UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
|X| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004.
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934.
Commission File Number: 027455
AirGate PCS, Inc.
(Exact name of registrant as specified in its charter)
Delaware 58-2422929
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
Harris Tower, 233 Peachtree St. NE, Suite 1700,
Atlanta, Georgia 30303
(Address of principal executive offices) (Zip code)
(404) 525-7272
(Registrant's telephone number, including area code)
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 and 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. Yes |X| No |_|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes |_| No |X|
11,815,284 shares of common stock, $0.01 par value, were outstanding as of
May 12, 2004.
AIRGATE PCS, INC.
FORM 10-Q FOR THE QUARTER ENDED
MARCH 31, 2004
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements..................................... 3
Condensed Consolidated Balance Sheets at
March 31, 2004 (unaudited) and September 30, 2003....... 3
Condensed Consolidated Statements of Operations
for the three months and six months ended
March 31, 2004 and 2003 (unaudited)..................... 4
Condensed Consolidated Statements of Cash Flows
for the six months ended March 31, 2004 and
2003 (unaudited)........................................ 5
Notes to Condensed Consolidated Financial
Statements (unaudited).................................. 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 16
Item 3. Quantitative and Qualitative Disclosures
About Market Risk....................................... 34
Item 4. Controls and Procedures.................................. 35
PART II OTHER INFORMATION
Item 1. Legal Proceedings........................................ 37
Item 2. Changes in Securities and Use of Proceeds................ 37
Item 3. Defaults Upon Senior Securities.......................... 37
Item 4. Submission of Matters to a Vote of Security Holders...... 37
Item 5. Other Information........................................ 38
Item 6. Exhibits and Reports on Form 8-K......................... 38
PART I. FINANCIAL INFORMATION
Item 1. -- Financial Statements
AIRGATE PCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, September 30,
2004 2003
---------------- -----------------
(unaudited)
(Dollars in thousands, except share
and per share amounts)
Assets
Current assets:
Cash and cash equivalents $ 48,593 $ 54,078
Accounts receivable, net of allowance for doubtful
accounts of $3,861 and $4,635 24,477 26,994
Receivable from Sprint 11,957 15,809
Inventories 3,469 2,132
Prepaid expenses 5,699 2,107
Other current assets 316 145
----------------- -----------------
Total current assets 94,511 101,265
Property and equipment, net of accumulated depreciation and
amortization of $153,645 and $129,986 161,772 178,070
Financing costs 3,182 6,682
Direct subscriber activation costs 2,662 3,907
Other assets 1,017 992
---------------- -----------------
Total assets $ 263,144 $ 290,916
================= =================
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 2,247 $ 5,945
Accrued expense 13,970 12,104
Payable to Sprint 48,761 45,069
Deferred revenue 8,621 7,854
Current maturities of long-term debt 17,113 17,775
----------------- -----------------
Total current liabilities 90,712 88,747
Deferred subscriber activation fee revenue 4,585 6,701
Other long-term liabilities 2,148 1,841
Long-term debt, excluding current maturities 257,237 386,509
Investment in iPCS - 184,115
----------------- -----------------
Total liabilities 354,682 667,913
Commitments and contingencies - -
Stockholders' deficit:
Preferred stock, $.01 par value; 1,000,000
shares authorized; no shares issued and
outstanding - -
Common stock, $.01 par value; 30,000,000
shares authorized; 11,761,951 and 5,192,238
shares issued and outstanding at March 31, 2004
and September 30, 2003 118 52
Additional paid-in-capital 1,046,193 924,095
Unearned stock compensation (37) (203)
Accumulated deficit (1,137,812) (1,300,941)
----------------- -----------------
Total stockholders' deficit (91,538) (376,997)
----------------- -----------------
Total liabilities and stockholders' deficit $ 263,144 $ 290,916
================= =================
See accompanying notes to the unaudited condensed
consolidated financial statements.
3
AIRGATE PCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Three Months Ended Six Months Ended
March 31, March 31,
------------------------------------ ------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
(Dollars in thousands, except share and per share amounts)
Revenue:
Service revenue 61,656 $ 60,163 $ 123,829 $ 120,096
Roaming revenue 13,498 13,895 29,981 32,805
Equipment revenue 2,882 2,691 5,729 5,713
----------------- ----------------- ----------------- -----------------
Total revenue 78,036 76,749 159,539 158,614
Operating Expense:
Cost of service and roaming (exclusive
of depreciation and amortization
as shown separately below) 39,422 40,747 81,911 92,170
Cost of equipment 7,202 3,455 13,788 10,302
Selling and marketing expense 11,916 11,384 26,063 28,203
General and administrative expense 6,337 5,844 12,804 10,036
Depreciation and amortization of
property and equipment 11,892 11,625 23,659 23,244
Loss (gain) on disposal of property
and equipment (3) 220 (5) 418
----------------- ----------------- ----------------- -----------------
Total operating expense 76,766 73,275 158,220 164,373
----------------- ----------------- ----------------- -----------------
Operating income (loss) 1,270 3,474 1,319 (5,759)
Interest income 165 25 322 25
Interest expense (11,311) (10,197) (22,627) (20,391)
----------------- ----------------- ----------------- -----------------
Loss from continuing operations
before income tax (9,876) (6,698) (20,986) (26,125)
Income tax - - - -
----------------- ----------------- ----------------- -----------------
Loss from continuing operations (9,876) (6,698) (20,986) (26,125)
Discontinued Operations:
Loss from discontinued operations - (14,324) - (42,571)
Gain on disposal of discontinued operations
net of $0 income tax expense - - 184,115 -
----------------- ----------------- ----------------- -----------------
Income (loss) from discontinued operations - (14,324) 184,115 (42,571)
----------------- ----------------- ----------------- -----------------
Net income (loss) $ (9,876) $ (21,022) $ 163,129 $ (68,696)
================= ================= ================= =================
Basic and diluted weighted-average number
of shares outstanding 8,152,162 5,185,887 6,664,131 5,175,241
Basic and diluted earnings (loss) per share:
Loss from continuing operations $ (1.21) $ (1.29) $ (3.15) $ (5.05)
Income (loss) from discontinued operations - (2.76) 27.63 (8.22)
----------------- ----------------- ----------------- -----------------
Net income (loss) $ (1.21) $ (4.05) $ 24.48 $ (13.27)
================= ================= ================= =================
See accompanying notes to the unaudited condensed
consolidated financial statements.
4
AIRGATE PCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Six Months Ended
March 31,
------------------------------------
2004 2003
----------------- -----------------
(Dollars in thousands)
Cash flows from operating activities:
Net income (loss) $ 163,129 $ (68,696)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Gain on disposal of discontinued operations (184,115) -
Loss from discontinued operations - 42,571
Depreciation and amortization of property and equipment 23,659 23,244
Amortization of financing costs into interest expense 629 605
Provision for doubtful accounts (718) 2,155
Interest expense associated with accretion of discounts 14,366 15,940
Non-cash stock compensation 302 352
Loss (gain) on disposal of property and equipment (5) 418
Changes in assets and liabilities:
Accounts receivable 3,235 364
Receivable from Sprint 3,852 17,362
Inventories (1,337) 1,974
Prepaid expenses, other current and non-current assets (2,528) (3,021)
Accounts payable, accrued expenses and other
long-term liabilities (3,654) (6,131)
Payable to Sprint 3,692 (12,811)
Deferred revenue 767 1,301
----------------- -----------------
Net cash provided by operating activities 21,274 15,627
----------------- -----------------
Cash flows from investing activities:
Purchases of property and equipment (7,361) (6,654)
----------------- -----------------
Net cash used in investing activities (7,361) (6,654)
----------------- -----------------
Cash flows from financing activities:
Borrowings under credit facility - 8,000
Repayments of credit facility (13,761) (1,012)
Financing cost on credit facility (884) -
Equity issue costs (4,758) -
Stock issued to employee stock purchase plan - 57
Proceeds from stock option exercises 5 -
----------------- -----------------
Net cash (used in) provided by financing activities (19,398) 7,045
----------------- -----------------
Net (decrease) increase in cash and cash equivalents (5,485) 16,018
Cash and cash equivalents at beginning of period 54,078 4,887
----------------- -----------------
Cash and cash equivalents at end of period $ 48,593 $ 20,905
================= =================
Supplemental disclosure of cash flow information:
Interest paid $ 3,777 $ 3,947
Supplemental disclosure for non-cash investing activities:
Capitalized interest 71 158
Supplemental disclosure of non-cash financing activities for debt recapitalization:
Net carrying value of Old Notes (264,888) -
Unamortized financing cost of Old Notes 3,755 -
Issuance of New Notes 159,035 -
Carrying value difference on New Notes (24,686) -
Common stock issued in exchange for Old Notes 126,784 -
See accompanying notes to the unaudited condensed
consolidated financial statements.
5
AIRGATE PCS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2004
(unaudited)
(1) Business, Basis of Presentation and Liquidity
(a) Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of
AirGate PCS, Inc. and subsidiaries (the "Company") are presented in accordance
with the rules and regulations of the Securities and Exchange Commission ("SEC")
and do not include all of the disclosures normally required by accounting
principles generally accepted in the United States of America. In the opinion of
management, these statements reflect all adjustments, including recurring
adjustments, which are necessary for a fair presentation of the condensed
consolidated financial statements for the interim periods. The condensed
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto contained in the Company's
Annual Report on Form 10-K/A, Amendment No. 2 to 10-K/A and in Form 8-K for
Discontinued Operations and to reflect the 1-for-5 reverse stock split
(collectively, the "Annual Report") for the fiscal year ended September 30,
2003, which are filed with the SEC and may be accessed via EDGAR on the SEC's
website at http://www.sec.gov. The results of operations for the quarter and six
months ended March 31, 2004 are not necessarily indicative of the results that
can be expected for the entire fiscal year ending September 30, 2004. Certain
prior year amounts have been reclassified to conform to the current year's
presentation. Management of the Company has made a number of estimates and
assumptions relating to the reporting of assets and liabilities and the
disclosure of contingent liabilities at the dates of the consolidated balance
sheets and revenues and expenses during the reporting periods to prepare these
condensed consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America. Actual results
could differ from those estimates. All significant intercompany accounts and
transactions have been eliminated in consolidation.
AirGate PCS, Inc. and its restricted subsidiaries were created for the purpose
of providing wireless Personal Communication Services ("PCS"). The Company is a
network partner of Sprint with the right to market and provide Sprint PCS
products and services using the Sprint brand name in a defined territory. The
accompanying condensed consolidated financial statements include the accounts of
AirGate PCS, Inc. and its wholly-owned restricted subsidiaries, AGW Leasing
Company, Inc., AirGate Service Company, Inc. and AirGate Network Services, LLC
for all periods presented.
On November 30, 2001, the Company acquired iPCS, Inc. and its subsidiaries
("iPCS") in a merger. The transaction was accounted for under the purchase
method of accounting. Although iPCS's growth rates initially met or exceeded
expectations, the slowdown in growth in the wireless industry, increased
competition, iPCS' dependence on Sprint and the reimposition and increase of the
deposit for sub-prime credit customers, all contributed to slower growth
subsequent to acquisition. In addition, iPCS' slow growth was compounded because
it was earlier in its life cycle when growth slowed, it had approximately
one-third fewer subscribers than the Company, and it had a less complete network
than the Company.
On February 23, 2003, iPCS filed a Chapter 11 bankruptcy petition in the United
States Bankruptcy Court for the Northern District of Georgia for the purpose of
effecting a court administered reorganization. Subsequent to February 23, 2003,
the Company no longer consolidated the accounts and results of operations of
iPCS, and the accounts of iPCS were recorded as an investment using the cost
method of accounting.
In connection with the issuance of common stock in the Company's
Recapitalization Plan (described below), the Company had an ownership change for
tax purposes. In order to avoid the ownership change of iPCS that would have
resulted from the Company's ownership change, on October 17, 2003, the Company
irrevocably transferred all of its shares of iPCS common stock to a trust for
the benefit of the Company's shareholders of record as of the date of transfer.
On October 17, 2003, the iPCS investment ($184.1 million credit balance carrying
amount) was eliminated and recorded as a non-monetary gain on disposition of
discontinuing operations. The Company's condensed consolidated financial
statements reflect the results of iPCS as discontinued operations.
(b) Liquidity, Financial Restructuring and Going Concern
The financial statements have been prepared on a going concern basis, which
contemplates the realization of assets and satisfaction of liabilities in the
normal course of business. The financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result should
the Company be unable to continue as a going concern. In connection with their
audit of the Company's fiscal 2003 consolidated financial statements, KPMG LLP
the Company's independent auditors, included an explanatory paragraph regarding
the Company's ability to continue as a going concern in their audit opinion.
The PCS market is characterized by significant risks as a result of rapid
changes in technology, intense competition and the costs associated with the
build-out, on-going operations and growth of a PCS network. The Company's
6
operations are dependent upon Sprint's ability to perform its obligations under
the agreements between the Company and Sprint (see Note 3) under which the
Company has agreed to construct and manage its Sprint PCS network (the "Sprint
Agreements"). The Company's ability to attract and maintain a subscriber base of
sufficient size and credit quality is critical to achieving sufficient positive
cash flow. Significant changes in technology, increased competition, or adverse
economic conditions could impair the Company's ability to achieve sufficient
positive cash flow.
As shown in the condensed consolidated financial statements, the Company has
generated significant losses from continuing operations since inception and has
an accumulated deficit of $1.1 billion and stockholders' deficit of $91.5
million at March 31, 2004. For the six months ended March 31, 2004, the
Company's loss from continuing operations amounted to $21.0 million. As of March
31, 2004, the Company had working capital of $3.8 million and cash and cash
equivalents of $48.6 million, and no remaining availability under its credit
facility. As a result, the Company is completely dependent on available cash and
operating cash flow to pay debt service and meet its other capital needs. If
such sources are not sufficient, alternative funding sources may not be
available.
In addition to its capital needs to fund operating losses, the Company has
invested large amounts to build-out its networks and for other capital assets.
Since inception, the Company has invested over $300 million to purchase property
and equipment.
A number of factors, including slower subscriber growth, increased competition
and churn and our dependence on Sprint and Sprint's changes to various programs
and fees have had an adverse affect on the Company's business and led the
Company to revise its business strategy and take actions to cut costs during
fiscal year 2003. These actions included the following:
o Restructuring the Company's organization and eliminating more than 150
positions;
o Reducing capital expenditures;
o Reducing spending for sales and marketing activities; and
o Reducing per minute network operating costs by more closely managing
connectivity costs.
Despite these measures and certain amendments to its credit facility, the
Company's compliance with the financial covenants under its credit facility was
not assured and the Company's ability to generate sufficient cash flow to meet
its financial covenants and payment obligations in 2005 and beyond was
substantially uncertain. In addition, there was substantial risk that the
Company would not have had sufficient liquidity to meet its cash interest
obligations under the Old Notes (defined below) in 2006. As a result, the
Company engaged in a financial restructuring (the "Recapitalization Plan") which
closed on February 13, 2004 and settled on February 20, 2004. See Note 10 to the
condensed consolidated financial statements. As a result, the Company believes
that it will be able to meet its liquidity needs for the next 12 months.
(2) Significant New Accounting Pronouncements
In May 2003, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 150, "Accounting for Certain
Financial Instruments with Characteristics of Liabilities and Equity," which
became effective at the beginning of the first interim period beginning after
June 15, 2003. However, certain aspects of SFAS 150 have been deferred. SFAS No.
150 establishes standards for the Company's classification of liabilities in the
financial statements that have characteristics of both liabilities and equity.
The implementation of SFAS 150 is not anticipated to have a significant impact
on our results of operations, financial position or cash flows.
In 2003, the FASB issued Interpretation No. 46R, "Consolidation of Variable
Interest Entities," an interpretation of Accounting Research Bulletin ("ARB")
No. 51. This interpretation addresses the consolidation by business enterprises
of variable interest entities as defined in the interpretation. This
interpretation applies immediately to variable interests entities created or
acquired after January 31, 2003 and to special purpose entities for the quarter
ended after December 15, 2003. The Interpretation is generally effective for
interim periods ending after March 15, 2004 for all variable interests entities
created or acquired prior to January 31, 2003. We do not have any variable
interest entity arrangements.
In November 2002, the Emerging Issues Task Force ("EITF") of the FASB reached a
consensus on EITF No. 00-21, "Accounting for Revenue Arrangements with Multiple
Element Deliverables." The EITF guidance addresses how to account for
arrangements that may involve multiple revenue-generating activities, i.e., the
delivery or performance of multiple products, services, and/or rights to use
assets. In applying this guidance, separate contracts with the same party,
entered into at or near the same time, will be presumed to be a package, and the
consideration will be measured and allocated to the separate units based on
their relative fair values. This consensus guidance is applicable to agreements
entered into for quarters beginning after June 15, 2003. The Company adopted
this EITF on July 1, 2003. The adoption of EITF 00-21 did not have a material
impact on our results of operations, financial position or cash flows.
(3) Sprint Agreements
Under the Sprint Agreements, Sprint is obligated to provide the Company
significant support services such as billing, collections, long distance,
customer care, network operations support, inventory logistics support, use of
Sprint brand names, national advertising, national distribution and product
development. Additionally, the Company derives substantial roaming revenue and
7
expenses when Sprint's and Sprint's network partners' wireless subscribers incur
minutes of use in the Company's territory and when the Company's subscribers
incur minutes of use in Sprint's and other Sprint network partners' PCS
territories. These transactions are recorded in roaming revenue, cost of service
and roaming, cost of equipment, and selling and marketing expense captions in
the accompanying condensed consolidated statements of operations. Cost of
service and roaming transactions include the 8% affiliation fee, long distance
charges, roaming expense and costs of services such as billing, collections,
customer service and pass-through expenses. Cost of equipment transactions
relate to inventory purchased by the Company from Sprint under the Sprint
Agreements. Selling and marketing transactions relate to subsidized costs on
handsets and commissions paid by the Company under Sprint's national
distribution programs. Amounts recorded relating to the Sprint Agreements for
the three months and six months ended March 31, 2004 and 2003 are as follows:
Three Months Ended Six Months Ended
March 31, March 31,
---------------------------------- ----------------------------------
2004 2003 2004 2003
---------------- ---------------- ---------------- ----------------
(Dollars in thousands)
Amounts included in the Condensed Consolidated
Statements of Operations:
Roaming revenue $ 12,905 $ 13,032 $ 28,652 $ 30,993
Cost of service and roaming:
Roaming $ 10,500 $ 10,861 $ 23,774 $ 25,713
Customer service 8,465 11,150 13,348 22,686
Affiliation fee 4,685 4,708 9,384 9,545
Long distance 3,407 3,259 6,675 6,044
Other 694 514 1,282 990
---------------- ---------------- ---------------- ----------------
Total cost of service and roaming $ 27,751 $ 30,492 $ 54,463 $ 64,978
================ ================ ================ ================
Purchased inventory $ 8,087 $ 2,695 $ 15,415 $ 8,345
================ ================ ================ ================
Selling and marketing $ 2,629 $ 2,716 $ 6,923 $ 6,112
================ ================ ================ ================
As of
----------------------------------
March 31, September 30,
2004 2003
---------------- ----------------
(Dollars in thousands)
Receivable from Sprint $ 11,957 $ 15,809
Payable to Sprint $ 48,761 $ 45,069
Because approximately 96% of our revenue is collected by Sprint and 66% of cost
of service and roaming in our financial statements for the six months ended
March 31, 2004, are derived from fees and charges by (or through) Sprint, we
have a variety of settlement issues and other contract disputes open and
outstanding from time to time. Currently, this includes, but is not limited to,
the following items, all of which, for accounting purposes, have been reserved
or otherwise provided for:
o In fiscal year 2002, Sprint PCS asserted it has the right to recoup up to
$3.9 million in long-distance access revenues previously paid by Sprint
PCS to AirGate, for which Sprint PCS has invoiced $1.2 million. We have
disputed these amounts.
o Sprint invoiced the Company and we have accrued approximately $0.4 million
for fiscal year 2002 and $1.0 million for fiscal year 2003, respectively
to reimburse Sprint for certain 3G related development expenses. For the
six months ended March 31, 2004, Sprint invoiced the Company and we have
accrued approximately $1.4 million. We are disputing Sprint's right to
charge 3G fees in 2002 and beyond.
o Sprint invoiced the Company and we have accrued for software maintenance
fees of approximately $1.7 million and $1.3 million for each of the fiscal
years 2002 and 2003, respectively. For the six months ended March 31,
2004, Sprint invoiced the Company and we have accrued approximately $1.0
million. We are disputing Sprint's right to charge software maintenance
fees.
o Sprint invoiced the Company and we have accrued $1.2 million for fiscal
year 2003 and $2.5 million for the six months ended March 31, 2004 for the
cost of IT projects completed by Sprint. We are disputing Sprint's right
to collect these fees.
8
The payable to Sprint includes disputed amounts (including, but not limited to
amounts disclosed above) for which Sprint has invoiced the Company of
approximately $12.4 million. The invoiced amount does not include $2.7 million
which has accrued for long-distance access revenues claimed but not invoiced by
Sprint, or other fees not yet invoiced relating to disputed 3G, software
maintenance and information technology that Sprint would assert have accrued.
We intend to vigorously contest these charges and to closely examine all fees
and charges imposed by Sprint. In addition to these disputes, we have other
outstanding issues with Sprint which could result in set-offs to the items
described above or in payments due from Sprint. For example, we believe Sprint
has failed to calculate, pay and report on collected revenues in accordance with
our Sprint Agreements which, together with other cash remittance issues, has
resulted in a shortfall in cash payments to the Company. Sprint also has
unilaterally reduced the reciprocal roaming rate charged among Sprint and its
network partners, in a manner which we believe is a breach of our Sprint
agreements.
During the six months ended March 31, 2004, the Company recorded $2.4 million in
credits from Sprint as a reduction of cost of service, consisting of a $1.2
million credit resulting from Sprint's decision to discontinue their billing
system conversion and a special cash settlement of the bad debt profile for
certain subscribers, which resulted in a credit of $1.2 million. Sprint had
previously billed and passed on to us their development costs related to the
billing system conversion as part of the IT service bureau fee we were charged.
This credit positively affects the six months ended March 31, 2004 results;
however, it is a non-cash item that was previously disputed and not paid. The
settlement for the bad debt profile for certain subscribers represents a special
settlement resulting from the improvement in actual bad debt experience as
compared to the estimated bad debt expense (bad debt profile) for the periods
April 2000 through December 2003.
Sprint estimates monthly service charges at the beginning of each calendar year.
At the end of each year, Sprint calculates the actual costs to provide these
services for its network partners and requires a final settlement for the
calendar year against the charges actually paid. If the costs to provide these
services are less than the amounts paid by Sprint's network partners, Sprint
issues a credit for these amounts. If the costs to provide the services are more
than the amounts paid by Sprint's network partners, Sprint charges the network
partners for these amounts. During the quarters ended December 31, 2003 and 2002
the Company received a credit from Sprint for $2.6 million and $1.3 million
related to the calendar years 2003 and 2002, respectively, which were recorded
as a reduction to cost of service. The calendar year 2003 service bureau fee
credit included $0.9 million in previously disputed unpaid amounts; therefore
$1.7 million of cash proceeds from Sprint were accrued during the quarter ended
December 31, 2003 and received during the quarter ended March 31, 2004.
The Sprint Agreements require the Company to maintain certain minimum network
performance standards and to meet other performance requirements. The Company
was in compliance in all material respects with these requirements as of March
31, 2004.
(4) Litigation
In May 2002, putative class action complaints were filed in the United States
District Court for the Northern District of Georgia against AirGate PCS, Inc.,
Thomas M. Dougherty, Barbara L. Blackford, Alan B. Catherall, Credit Suisse
First Boston, Lehman Brothers, UBS Warburg LLC, William Blair & Company, Thomas
Wiesel Partners LLC and TD Securities. The complaints do not specify an amount
or range of damages that the plaintiffs are seeking. The complaints seek class
certification and allege that the prospectus used in connection with the
secondary offering of the Company's common stock by certain former iPCS
shareholders on December 18, 2001 contained materially false and misleading
statements and omitted material information necessary to make the statements in
the prospectus not false and misleading. The alleged omissions included (i)
failure to disclose that in order to complete an effective integration of iPCS,
drastic changes would have to be made to the Company's distribution channels,
(ii) failure to disclose that the sales force in the acquired iPCS markets would
require extensive restructuring and (iii) failure to disclose that the "churn"
or "turnover" rate for subscribers would increase as a result of an increase in
the amount of sub-prime credit quality subscribers the Company added from its
merger with iPCS. On July 15, 2002, certain plaintiffs and their counsel filed a
motion seeking appointment as lead plaintiffs and lead counsel. Subsequently,
the court denied this motion without prejudice, and two of the plaintiffs and
their counsel filed a renewed motion seeking appointment as lead plaintiffs and
lead counsel. On September 12, 2003, the court again denied the motion without
prejudice and on December 2, 2003, certain plaintiffs and their counsel filed a
modified renewed motion.
On December 11, 2003, Stuart Tinney, an AirGate shareholder, filed suit in the
U.S. District Court for the District of Delaware against Genesco Communications,
Inc., Cambridge Telecom, Inc., The Blackstone Group, Trust Company of the West,
Cass Communications Management, Inc., Technology Group, LLC, Montrose Mutual
PCS, Inc., Gridley Enterprises, Inc., Timothy M. Yager, Peter G. Peterson and
Stephen A. Schwarzman (collectively, the "Defendants"). The lawsuit alleges that
the Defendants, as either officers, directors or 10% shareholders of the
Company, purchased and sold the Company's securities within a six-month period
ended December 15, 2001 and profited from these transactions in violation of
Section 16(b) of the Exchange Act. The lawsuit seeks disgorgement of these
"short swing" profits and payment of the profits to the Company, which is named
as a nominal defendant in the lawsuit for its failure to directly take action
against the Defendants.
While there is no pending litigation with Sprint, we have a variety of disputes
with Sprint, which are described in Note 3.
9
We are also subject to a variety of other claims and suits that arise from time
to time in the ordinary course of business.
While management currently believes that resolving all of these matters,
individually or in the aggregate, will not have a material adverse impact on our
liquidity, financial condition or results of operations, the litigation and
other claims noted above are subject to inherent uncertainties and management's
view may change in the future. If an unfavorable outcome were to occur, there
exists the possibility of a material adverse impact on our liquidity, financial
condition and results of operations for the period in which the effect becomes
reasonably estimable.
(5) Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred
income tax assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and operating
loss and tax credit carry forwards. Deferred income tax assets and liabilities
are measured using enacted tax rates applied to expected taxable income for the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred income tax assets and liabilities for a change
in tax rates is recognized as income in the period that includes the enactment
date. A valuation allowance is provided for deferred income tax assets based
upon the Company's assessment of whether it is more likely than not that the
deferred income tax assets will be realized. No such amounts were realized in
the quarters and six months ended March 31, 2004 and 2003, nor will amounts be
realized in the future unless management believes the recoverability of deferred
tax assets is more likely than not. The non-monetary gain on the disposition of
discontinued operations recorded during the quarter ended December 31, 2003 did
not impact the Company's net operating loss carryforwards as the disposition
resulted in a non-deductible loss for tax purposes. As a result of the Company's
restructuring, the Company's existing net operating losses ("NOLs") will be
subject to annual limitations as required by Section 382 of the Internal Revenue
Code of 1986, as amended. The Company estimates that it had NOLs of
approximately $290 million through the date of restructuring. The Company
estimates that the annual limitation associated with these NOLs is approximately
$4.5 million. Thus, should the Company generate taxable income in excess of the
annual limit, it would be exposed to a liability for current income taxes.
(6) Discontinued Operations
On October 17, 2003, the Company irrevocably transferred all of its shares of
iPCS common stock to a trust for the benefit of the Company's shareholders of
record on the date of the transfer. On that date, the iPCS investment ($184.1
million credit balance carrying amount) was eliminated and recorded as a gain on
disposal of discontinued operations. The results for iPCS for all periods
presented are shown as discontinued operations. Subsequent to February 23, 2003,
the Company accounted for iPCS under the cost method. Therefore, excluding the
gain on disposal of $184.1 million recorded October 17, 2003, there were no
losses from discontinued operations for the quarter and six months ended March
31, 2004. The following reflects the loss from discontinued operations of iPCS
for the quarter and six months ended March 31, 2003 (dollars in thousands):
For the Quarter For the Six Months
Ended Ended
March 31, March 31,
------------------ -----------------
2003 2003
------------------ -----------------
Revenue $ 27,829 $ 79,364
Cost of revenue 21,197 63,200
Selling and marketing 4,312 16,418
General and administrative 3,550 6,881
Depreciation and amortization 7,718 20,989
------------------ -----------------
Operating expense 36,777 107,488
------------------ -----------------
Operating loss (8,948) (28,124)
Interest expense, net (5,376) (14,447)
------------------ -----------------
Loss from discontinued operations $ (14,324) $ (42,571)
================== =================
(7) Condensed Consolidating Financial Statements
AGW Leasing Company, Inc. ("AGW") is a wholly-owned restricted subsidiary of
AirGate. AGW has fully and unconditionally guaranteed the New Notes (see Note
10), Old Notes and the credit facility. AGW was formed to hold the real estate
interests for the Company's PCS network and retail operations. AGW also was a
registrant under the Company's registration statement declared effective by the
SEC on September 27, 1999.
10
AirGate Network Services LLC ("ANS") is a wholly-owned restricted subsidiary of
the Company. ANS has fully and unconditionally guaranteed the New Notes, Old
Notes and the credit facility. ANS was formed to provide construction management
services for the Company's PCS network.
AirGate Service Company, Inc. ("Service Co") is a wholly-owned restricted
subsidiary of the Company. Service Co has fully and unconditionally guaranteed
the New Notes, Old Notes and the credit facility. Service Co was formed to
provide management services to the Company and iPCS.
The following shows the unaudited condensed consolidating financial statements
for the Company and its guarantor subsidiaries, as listed above, as of March 31,
2004 and September 30, 2003 and for the three months and six months ended March
31, 2004 and 2003 (dollars in thousands):
Unaudited Condensed Consolidating Balance Sheets
As of March 31, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
------------------- ------------------- ------------------- -------------------
Cash and cash equivalents $ 48,605 $ (12) $ - $ 48,593
Other current assets 106,935 529 (61,546) 45,918
------------------- ------------------- ------------------- -------------------
Total current assets 155,540 517 (61,546) 94,511
Property and equipment, net 129,449 32,323 - 161,772
Other noncurrent assets 6,861 - - 6,861
------------------- ------------------- ------------------- -------------------
Total assets $ 291,850 $ 32,840 $ (61,546) $ 263,144
=================== =================== =================== ===================
Current liabilities $ 91,016 $ 61,242 $ (61,546) $ 90,712
Intercompany (118,644) 118,644 - -
Long-term debt 257,237 - - 257,237
Other long-term liabilities 6,733 - - 6,733
Investment in subsidiaries 147,046 - (147,046) -
------------------- ------------------- ------------------- -------------------
Total liabilities 383,388 179,886 (208,592) 354,682
------------------- ------------------- ------------------- -------------------
Stockholders' deficit (91,538) (147,046) 147,046 (91,538)
------------------- ------------------- ------------------- -------------------
Total liabilities and
stockholders' deficit $ 291,850 $ 32,840 $ (61,546) $ 263,144
=================== =================== =================== ===================
Unaudited Condensed Consolidating Balance Sheets
As of September 30, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
------------------- ------------------- ------------------- -------------------
Cash and cash equivalents $ 54,078 $ - $ - $ 54,078
Other current assets 108,136 529 (61,478) 47,187
------------------- ------------------- ------------------- -------------------
Total current assets 162,214 529 (61,478) 101,265
Property and equipment, net 141,129 36,941 - 178,070
Other noncurrent assets 11,581 - - 11,581
------------------- ------------------- ------------------- -------------------
Total assets $ 314,924 $ 37,470 $ (61,478) $ 290,916
=================== =================== =================== ===================
Current liabilities $ 89,036 $ 61,189 $ (61,478) $ 88,747
Intercompany (108,890) 108,890 - -
Long-term debt 386,509 - - 386,509
Other long-term liabilities 8,542 - - 8,542
Investment in subsidiaries 316,724 - (132,609) 184,115
Total liabilities 691,921 170,079 (194,087) 667,913
------------------- ------------------- ------------------- -------------------
Stockholders deficit (376,997) (132,609) 132,609 (376,997)
------------------- ------------------- ------------------- -------------------
Total liabilities and
stockholders' deficit $ 314,924 $ 37,470 $ (61,478) $ 290,916
=================== =================== =================== ===================
11
Unaudited Condensed Consolidating Statement of Operations
For the Quarter Ended March 31, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ---------------- ----------------- -----------------
Revenue $ 78,036 $ - $ - $ 78,036
Cost of revenue 42,426 4,198 - 46,624
Selling and marketing 11,347 569 - 11,916
General and administrative 6,180 157 - 6,337
Depreciation and amortization of property
and equipment 9,508 2,384 - 11,892
Gain on disposal of property and equipment (3) - - (3)
----------------- ---------------- ----------------- -----------------
Total operating expense 69,458 7,308 - 76,766
----------------- ---------------- ----------------- -----------------
Operating income (loss) 8,578 (7,308) - 1,270
Loss in subsidiaries (7,267) - 7,267 -
Interest income 165 - - 165
Interest expense (11,352) 41 - (11,311)
----------------- ---------------- ----------------- -----------------
Loss from continuing operations before
income tax (9,876) (7,267) 7,267 (9,876)
Income tax - - - -
----------------- ---------------- ----------------- -----------------
Loss from continuing operations (9,876) (7,267) 7,267 (9,876)
Income from discontinued operations - - - -
----------------- ---------------- ----------------- -----------------
Net loss $ (9,876) $ (7,267) $ 7,267 $ (9,876)
================= ================ ================= =================
Unaudited Condensed Consolidating Statement of Operations
For the Quarter Ended March 31, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ---------------- ----------------- -----------------
Revenue $ 76,749 $ - $ - $ 76,749
Cost of revenue 39,598 4,604 - 44,202
Selling and marketing 10,195 1,189 - 11,384
General and administrative 5,335 509 - 5,844
Depreciation and amortization of property
and equipment 9,272 2,353 - 11,625
Loss on disposal of property and equipment 220 - - 220
----------------- ---------------- ----------------- -----------------
Total operating expense 64,620 8,655 - 73,275
----------------- ---------------- ----------------- -----------------
Operating income (loss) 12,129 (8,655) - 3,474
Loss in subsidiaries (8,616) - 8,616 -
Interest income (14) 39 - 25
Interest expense (10,197) - - (10,197)
----------------- ---------------- ----------------- -----------------
Loss from continuing operations before
income tax (6,698) (8,616) 8,616 (6,698)
Income tax - - - -
----------------- ---------------- ----------------- -----------------
Loss from continuing operations (6,698) (8,616) 8,616 (6,698)
Loss from discontinued operations (14,324) - - (14,324)
----------------- ---------------- ----------------- -----------------
Net loss $ (21,022) $ (8,616) $ 8,616 $ (21,022)
================= ================ ================= =================
12
Unaudited Condensed Consolidating Statement of Operations
For the Six Months Ended March 31, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ---------------- ----------------- -----------------
Revenue $ 159,539 $ - $ - $ 159,539
Cost of revenue 87,300 8,399 - 95,699
Selling and marketing 24,984 1,079 - 26,063
General and administrative 12,527 277 - 12,804
Depreciation and amortization of property
and equipment 18,906 4,753 - 23,659
Gain on disposal of property and equipment (5) - - (5)
----------------- ---------------- ----------------- -----------------
Total operating expense 143,712 14,508 - 158,220
----------------- ---------------- ----------------- -----------------
Operating income (loss) 15,827 (14,508) - 1,319
Loss in subsidiaries (14,437) - 14,437 -
Interest income 322 - - 322
Interest expense (22,698) 71 - (22,627)
----------------- ---------------- ----------------- -----------------
Loss from continuing operations before
income tax (20,986) (14,437) 14,437 (20,986)
Income tax - - - -
----------------- ---------------- ----------------- -----------------
Loss from continuing operations (20,986) (14,437) 14,437 (20,986)
Income from discontinued operations 184,115 - - 184,115
----------------- ---------------- ----------------- -----------------
Net income (loss) $ 163,129 $ (14,437) $ 14,437 $ 163,129
================= ================ ================= =================
Unaudited Condensed Consolidating Statement of Operations
For the Six Months Ended March 31, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ---------------- ----------------- -----------------
Revenue $ 158,614 $ - $ - $ 158,614
Cost of revenue 93,535 8,937 - 102,472
Selling and marketing 26,256 1,947 - 28,203
General and administrative 8,797 1,239 - 10,036
Depreciation and amortization of property
and equipment 18,448 4,796 - 23,244
Loss on disposal of property and equipment 418 - - 418
----------------- ---------------- ----------------- -----------------
Total operating expense 147,454 16,919 - 164,373
----------------- ---------------- ----------------- -----------------
Operating income (loss) 11,160 (16,919) - (5,759)
Loss in subsidiaries (16,766) - 16,766 -
Interest income (128) 153 - 25
Interest expense (20,391) - - (20,391)
----------------- ---------------- ----------------- -----------------
Loss from continuing operations
before income tax (26,125) (16,766) 16,766 (26,125)
Income tax - - - -
----------------- ---------------- ----------------- -----------------
Loss from continuing operations (26,125) (16,766) 16,766 (26,125)
Loss from discontinued operations (42,571) - - (42,571)
----------------- ---------------- ----------------- -----------------
Net loss $ (68,696) $ (16,766) $ 16,766 $ (68,696)
================= ================ ================= =================
13
Unaudited Condensed Consolidating Statement of Cash Flows
For the Six Months Ended March 31, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
-------------------- ------------------- -------------------- -------------------
Operating activities, net $ 21,151 $ 123 $ - $ 21,274
Investing activities, net (7,226) (135) - (7,361)
Financing activities, net (19,398) - - (19,398)
-------------------- ------------------- -------------------- -------------------
Change in cash and cash equivalents (5,473) (12) - (5,485)
Cash and cash equivalents at
beginning of period 54,078 - - 54,078
-------------------- ------------------- -------------------- -------------------
Cash and cash equivalents at end of period $ 48,605 $ (12) $ - $ 48,593
==================== =================== ==================== ===================
Unaudited Condensed Consolidating Statement of Cash Flows
For the Six Months Ended March 31, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
-------------------- ------------------- -------------------- -------------------
Operating activities, net $ 15,101 $ 526 $ - $ 15,627
Investing activities, net (6,000) (654) - (6,654)
Financing activities, net 7,045 - - 7,045
-------------------- ------------------- -------------------- -------------------
Change in cash and cash equivalents 16,146 (128) - 16,018
Cash and cash equivalents at
beginning of period 4,769 118 - 4,887
-------------------- ------------------- -------------------- -------------------
Cash and cash equivalents at end of period $ 20,915 $ (10) $ - $ 20,905
==================== =================== ==================== ===================
(8) Basic and Diluted Earnings (Loss) Per Share
Basic earnings (loss) per share is computed by dividing net income (loss) by the
weighted-average number of common shares outstanding during the period. Common
stock equivalent securities of 24,106, 11,465, 24,133, and 9,191 for the
quarters and six months ended March 31, 2004 and 2003 respectively, have been
excluded from the computation of dilutive earnings (loss) per share for the
periods because the Company has a loss from continuing operations and their
effect would have been antidilutive. All share and per share amounts have been
restated to give retroactive effect to the 1-for-5 reverse stock split.
(9) Stock-based Compensation Plans
We have elected to continue to account for our stock-based compensation plans
under APB Opinion No. 25, "Accounting for Stock Issued to Employees", and
disclose pro forma effects of the plans on a net income (loss) and earnings
(loss) per share basis as provided by SFAS No. 123, "Accounting for Stock-Based
Compensation." Consistent with the provisions of SFAS No. 123, had compensation
expense for these plans been determined based on the fair value at the grant
date during the three months and six months ended March 31, 2004 and 2003, the
pro forma net income (loss) and earnings (loss) per share would have been as
follows:
14
Three Months Ended Six Months Ended
March 31, March 31,
----------------------------------- -----------------------------------
2004 2003 2004 2003
---------------- ----------------- ---------------- -----------------
(Dollars in thousands, except per share data)
Net income (loss), as reported $ (9,876) $ (21,022) $ 163,129 $ (68,696)
Add: stock based compensation expense included in
determination of net income (loss) 197 177 302 353
Less: stock based compensation expense determined
under the fair value based method (1,398) (2,426) (2,797) (4,852)
---------------- ----------------- ---------------- -----------------
Pro forma, net income (loss) $ (11,077) $ (23,271) $ 160,634 $ (73,195)
================ ================= ================ =================
Basic and diluted earnings (loss) per share:
As reported $ (1.21) $ (4.05) $ 24.48 $ (13.27)
Pro forma $ (1.36) $ (4.49) $ 24.10 $ (14.14)
(10) Recapitalization Plan
The Recapitalization Plan included the following public and private exchange
offers and consent solicitations:
o The Company offered to exchange all of the outstanding 13.5% senior
subordinated discount notes due 2009 (the "Old Notes") for (i) newly issued
shares of common stock representing 56% of the shares of common stock to be
issued and outstanding immediately after the Recapitalization Plan and (ii)
$160.0 million aggregate principal amount of newly issued 9 3/8% senior
subordinated notes due 2009 (the "New Notes");
o The consent solicitations requested the consents of holders of the Old
Notes to remove substantially all of the restrictive covenants in the
indenture governing the Old Notes, release collateral that secured the
Company's obligations thereunder and waive any defaults or events of
default that occur in connection with the restructuring;
o The Company also solicited acceptances from holders of the Old Notes of a
prepackaged plan of reorganization under Chapter 11 of the United States
Bankruptcy Code (the "Prepackaged Plan"). The Prepackaged Plan would have
effected the same transactions as the Recapitalization Plan, only under the
governance of a bankruptcy court.
In addition, the Company held a Special Meeting of Shareholders ("Special
Meeting") on February 12, 2004 at which its shareholders:
o Approved the issuance in the restructuring of an additional 56% of the
Company's common stock immediately after the restructuring;
o Approved the amendment and restatement of the Company's certificate of
incorporation to implement a 1-for-5 reverse stock split; and
o Approved the amendment and restatement of the 2002 AirGate PCS, Inc. Long
Term Incentive Plan to increase the number of shares available and reserved
for issuance thereunder, and to make certain other changes, and approved
the grant of certain performance-vested restricted stock units and stock
options to certain executives of the Company.
On the same date, the exchange offers expired, and the Company accepted
$298,205,000 of Old Notes (or 99.4% of the Old Notes outstanding) that were
validly tendered and not withdrawn in the exchange offers. Under the offers,
each holder of the Company's Old Notes received, for each $1,000 of aggregate
principal amount due at maturity tendered, 22.0277 shares of the Company's post
reverse stock split common stock, $533.33 in principal amount of the Company's
New Notes and cash resulting from the elimination of any fractional shares and
fractional notes.
On February 13, 2004, the Company effected the 1-for-5 reverse stock split and
shareholders received one share of common stock, and cash resulting from the
elimination of any fractional shares, in exchange for each five shares of common
stock then outstanding. Unless otherwise indicated, all share and per share
amounts have been restated to give retroactive effect to this 1-for-5 reverse
stock split.
On February 17, 2004, our stock began trading on a post split basis. We settled
the exchange offers on February 20, 2004.
Debt Restructuring
The following summarizes the accounting related to certain key provisions of the
Recapitalization Plan as it relates to the condensed consolidated financial
statements as of and for the six months ended March 31, 2004.
The Old Notes with a net carrying value of $264.8 million and related
unamortized financing costs of $3.8 million as of February 13, 2004 were
exchanged for New Notes with a principal balance of $159.0 million and 6,568,706
15
shares of common stock as adjusted for the 1-for-5 reverse stock split, valued
at $126.8 million as of February 13, 2004, based upon a closing common stock
market price of $19.30 on that date.
The financial restructuring was accounted for as a troubled debt restructuring
in accordance with Statement of Financial Accounting Standards No. 15
"Accounting by Debtors and Creditors for Troubled Debt Restructurings" and EITF
02-4, "Determining Whether a Debtors Modification or Exchange of Debt is within
the scope of FASB statement No. 15." Based on the terms of the Recapitalization
Plan, no gain on the transaction was recognized since total future cash
payments, including interest, exceeded the remaining carrying amount of the Old
Notes after reducing the Old Notes by the fair value of the common stock. The
difference of approximately $24.7 million between the principal value of the New
Notes and the carrying value of the Old Notes will be amortized as interest
expense over the term of the New Notes under the interest method. The New Notes
have a stated rate of 9.375% with interest due July and January of each year,
beginning July 1, 2004. As of March 31, 2004, the carrying value of the New
Notes was approximately $135.1 million, with an effective interest rate of
approximately 13.3%.
Transaction costs of $3.0 million and $3.1 million were incurred during the year
ended September 30, 2003 and during the six months ended March 31, 2004,
respectively, to raise capital related to the debt and were expensed as
incurred. Transaction costs of $4.8 million, incurred to raise capital, related
to the equity were recorded as an offset to additional paid in capital.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") contains "forward-looking statements." These forward-looking
statements are based on current expectations, estimates, forecasts and
projections about us, our future performance, our liquidity, the wireless
industry, our beliefs and management's assumptions. In addition, other written
and oral statements that constitute forward-looking statements may be made by us
or on our behalf. Such forward-looking statements include statements regarding
expected financial results and other planned events, including but not limited
to, anticipated liquidity, churn rates, ARPU and CPGA (all as defined below in
"Non-GAAP Financial Measures and Key Operating Metrics"), roaming rates, EBITDA
(as defined below in "Non-GAAP Financial Measures and Key Operating Metrics"),
and capital expenditures. Words such as "anticipate," "assume," "believe,"
"estimate," "expect," "intend," "plan," "seek," "project," "target," "goal,"
variations of such words and similar expressions are intended to identify such
forward-looking statements. These statements are not guarantees of future
performance and involve certain risks, uncertainties and assumptions that are
difficult to predict. Therefore, actual future events or results may differ
materially from these statements. These risks and uncertainties include:
o our dependence on the success of Sprint's wireless business;
o the competitiveness and impact of Sprint's pricing plans and PCS
products and services and introduction of pricing plans and programs
that may adversely affect our business;
o intense competition in the wireless market and the unsettled nature of
the wireless market;
o the potential to experience a continued high rate of subscriber
turnover;
o the ability of Sprint (directly or through third parties) to provide
back office billing, subscriber care and other services and the
quality and costs of such services or, alternatively, our ability to
outsource all or a portion of these services at acceptable costs and
the quality of such services;
o subscriber credit quality;
o the ability to successfully leverage 3G products and services;
o inaccuracies in financial information provided by Sprint;
o new charges and fees, or increased charges and fees, imposed by
Sprint;
o the impact and outcome of disputes with Sprint;
o our ability to predict future customer growth, as well as other key
operating metrics;
o the impact of spending cuts on network quality, customer retention and
customer growth;
o rates of penetration in the wireless industry;
o our significant level of indebtedness and debt covenant requirements;
o the impact and outcome of legal proceedings between other Sprint
network partners and Sprint;
o the potential need for additional sources of capital and liquidity;
o risks related to our ability to compete with larger, more established
businesses;
o anticipated future losses;
o rapid technological and market change;
o an adequate supply of subscriber equipment;
o declines in growth of wireless subscribers;
16
o the effect of wireless local number portability; and
o the volatility of the market price of our common stock.
These forward-looking statements involve a number of risks and uncertainties
that could cause actual results to differ materially from those suggested by the
forward-looking statements. Forward-looking statements should, therefore, be
considered in light of various important factors, including those set forth in
the Company's Annual Report for the fiscal year ended September 30, 2003 and
elsewhere in this report. Moreover, we caution you not to place undue reliance
on these forward-looking statements, which speak only as of the date they were
made. Except as required under Federal Securities laws and the rule and
regulations of the SEC, we do not undertake any obligation to publicly release
any revisions to these forward-looking statements to reflect events or
circumstances after the date of this report or to reflect the occurrence of
unanticipated events. All subsequent forward-looking statements attributable to
us or any person acting on our behalf are expressly qualified in their entirety
by the cautionary statements contained in or referred to in this report.
For a further listing and description of such risks and uncertainties, see the
Company's Annual Report for the fiscal year ended September 30, 2003 and other
reports filed by us with the SEC.
You should read this discussion in conjunction with our consolidated financial
statements and accompanying notes contained in our Annual Report for the year
ended September 30, 2003.
Overview
AirGate PCS, Inc. and its subsidiaries and predecessors were formed for the
purpose of becoming a leading regional provider of wireless Personal
Communication Services, or "PCS." We are a network partner of Sprint PCS, which
is a group of wholly-owned subsidiaries of Sprint Corporation (a diversified
telecommunications service provider), that operate and manage Sprint's PCS
products and services.
Sprint operates a 100% digital PCS wireless network in the United States and
holds the licenses to provide PCS nationwide using a single frequency band and a
single technology. Sprint, directly and indirectly through network partners such
as us, provides wireless services in more than 4,000 cities and communities
across the country. Sprint directly operates its PCS network in major
metropolitan markets throughout the United States. Sprint has also entered into
independent agreements with various network partners, such as us, under which
the network partners have agreed to construct and manage PCS networks in smaller
metropolitan areas and along major highways.
As of March 31, 2004, the Company had 367,807 subscribers and total network
coverage of approximately 6.1 million residents, representing approximately 82%
of the residents in its territory.
iPCS, Inc.
On November 30, 2001, we acquired iPCS in a merger. In light of consolidation in
the wireless communications industry in general and among Sprint PCS network
partners in particular, we believed that the merger represented a strategic
opportunity to significantly expand the size and scope of our operations, attain
access to attractive markets, and provide greater operational efficiencies and
growth potential than we would have had on our own. The transaction was
accounted for under the purchase method of accounting.
Although iPCS's growth rates initially met or exceeded expectations, the
slowdown in growth in the wireless industry, increased competition, iPCS'
dependence on Sprint and the reimposition and increase of the deposit for
sub-prime credit customers, all contributed to slower growth subsequent to
acquisition. In addition, iPCS' slow growth was compounded because it was
earlier in its life cycle when growth slowed, it had approximately one-third
fewer subscribers than the Company, and it had a less complete network than the
Company.
On February 23, 2003, iPCS filed a Chapter 11 bankruptcy petition in the United
States Bankruptcy Court for the Northern District of Georgia for the purpose of
effecting a court administered reorganization. Subsequent to February 23, 2003,
the Company no longer consolidated the accounts and results of operations of
iPCS, and the accounts of iPCS were recorded as an investment using the cost
method of accounting.
In connection with the issuance of common stock in the Company's
Recapitalization Plan (as described in Note 10 to our Condensed Consolidated
Financial Statements), the Company had an ownership change for tax purposes.
Such ownership change would also have caused an ownership change of iPCS, which
could have had a detrimental effect on the use of certain net operating losses
of iPCS. In order to avoid the ownership change of iPCS that would have resulted
from the Company's ownership change, on October 17, 2003, the Company
irrevocably transferred all of its shares of iPCS common stock to a trust for
the benefit of the Company's shareholders of record as of the date of transfer.
On October 17, 2003, the iPCS investment ($184.1 million credit balance carrying
amount) was eliminated and recorded as a non-monetary gain on disposition of
discontinuing operations. The results for iPCS for all periods presented are
shown as discontinued operations. The results for AirGate only are shown as
continuing operations.
The following description of the Company's business is limited to AirGate alone,
and does not reflect the business of iPCS.
17
Critical Accounting Policies
The Company relies on the use of estimates and makes assumptions that impact its
financial condition and results. These estimates and assumptions are based on
historical results and trends as well as the Company's forecasts as to how these
might change in the future. While we believe that the estimates we use are
reasonable, actual results could differ from those estimates. The Company's most
critical accounting policies that may materially impact the Company's results of
operations include:
Revenue Recognition
The Company recognizes revenue when persuasive evidence of an arrangement
exists, services have been rendered or products have been delivered, the price
to the buyer is fixed and determinable, and collectibility is reasonably
assured. Effective July 1, 2003 the Company adopted EITF No. 00-21, "Accounting
for Revenue Arrangements with Multiple Element Deliverables." The EITF guidance
addresses how to account for arrangements that may involve multiple
revenue-generating activities, i.e., the delivery or performance of multiple
products, services, and/or rights to use assets. In applying this guidance,
separate contracts with the same party, entered into at or near the same time,
will be presumed to be a bundled transaction, and the consideration will be
measured and allocated to the separate units based on their relative fair
values. The consensus guidance is applicable to agreements entered into for
quarters beginning after June 15, 2003. The adoption of EITF 00-21 has resulted
in substantially all of the activation fee revenue generated from Company-owned
retail stores and associated costs being recognized at the time the related
wireless handset is sold. Upon adoption of EITF 00-21, previously deferred
revenues and costs will continue to be amortized over the remaining estimated
life of a subscriber, not to exceed 30 months. Revenue and costs for activations
at other retail locations will continue to be deferred and amortized over their
estimated lives.
The Company recognizes service revenue from its subscribers as they use the
service. The Company provides a reduction of recorded revenue for billing
adjustments and credits, and estimated uncollectible late payment fees and early
cancellation fees. The Company also reduces recorded revenue for rebates and
discounts given to subscribers on wireless handset sales in accordance with EITF
No. 01-9 "Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor's Products)." For industry competitive
reasons, the Company sells wireless handsets at a loss. The Company participates
in the Sprint national and regional distribution programs in which national
retailers such as Radio Shack and Best Buy sell Sprint PCS products and
services. In order to facilitate the sale of Sprint PCS products and services,
national retailers purchase wireless handsets from Sprint for resale and receive
compensation from Sprint for Sprint PCS products and services sold. For industry
competitive reasons, Sprint subsidizes the price of these handsets by selling
the handsets at a price below cost. Under the Company's Sprint Agreements, when
a national retailer sells a handset purchased from Sprint to a subscriber in the
Company's territory, the Company is obligated to reimburse Sprint for the
handset subsidy. The Company does not receive any revenue from the sale of
handsets and accessories by such national retailers. The Company classifies
these handset subsidy charges as a selling and marketing expense for a new
subscriber handset sale and classifies these subsidies as a cost of service and
roaming for a handset upgrade to an existing subscriber.
The Company records equipment revenue from the sale of handsets to subscribers
in its retail stores upon delivery in accordance with EITF 00-21. The Company
does not record equipment revenue on handsets and accessories purchased from
national third-party retailers such as Radio Shack and Best Buy or directly from
Sprint by subscribers in its territory.
Sprint is entitled to retain 8% of collected service revenue from subscribers
based in the Company's markets and from non-Sprint subscribers who roam onto the
Company's network. The amount of affiliation fees retained by Sprint is recorded
as cost of service and roaming. Revenue derived from the sale of handsets and
accessories by the Company and from certain roaming services are not subject to
the 8% affiliation fee from Sprint.
Allowance for Doubtful Accounts
Estimates are used in determining the allowance for doubtful accounts and are
based on historical collection and write-off experience, current trends, credit
policies, accounts receivable by aging category and current trends in the credit
quality of its subscriber base. In determining these estimates, the Company
compares historical write-offs in relation to the estimated period in which the
subscriber was originally billed. The Company also looks at the historical and
projected average length of time that elapses between the original billing date
and the date of write-off in determining the adequacy of the allowance for
doubtful accounts by aging category. From this information, the Company provides
specific amounts to the aging categories. The Company provides an allowance for
substantially all receivables over 90 days old.
Using historical information, the Company provides a reduction in revenues for
certain billing adjustments and credits, late payment fees and early
cancellation fees that it anticipates will not be collected. The reserves for
billing adjustments and credits, late payment fees and early cancellation fees
are included in the allowance for doubtful accounts balance. If the allowance
for doubtful accounts is not adequate, it could have a material adverse affect
on the Company's liquidity, financial position and results of operations.
18
First Payment Default Subscribers
Prior to March 2003, the Company estimated the percentage of new subscribers
that would never pay a bill and reserved for the related percentage of monthly
revenue through a reduction in revenues. In 2002, the Company reinstated the
deposit requirement for sub-prime credit customers, and then increased the
deposit amounts in February 2003. These changes to our credit policy were
sufficient to mitigate the collection risk and resulted in improvements in the
credit quality of our subscriber base. Accordingly, in March 2003 the Company
ceased recording this reserve, which resulted in the addition of 4,187 net
subscriber additions.
The Company continually evaluates its credit policy and evaluates the impact the
subscriber base will have on the business and raises or lowers credit standards
periodically, as allowed by Sprint. On April 6, 2004, the Company reduced or
eliminated the deposit requirement for a segment of potential subscribers in
selected market areas. The Company will continue to review our customer
performance and modify our credit policy to meet short-term and long-term
business objectives and monitor the impact of sub-prime customers on our
allowance for doubtful accounts.
Valuation and Recoverability of Long-Lived Assets
Long-lived assets such as property and equipment represent approximately 61% of
the Company's total assets as of March 31, 2004. Property and equipment are
stated at original cost, less accumulated depreciation and amortization.
Depreciation is recorded using the straight-line method over the estimated
useful lives of 15 years for the 1 tower which we own, 3 to 5 years for computer
equipment, 5 years for furniture, fixtures and office equipment and 5 to 7 years
for network assets (other than towers). The Company reviews long-lived assets
for impairment in accordance with the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets."
We review our long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount may not be recoverable. If the
total of the expected undiscounted future cash flows is less than the carrying
amount of the asset, a loss, if any, is recognized for the difference between
the fair value and the carrying value of the asset. Impairment analysis is based
on our current business and technology strategy, our views of growth rates for
the business, anticipated future economic and regulatory conditions and expected
technological availability. Assets to be disposed of are reported at the lower
of the carrying amount or fair value less costs to sell the asset.
Significant New Accounting Pronouncements
See Note 2 to the condensed consolidated financial statements for a description
of significant new accounting pronouncements and their impact on the Company.
Results of Operations
Revenues
We derive our revenue from the following sources:
Service. We sell wireless personal communications services. The various types of
service revenue associated with wireless communications services include monthly
recurring access and feature charges and monthly non-recurring charges for
local, wireless long distance and roaming airtime usage in excess of the
subscribed usage plan.
Roaming. The Company receives roaming revenue at a per-minute rate from Sprint
and other Sprint PCS network partners when Sprint's or its network partner's PCS
subscribers from outside of the Company's territory use the Company's network.
The Company pays the same reciprocal roaming rate when subscribers from its
territories use the network of Sprint or its other PCS network partners. The
Company also receives non-Sprint roaming revenue when subscribers of other
wireless service providers who have roaming agreements with Sprint roam on the
Company's network.
Equipment. We sell wireless personal communications handsets and accessories
that are used by our subscribers in connection with our wireless services.
Equipment revenue is derived from the sale of handsets and accessories from
Company owned stores, net of sales incentives, rebates and an allowance for
returns. The Company's handset return policy allows subscribers to return their
handsets for a full refund within 14 days of activation. When handsets are
returned to the Company, the Company may be able to reissue the handsets to
subscribers at little additional cost. When handsets are returned to Sprint for
refurbishing, the Company receives a credit from Sprint.
19
For the Quarters Ended March 31,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- -------------- ----------------
(Dollars in thousands)
Service revenue $ 61,656 $ 60,163 $ 1,493 2.5%
Roaming revenue 13,498 13,895 (397) (2.9%)
Equipment revenue 2,882 2,691 191 7.1%
----------------- ---------------- --------------
Total $ 78,036 $ 76,749 $ 1,287 1.7%
================= ================ ==============
For the quarter ended March 31, 2004 compared to the quarter ended March 31,
2003:
Service Revenue
The increase in service revenue for the quarter ended March 31, 2004 over the
same quarter of the previous year reflects a higher average number of
subscribers using our network, relatively consistent average revenue per
subscriber, higher monthly recurring revenue and feature charges and increased
data revenue, partially offset by higher credits and lower revenue from "minutes
over plan," or airtime usage in excess of the subscribed usage plans. In late
calendar year 2002, Sprint implemented a new PCS to PCS product offering under
which subscribers receive unlimited quantities of minutes for little or no
additional cost for any calls made from one Sprint PCS subscriber to another
("PCS to PCS"). Pursuant to our Sprint Agreements, we are required to support
this program in our territory. The number of minutes-over-plan charged to
subscribers for plan overages used and associated revenues decreased while the
number of minutes used for PCS to PCS calls has increased significantly.
Roaming Revenue
The decrease in roaming revenue for the quarter ended March 31, 2004 over the
same quarter of the previous year is attributable primarily to the lower
reciprocal roaming rate charged among Sprint and its PCS network partners,
partially offset by increased volume in inbound roaming traffic. The reciprocal
roaming rate between Sprint and the Company declined from $0.058 per minute of
use to $0.041 in calendar years 2003 and 2004, respectively. The Company
believes that these reductions are in violation of our agreements with Sprint.
The Company's roaming revenue from Sprint and its PCS network partners was $12.9
million and $13.0 million or 96% and 94% of total roaming revenue for the
quarters ended March 31, 2004 and 2003, respectively.
Equipment Revenue
Equipment revenue for the quarter ended March 31, 2004 increased over the same
quarter of the previous year, primarily due to increased handset sales of $5.0
million or 168% prior to rebates and promotion costs, offset by a $4.8 million
increase in handset rebates and promotions. The increase in handset sales is
comprised of a $2.5 million increase in sales of new or upgraded handsets to
existing subscribers, a $2.3 million increase in sales to new subscribers and a
$0.2 million increase in accessory sales.
Cost of Service and Roaming
Cost of service and roaming principally consists of costs to support the
Company's subscriber base including:
o Cost of roaming;
o Network operating costs (including salaries, cell site lease payments,
fees related to the connection of the Company's switches to the cell
sites that they support, inter-connect fees and other expenses related
to network operations);
o Bad debt expense related to estimated uncollectible accounts
receivable;
o Wireless handset subsidies on existing subscriber upgrades through
national third-party retailers; and
o Other cost of service, which includes:
o Back office services provided by Sprint such as customer care,
billing and activation;
o The 8% of collected service revenue representing the Sprint
affiliation fee; and
20
o Long distance expense relating to inbound roaming revenue and the
Company's own subscriber's long distance usage and roaming
expense when subscribers from the Company's territory place calls
on Sprint's or its network partners' networks.
For the Quarters Ended March 31,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- -------------- ----------------
(Dollars in thousands)
Cost of roaming $ 11,022 $ 11,468 $ (446) (3.9%)
Network operating costs 15,416 13,971 1,445 10.3%
Bad debt expense (1,122) (32) (1,090) 3406.3%
Wireless handset subsidies 298 1,770 (1,472) (83.2%)
Other cost of service 13,808 13,570 238 1.8%
----------------- ---------------- --------------
Total cost of service and roaming $ 39,422 $ 40,747 $ (1,325) (3.3%)
================= ================ ==============
Cost of Roaming
Cost of roaming decreased for the quarter ended March 31, 2004 compared to the
same quarter of the previous year as a result of the decrease in the reciprocal
roaming rate charged among Sprint and its network partners, partially offset by
increased volume. The reciprocal roaming rate between Sprint and the Company
declined from $0.058 per minute of use to $0.041 in calendar years 2003 and
2004, respectively. The Company believes that these reductions are in violation
of our agreements with Sprint. The Company's cost of roaming attributable to
Sprint and its network partners was 95% of the total cost of roaming for each of
the quarters ended March 31, 2004 and 2003.
Network Operating Costs
Network operating costs increased for the quarter ended March 31, 2004 compared
to the same quarter of the previous year as a result of increased network costs
related to increased network usage of approximately 36%, including higher long
distance costs and increased interconnect charges.
Bad Debt Expense
Bad debt expense decreased for the quarter ended March 31, 2004 compared to the
same quarter of the previous year. During the quarter ended March 31, 2004, the
Company recorded a $1.2 million special settlement received from Sprint
resulting from a change in the bad debt profile for certain subscribers. In
addition, we believe the improvements in the credit quality and payment profile
of our subscriber base since we re-imposed deposits for sub-prime credit
subscribers in early 2002 and the subsequent increases in February 2003 resulted
in significant improvements in accounts receivable write-off experience,
increased collections, and the associated decrease in bad debt expense for the
quarter.
Wireless Handset Subsidies
Despite an increase in the number of subscribers making handset upgrade
purchases, wireless handset subsidies on existing subscriber upgrades sold
through national third-party retailers decreased for the quarter ended March 31,
2004 compared to the same quarter of the previous year as a result of reduced
subsidies per handset paid to national third-party retailers. Subsidies paid to
national third-party retailers decreased as a result of increased handset
rebates and promotions offered directly to our customers through the national
third party channels. Handset rebates and promotions sold through the national
third party channels offered directly to our customers are included in selling
and marketing expense.
Other Cost of Service
Other cost of service increased for the quarter ended March 31, 2004 compared to
the same quarter of the previous year as a result of higher customer loyalty
retention costs, offset by a rate reduction in the fees paid to Sprint for back
office services provided.
21
Cost of Equipment, Other Operating Expenses and Interest
For the Quarters Ended March 31,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- -------------- ----------------
(Dollars in thousands)
Cost of equipment $ 7,202 $ 3,455 3,747 108.5%
Selling and marketing expense 11,916 11,384 532 4.7%
General and administrative expense 6,337 5,844 493 8.4%
Depreciation and amortization of property and equipment 11,892 11,625 267 2.3%
Loss (gain) on disposal of property
and equipment (3) 220 223 101.4%
Interest income 165 25 140 560.0%
Interest expense (11,311) (10,197) 1,114 10.9%
Cost of Equipment
We purchase handsets and accessories to resell to our subscribers for use in
connection with our services. To remain competitive in the marketplace, we
subsidize the price of the handset sales; therefore the cost of handsets is
higher than the retail price to the subscriber. Cost of equipment increased for
the quarter ended March 31, 2004 compared to the same quarter of the previous
year primarily as a result of increased retail upgrade sales for handsets to
existing subscribers, partially offset by decreased subscriber gross additions.
Selling and Marketing Expense
Selling and marketing expense includes retail store costs such as salaries and
rent, promotion, advertising and commission costs, and handset subsidies for new
activations on units sold by national third-party retailers and Sprint sales
channels for which the Company does not record revenue. Under the Company's
agreements with Sprint, when a national retailer or other Sprint distribution
channel sells a handset purchased from Sprint to a subscriber from the Company's
territory, the Company is obligated to reimburse Sprint for the handset subsidy
and related selling costs that Sprint originally incurred. Selling and marketing
expenses increased for the quarter ended March 31, 2004 compared to the same
quarter of the previous year reflecting increased advertising and promotion
expense, offset by staff reductions and store closings implemented in early
fiscal 2003.
General and Administrative Expense
General and administrative expense i