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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 JUNE 30, 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|
11,771,019 shares of common stock, $0.01 par value, were outstanding as of
August 4, 2004.
AIRGATE PCS, INC.
FORM 10-Q FOR THE QUARTER ENDED
JUNE 30, 2004
TABLE OF CONTENTS
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.......................................... 3
Condensed Consolidated Balance Sheets at
June 30, 2004 (unaudited) and September 30, 2003............. 3
Condensed Consolidated Statements of Operations
for the Quarters and Nine Months ended
June 30, 2004 and 2003 (unaudited)........................... 4
Condensed Consolidated Statements of Cash Flows
for the Nine Months ended June 30, 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.................................................. 33
Item 4. Controls and Procedures....................................... 34
PART II OTHER INFORMATION
Item 1. Legal Proceedings............................................. 35
Item 2. Changes in Securities and Use of Proceeds..................... 35
Item 3. Defaults Upon Senior Securities............................... 35
Item 4. Submission of Matters to a Vote of Security Holders........... 35
Item 5. Other Information............................................. 35
Item 6. Exhibits and Reports on Form 8-K.............................. 35
-2-
PART I. FINANCIAL INFORMATION
Item 1. -- Financial Statements
AIRGATE PCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, September 30,
2004 2003
----------------- -----------------
(unaudited)
(Dollars in thousands, except share
and per share amounts)
Assets
Current assets:
Cash and cash equivalents $ 61,962 $ 54,078
Accounts receivable, net of allowance for doubtful
accounts of $4,009 and $4,635 26,219 26,994
Receivable from Sprint 14,371 15,809
Inventories 2,709 2,132
Prepaid expenses 3,519 2,107
Other current assets 306 145
----------------- -----------------
Total current assets 109,086 101,265
Property and equipment, net of accumulated depreciation and
amortization of $165,660 and $129,986 154,199 178,070
Financing costs 2,999 6,682
Direct subscriber activation costs 2,245 3,907
Other assets 1,046 992
----------------- -----------------
Total assets $ 269,575 $ 290,916
================= =================
Liabilities and Stockholders' Deficit
Current liabilities:
Accounts payable $ 2,775 $ 5,945
Accrued expense 18,969 12,104
Payable to Sprint 50,215 45,069
Deferred revenue 8,694 7,854
Current maturities of long-term debt 19,156 17,775
----------------- -----------------
Total current liabilities 99,809 88,747
Deferred subscriber activation fee revenue 3,829 6,701
Other long-term liabilities 2,273 1,841
Long-term debt, excluding current maturities 252,812 386,509
Investment in iPCS - 184,115
----------------- -----------------
Total liabilities 358,723 667,913
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; 11,771,019 and 5,192,238
shares issued and outstanding at June 30, 2004
and September 30, 2003 118 52
Additional paid-in-capital 1,046,376 924,095
Unearned stock compensation (5) (203)
Accumulated deficit (1,135,637) (1,300,941)
----------------- -----------------
Total stockholders' deficit (89,148) (376,997)
----------------- -----------------
Total liabilities and stockholders' deficit $ 269,575 $ 290,916
================= =================
See accompanying notes to the unaudited condensed
consolidated financial statements.
-3-
AIRGATE PCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)
Quarter Ended Nine Months Ended
June 30, June 30,
------------------------------------ ------------------------------------
2004 2003 2004 2003
----------------- ----------------- ----------------- -----------------
(Dollars in thousands, except share and per share amounts)
Revenue:
Service revenue $ 65,037 $ 64,936 $ 188,866 $ 185,032
Roaming revenue 17,389 15,764 47,370 48,569
Equipment revenue 3,612 2,486 9,341 8,199
----------------- ----------------- ----------------- -----------------
Total revenue 86,038 83,186 245,577 241,800
Operating Expense:
Cost of service and roaming (exclusive of
depreciation and amortization as shown
separately below) 43,278 46,040 125,179 138,210
Cost of equipment 6,670 4,969 20,458 15,271
Selling and marketing expense 10,890 12,703 36,931 40,906
General and administrative expense 4,970 5,401 17,806 15,437
Depreciation and amortization of property
and equipment 12,015 11,588 35,674 34,832
Loss (gain) on disposal of property and
equipment (2) - (7) 418
----------------- ----------------- ----------------- -----------------
Total operating expense 77,821 80,701 236,041 245,074
----------------- ----------------- ----------------- -----------------
Operating income (loss) 8,217 2,485 9,536 (3,274)
Interest income 188 38 510 63
Interest expense (6,230) (10,770) (28,857) (31,161)
----------------- ----------------- ----------------- -----------------
Income (loss) from continuing operations
before income tax 2,175 (8,247) (18,811) (34,372)
Income tax - - - -
----------------- ----------------- ----------------- -----------------
Income (loss) from continuing operations 2,175 (8,247) (18,811) (34,372)
Discontinued Operations:
Loss from discontinued operations - - - (42,571)
Gain on disposal of discontinued operations
net of $0 income tax expense - - 184,115 -
----------------- ----------------- ----------------- -----------------
Income (loss) from discontinued operations - - 184,115 (42,571)
----------------- ----------------- ----------------- -----------------
Net income (loss) $ 2,175 $ (8,247) $ 165,304 $ (76,943)
================= ================= ================= =================
Weighted-average number of shares outstanding
Basic shares 11,769,976 5,187,967 8,359,868 5,179,483
Dilutive shares 11,857,479 5,187,967 8,359,868 5,179,483
Basic and diluted earnings (loss) per share:
Basic:
Income (loss) from continuing operations $ 0.18 $ (1.59) $ (2.25) $ (6.64)
Income (loss) from discontinued operations - - 22.02 (8.22)
----------------- ----------------- ----------------- -----------------
Net income (loss) $ 0.18 $ (1.59) $ 19.77 $ (14.86)
================= ================= ================= =================
Diluted:
Income (loss) from continuing operations $ 0.18 $ (1.59) $ (2.25) $ (6.64)
Income (loss) from discontinued operations - - 22.02 (8.22)
----------------- ----------------- ----------------- -----------------
Net income (loss) $ 0.18 $ (1.59) $ 19.77 $ (14.86)
================= ================= ================= =================
See accompanying notes to the unaudited condensed
consolidated financial statements.
-4-
AIRGATE PCS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended
June 30,
------------------------------------
2004 2003
----------------- -----------------
(Dollars in thousands)
Cash flows from operating activities:
Net income (loss) $ 165,304 $ (76,943)
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 35,674 34,832
Amortization of financing costs into interest expense 812 907
Provision for doubtful accounts (553) 3,724
Interest expense associated with accretion of discounts 15,242 24,480
Non-cash stock compensation 485 506
Loss (gain) on disposal of property and equipment (7) 418
Changes in assets and liabilities:
Accounts receivable 1,328 (2,555)
Receivable from Sprint 1,438 15,173
Inventories (577) 2,093
Prepaid expenses, other current and non-current assets 35 401
Accounts payable, accrued expenses and
other long-term liabilities 1,262 (1,781)
Payable to Sprint 5,146 (13,376)
Deferred revenue 840 (713)
----------------- -----------------
Net cash provided by operating activities 42,314 29,737
----------------- -----------------
Cash flows from investing activities:
Purchases of property and equipment (11,803) (10,369)
----------------- -----------------
Net cash used in investing activities (11,803) (10,369)
----------------- -----------------
Cash flows from financing activities:
Borrowings under credit facility - 8,000
Repayments of credit facility (17,019) (1,518)
Financing cost on credit facility (884) -
Transaction costs capitalized to equity (4,759) -
Stock issued to employee stock purchase plan - 56
Proceeds from stock option exercises 35 -
----------------- -----------------
Net cash (used in) provided by financing activities (22,627) 6,538
----------------- -----------------
Net increase in cash and cash equivalents 7,884 25,906
Cash and cash equivalents at beginning of period 54,078 4,887
----------------- -----------------
Cash and cash equivalents at end of period $ 61,962 $ 30,793
================= =================
Supplemental disclosure of cash flow information:
Interest paid $ 5,518 $ 5,748
Supplemental disclosure for non-cash investing activities:
Capitalized interest 112 173
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
June 30, 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")
for interim financial reporting 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
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 nine months ended June 30, 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 PCS ("Sprint"), which is a group of wholly-owned
subsidiaries of Sprint Corporation that operate and manage Sprint's PCS products
and services. We have 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 October 17, 2003, the Company irrevocably transferred all of its shares of
common stock of iPCS, Inc. and its subsidiaries ("iPCS") to a trust for the
benefit of the Company's shareholders of record as of the date of the 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 disposal of
discontinued operations. The Company's condensed consolidated financial
statements reflect the results of iPCS as discontinued operations (described
below in Note 6).
(b) Liquidity
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
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").
Since inception, the Company has financed its operations through debt financing
and proceeds generated from public offerings of its common stock. The proceeds
from these transactions have been used to fund the build-out of the Company's
portion of the PCS network of Sprint, subscriber acquisition costs and working
capital. Since inception, the Company has invested over $300.0 million in
capital expenditures.
As of June 30, 2004, the Company had working capital of $9.3 million and cash
and cash equivalents of $62.0 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. The Company believes that the cash on hand plus the additional
liquidity that it expects to generate from operations will be sufficient to fund
expected capital expenditures and to cover its working capital and debt service
requirements for at least the next 12 months.
While the Company has incurred substantial net losses since inception and
negative cash flows from operating activities through September 30, 2002, the
Company generated $42.5 million of cash flows from operating activities for the
year ended September 30, 2003. For the nine months ended June 30, 2004, the
Company generated $42.3 million of cash flows from operating activities.
As part of the Company's financial restructuring to address future liquidity
concerns (the "Recapitalization Plan"), in November 2003 the Company amended its
credit facility and in February 2004 completed an exchange of 99.4% of the
$300.0 million in outstanding 13 1/2% Old Notes for $159.0 million in 9 3/8% New
-6-
Notes and issuance of 6,568,706 shares of common stock, representing 56% of the
shares of common stock issued and outstanding immediately after the completion
of the Recapitalization Plan.
The accompanying 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 registered public accounting
firm, included an explanatory paragraph regarding the Company's ability to
continue as a going concern in their audit opinion.
The Company's future liquidity will be dependent on a number of factors
influencing its projections of operating cash flow, including those related to
subscriber growth, retention and credit quality; revenue growth and the
Company's ability to manage operating expense. Should actual results differ
significantly from these assumptions, the Company's liquidity position could be
adversely affected and it could be in a position that would require it to raise
additional capital which may or may not be available on terms acceptable to the
Company, if at all. The Company's inability to raise capital when needed could
have a material adverse effect on the Company's ability to achieve its intended
business objectives.
(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 did not 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.
(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
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 an 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.
Although the Company acknowledges its responsibility for all of its internal
controls, the Company relies upon Sprint as a service provider to provide
accurate information for the settlement of revenue and certain expense items.
The Company makes estimates used in connection with the preparation of financial
statements based on the financial and statistical information provided by
Sprint. The Company assesses the accuracy of this information through the
Company's audit procedures, analytic reviews and the reliance on the Type II SAS
70 report, "Report on Controls Placed in Operation and Tests of Operating
Effectiveness for the Reporting and Financial Settlement Process," for Sprint's
internal control processes. The report is prepared for Sprint by Sprint's
service auditor. Inaccurate or incomplete data from Sprint in connection with
the services provided to the Company by Sprint could have a material adverse
effect on the Company's financial position, results of operations or cash flow.
Amounts recorded relating to the Sprint Agreements for the quarter and nine
months ended June 30, 2004 and 2003 are as follows:
-7-
Quarter Ended Nine Months Ended
June 30, June 30,
---------------------------------- ----------------------------------
2004 2003 2004 2003
---------------- ---------------- ---------------- ----------------
(Dollars in thousands)
Amounts included in the Condensed Consolidated
Statements of Operations:
Roaming revenue $ 16,737 $ 14,595 $ 45,389 $ 45,588
Cost of service and roaming:
Roaming $ 12,380 $ 11,548 $ 36,154 $ 37,261
Customer service 7,195 9,313 20,542 31,040
Affiliation fee 4,879 4,203 14,263 13,748
Long distance 3,301 3,309 9,976 9,353
Other 906 546 2,188 1,536
---------------- ---------------- ---------------- ----------------
Total cost of service and roaming $ 28,661 $ 28,919 $ 83,123 $ 92,938
================ ================ ================ ================
Purchased inventory $ 5,600 $ 3,971 $ 21,015 $ 12,192
================ ================ ================ ================
Selling and marketing $ 2,750 $ 3,672 $ 9,672 $ 9,784
================ ================ ================ ================
As of
----------------------------------
June 30, September 30,
2004 2003
---------------- ----------------
(Dollars in thousands)
Receivable from Sprint $ 14,371 $ 15,809
Payable to Sprint $ 50,215 $ 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 nine months ended
June 30, 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 to reimburse
Sprint for certain 3G related development expenses. For the nine months
ended June 30, 2004, Sprint invoiced the Company and we have accrued
approximately $3.2 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 nine months ended June 30,
2004, Sprint invoiced the Company and we have accrued approximately $1.3
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 $2.3 million for the nine months ended June 30, 2004 for the
cost of IT projects completed by Sprint. We are disputing Sprint's right
to collect these fees.
The payable to Sprint includes disputed amounts (including, but not limited to
amounts disclosed above) for which Sprint has invoiced the Company approximately
$15.0 million. The invoiced amount does not include $2.7 million which has been
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. Sprint has unilaterally reduced
the reciprocal roaming rate charged among Sprint and its network partners, in a
manner we believe is a breach of the Sprint Agreements.
During the nine months ended June 30, 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
-8-
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 nine months ended June 30, 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 reductions to cost of service.
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 June
30, 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.
While there is no pending litigation with Sprint, we have a variety of disputes
with Sprint, which are described in Note 3.
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.
(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 nine months ended June 30, 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 disposal 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.
-9-
(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 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 disposal of discontinued operations. The Company's
condensed consolidated financial statements reflect the results of iPCS as
discontinued operations. Subsequent to February 23, 2003 and prior to October
17, 2003 the Company accounted for iPCS as an investment using the cost method
of accounting. Excluding the gain on disposal of $184.1 million recorded October
17, 2003, there were no losses from discontinued operations for the quarter and
nine months ended June 30, 2004. The following reflects the loss from
discontinued operations of iPCS for the nine months ended June 30, 2003 (dollars
in thousands):
Nine Months Ended
June 30,
-----------------------
2003
-----------------------
Revenue $ 79,364
Cost of revenue 63,200
Selling and marketing 16,418
General and administrative 6,881
Depreciation and amortization 20,989
-----------------------
Operating expense 107,488
-----------------------
Operating loss (28,124)
Interest expense, net (14,447)
-----------------------
Loss from discontinued operations $ (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), the Old Notes (see Note 10) 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.
AirGate Network Services LLC ("ANS") is a wholly-owned restricted subsidiary of
the Company. ANS has fully and unconditionally guaranteed the New Notes, the 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, the 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 June 30,
2004 and September 30, 2003 and for the quarters and nine months ended June 30,
2004 and 2003 (dollars in thousands):
-10-
Unaudited Condensed Consolidating Balance Sheets
As of June 30, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
-------------------- ------------------- ------------------- --------------------
Cash and cash equivalents $ 61,970 $ (8) $ - $ 61,962
Other current assets 108,236 529 (61,641) 47,124
-------------------- ------------------- ------------------- --------------------
Total current assets 170,206 521 (61,641) 109,086
Property and equipment, net 124,119 30,080 - 154,199
Other noncurrent assets 6,290 - - 6,290
-------------------- ------------------- ------------------- --------------------
Total assets $ 300,615 $ 30,601 $ (61,641) $ 269,575
==================== =================== =================== ====================
Current liabilities $ 100,110 $ 61,340 $ (61,641) $ 99,809
Intercompany (123,601) 123,601 - -
Long-term debt 252,812 - - 252,812
Other long-term liabilities 6,102 - - 6,102
Investment in subsidiaries 154,340 - (154,340) -
-------------------- ------------------- ------------------- --------------------
Total liabilities 389,763 184,941 (215,981) 358,723
-------------------- ------------------- ------------------- --------------------
Stockholders' deficit (89,148) (154,340) 154,340 (89,148)
-------------------- ------------------- ------------------- --------------------
Total liabilities and
stockholders' deficit $ 300,615 $ 30,601 $ (61,641) $ 269,575
==================== =================== =================== ====================
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 June 30, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ----------------- ----------------- -----------------
Revenue $ 86,038 $ - $ - $ 86,038
Cost of revenue 45,627 4,321 - 49,948
Selling and marketing 10,377 513 - 10,890
General and administrative 4,846 124 - 4,970
Depreciation and amortization of
property and equipment 9,638 2,377 - 12,015
Gain on disposal of property and equipment (2) - - (2)
----------------- ----------------- ----------------- -----------------
Total operating expense 70,486 7,335 - 77,821
----------------- ----------------- ----------------- -----------------
Operating income (loss) 15,552 (7,335) - 8,217
Loss in subsidiaries (7,294) - 7,294 -
Interest income 188 - - 188
Interest expense (6,271) 41 - (6,230)
----------------- ----------------- ----------------- -----------------
Income (loss) from continuing operations
before income tax 2,175 (7,294) 7,294 2,175
Income tax - - - -
----------------- ----------------- ----------------- -----------------
Net income (loss) $ 2,175 $ (7,294) $ 7,294 $ 2,175
================= ================= ================= =================
Unaudited Condensed Consolidating Statement of Operations
For the Quarter Ended June 30, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ----------------- ----------------- -----------------
Revenue $ 83,186 $ - $ - $ 83,186
Cost of revenue 46,786 4,223 - 51,009
Selling and marketing 11,656 1,047 - 12,703
General and administrative 5,069 332 - 5,401
Depreciation and amortization of
property and equipment 10,798 790 - 11,588
----------------- ----------------- ----------------- -----------------
Total operating expense 74,309 6,392 - 80,701
----------------- ----------------- ----------------- -----------------
Operating income (loss) 8,877 (6,392) - 2,485
Loss in subsidiaries (6,383) - 6,383 -
Interest income 38 - - 38
Interest expense (10,779) 9 - (10,770)
----------------- ----------------- ----------------- -----------------
Loss before income tax (8,247) (6,383) 6,383 (8,247)
Income tax - - - -
----------------- ----------------- ----------------- -----------------
Net loss $ (8,247) $ (6,383) $ 6,383 $ (8,247)
================= ================= ================= =================
-12-
Unaudited Condensed Consolidating Statement of Operations
For the Nine Months Ended June 30, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ----------------- ----------------- -----------------
Revenue $ 245,577 $ - $ - $ 245,577
Cost of revenue 132,917 12,720 - 145,637
Selling and marketing 35,339 1,592 - 36,931
General and administrative 17,405 401 - 17,806
Depreciation and amortization of
property and equipment 28,544 7,130 - 35,674
Gain on disposal of property and equipment (7) - - (7)
----------------- ----------------- ----------------- -----------------
Total operating expense 214,198 21,843 - 236,041
----------------- ----------------- ----------------- -----------------
Operating income (loss) 31,379 (21,843) - 9,536
Loss in subsidiaries (21,731) - 21,731 -
Interest income 510 - - 510
Interest expense (28,969) 112 - (28,857)
----------------- ----------------- ----------------- -----------------
Loss from continuing operations
before income tax (18,811) (21,731) 21,731 (18,811)
Income tax - - - -
----------------- ----------------- ----------------- -----------------
Loss from continuing operations (18,811) (21,731) 21,731 (18,811)
Income from discontinued operations 184,115 - - 184,115
----------------- ----------------- ----------------- -----------------
Net income (loss) $ 165,304 $ (21,731) $ 21,731 $ 165,304
================= ================= ================= =================
Unaudited Condensed Consolidating Statement of Operations
For the Nine Months Ended June 30, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
----------------- ----------------- ----------------- -----------------
Revenue $ 241,800 $ - $ - $ 241,800
Cost of revenue 140,678 12,803 - 153,481
Selling and marketing 37,910 2,996 - 40,906
General and administrative 13,824 1,613 - 15,437
Depreciation and amortization of
property and equipment 27,671 7,161 - 34,832
Loss on disposal of property and equipment 418 - - 418
----------------- ----------------- ----------------- -----------------
Total operating expense 220,501 24,573 - 245,074
----------------- ----------------- ----------------- -----------------
Operating income (loss) 21,299 (24,573) - (3,274)
Loss in subsidiaries (24,456) - 24,456 -
Interest income 63 - - 63
Interest expense (31,278) 117 - (31,161)
----------------- ----------------- ----------------- -----------------
Loss from continuing operations
before income tax (34,372) (24,456) 24,456 (34,372)
Income tax - - - -
----------------- ----------------- ----------------- -----------------
Loss from continuing operations (34,372) (24,456) 24,456 (34,372)
Loss from discontinued operations (42,571) - - (42,571)
----------------- ----------------- ----------------- -----------------
Net loss $ (76,943) $ (24,456) $ 24,456 $ (76,943)
================= ================= ================= =================
-13-
Unaudited Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended June 30, 2004
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
-------------------- ------------------- -------------------- -------------------
Operating activities, net $ 42,053 $ 261 $ - $ 42,314
Investing activities, net (11,534) (269) - (11,803)
Financing activities, net (22,627) - - (22,627)
-------------------- ------------------- -------------------- -------------------
Change in cash and
cash equivalents 7,892 (8) - 7,884
Cash and cash equivalents
at beginning of period 54,078 - - 54,078
-------------------- ------------------- -------------------- -------------------
Cash and cash equivalents
at end of period $ 61,970 $ (8) $ - $ 61,962
==================== =================== ==================== ===================
Unaudited Condensed Consolidating Statement of Cash Flows
For the Nine Months Ended June 30, 2003
AirGate
AirGate PCS, Guarantor
Inc. Subsidiaries Eliminations Consolidated
-------------------- ------------------- -------------------- -------------------
Operating activities, net $ 29,121 $ 616 $ - $ 29,737
Investing activities, net (9,632) (737) - (10,369)
Financing activities, net 6,538 - - 6,538
-------------------- ------------------- -------------------- -------------------
Change in cash and cash equivalents 26,027 (121) - 25,906
Cash and cash equivalents
at beginning of period 4,769 118 - 4,887
-------------------- ------------------- -------------------- -------------------
Cash and cash equivalents at end of period $ 30,796 $ (3) $ - $ 30,793
==================== =================== ==================== ===================
(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 39,835, 53,841, and 39,588 for the quarter ended
June 30, 2003 and the nine months ended June 30, 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
effected on February 13, 2004 (described below in Note 10).
(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 quarters and nine months ended June 30, 2004 and 2003, the pro
forma net income (loss) and earnings (loss) per share would have been as
follows:
-14-
Quarters Ended Nine Months Ended
June 30, June 30,
------------------------------------ -----------------------------------
2004 2003 2004 2003
------------------ ---------------- ---------------- ----------------
(Dollars in thousands, except per share data)
Net income (loss), as reported $ 2,175 $ (8,247) $ 165,304 $ (76,943)
Add: stock based compensation expense included in
determination of net income (loss) 185 177 467 530
Less: stock based compensation expense determined
under the fair value based method (1,651) (2,426) (4,953) (7,278)
------------------ ---------------- ---------------- ----------------
Pro forma, net income (loss) $ 709 $ (10,496) $ 160,818 $ (83,691)
================== ================ ================ ================
Basic and diluted earnings (loss) per share:
Basic
As reported $ 0.18 $ (1.59) $ 19.77 $ (14.86)
Pro forma $ 0.06 $ (2.02) $ 19.24 $ (16.16)
Diluted
As reported $ 0.18 $ (1.59) $ 19.77 $ (14.86)
Pro forma $ 0.06 $ (2.02) $ 19.24 $ (16.16)
On April 8, 2004, the Company issued 99,750 shares of performance-restricted
stock. The restrictions on the stock lapse three years from the date of issuance
if certain cumulative performance criteria are met at September 30, 2006. The
shares qualify for variable accounting under Accounting Principles Board (APB)
Statement No. 25 and Financial Accounting Standards Board Interpretation 28. The
Company recorded compensation expense of $0.2 million related to these shares
during the quarter ended June 30, 2004.
On April 8, 2004, the Company also issued 299,250 stock options with an exercise
price of $15.93, which vest ratably over three years. The shares were accounted
for in accordance with APB No. 25. No related compensation expense was
recognized during the quarter ended June 30, 2004.
(10) Recapitalization Plan
In November 2003, the Company completed an amendment to its credit facility.
Certain changes were effective and used in determining compliance with financial
covenants for periods ended December 31, 2003 and thereafter. Such changes
included clarifying and modifying the definition of, and period for calculating,
EBITDA for purposes of complying with financial covenants under the credit
facility.
In February 2004, the Company completed the Recapitalization Plan, comprised of:
o The exchange of $298,205,000 of 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 issued and
outstanding immediately after the Recapitalization Plan and (ii) $159.0
million aggregate principal amount of newly issued 9 3/8% senior
subordinated notes due 2009 (the "New Notes"); and
o The removal of substantially all of the restrictive covenants in the
indenture governing the Old Notes, release of collateral that secured the
Company's obligations thereunder and waiver of any defaults or events of
default that occurred in connection with the recapitalization.
The $298,205,000 of Old Notes exchanged constituted 99.4% of the Old Notes
outstanding. In the recapitalization, each tendering 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 a 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.
The exchange offer comprising the Recapitalization Plan was settled 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
-15-
condensed consolidated financial statements as of and for the nine months ended
June 30, 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
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 issued
in the restructuring. 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 June 30, 2004, the carrying
value of the New Notes was approximately $135.9 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 nine months ended June 30, 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;
-16-
o anticipated future losses;
o rapid technological and market change;
o an adequate supply of subscriber equipment;
o declines in growth of wireless subscribers;
o the effect of wireless local number portability;
o the volatility of the market price of our common stock and
o the future obsolescence of our network assets based on technological
changes.
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.
During the third quarter of 2004 we continued to stay focused on our key
financial and operating performance metrics, including net income and EBITDA.
Accomplishments during the third quarter of fiscal 2004, which we believe are
important indicators of our overall performance and financial well-being,
include:
o Achieving for the first time in our Company's history, income from
continuing operations for the quarter ended June 30, 2004 of $2.2 million,
or $0.18 per share for both basic and diluted outstanding common shares,
compared to a loss of ($8.2) million or $(1.59) per share for the same
quarter of the previous year.
o EBITDA, earnings before interest, taxes, depreciation and amortization (as
later defined), was $20.2 million for the quarter ended June 30, 2004,
compared to $14.1 million for the same quarter of the previous year.
o Gross additions were 38,223 for the quarter ended June 30, 2004, compared
to 38,919 for the same quarter of the previous year.
o Churn (as later defined) decreased to 2.55% in the quarter ended June 30,
2004, compared to 2.90% for the same quarter of the previous year and
2.92% in the second quarter of fiscal 2004.
The Company generated $42.3 million in cash from operating activities during the
nine months ended June 30, 2004, compared to $29.7 million for the prior year.
We believe these results have strengthened our balance sheet by increasing cash
and cash equivalents to $62.0 million from $48.6 million in the second quarter
of fiscal 2004 and from $30.8 million from the previous year.
As of June 30, 2004, the Company had 375,241 subscribers and total network
coverage of approximately 6.1 million residents, representing approximately 82%
of the residents in its territory.
-17-
iPCS, Inc.
On November 30, 2001, we acquired iPCS in a merger. 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 disposal of
discontinued 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.
Critical Accounting Policies and Estimates
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.
-18-
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.
Revenue and Cost Data Provided by Sprint
Although the Company recognizes its responsibility for all of its internal
controls, we place substantial reliance on the timeliness, accuracy and
sufficiency of certain revenue, accounts receivable and cost data provided by
Sprint which we use in the preparation of our financial statements and financial
disclosures. The data provided by Sprint is the primary source for our
recognition of service revenue and a significant portion of our selling and
marketing and cost of service and operations expenses. At times, we have been
invoiced by Sprint for charges that we believed to be incorrect based on our
agreements with Sprint. We review all charges from Sprint and dispute charges if
appropriate based upon our interpretation of our agreements with Sprint PCS.
When Sprint does not notify us timely of charges that we have incurred, we
record estimates primarily based on our historical trends and our estimate of
the amount due to Sprint. Amounts in dispute with Sprint have been fully
reserved or otherwise provided for.
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 our 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.
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.
Valuation and Recoverability of Long-Lived Assets
Long-lived assets such as property and equipment represent approximately 57% of
the Company's total assets as of June 30, 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. The 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
For the quarter ended June 30, 2004 compared to the quarter ended June 30, 2003:
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.
-19-
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 generally 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.
For the Quarters Ended June 30,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- ----------------- ------------
(Dollars in thousands)
Service revenue $ 65,037 $ 64,936 $ 101 0.2%
Roaming revenue 17,389 15,764 1,625 10.3%
Equipment revenue 3,612 2,486 1,126 45.3%
----------------- ---------------- --------------
Total $ 86,038 $ 83,186 $ 2,852 3.4%
================= ================ ==============
Service Revenue
The slight increase in service revenue for the quarter ended June 30, 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, substantially offset by higher customer care and promotional
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. As a
result, the number of minutes-over-plan charged to subscribers for plan overages
used and associated revenues have decreased while the number of minutes used for
PCS to PCS calls has increased significantly as compared to periods prior to
adoption of this program.
Roaming Revenue
The increase in roaming revenue for the quarter ended June 30, 2004 over the
same quarter of the previous year is attributable to an increase of $8.8 million
resulting from higher inbound roaming traffic, partially offset by a decrease of
$7.2 million as a result of a decrease in the reciprocal roaming rate. 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. For the quarter ended June 30, 2004, the Company's roaming revenue from
Sprint and its PCS network partners was $16.7 million or 96% compared to $14.6
million or 92% of total roaming revenue for the quarter ended June 30, 2003.
Equipment Revenue
Equipment revenue for the quarter ended June 30, 2004 increased over the same
quarter of the previous year, primarily due to increased handset sales of $3.7
million or an 82% increase prior to rebates and promotion costs, offset by a
$2.6 million increase in handset rebates and promotions. The increase in handset
sales is comprised of a $3.0 million increase in sales of handsets to existing
subscribers, a $0.6 million increase in sales to new subscribers and a $0.1
million increase in accessory sales.
Cost of Service and Roaming
Cost of service and roaming principally consists of costs to support the
Company's subscriber base including:
o Cost of roaming;
o Network operating costs (including salaries, cell site lease payments, fees
related to the connection of the Company's switches to the cell sites that
they support, inter-connect fees and other expenses related to network
operations);
o Bad debt expense related to estimated uncollectible accounts receivable;
o Other cost of service, which includes:
-20-
o Back office services provided by Sprint such as customer care, billing and
activation;
o The 8% of collected service revenue representing the Sprint affiliation
fee;
o Long distance expense relating to inbound roaming revenue and the Company's
own subscriber's long distance usage and roaming expense when subscribers
from the Company's territory place calls on Sprint's or its network
partners' networks; and
o Wireless handset subsidies on existing subscriber purchases of handsets
through national third-party retailers.
For the Quarters Ended June 30,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- ----------------- ------------
(Dollars in thousands)
Cost of roaming $ 12,981 $ 12,123 $ 858 7.1%
Network operating costs 15,782 14,606 1,176 8.1%
Bad debt expense 165 1,570 (1,405) (89.5%)
Other cost of service 14,350 17,741 (3,391) (19.1%)
----------------- ---------------- --------------
Total cost of service and roaming $ 43,278 $ 46,040 $ (2,762) (6.0%)
================= ================ ==============
Cost of Roaming
The increase in cost of roaming for the quarter ended June 30, 2004 compared to
the same quarter of the previous year is attributable to an increase of $6.2
million resulting from higher outbound roaming traffic, partially offset by a
decrease of $5.3 million as a result of a decrease in the reciprocal roaming
rate (see roaming revenue above). The Company's cost of roaming attributable to
Sprint and its network partners was $12.4 million and $11.5 million or 95% of
the total cost of roaming for both quarters ended June 30, 2004 and 2003.
Network Operating Costs
Network operating costs increased for the quarter ended June 30, 2004 compared
to the same quarter of the previous year primarily due to increased network
costs resulting from a 28% increase in network usage and increased interconnect
charges and higher feature costs.
Bad Debt Expense
Bad debt expense decreased for the quarter ended June 30, 2004 compared to the
same quarter of the previous year. During the quarter ended June 30, 2004, the
Company recorded a $0.3 million reduction to bad debt expense related to
significantly past due accounts receivable which were previously written off by
Sprint. In addition, we believe the improvements in the credit quality and
payment profile of our subscriber base since we re-imposed deposits for
sub-prime credit subscribers in early 2002 and the subsequent increases in
February 2003 resulted in significant improvements in accounts receivable
write-off experience, increased collections, and the associated decrease in bad
debt expense for the quarter. On April 6, 2004, the Company reduced or
eliminated the deposit requirement for certain subscribers in selected market
areas. As of June 30, 2004, the Company has not experienced a significant
increase in delinquent customers. While we will continue to review our customer
performance and modify our credit policy to meet short-term and long-term
business objectives and closely monitor the impact of sub-prime customers, we
are not certain what impact in the future the change in credit policy will have
on our financial results.
Other Cost of Service
Other cost of service decreased for the quarter ended June 30, 2004 compared to
the same quarter of the previous year as a result of a rate reduction in the
fees paid to Sprint for back office services provided lower subsidies and lower
customer loyalty retention costs.
-21-
Cost of Equipment, Other Operating Expenses and Interest
For the Quarters Ended June 30,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- ----------------- ------------
(Dollars in thousands)
Cost of equipment $ 6,670 $ 4,969 1,701 34.2%
Selling and marketing expense 10,890 12,703 (1,813) (14.3%)
General and administrative expense 4,970 5,401 (431) (8.0%)
Depreciation and amortization of property and equipment 12,015 11,588 427 3.7%
Loss (gain) on disposal of property
and equipment (2) - 2 NM
Interest income 188 38 150 394.7%
Interest expense 6,230 10,770 (4,540) (42.2%)
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 June 30, 2004 compared to the same quarter of the previous
year primarily as a result of increased retail handset sales to existing
subscribers, partially offset by slightly lower 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 decreased for the quarter ended June 30, 2004 compared to the same
quarter of the previous year as a result of staff reductions and store closings
implemented in fiscal 2003 and lower estimated commission payments, offset by
increased advertising and promotional expense.
General and Administrative Expense
General and administrative expense decreased for the quarter ended June 30, 2004
compared to the same quarter of the previous year, as a result of decreased use
of outside consulting services.
Depreciation and Amortization of Property and Equipment
The Company capitalizes network development costs incurred to ready its network
for use and costs for leasehold improvements to our retail stores and office
space. Depreciation of these costs begins when the equipment is ready for its
intended use and is amortized over the estimated useful life of the asset.
Depreciation expense increased for the quarter ended June 30, 2004 compared to
the same quarter of the previous year primarily as a result of increased capital
spending over the comparable quarter in fiscal year 2003 and prior quarters. The
Company purchased $4.4 million of property and equipment in the quarter ended
June 30, 2004, compared to property and equipment purchases of $3.7 million in
the quarter ended June 30, 2003.
Interest Expense
Interest expense decreased for the quarter ended June 30, 2004 compared to the
same quarter of the previous year as a result of lower outstanding debt
balances. As a result of the debt restructuring, our outstanding notes were
reduced from $300.0 million to $159.0 million in New Notes and $1.7 million in
Old Notes and our interest rate on the New Notes is 9 3/8% compared to 13.5% on
the Old Notes. Additionally, the outstanding balance on the credit facility is
$134.5 million with a weighted average rate of 5.02% at June 30, 2004 compared
to $143.0 million with a weighted average rate of 5.14% at June 30, 2003.
Income Tax
No income tax benefit on continuing operations was recorded for the quarters
ended June 30, 2004 and 2003, as it was not more likely than not that the income
tax benefit would be realized.
-22-
Income (Loss) from Continuing Operations
For the quarter ended June 30, 2004, income from continuing operations was $2.2
million compared to a loss from continuing operations of $8.2 million for the
same quarter of the previous year. The improvement is primarily the result of
higher roaming revenue, lower cost of service and roaming, lower selling and
marketing expense and lower interest expense.
For the nine months ended June 30, 2004 compared to the nine months ended June
30, 2003:
For the Nine Months Ended June 30,
-----------------------------------------------------------------------
Increase Increase
2004 2003 (Decrease)$ (Decrease)%
----------------- ---------------- ---------------- -------------
(Dollars in thousands)