-length cash transactions during the years ended December
31, 2005 and 2006 were as follows:
Customer Recognition and Disconnect Policies
When a new customer subscribes to our service, the first month of service and activation fee
is included with the handset purchase. Under GAAP, we are required to allocate the purchase price
to the handset and to the
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wireless service revenue. Generally, the amount allocated to the handset
will be less than our cost, and this difference is included in Cost Per Gross Addition, or CPGA. We
recognize new customers as gross customer
additions upon activation of service. Prior to January 23, 2006, we offered our customers the
Metro Promise, which allowed a customer to return a newly purchased handset for a full refund prior
to the earlier of 7 days or 60 minutes of use. Beginning on January 23, 2006, we expanded the terms
of the Metro Promise to allow a customer to return a newly purchased handset for a full refund
prior to the earlier of 30 days or 60 minutes of use. Customers who return their phones under the
Metro Promise are reflected as a reduction to gross customer additions. Customers’ monthly service
payments are due in advance every month. Our customers must pay their monthly service amount by the
payment date or their service will be suspended, or hotlined, and the customer will not be able to
make or receive calls on our network. However, a hotlined customer is still able to make E-911
calls in the event of an emergency. There is no service grace period. Any call attempted by a
hotlined customer is routed directly to our interactive voice response system and customer service
center in order to arrange payment. If the customer pays the amount due within 30 days of the
original payment date then the customer’s service is restored. If a hotlined customer does not pay
the amount due within 30 days of the payment date the account is disconnected and counted as churn.
Once an account is disconnected we charge a $15 reconnect fee upon reactivation to reestablish
service and the revenue associated with this fee is deferred and recognized over the estimated life
of the customer.
Revenues
We derive our revenues from the following sources:
Service. We sell wireless broadband PCS services. The various types of service revenues
associated with wireless broadband PCS for our customers include monthly recurring charges for
airtime, monthly recurring charges for optional features (including nationwide long distance and
text messaging, ringtones, games and content applications, unlimited directory assistance, ring
back tones, mobile Internet browsing, push e-mail and nationwide roaming) and charges for long
distance service. Service revenues also include intercarrier compensation and nonrecurring
activation service charges to customers.
Equipment. We sell wireless broadband PCS handsets and accessories that are used by our
customers in connection with our wireless services. This equipment is also sold to our independent
retailers to facilitate distribution to our customers.
Costs and Expenses
Our costs and expenses include:
Cost of Service. The major components of our cost of service are:
Cost of Equipment. We purchase wireless broadband PCS handsets and accessories from
third-party vendors to resell to our customers and independent retailers in connection with our
services. We subsidize the sale of handsets to encourage the sale and use of our services. We do
not manufacture any of this equipment.
Selling, General and Administrative Expenses. Our selling expense includes advertising and
promotional costs associated with marketing and selling to new customers and fixed charges such as
retail store rent and retail associates’ salaries. General and administrative expense includes
support functions including, technical operations, finance, accounting, human resources,
information technology and legal services. We record stock-based
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compensation expense in cost of
service and selling, general and administrative expenses associated with employee stock options
which is measured at the date of grant, based on the estimated fair value of the award. Prior to
the adoption of SFAS No. 123(R), we recorded stock-based compensation expense at the end of each
reporting period with respect to our variable stock options.
Depreciation and Amortization. Depreciation is applied using the straight-line method over
the estimated useful lives of the assets once the assets are placed in service, which are ten years
for network infrastructure assets and capitalized interest, three to seven years for office
equipment, which includes computer equipment, three to seven years for furniture and fixtures and
five years for vehicles. Leasehold improvements are amortized over the term of the respective
leases, which includes renewal periods that are reasonably assured, or the estimated useful life of
the improvement, whichever is shorter.
Interest Expense and Interest Income. Interest expense includes interest incurred on our
borrowings, amortization of debt issuance costs and amortization of discounts and premiums on
long-term debt. Interest income is earned primarily on our cash and cash equivalents.
Income Taxes. As a result of our operating losses and accelerated depreciation available
under federal tax laws, we paid no federal income taxes prior to 2006. For the year ended December
31, 2006, we paid approximately $2.7 million in federal income taxes. In addition, we have paid an
immaterial amount of state income tax through December 31, 2006.
Seasonality
Our customer activity is influenced by seasonal effects related to traditional retail selling
periods and other factors that arise from our target customer base. Based on historical results, we
generally expect net customer additions to be strongest in the first and fourth quarters. Softening
of sales and increased customer turnover, or churn, in the second and third quarters of the year
usually combine to result in fewer net customer additions. However, sales activity and churn can be
strongly affected by the launch of new markets and promotional activity, which have the ability to
reduce or outweigh certain seasonal effects.
Operating Segments
Operating segments are defined by SFAS No. 131 “Disclosure About Segments of an Enterprise and
Related Information,” (“SFAS No. 131”), as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief operating decision
maker in deciding how to allocate resources and in assessing performance. Our chief operating
decision maker is the Chairman of the Board and Chief Executive Officer.
As of December 31, 2006, we had eight operating segments based on geographic region within the
United States: Atlanta, Dallas/Ft. Worth, Detroit, Miami, San Francisco, Sacramento,
Tampa/Sarasota/Orlando and Los Angeles. Each of these operating segments provide wireless voice and
data services and products to customers in its service areas or is currently constructing a network
in order to provide these services. These services include unlimited local and long distance
calling, voicemail, caller ID, call waiting, text messaging, picture and multimedia messaging,
international long distance and text messaging, ringtones, games and content applications,
unlimited directory assistance, ring back tones, nationwide roaming, mobile Internet browsing, push
e-mail and other value-added services.
We aggregate our operating segments into two reportable segments: Core Markets and Expansion
Markets.
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The accounting policies of the operating segments are the same as those described in the
summary of significant accounting policies. General corporate overhead, which includes expenses
such as corporate employee labor costs, rent and utilities, legal, accounting and auditing
expenses, is allocated equally across all operating segments. Corporate marketing and advertising
expenses are allocated equally to the operating segments, beginning in the period during which we
launch service in that operating segment. Expenses associated with our national data center are
allocated based on the average number of customers in each operating segment. All intercompany
transactions between reportable segments have been eliminated in the presentation of operating
segment data.
Interest expense, interest income, gain/loss on extinguishment of debt and income taxes are
not allocated to the segments in the computation of segment operating profit for internal
evaluation purposes.
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Results of Operations
Year Ended December 31, 2006 Compared to Year Ended December 31, 2005
Set forth below is a summary of certain financial information by reportable operating segment
for the periods indicated:
Service Revenues: Service revenues increased $418.8 million, or 48%, to $1,290.9 million
for the year ended December 31, 2006 from $872.1 million for the year ended December 31, 2005. The
increase is due to increases in Core Markets and Expansion Markets service revenues as follows:
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Equipment Revenues: Equipment revenues increased $89.6 million, or 54%, to $255.9 million for
the year ended December 31, 2006 from $166.3 million for the year ended December 31, 2005. The
increase is due to increases in Core Markets and Expansion Markets equipment revenues as follows:
Cost of Services: Cost of Service increased $162.1 million, or 57%, to $445.3 million for the
year ended December 31, 2006 from $283.2 million for the year ended December 31, 2005. The increase
is due to increases in Core Markets and Expansion Markets cost of service as follows:
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Cost of Equipment: Cost of equipment increased $176.0 million, or 59%, to $476.9 million for
the year ended December 31, 2006 from $300.9 million for the year ended December 31, 2005. The
increase is due to increases in Core Markets and Expansion Markets cost of equipment as follows:
Selling, General and Administrative Expenses. Selling, general and administrative expenses
increased $81.1 million, or 50%, to $243.6 million for the year ended December 31, 2006 from $162.5
million for the year ended December 31, 2005. The increase is due to increases in Core Markets and
Expansion Markets selling, general and administrative expenses as follows:
Depreciation and Amortization. Depreciation and amortization expense increased $47.1 million,
or 54%, to $135.0 million for the year ended December 31, 2006 from $87.9 million for the year
ended December 31, 2005. The increase is primarily due to increases in Core Markets and Expansion
Markets depreciation and amortization expense as follows:
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Stock-Based Compensation Expense. Stock-based compensation expense increased $11.9 million,
or 457%, to $14.5 million for the year ended December 31, 2006 from $2.6 million for the year ended
December 31, 2005. The increase is primarily due to increases in Core Markets and Expansion Markets
stock-based compensation expense as follows:
Loss (Gain) on Disposal of Assets. In May 2005, we completed the sale of a 10 MHz
portion of our 30 MHz PCS license in the San Francisco-Oakland-San Jose basic trading area for cash
consideration of $230.0 million. The sale of PCS spectrum resulted in a gain on disposal of asset
in the amount of $228.2 million.
Loss on Extinguishment of Debt. In November 2006, we repaid all amounts outstanding under our
first and second lien credit agreements and the exchangeable secured and unsecured bridge credit
agreements. As a result, we recorded a loss on extinguishment of debt in the amount of
approximately $42.7 million of the first and second lien credit agreements and an approximately
$9.4 million loss on the extinguishment of the exchangeable secured and unsecured bridge credit
agreements. In May 2005, we repaid all of the outstanding debt under our FCC notes, 103/4% senior
notes and bridge credit agreement. As a result, we recorded a $1.9 million loss on the
extinguishment of the FCC notes; a $34.0 million loss on extinguishment of the 103/4% senior notes;
and a $10.4 million loss on the extinguishment of the bridge credit agreement.
Interest Expense. Interest expense increased $58.0 million, or 100%, to $116.0 million for
the year ended December 31, 2006 from $58.0 million for the year ended December 31, 2005. The
increase in interest expense was primarily due to increased average principal balance outstanding
as a result of additional borrowings of $150.0 million under our first and second lien credit
agreements in the fourth quarter of 2005, $200.0 million under the secured bridge credit facility
in the third quarter of 2006 and an additional $1,300.0 million under the secured and unsecured
bridge credit facilities in the fourth quarter of 2006. Interest expense also increased due to the
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weighted average interest rate increasing to 10.30% for the year ended December 31, 2006 compared
to 8.92% for the year ended December 31, 2005. The increase in interest expense was partially
offset by the capitalization of $17.5 million of interest during the year ended December 31, 2006,
compared to $3.6 million of interest capitalized
during the same period in 2005. We capitalize interest costs associated with our FCC licenses
and property and equipment beginning with pre-construction period administrative and technical
activities, which includes obtaining leases, zoning approvals and building permits. The amount of
such capitalized interest depends on the carrying values of the FCC licenses and construction in
progress involved in those markets and the duration of the construction process. With respect to
our FCC licenses, capitalization of interest costs ceases at the point in time in which the asset
is ready for its intended use, which generally coincides with the market launch date. In the case
of our property and equipment, capitalization of interest costs ceases at the point in time in
which the network assets are placed into service. We expect capitalized interest to be significant
during the construction of our additional Expansion Markets and related network assets.
Provision for Income Taxes. Income tax expense for the year ended December 31, 2006 decreased
to $36.7 million, which is approximately 41% of our income before provision for income taxes. For
the year ended December 31, 2005 the provision for income taxes was $127.4 million, or
approximately 39% of income before provision for income taxes. The year ended December 31, 2005
included a gain on the sale of a 10 MHz portion of our 30 MHz PCS license in the San
Francisco-Oakland-San Jose basic trading area in the amount of $228.2 million.
Net Income. Net income decreased $144.9 million, or 73%, to $53.8 million for the year ended
December 31, 2006 compared to $198.7 million for the year ended December 31, 2005. The significant
decrease is primarily attributable to our non-recurring sale of a 10 MHz portion of our 30 MHz PCS
license in the San Francisco-Oakland-San Jose basic trading area in May 2005 for cash consideration
of $230.0 million. The sale of PCS spectrum resulted in a gain on disposal of asset in the amount
of $139.2 million, net of income taxes. Net income for the year ended December 31, 2006, excluding
the tax effected impact of the gain on the sale of the PCS license, decreased approximately 10%.
The decrease in net income, excluding the tax effected impact of the gain on the sale of spectrum,
is primarily due to the increase in operating losses in our Expansion
Markets. This increase in operating losses in our Expansion Markets is attributable to the launch of the
Dallas/Ft. Worth metropolitan area in March 2006, the Detroit metropolitan area in April 2006, and the expansion of the
Tampa/Sarasota area to include the Orlando metropolitan area in November 2006 as well as build-out expenses related to the Los Angeles metropolitan area.
We have obtained positive operating income in our
Core Markets at or before five full quarters of operations. Based on our experience to date in our Expansion Markets and current industry trends,
we expect our Expansion Markets to achieve positive operating income in a period similar to or better than the Core Markets.
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Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Set forth below is a summary of certain financial information by reportable operating segment
for the periods indicated. For the year ended December 31, 2004, the consolidated financial
information represents the Core Markets reportable operating segment, as the Expansion Markets
reportable operating segment had no operations until 2005.
Service Revenues. Service revenues increased $255.7 million, or 41%, to $872.1 million
for the year ended December 31, 2005 from $616.4 million for the year ended December 31, 2004. The
increase is due to increases in Core Markets and Expansion Markets service revenues as follows:
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Equipment Revenues. Equipment revenues increased $34.5 million, or 26%, to $166.3 million for
the year ended December 31, 2005 from $131.8 million for the year ended December 31, 2004. The
increase is due to increases in Core Markets and Expansion Markets equipment revenues as follows:
Cost of Service. Cost of service increased $82.4 million, or 41%, to $283.2 million for the
year ended December 31, 2005 from $200.8 million for the year ended December 31, 2004. The increase
is due to increases in Core Markets and Expansion Markets cost of service as follows:
Cost of Equipment. Cost of equipment increased $78.1 million, or 35%, to $300.9 million for
the year ended December 31, 2005 from $222.8 million for the year ended December 31, 2004. The
increase is due to increases in Core Markets and Expansion Markets cost of equipment as follows:
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Selling, General and Administrative Expenses. Selling, general and administrative expenses
increased $31.0 million, or 24%, to $162.5 million for the year ended December 31, 2005 from $131.5
million for the year ended December 31, 2004. The increase is due to increases in Core Markets and
Expansion Markets selling, general and administrative expenses as follows:
Depreciation and Amortization. Depreciation and amortization expense increased $25.7 million,
or 41%, to $87.9 million for the year ended December 31, 2005 from $62.2 million for the year ended
December 31, 2004. The increase is primarily due to increases in Core Markets and Expansion Markets
depreciation expense as follows:
Loss (Gain) on Disposal of Assets. In May 2005, we completed the sale of a 10 MHz
portion of our 30 MHz PCS license in the San Francisco-Oakland-San Jose basic trading area for cash
consideration of $230.0 million. The sale of PCS spectrum resulted in a gain on disposal of asset
in the amount of $228.2 million.
(Gain) Loss on Extinguishment of Debt. In May 2005, we repaid all of the outstanding debt
under our FCC notes, Senior Notes and bridge credit agreement. As a result, we recorded a $1.9
million loss on the extinguishment
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of the FCC notes; a $34.0 million loss on extinguishment of the
Senior Notes; and a $10.4 million loss on the extinguishment of the bridge credit agreement.
Interest Expense. Interest expense increased $39.0 million, or 205%, to $58.0 million for the
year ended December 31, 2005 from $19.0 million for the year ended December 31, 2004. The increase
was primarily attributable to $40.9 million in interest expense related to our Credit Agreements
that were executed on May 31, 2005 as well as the amortization of the deferred debt issuance costs
in the amount of $3.6 million associated with the Credit Agreements. On May 31, 2005, we paid all
of our outstanding obligations under our FCC notes and Senior Notes, which generally had lower
interest rates than our Credit Agreements.
Provision for Income Taxes. Income tax expense for year ended December 31, 2005 increased to
$127.4 million, which is approximately 39% of our income before provision for income taxes. For the
year ended December 31, 2004 the provision for income taxes was $47.0 million, or approximately 42%
of income before provision for income taxes. The increase in our income tax expense in 2005 was
attributable to our increased operating profits. The decrease in the effective tax rate from 2004
to 2005 relates primarily to the increase in book income which lowers the effective rate of tax
items included in the calculation.
Net Income. Net income increased $133.8 million, or 206%, for the year ended December 31,
2005 compared to the year ended December 31, 2004. The significant increase in net income is
primarily attributable to our nonrecurring sale of a 10 MHz portion of our 30 MHz PCS license in
the San Francisco-Oakland-San Jose basic trading area in May 2005 for cash consideration of $230.0
million. The sale of PCS spectrum resulted in a gain on disposal of asset in the amount of $139.2
million, net of income taxes. In addition, growth in average customers of approximately 37% during
2005 also contributed to the increase in net income for the year ended December 31, 2005. These
increases were partially offset by a $46.5 million loss on extinguishment of debt.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
For the years ended December 31, 2004 and 2003, the consolidated summary information presented
below represents Core Markets reportable segment information, as the Expansion Markets reportable
segment had no operations until 2005.
Set forth below is a summary of certain financial information for the periods indicated:
Service Revenues. Service revenues increased $246.5 million, or 67%, to $616.4 million
for the year ended December 31, 2004 from $369.9 million for the year ended December 31, 2003. The
increase is primarily attributable to the addition of approximately 422,000 customers accounting
for $159.7 million of the increase, coupled with the migration of existing customers to higher
priced rate plans accounting for $86.8 million of the increase.
The increase in customers migrating to higher priced rate plans is primarily the result of our
emphasis on offering additional services under our $45 rate plan, which includes unlimited
nationwide long distance and various unlimited data features. In addition, this migration is
expected to continue as our higher priced rate plans become more attractive to our existing
customer base.
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Equipment Revenues. Equipment revenues increased $50.6 million, or 62%, to $131.9 million for
the year ended December 31, 2004 from $81.3 million for the year ended December 31, 2003. The
increase is attributable to higher priced handset models accounting for $28.7 million of the
increase; coupled with the increase in gross
customer additions during the year of approximately 240,000 customers accounting for $21.9
million of the increase.
The increase in handset model availability is primarily the result of our emphasis on
enhancing our product offerings and appealing to our customer base in connection with our wireless
services.
Cost of Service. Cost of service increased $78.6 million, or 64%, to $200.8 million for the
year ended December 31, 2004 from $122.2 million for the year ended December 31, 2003. The increase
was attributable to the addition of approximately 422,000 customers during the year. Additionally,
employee costs, cell site and switch facility lease expense and repair and maintenance expense
increased as a result of the growth of our business and the expansion of our network.
Cost of Equipment. Cost of equipment increased $71.9 million, or 48%, to $222.7 million for
the year ended December 31, 2004 from $150.8 million for the year ended December 31, 2003. The
increase in cost of equipment was due to a slight increase in the average handset cost per unit
which related to an increase in sales of higher priced handset models in 2004. In addition, we
experienced an increase in the number of handsets sold to new customers during the year.
Selling, General and Administrative Expenses. Selling, general and administrative expenses
increased $37.4 million, or 40%, to $131.5 million for the year ended December 31, 2004 from $94.1
million for the year ended December 31, 2003. Selling, general and administrative expenses include
stock-based compensation expense, which increased $4.8 million, or 87%, to $10.4 million for the
year ended December 31, 2004 from $5.6 million for the year ended December 31, 2003. This increase
was primarily related to the extension of the exercise period of stock options for a terminated
employee in the amount of approximately $3.6 million. The remaining increase was a result of an
increase in the estimated fair market value of our stock used for valuing stock options accounted
for under variable accounting. Selling expenses increased by $8.6 million as a result of increased
sales and marketing activities. General and administrative expenses increased by $25.6 million
primarily due to the increase in our administrative costs associated with our customer base and to
network expansion, a $8.1 million increase in professional fees including legal and accounting
services, a $3.7 million increase in employee salaries and benefits, a $3.6 million increase in
bank service charges, a $0.5 million increase in rent expense, a $1.2 million increase in personal
property tax expense, and a $1.1 million increase in property insurance. Of the $8.1 million
increase in professional fees, approximately $3.2 million was related to the preparation of a
registration statement for an initial public offering of our common stock to the public. These
costs were expensed, as this initial public offering was not completed and the registration
statement was withdrawn.
Depreciation and Amortization. Depreciation and amortization expense increased $19.8 million,
or 47%, to $62.2 million for the year ended December 31, 2004 from $42.4 million for the year ended
December 31, 2003. The increase related primarily to an increase in network infrastructure assets
placed into service in 2004. In-service base stations and switching equipment increased by
approximately $237.2 million during the year ended December 31, 2004. In addition, we had 460 more
cell sites in service at December 31, 2004 than at December 31, 2003. We expect depreciation to
continue to increase due to the additional cell sites, switches and other network equipment that we
plan to place in service to meet future customer growth and usage.
Interest Expense. Interest expense increased $7.9 million, or 71%, to $19.0 million for the
year ended December 31, 2004 from $11.1 million for the year ended December 31, 2003. The increase
was primarily attributable to interest expense on our $150.0 million Senior Notes that were issued
in September 2003.
Provision for Income Taxes. Income tax expense for year ended December 31, 2004 increased to
$47.0 million, which is approximately 42% of our income before provision for income taxes. For the
year ended December 31, 2003 the provision for income taxes was $16.2 million, or approximately 51%
of income before provision for income taxes. The increase in our income tax expense in 2004 was
attributable to our increased operating profits. The decrease in the effective tax rate from 2003
to 2004 relates primarily to the increase in book income which lowers the effective rate of tax
items included in the calculation. In addition, the 2003 income tax provision includes a charge
required under California law to partially reduce the 2003 California net operating loss
carryforwards. However, this statutory requirement did not exist in 2004.
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Net Income. Net income increased $49.5 million, or 323%, for the year ended December 31,
2004 compared to the year ended December 31, 2003. The increase in net income is primarily
attributable to growth in average customers of approximately 56% for the year ended December 31,
2004 compared to the same period in 2003 in addition to the migration of existing customers to
higher priced rate plans.
Quarterly Results of Operations
The following tables present our unaudited condensed consolidated quarterly statement of
operations data for the years ended December 31, 2005 and 2006. We derived our quarterly results of
operations data from our unaudited consolidated financial statements.
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Performance Measures
In managing our business and assessing our financial performance, we supplement the
information provided by financial statement measures with several customer-focused performance
metrics that are widely used in the wireless industry. These metrics include average revenue per
user per month, or ARPU, which measures service revenue per customer; cost per gross customer
addition, or CPGA, which measures the average cost of acquiring a new customer; cost per user per
month, or CPU, which measures the non-selling cash cost of operating our business on a per customer
basis; and churn, which measures turnover in our customer base. For a reconciliation of Non-GAAP
performance measures and a further discussion of the measures, please read “— Reconciliation of
Non-GAAP Financial Measures” below.
The following table shows annual metric information for 2004, 2005 and 2006.
Customers. Net customer additions were 1,016,365 for the year ended December 31, 2006,
compared to 525,889 for the year ended December 31, 2005, an increase of 93%. Total customers were
2,940,986 as of December 31, 2006, an increase of 53% over the customer total as of December 31,
2005. Total customers as of December 31, 2005 were approximately 1.9 million, an increase of 38%
over the total customers as of December 31, 2004. These increases are primarily attributable to the
continued demand for our service offering.
Churn. As we do not require a long-term service contract, our churn percentage is expected to
be higher than traditional wireless carriers that require customers to sign a one- to two-year
contract with significant early termination fees. Average monthly churn represents (a) the number
of customers who have been disconnected from our system during the measurement period less the
number of customers who have reactivated service, divided by (b) the sum of the average monthly
number of customers during such period. We classify delinquent customers as churn after they have
been delinquent for 30 days. In addition, when an existing customer establishes a new account in
connection with the purchase of an upgraded or replacement phone and does not identify themselves
as an existing customer, we count that phone leaving service as a churn and the new phone entering
service as a gross customer addition. Churn for the year ended December 31, 2006 was 4.6% compared
to 5.1% for the year ended December 31, 2005. Based upon a change in the allowable return period
from 7 days to 30 days, we revised our definition of gross customer additions to exclude customers
that discontinue service in the first 30 days of service. This revision reduces deactivations and
gross customer additions commencing March 23, 2006, and reduces churn. Churn computed under the
original 7 day allowable return period would have been 5.1% for the year ended December 31, 2006.
Our average monthly rate of customer turnover, or churn, was 5.1% and 4.9% for the years ended
December 31, 2005 and 2004, respectively. Average monthly churn rates for selected traditional
wireless carriers ranges from 1.0% to 2.6% for post-pay customers and over 6.0% for pre-pay
customers based on public filings or press releases.
Average Revenue Per User. ARPU represents (a) service revenues less activation revenues,
E-911, FUSF, and vendor’s compensation charges for the measurement period, divided by (b) the sum
of the average monthly number of customers during such period. ARPU was $42.98 and $42.40 for the
years ended December 31, 2006 and 2005, respectively, an increase of $0.58, or 1.4%. ARPU increased
$1.27, or approximately 3.1%, during 2005 from $41.13 for the year ended December 31, 2004. The
increase in ARPU was primarily the result of attracting customers to higher priced service plans,
which include unlimited nationwide long distance for $40 per month as well as unlimited nationwide
long distance and certain calling and data features on an unlimited basis for $45 per month.
Cost Per Gross Addition. CPGA is determined by dividing (a) selling expenses plus the total
cost of equipment associated with transactions with new customers less activation revenues and
equipment revenues associated with transactions with new customers during the measurement period by
(b) gross customer additions
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during such period. Retail customer service expenses and equipment
margin on handsets sold to existing customers
when they are identified, including handset upgrade transactions, are excluded, as these costs
are incurred specifically for existing customers. CPGA costs have increased to $117.58 for the year
ended December 31, 2006 from $102.70 for the year ended December 31, 2005, which was primarily
driven by the selling expenses associated with the launch of the Dallas/Ft. Worth metropolitan
area, the Detroit metropolitan area and the expansion of the Tampa/Sarasota area to include the
Orlando metropolitan area. In addition, on January 23, 2006, we revised the terms of our return
policy from 7 days to 30 days, and as a result we revised our definition of gross customer
additions to exclude customers that discontinue service in the first 30 days of service. This
revision, commencing March 23, 2006, reduces deactivations and gross customer additions and
increases CPGA. CPGA decreased $1.08, or 1.0%, in 2005 from $103.78 for the year ended December 31,
2004. The decrease in CPGA was the result of the higher rate of growth in customer activations and
the relatively fixed nature of the expenses associated with those activations.
Cost Per User. CPU is cost of service and general and administrative costs (excluding
applicable non-cash stock-based compensation expense included in cost of service and general and
administrative expense) plus net loss on handset equipment transactions unrelated to initial
customer acquisition (which includes the gain or loss on sale of handsets to existing customers and
costs associated with handset replacements and repairs (other than warranty costs which are the
responsibility of the handset manufacturers)), divided by sum of the average monthly number of
customers during such period. CPU for the years ended December 31, 2006 and 2005 was $19.65 and
$19.57, respectively. CPU for the year ended December 31, 2004 was $18.95. We continue to achieve
cost benefits due to the increasing scale of our business. However, these benefits have been offset
by a combination of the construction and launch expenses associated with our Expansion Markets,
which contributed approximately $3.42 of additional CPU for the year ended December 31, 2006. In
addition, CPU has increased historically due to costs associated with higher ARPU service plans
such as those related to unlimited nationwide long distance. During the years ended December 31,
2004 and 2005, CPU was impacted by substantial legal and accounting expenses in the amount of
approximately $1.5 million and $5.9 million, respectively, associated with an internal
investigation related to material weaknesses in our internal control over financial reporting as
well as financial statement audits related to our restatement efforts.
The following table shows quarterly metric information for the year ended December 31, 2005
and December 31, 2006.
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Core Markets Performance Measures
Set forth below is a summary of certain key performance measures for the periods indicated for
our Core Markets:
We launched our service initially in 2002 in the greater Miami, Atlanta, Sacramento and
San Francisco metropolitan areas. Our Core Markets have a licensed population of approximately 26
million, of which our networks currently cover approximately 22 million. In addition, we had
positive adjusted earnings before interest, taxes, depreciation and amortization, gain/loss on
disposal of assets, accretion of put option in majority-owned subsidiary, gain/loss on
extinguishment of debt, cumulative effect of change in accounting principle and non-cash
stock-based compensation, or Adjusted EBITDA, in our Core Markets after only four full quarters of
operations.
Customers. Net customer additions in our Core Markets were 429,293 for the year ended
December 31, 2006, compared to 472,933 for the year ended December 31, 2005. Total customers were
2,300,958 as of December 31, 2006, an increase of 23% over the customer total as of December 31,
2005. Net customer additions in our Core Markets were 472,933 for the year ended December 31, 2005,
bringing our total customers to approximately 1.9 million as of December 31, 2005, an increase of
34% over the total customers as of December 31, 2004. These increases are primarily attributable to
the continued demand for our service offering.
Adjusted EBITDA. Adjusted EBITDA is presented in accordance with SFAS No. 131 as it is the
primary performance metric for which our reportable segments are evaluated and it is utilized by
management to facilitate evaluation of our ability to meet future debt service, capital
expenditures and working capital requirements and to fund future growth. For the year ended
December 31, 2006, Core Markets Adjusted EBITDA was $492.8 million compared to $316.6 million for
the year ended December 31, 2005. For the year ended December 31, 2004, Core Markets Adjusted
EBITDA was $203.6 million. We continue to experience increases in Core Markets Adjusted EBITDA as a
result of continued customer growth and cost benefits due to the increasing scale of our business
in the Core Markets.
Adjusted EBITDA as a Percent of Service Revenues. Adjusted EBITDA as a percent of service
revenues is calculated by dividing Adjusted EBITDA by total service revenues. Core Markets Adjusted
EBITDA as a percent of service revenues for the year ended December 31, 2006 and 2005 was 43% and
36%, respectively. Core Markets Adjusted EBITDA as a percent of service revenues for the year ended
December 31, 2004 was 33%. Consistent with the increase in Core Markets Adjusted EBITDA, we
continue to experience corresponding increases in Core Markets Adjusted EBITDA as a percent of
service revenues due to the growth in service revenues as well as cost benefits due to the
increasing scale of our business in the Core Markets.
The following table shows a summary of certain quarterly key performance measures for the
periods indicated for our Core Markets.
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Expansion Markets Performance Measures
Set forth below is a summary of certain key performance measures for the periods indicated for
our Expansion Markets:
Customers. Net customer additions in our Expansion Markets were 587,072 for the year
ended December 31, 2006. Total customers were 640,028 as of December 31, 2006 compared to 52,956
for the year ended December 31, 2005. The increase in customers was primarily attributable to the
launch of the Dallas/Ft. Worth metropolitan area in March 2006, the Detroit metropolitan area in
April 2006 and the expansion of the Tampa/Sarasota area to include the Orlando metropolitan area in
November 2006. Net customer additions in our Expansion Markets were 52,956 for the year ended
December 31, 2005, which was attributable to the launch of the Tampa/Sarasota metropolitan area in
October 2005.
Adjusted EBITDA (Deficit). Adjusted EBITDA is presented in accordance with SFAS No. 131 as it
is the primary performance metric for which our reportable segments are evaluated and it is
utilized by management to facilitate evaluation of our ability to meet future debt service, capital
expenditures and working capital requirements and to fund future growth. For the year ended
December 31, 2006, Expansion Markets Adjusted EBITDA deficit was $97.2 million compared to $22.1
million for the year ended December 31, 2005. The increases in Adjusted EBITDA deficit, when
compared to the same periods in the previous year, were attributable to the launch of the
Tampa/Sarasota metropolitan area in October 2005, the Dallas/Ft. Worth metropolitan area in March
2006, the Detroit metropolitan area in April 2006 and the expansion of the Tampa/Sarasota area to
include the Orlando metropolitan area in November 2006 as well as expenses associated with the
construction of the Los Angeles metropolitan area.
The following table shows a summary of certain quarterly key performance measures for the
periods indicated for our Expansion Markets.
Reconciliation of Non-GAAP Financial Measures
We utilize certain financial measures and key performance indicators that are not calculated
in accordance with GAAP to assess our financial and operating performance. A non-GAAP financial
measure is defined as a numerical measure of a company’s financial performance that (i) excludes
amounts, or is subject to adjustments that have the effect of excluding amounts, that are included
in the comparable measure calculated and presented in accordance with GAAP in the statement of
income or statement of cash flows; or (ii) includes amounts, or is subject to adjustments that have
the effect of including amounts, that are excluded from the comparable measure so calculated and
presented.
Average revenue per user, or ARPU, cost per gross addition, or CPGA, and cost per user, or
CPU, are non-GAAP financial measures utilized by our management to judge our ability to meet our
liquidity requirements and to evaluate our operating performance. We believe these measures are
important in understanding the performance of our operations from period to period, and although
every company in the wireless industry does not define each of these measures in precisely the same
way, we believe that these measures (which are common in the wireless industry) facilitate key
liquidity and operating performance comparisons with other companies in the wireless industry. The
following tables reconcile our non-GAAP financial measures with our financial statements presented
in accordance with GAAP.
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ARPU — We utilize average revenue per user, or ARPU, to evaluate our per-customer service
revenue realization and to assist in forecasting our future service revenues. ARPU is calculated
exclusive of activation revenues, as these amounts are a component of our costs of acquiring new
customers and are included in our calculation of CPGA. ARPU is also calculated exclusive of E-911,
FUSF and vendor’s compensation charges, as these are generally pass through charges that we collect
from our customers and remit to the appropriate government agencies.
Average number of customers for any measurement period is determined by dividing (a) the sum
of the average monthly number of customers for the measurement period by (b) the number of months
in such period. Average monthly number of customers for any month represents the sum of the number
of customers on the first day of the month and the last day of the month divided by two. The
following table shows the calculation of ARPU for the periods indicated.
CPGA — We utilize cost per gross customer addition, or CPGA, to assess the efficiency of
our distribution strategy, validate the initial capital invested in our customers and determine the
number of months to recover our customer acquisition costs. This measure also allows us to compare
our average acquisition costs per new customer to those of other wireless broadband PCS providers.
Activation revenues and equipment revenues related to new customers are deducted from selling
expenses in this calculation as they represent amounts paid by customers at the time their service
is activated that reduce our acquisition cost of those customers. Additionally, equipment costs
associated with existing customers, net of related revenues, are excluded as this measure is
intended to reflect only the acquisition costs related to new customers. The following table
reconciles total costs used in the calculation of CPGA to selling expenses, which we consider to be
the most directly comparable GAAP financial measure to CPGA.
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CPU — Cost per user, or CPU, is cost of service and general and administrative costs
(excluding applicable non-cash stock-based compensation expense included in cost of service and
general and administrative expense) plus net loss on equipment transactions unrelated to initial
customer acquisition (which includes the gain or loss on sale of handsets to existing customers and
costs associated with handset replacements and repairs (other than warranty costs which are the
responsibility of the handset manufacturers)) exclusive of E-911, FUSF and vendor’s compensation
charges, divided by the sum of the average monthly number of customers during such period. CPU does
not include any depreciation and amortization expense. Management uses CPU as a tool to evaluate
the non-
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selling cash expenses associated with ongoing business operations on a per customer basis,
to track changes in these non-selling cash costs over time, and to help evaluate how changes in our
business operations affect non-selling cash costs per customer. In addition, CPU provides
management with a useful measure to compare our non-selling cash costs per customer with those of
other wireless providers. We believe investors use CPU primarily as a tool to track changes in our
non-selling cash costs over time and to compare our non-selling cash costs to those of other
wireless providers. Other wireless carriers may calculate this measure differently. The following
table reconciles total costs used in the calculation of CPU to cost of service, which we consider
to be the most directly comparable GAAP financial measure to CPU.
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Liquidity and Capital Resources
Our principal sources of liquidity are our existing cash, cash equivalents and short-term
investments, cash generated from operations, proceeds from our recent sale of senior notes and our
senior secured credit facility. At December 31, 2006, we had a total of approximately $552.1
million in cash, cash equivalents and short-term investments. We believe that our existing cash,
cash equivalents and short-term investments, proceeds from our currently pending initial public
offering, and our anticipated cash flows from operations will be sufficient to fully fund our
projected operating and capital requirements for our existing business, currently planned
expansion, planned enhancements of network capacity and upgrades for EVDO Revision A with VoIP, and
service of our debt incurred in November 2006 through at least December 31, 2009.
Our strategy has been to offer our services in major metropolitan areas and their surrounding
areas, which we refer to as clusters. We are seeking opportunities to enhance our current market
clusters and to provide service in new geographic areas. From time to time, we may purchase
spectrum and related assets from third parties or the FCC. We participated as a bidder in FCC
Auction 66 and in November 2006 we were granted eight licenses for a total aggregate purchase price
of approximately $1.4 billion. See “Business — Auction 66 Markets.”
As a result of the acquisition of the spectrum licenses from Auction 66 and the opportunities
that these licenses provide for us to expand our operations into major metropolitan markets, we
will require significant additional capital in the future to finance the construction and initial
operating costs associated with such licenses, including clearing costs associated with
non-governmental incumbent licenses which we currently estimate to be
between approximately $40 million and $60 million. We generally do not intend to commence the
construction of any individual license area until we have sufficient funds available to provide for
the related construction and operating costs associated with such license area. We currently plan
to focus on building out approximately 40 million of the total population in our Auction 66 Markets
with a primary focus on the New York, Philadelphia, Boston and Las Vegas metropolitan areas. Of the
approximate 40 million total population, we are targeting launch of operations with an initial
covered population of approximately 30 to 32 million by late 2008 or early 2009. Total estimated
capital expenditures to the launch of these operations are expected to be between $18 and $20 per
covered population which equates to a total capital investment of approximately $550 million to
$650 million. Total estimated expenditures, including capital expenditures, to become free cash
flow positive, defined as Adjusted EBITDA less capital expenditures, are expected to be
approximately $29 to $30 per covered population, which equates to $875 million to $1.0 billion
based on an estimated initial covered population of approximately 30 to 32 million. We believe that
our existing cash, cash equivalents and short-term investments, proceeds from our currently pending
initial public offering, and our anticipated cash flows from operations will be sufficient to fully
fund this planned expansion. Moreover, we have made no commitments for capital expenditures and we
have the ability to reduce the rate of capital expenditure deployment.
The construction of our network and the marketing and distribution of our wireless
communications products and services have required, and will continue to require, substantial
capital investment. Capital outlays have included license acquisition costs, capital expenditures
for construction of our network infrastructure, costs associated with clearing and relocating
non-governmental incumbent licenses, funding of operating cash flow losses incurred as we launch
services in new metropolitan areas and other working capital costs, debt service and financing fees
and expenses. Our capital expenditures for 2006 were approximately $550.7 million and aggregate
capital expenditures for 2005 were approximately $266.5 million. These expenditures were primarily
associated with the construction of the network infrastructure in our Expansion Markets and our
efforts to increase the service area and capacity of our existing Core Markets network through the
addition of cell sites and switches. We believe the increased service area and capacity in existing
markets will improve our service offering, helping us to attract additional customers and increase
revenues. In addition, we believe our new Expansion Markets have attractive demographics which will
result in increased revenues.
In connection with our payment of the purchase price for the Auction 66 licenses in October
2006, certain of our subsidiaries borrowed $1.25 billion under a secured bridge credit facility and
an additional $250 million under a unsecured bridge credit facility. See “— Bridge Credit
Facilities” below. The funds borrowed under the bridge credit facilities were used primarily to pay
the aggregate purchase price of approximately $1.4 billion for the licenses we purchased in Auction
66. In November 2006, we consummated the sale of $1.0 billion in aggregate principal amount of 91/4%
senior notes and entered into a senior secured credit facility, pursuant to which we may borrow up
to $1.7 billion. We borrowed $1.6 billion under our senior secured credit facility concurrently
with the closing of the sale of the 91/4% senior notes and used the amount borrowed, together with
the net proceeds from the
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sale of the 91/4% senior notes, to repay all amounts owed under the first
and second lien credit agreements and the secured and unsecured bridge credit facilities and to pay
the related premiums, fees and expenses and we intend to use the remaining amounts for general
corporate purposes. As of December 31, 2006, we owed an aggregate of approximately $2.6 billion
under our senior secured credit facility and 91/4% Senior Notes. On February 20, 2007, MetroPCS
Wireless, Inc. entered into an amendment to the senior secured credit facility. Under the
amendment, the margin used to determine the senior secured credit facility interest rate was
reduced to 2.25% from 2.50%.
Our senior secured credit facility calculates consolidated Adjusted EBITDA as: consolidated
net income plus depreciation and amortization; gain (loss) on disposal of assets; non-cash
expenses; gain (loss) on extinguishment of debt; provision for income taxes; interest expense; and
certain expenses of MetroPCS Communications minus interest and other income and non-cash items
increasing consolidated net income.
We consider Adjusted EBITDA, as defined above, to be an important indicator to investors
because it provides information related to our ability to provide cash flows to meet future debt
service, capital expenditures and working capital requirements and fund future growth. We present
this discussion of Adjusted EBITDA because covenants in our senior secured credit facility contain
ratios based on this measure. If our Adjusted EBITDA were to decline below certain levels,
covenants in our senior secured credit facility that are based on Adjusted EBITDA, including our
maximum senior secured leverage ratio covenant, may be violated and could cause, among other
things, an inability to incur further indebtedness and in certain circumstances a default or
mandatory prepayment under our senior secured credit facility. Our maximum senior secured leverage
ratio is required to be less than 4.5 to 1.0 based on Adjusted EBITDA plus the impact of certain
new markets. The maximum senior secured leverage ratio is calculated as the ratio of senior secured
indebtedness to Adjusted EBITDA, as defined by our senior secured
credit facility. For the year ended December 31, 2006, our senior secured leverage ratio was 3.24 to 1.0. In addition, consolidated Adjusted EBITDA is also utilized, among other
measures, to determine management’s compensation levels. Adjusted EBITDA is not a measure
calculated in accordance with GAAP, and should not be considered a substitute for, operating income
(loss), net income (loss), or any other measure of financial performance reported in accordance
with GAAP. In addition, Adjusted EBITDA should not be construed as an alternative to, or more
meaningful than cash flows from operating activities, as determined in accordance with GAAP.
The following table shows the calculation of our consolidated Adjusted EBITDA, as defined in
our senior secured credit facility, for the years ended December 31, 2004, 2005 and 2006.
In addition, for further information, the following table reconciles consolidated
Adjusted EBITDA, as defined in our senior secured credit facility, to cash flows from operating
activities for the years ended December 31, 2004, 2005 and 2006.
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In connection with the closing of the sale of the 91/4% senior notes, the entry into our
senior secured credit facility and the repayment of all amounts outstanding under our first and
second lien credit agreements and secured and unsecured bridge credit facilities, we consummated a
concurrent restructuring transaction. As a result of the restructuring transaction, MetroPCS
Wireless, Inc. became a wholly-owned direct subsidiary of MetroPCS, Inc. (formerly MetroPCS V,
Inc.), which is a wholly-owned direct subsidiary of MetroPCS Communications, Inc. MetroPCS
Communications, Inc. and MetroPCS, Inc. guaranteed the 91/4% senior notes and the obligations under
the senior secured credit facility. MetroPCS, Inc. also pledged the capital stock of MetroPCS
Wireless, Inc. as security for the obligations under the senior secured credit facility. All of our
FCC licenses and our 85% limited liability company member interest in Royal Street Communications
are now held by MetroPCS Wireless, Inc. and its wholly-owned subsidiaries.
Operating Activities
Cash provided by operating activities was $364.8 million during the year ended December 31,
2006 compared to $283.2 million for the year ended December 31, 2005. The increase was primarily
attributable to the timing of payments on accounts payable and accrued expenses for the year ended
December 31, 2006 as well as an increase in deferred revenues due to an approximately 53% increase
in customers during the year ended December 31, 2006 compared to the year ended December 31, 2005.
Cash provided by operating activities was $283.2 million during the year ended December 31,
2005 compared to cash provided by operating activities of $150.4 million during the year ended
December 31, 2004. The increase was primarily attributable to a significant increase in net income,
including a $228.2 million gain on the sale of a 10 MHz portion of our 30MHz PCS license for the
San Francisco — Oakland — San Jose basic trading area, and the timing of payments on accounts
payable and accrued expenses in the year ended December 31, 2005, partially offset by interest
payments on the Credit Agreements that were executed in May 2005.
Cash provided by operating activities was $150.4 million during the year ended December 31,
2004 compared to cash provided by operating activities of $112.6 million during the year ended
December 31, 2003. The increase was primarily attributable to an increase in the net income,
partially offset by an increase of $66.1 million used in cash due to changes in working capital
compared to the year ended December 31, 2003. This increase is primarily due to increases in
inventories and the timing of payments on accounts payable and accrued expenses.
Investing Activities
Cash used in investing activities was $1.9 billion during the year ended December 31, 2006
compared to $905.2 million during the year ended December 31, 2005. The increase was due primarily
to a $887.7 million increase in purchases of FCC licenses and a $284.3 million increase in
purchases of property and equipment, partially offset by a $355.5 million decrease in net purchases
of investments.
Cash used in investing activities was $905.2 million during the year ended December 31, 2005
compared to $190.9 million during the year ended December 31, 2004. This increase was due primarily
to a $416.9 million increase in the purchase of FCC licenses, an increase in purchases of
investments in the amount of $580.8 million,
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and a $27.5 million increase in purchases of property
and equipment, partially offset by proceeds of $230.0 million from the sale of a 10 MHz portion of
our 30 MHz PCS license for the San Francisco-Oakland-San Jose basic trading area.
Cash used in investing activities was $190.9 million during the year ended December 31, 2004,
compared to $306.9 million for the year ended December 31, 2003. The decrease during 2004 is
primarily attributable to a $284.6 million increase in proceeds from the sale and maturity of
investments, as well as a $50.5 million decrease in the purchases of investments, partially offset
by an increase in purchases of property and equipment in the amount of $133.1 million.
Financing Activities
Cash provided by financing activities was $1.6 billion for the year ended December 31, 2006
compared to $712.2 million for the year ended December 31, 2005. The increase was due primarily to
net proceeds from the senior secured credit facility and the 91/4% senior notes.
Cash provided by financing activities during the year ended December 31, 2005 was $712.2
million, compared to cash used in financing activities of $5.4 million for the year ended December
31, 2004. The increase during 2005 is mainly attributable to proceeds from borrowings under our
Credit Agreements of $902.9 million as well as net proceeds from the issuance of Series E Preferred
Stock in the amount of $46.7 million. These proceeds are partially offset by various transactions
including repayment of the FCC notes in the amount of $33.4 million, repayment of the Senior Notes
in the amount of $178.9 million, which included a premium of $28.9 million, and payment of debt
issuance costs in the amount of $29.5 million.
Cash used in financing activities during the year ended December 31, 2004 was $5.4 million,
compared to cash provided by financing activities of $201.9 million for the year ended December 31,
2003. During 2003, we had net proceeds of $145.5 million from the issuance of our 103/4% Senior Notes
and $65.5 million from the issuance of Series D Preferred Stock, which are the primary reasons for
the decrease in cash provided by financing activities in 2004.
First and Second Lien Credit Agreements
On November 3, 2006, we paid the lenders under the first and second lien credit agreements
$931.5 million plus accrued interest of $8.6 million to extinguish the aggregate outstanding
principal balance under the first and second lien credit agreements. As a result, we recorded a
loss on extinguishment of debt in the amount of approximately $42.7 million.
On November 21, 2006, we terminated the interest rate cap agreement that was required by our
first and second lien credit agreements. We received approximately $4.3 million upon termination of
the agreement. The proceeds from the termination of the agreement approximated its carrying value.
Bridge Credit Facilities
In July 2006, MetroPCS II, Inc., or MetroPCS II, an indirect wholly-owned subsidiary of
MetroPCS Communications, Inc. (which has since merged into MetroPCS Wireless, Inc.), entered into
an Exchangeable Senior Secured Credit Agreement and Guaranty Agreement, dated as of July 13, 2006,
or the secured bridge credit facility. The aggregate credit commitments available under the secured
bridge credit facility were $1.25 billion and were fully funded.
On November 3, 2006, MetroPCS II repaid the aggregate outstanding principal balance under the
secured bridge credit facility of $1.25 billion and accrued interest of $5.9 million. As a result,
MetroPCS II recorded a loss on extinguishment of debt of approximately $7.0 million.
In October 2006, MetroPCS IV, Inc., an indirect wholly-owned subsidiary of MetroPCS
Communications, Inc. (which has since merged into MetroPCS Wireless, Inc.), entered into an
additional Exchangeable Senior Unsecured Bridge Credit Facility, or the unsecured bridge credit
facility. The aggregate credit commitments available under the unsecured bridge credit facility
were $250 million and were fully funded.
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On November 3, 2006, MetroPCS IV, Inc. repaid the aggregate outstanding principal balance
under the unsecured bridge credit facility of $250.0 million and accrued interest of $1.2 million.
As a result, MetroPCS IV, Inc. recorded a loss on extinguishment of debt of approximately $2.4
million.
Senior Secured Credit Facility
MetroPCS Wireless, Inc., an indirect wholly-owned subsidiary of MetroPCS Communications, Inc.,
entered into the senior secured credit facility on November 3, 2006. The senior secured credit
facility consists of a $1.6 billion term loan facility and a $100 million revolving credit
facility. The term loan facility is repayable in quarterly installments in annual aggregate amounts
equal to 1% of the initial aggregate principal amount of $1.6 billion. The term loan facility will
mature seven years following the date of its execution in November 2006. The revolving credit
facility will mature five years following the date of its execution in November 2006.
The facilities under the senior secured credit agreement are guaranteed by MetroPCS
Communications, Inc., MetroPCS, Inc. and each of MetroPCS Wireless, Inc.’s direct and indirect
present and future wholly-owned domestic subsidiaries. The facilities are not guaranteed by Royal
Street or its subsidiaries, but MetroPCS Wireless, Inc. has pledged the promissory note given by
Royal Street in connection with amounts borrowed by Royal Street from MetroPCS Wireless, Inc. and
we pledged the limited liability company member interests we hold in Royal Street. The senior
secured credit facility contains customary events of default, including cross defaults. The
obligations are also secured by the capital stock of MetroPCS Wireless, Inc. as well as
substantially all of the present and future assets of MetroPCS Wireless, Inc. and each of its
direct and indirect present and future wholly-owned subsidiaries (except as prohibited by law and
certain permitted exceptions).
Under the senior secured credit agreement, MetroPCS Wireless, Inc. will be subject to certain
limitations, including limitations on its ability to incur additional debt, make certain restricted
payments, sell assets, make certain investments or acquisitions, grant liens and pay dividends.
MetroPCS Wireless, Inc. is also subject to certain financial covenants, including maintaining a
maximum senior secured consolidated leverage ratio and, under certain circumstances, maximum
consolidated leverage and minimum fixed charge coverage ratios. There is no prohibition on our
ability to make investments in or loan money to Royal Street.
Amounts outstanding under our senior secured credit facility bear interest at a LIBOR rate
plus a margin as set forth in the facility and the terms of the senior secured credit facility
require us to enter into interest rate hedging agreements that fix the interest rate in an amount
equal to at least 50% of our outstanding indebtedness, including the notes.
On November 21, 2006, MetroPCS Wireless, Inc. entered into a three-year interest rate
protection agreement to manage its interest rate risk exposure and fulfill a requirement of its
senior secured credit facility. The agreement covers a notional amount of $1.0 billion and
effectively converts this portion of MetroPCS Wireless, Inc.’s variable rate debt to fixed rate
debt at an annual rate of 7.419%. The quarterly interest settlement periods begin on February 1,
2007. The interest rate protection agreement expires on February 1, 2010.
On February 20, 2007, MetroPCS Wireless, Inc. entered into an amendment to the senior secured
credit facility. Under the amendment, the margin used to determine the senior secured credit
facility interest rate was reduced to 2.25% from 2.50%.
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