UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended June 30, 2003

 

OR

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

 

 

For the transition period from                      to                      .

 

Commission file number:  000-29633

 

NEXTEL PARTNERS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

91-1930918

(State or Other Jurisdiction of
Incorporation or Organization)

 

(I.R.S. Employer
Identification No.)

 

 

 

4500 Carillon Point
Kirkland, Washington 98033
(425) 576-3600

(Address of principal executive offices, zip code and 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 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 ý No o.

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Title of Class

 

Number of Shares Outstanding on July 31, 2003

Class A Common Stock

 

172,321,329

Class B Common Stock

 

79,056,228

 

 



 

NEXTEL PARTNERS, INC.

 

INDEX

 

PART I

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Consolidated Condensed Balance Sheets
As of June 30, 2003 and December 31, 2002

 

 

 

 

 

Consolidated Condensed Statements of Operations
Three and six months ended June 30, 2003 and 2002

 

 

 

 

 

Consolidated Condensed Statements of Cash Flows
Six months ended June 30, 2003 and 2002

 

 

 

 

 

Notes to Consolidated Condensed Financial Statements

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

 

 

 

 

Item 4.

Controls and Procedures

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

 

 

 

 

Item 2.

Changes in Securities and Use of Proceeds

 

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

 

 

 

 

Item 6.

Exhibits and Reports on Form 8-K

 

 

 

 

 

Signatures

 

2



 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

NEXTEL PARTNERS, INC. AND SUBSIDIARIES
Consolidated Condensed Balance Sheets
(dollars in thousands, except per share amounts)

(unaudited)

 

 

 

June 30,
2003

 

December 31,
2002

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

 

$

72,428

 

$

67,522

 

Short-term investments

 

135,395

 

127,507

 

Accounts receivable, net of allowance $12,349 and $10,197, respectively

 

134,999

 

130,459

 

Subscriber equipment inventory

 

15,820

 

16,413

 

Receivable from officer

 

 

2,200

 

Other current assets

 

18,738

 

13,393

 

Total current assets

 

377,380

 

357,494

 

 

 

 

 

 

 

PROPERTY, PLANT AND EQUIPMENT, at cost

 

1,310,265

 

1,222,183

 

Less — accumulated depreciation and amortization

 

(286,712

)

(222,107

)

Property, plant and equipment, net

 

1,023,553

 

1,000,076

 

 

 

 

 

 

 

OTHER NON-CURRENT ASSETS:

 

 

 

 

 

FCC licenses, net of accumulated amortization of $8,744

 

368,958

 

348,440

 

Debt issuance costs, net of accumulated amortization of $15,858 and $13,527, respectively

 

33,888

 

29,915

 

Total non-current assets

 

402,846

 

378,355

 

 

 

 

 

 

 

TOTAL ASSETS

 

$

1,803,779

 

$

1,735,925

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Accounts payable

 

$

45,735

 

$

57,374

 

Accrued expenses and other current liabilities

 

84,078

 

80,502

 

Due to Nextel WIP

 

5,273

 

23,691

 

Total current liabilities

 

135,086

 

161,567

 

 

 

 

 

 

 

LONG-TERM OBLIGATIONS:

 

 

 

 

 

Credit facility — term B, C and D

 

371,438

 

373,312

 

14% Senior discount notes due 2009

 

21,312

 

425,861

 

11% Senior notes due 2010

 

390,000

 

390,000

 

12 1/2% Senior notes due 2009

 

212,187

 

211,572

 

1 1/2% Convertible Senior notes due 2008

 

175,000

 

 

8 1/8% Senior notes due 2011

 

450,000

 

 

Long-term capital lease obligation

 

22,611

 

23,855

 

Deferred income taxes

 

43,666

 

18,188

 

Other long-term liabilities

 

20,265

 

20,220

 

Total long-term obligations

 

1,706,479

 

1,463,008

 

 

 

 

 

 

 

Total liabilities

 

1,841,565

 

1,624,575

 

 

 

 

 

 

 

COMMITMENTS AND CONTINGENCIES (See Notes)

 

 

 

 

 

 

 

 

 

 

 

MANDATORILY REDEEMABLE PREFERRED STOCK, Series B Mandatorily redeemable 2010, par value $.001 per share, 12% cumulative annual dividend; 13,110,000 shares issued and outstanding

 

37,112

 

34,971

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY (DEFICIT):

 

 

 

 

 

Common stock, Class A, par value $.001 per share 172,204,369 and 170,797,589 shares, respectively, issued and outstanding, and paid-in capital

 

907,000

 

897,756

 

Common stock, Class B, par value $.001 per share convertible, 79,056,228 shares issued and outstanding, and paid-in capital

 

163,312

 

163,312

 

Accumulated deficit

 

(1,143,691

)

(983,444

)

Deferred compensation

 

(1,519

)

(1,245

)

Total stockholders’ equity (deficit)

 

(74,898

)

76,379

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

 

$

1,803,779

 

$

1,735,925

 

 

See accompanying notes to the consolidated condensed financial statements.

 

3



 

NEXTEL PARTNERS, INC. AND SUBSIDIARIES

Consolidated Condensed Statements of Operations

(dollars in thousands, except for per share amounts)

(unaudited)

 

 

 

For the three months ended
June 30,

 

For the six months ended
June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

REVENUES:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Service revenues (Received from Nextel WIP $26,917, $19,997, $49,866 and $35,349, respectively)

 

$

226,507

 

$

153,418

 

$

427,049

 

$

281,082

 

Equipment revenues

 

7,762

 

7,668

 

15,029

 

13,155

 

Total revenues

 

234,269

 

161,086

 

442,078

 

294,237

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of service revenues (excludes depreciation of $32,558, $23,531, $64,135 and $45,644, respectively)
(Paid to Nextel WIP $23,971, $21,160, $43,813 and $36,953, respectively.)

 

77,492

 

66,350

 

149,073

 

127,779

 

Cost of equipment revenues

 

23,333

 

23,637

 

44,935

 

43,170

 

Selling, general and administrative (paid to Nextel WIP $2,028, $1,248, $4,532 and $2,576, respectively)

 

98,734

 

76,846

 

187,369

 

146,916

 

Stock based compensation (primarily selling, general and administrative related)

 

218

 

2,865

 

481

 

5,756

 

Depreciation and amortization

 

33,488

 

23,532

 

65,994

 

45,647

 

Total operating expenses

 

233,265

 

193,230

 

447,852

 

369,268

 

INCOME (LOSS) FROM OPERATIONS

 

1,004

 

(32,144

)

(5,774

)

(75,031

)

Interest expense, net

 

(39,104

)

(42,158

)

(79,397

)

(80,157

)

Interest income

 

481

 

2,084

 

1,282

 

4,517

 

Loss on early retirement of debt

 

(68,082

)

 

(68,127

)

 

LOSS BEFORE DEFERRED INCOME TAX PROVISION

 

(105,701

)

(72,218

)

(152,016

)

(150,671

)

Deferred income tax provision

 

(3,216

)

(1,779

)

(6,090

)

(14,058

)

NET LOSS

 

(108,917

)

(73,997

)

(158,106

)

(164,729

)

Mandatorily redeemable preferred stock dividends

 

(1,092

)

(970

)

(2,141

)

(1,899

)

 

 

 

 

 

 

 

 

 

 

LOSS ATTRIBUTABLE TO COMMON STOCKHOLDERS

 

$

(110,009

)

$

(74,967

)

$

(160,247

)

$

(166,628

)

 

 

 

 

 

 

 

 

 

 

LOSS PER SHARE ATTRIBUTABLE TO COMMON STOCKHOLDERS, BASIC AND DILUTED:

 

$

(0.44

)

$

(0.31

)

$

(0.64

)

$

(0.68

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding, basic and diluted

 

250,959,915

 

244,374,968

 

250,718,365

 

244,244,960

 

 

See accompanying notes to the consolidated condensed financial statements.

 

4



 

NEXTEL PARTNERS, INC. AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows

(in thousands)

(unaudited)

 

 

 

For the Six Months Ended
June 30,

 

 

 

2003

 

2002

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(158,106

)

$

(164,729

)

Adjustments to reconcile net loss to net cash used in operating activities

 

 

 

 

 

Deferred income tax provision

 

6,090

 

14,058

 

Depreciation and amortization

 

65,994

 

45,647

 

Amortization of debt issuance costs

 

2,331

 

2,219

 

Interest accretion for senior discount notes

 

26,802

 

26,773

 

Bond discount amortization

 

616

 

504

 

Loss on retirement of debt

 

68,127

 

 

Fair value adjustments of derivative instruments

 

(1,406

)

595

 

Stock based compensation

 

481

 

5,756

 

Other

 

313

 

(198

)

Changes in current assets and liabilities:

 

 

 

 

 

Accounts receivable, net

 

(4,540

)

(24,756

)

Subscriber equipment inventory

 

593

 

(1,180

)

Other current and long-term assets

 

(3,497

)

(5,570

)

Accounts payable, accrued expenses and other current liabilities

 

(15,570

)

5,908

 

Operating advances due to (from) Nextel WIP

 

(8,887

)

1,184

 

Net cash used in operating activities

 

(20,659

)

(93,789

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Capital expenditures

 

(84,824

)

(148,054

)

FCC licenses

 

(13,607

)

(34,416

)

Proceeds (purchases) from sale and maturities of short-term investments, net

 

(7,888

)

32,432

 

Net cash used in investing activities

 

(106,319

)

(150,038

)

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from borrowings

 

625,000

 

50,000

 

Stock options exercised

 

246

 

435

 

Proceeds from stock issued for employee stock purchase plan

 

847

 

929

 

Proceeds from sale lease-back transactions

 

6,250

 

1,848

 

Debt repayments

 

(486,497

)

 

Capital lease payment

 

(1,114

)

 

Equity issuance costs

 

 

(5

)

Debt issuance costs

 

(12,848

)

(1,480

)

Net cash provided by financing activities

 

131,884

 

51,727

 

 

 

 

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

4,906

 

(192,100

)

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, beginning of period

 

67,522

 

304,359

 

 

 

 

 

 

 

CASH AND CASH EQUIVALENTS, end of period

 

$

72,428

 

$

112,259

 

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS

 

 

 

 

 

Cash paid for taxes

 

$

 

$

 

Capitalized interest on accretion of senior discount notes

 

$

373

 

$

612

 

Accretion of mandatorily redeemable preferred stock dividends

 

$

2,141

 

$

1,899

 

Retirement of long-term debt with common stock

 

$

6,973

 

$

 

CASH PAID FOR INTEREST, net of capitalized amount

 

$

51,359

 

$

48,105

 

 

See accompanying notes to the consolidated condensed financial statements.

 

5



 

NEXTEL PARTNERS, INC. AND SUBSIDIARIES

 

Notes to Consolidated Condensed Financial Statements

 

June 30, 2003

 

(unaudited)

 

1.  BASIS OF PRESENTATION

 

Our interim consolidated condensed financial statements for the three- and six-month periods ended June 30, 2003 and 2002 have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission for interim financial reporting.  Certain information and footnote disclosures normally included in the annual financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations for interim financial statements.  These consolidated condensed financial statements should be read in conjunction with the audited consolidated financial statements and notes contained in our annual report on Form 10-K for the year ended December 31, 2002 and our subsequent quarterly report on Form 10-Q for the quarter ended March 31, 2003 filed with the Securities and Exchange Commission.

 

The financial information included herein reflects all adjustments (consisting only of normal recurring adjustments and accruals), which are, in the opinion of management, necessary for the fair presentation of the results of the interim periods.  The results of operations for the three- and six-month periods ended June 30, 2003 are not necessarily indicative of the results to be expected for the full year ending December 31, 2003.

 

2.  OPERATIONS

 

Description of Business

 

Nextel Partners  provides a wide array of digital wireless communications services throughout the United States, primarily to business users, utilizing frequencies licensed by the FCC. Our operations are primarily conducted by Nextel Partners Operating Corporation (“OPCO”), our wholly owned subsidiary.  Substantially all of our assets, liabilities, operating losses and cash flows are within OPCO and our other wholly owned subsidiaries.

 

Our digital network (“Nextel Digital Mobile Network”) has been developed with advanced mobile communication systems employing digital technology developed by Motorola, Inc. (such technology is referred to as the “integrated Digital Enhanced Network” or “iDEN”) with a multi-site configuration permitting frequency reuse. Our principal business objective is to offer high-capacity, high-quality, advanced communication services in our territories throughout the United States targeted towards mid-sized and tertiary markets. Various operating agreements entered into by our subsidiaries and Nextel WIP Corp. (“Nextel WIP”), an indirect wholly owned subsidiary of Nextel Communications, Inc. (“Nextel”), govern the support services to be provided by Nextel WIP (see Note 7).

 

3.  SIGNIFICANT ACCOUNTING POLICIES

 

Concentration of Risk

 

We believe that the geographic and industry diversity of our customer base minimizes the risk of incurring material losses due to concentration of credit risk.

 

We are a party to certain equipment purchase agreements with Motorola (see Note 7). For the foreseeable future we expect that we will need to rely on Motorola for the manufacture of a substantial portion of the infrastructure equipment necessary to construct and make operational our digital mobile network as well as for the provision of digital mobile telephone handsets and accessories.

 

As previously discussed, we are reliant on Nextel WIP for the provision of certain services. For the foreseeable future, we will need to rely on Nextel WIP for the provision of these services, as we will not have the infrastructure to support those services.

 

6



 

In addition, if Nextel encounters financial or operating difficulties relating to its portion of the Nextel Digital Mobile Network, or experiences a significant decline in customer acceptance of services and products, our business may be adversely affected, including the quality of our services, the ability of our customers to roam within the entire network and our ability to attract and retain customers.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

 

Principles of Consolidation

 

The consolidated condensed financial statements include our accounts and those of our wholly owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.

 

Net Loss per Share

 

In accordance with SFAS No. 128, “Computation of Earnings Per Share,” basic earnings per share is computed by dividing loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period, reduced by the weighted average number of common shares subject to repurchase. Diluted earnings per share is computed by dividing loss attributable to common stockholders by the weighted average number of common and dilutive common equivalent shares outstanding during the period. Common equivalent shares consist of shares of common stock issuable upon the conversion of the redeemable preferred stock and senior convertible notes (using the if-converted method) and shares issuable upon the exercise of stock options  (using the treasury stock method).  As presented, basic and diluted loss per share are equal since common equivalent shares are excluded from the calculation of diluted earnings per share as their effects are antidilutive due to our net losses.

 

At June 30, 2003 approximately 13.1 million shares of redeemable preferred stock and 23.1 million shares issuable upon the assumed conversion of our 1½ % senior convertible notes could potentially dilute earnings per share in the future but were excluded from the calculation of diluted earnings per common share due to their antidilutive effects.  Additionally, at June 30, 2003 and 2002, approximately 180,000 and 544,770 shares of restricted stock, respectively, and 19.2 million and 14.7 million stock options outstanding, respectively, were excluded from the calculation of common equivalent shares, as their effects are antidilutive.

 

7



 

The following schedule is our net loss per share calculation for the three and six months ended June 30, 2003 and 2002:

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(dollars in thousands, except per share amounts)

 

Loss attributable to common stockholders (numerator for Basic and diluted)

 

$

(110,009

)

$

(74,967

)

$

(160,247

)

$

(166,628

)

 

 

 

 

 

 

 

 

 

 

Gross weighted average common shares outstanding (denominator for basic and diluted)

 

251,139,915

 

244,919,738

 

250,898,365

 

244,789,730

 

Less:

 

 

 

 

 

 

 

 

 

Weighted average shares subject to repurchase

 

(180,000

)

(544,770

)

(180,000

)

(544,770

)

Shares used in computation

 

250,959,915

 

244,374,968

 

250,718,365

 

244,244,960

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share

 

$

(0.44

)

$

(0.31

)

$

(0.64

)

$

(0.68

)

 

Short-term Investments

 

Marketable debt securities with original purchase maturities greater than three months are classified as short-term investments. Short-term investments at June 30, 2003 and 2002 consisted of U.S. Treasuries, mortgage-backed securities, and commercial paper. We classify our debt securities as trading securities because the securities are bought and held principally for the purpose of selling them in the near term. Trading securities are recorded at fair value. Unrealized holding gains and losses on trading securities are included in earnings.

 

Sale-Leaseback Transactions

 

We periodically enter into transactions whereby we transfer specified switching equipment and telecommunication towers and related assets to third parties, and subsequently lease all or a portion of these assets from these parties. During the three months ended June 30, 2003 and 2002 we received cash proceeds of approximately $5.4 million and $785,000, respectively, and for the six months ended June 30, 2003 and 2002 we received cash proceeds of approximately $6.3 million and $1.8 million, respectively, for assets sold to third parties.  No gains were recognized on these transactions.

 

FCC Licenses and Adoption of SFAS 142

 

On January 1, 2002 we implemented SFAS No. 142, “Goodwill and Other Intangible Assets.” SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed at least annually for impairment and written down as a charge to results of operations only in the periods in which the recorded value of goodwill and certain intangibles exceeds fair value. We have determined that FCC licenses have indefinite lives; therefore, as of January 1, 2002, we no longer amortize the cost of these licenses. We performed asset impairment analyses on our FCC licenses as of January 1, 2002 for the adoption of SFAS No. 142 and our annual assessment during the fourth quarter of 2002. In both cases we determined there had been no impairment related to our FCC licenses.  For our impairment analysis, we used the aggregate of all our FCC licenses, which constitutes the footprint of our portion of the Nextel Digital Mobile Network, as the unit of accounting for our FCC licenses based on the guidance in Emerging Issues Task Force, or EITF, Issue No. 02-7, “Unit of Accounting for Testing Impairment Indefinite-Lived Intangible Assets.”

 

As a result of adopting SFAS No. 142, we are now required to record a non-cash income tax provision. This charge is required because we have significant deferred tax liabilities related to FCC licenses with a lower tax than book basis as a result of accelerated and continued amortization of FCC licenses for tax purposes. Historically, we did not need a valuation allowance for the portion of our net operating loss equal to the amount of license amortization expected to occur during the carry forward period of our net operating loss.  Since we ceased amortizing licenses for financial statement purposes on January 1, 2002, we can no longer estimate the amount, if any, of deferred tax liabilities related to our FCC licenses which will reverse during the net operating

 

8



 

loss carry forward period.  Accordingly, we increased the valuation allowance upon the adoption of SFAS No. 142 to $12.3 million and continue to increase the valuation allowance as the deferred tax liabilities related to FCC licenses increase. During the three and six month periods ended June 30, 2003, we recorded a deferred income tax provision of $3.2 million and $6.1 million, respectively,  relating to our FCC licenses.

 

Interest Rate Risk Management

 

We use derivative financial instruments consisting of interest rate swap and interest rate protection agreements in the management of our interest rate exposures.

 

On January 1, 2001, we adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), as amended by SFAS No. 138.  These statements establish accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at fair value.  The interest rate swap agreements are included in other long-term liabilities on the balance sheet.  For the three months ended June 30, 2003 and 2002, we recorded a non-cash, non-operating gain of $796,000 and a charge of $2.0 million, respectively, related to the change in market value of the interest rate swap agreements in interest expense, and for the six months ended June 30, 2003 and 2002, we recorded a non-cash, non-operating gain of $1.4 million and a charge of $595,000, respectively.

 

We will not use financial instruments for trading or other speculative purposes, nor are we a party to any leveraged derivative instrument. The use of derivative financial instruments is monitored through regular communication with senior management. We will be exposed to credit loss in the event of nonperformance by the counterparties. This credit risk is minimized by dealing with a group of major financial institutions with which we have other financial relationships. We do not anticipate nonperformance by these counterparties.

 

Revenue Recognition

 

Service revenue, net of customer discounts and adjustments, is recognized for airtime and other services over the period earned.  We recognize revenue for phone equipment on a straight-line basis over the expected customer relationship, starting when the customer takes title.  As required by Staff Accounting Bulletin 101 (SAB No. 101), “Revenue Recognition in Financial Statements,” our activation fees and phone equipment revenues are deferred and recognized over three years.  The decision to defer these revenues is based on the conclusion that while the service contract and the phone equipment revenues are a multiple element arrangement, the elements of the arrangement should not be accounted for separately. The key factor in our conclusion is that our wireless service is essential to the functionality of the phone, due to the fact that our phones, which have a unique “push to talk” feature, can only be used on our digital network. Concurrently, the related costs for the phone equipment are deferred solely to the extent of deferred revenues. The direct and incremental equipment costs in excess of revenues generated from phone equipment sales are expensed. Subsequent to the initial deferral, the amortization of deferred revenue is equal to the amortization of the deferred costs, resulting in no change to income (loss) from operations or net loss. For the three months ended June 30, 2003 and 2002, we recognized $7.8 million and $5.2 million, respectively, and $15.0 million and $9.6 million for the six months end June 30, 2003 and 2002, respectively, of activation fees and phone equipment revenues and equipment costs that had been previously deferred.

 

Reclassifications

 

Certain amounts in prior years’ financial statements have been reclassified to conform to the current year presentation.

 

Long-Lived Assets

 

Our long-lived assets consist principally of property, plant and equipment.  It is our policy to assess impairment of long-lived assets pursuant to SFAS No.144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”  This includes determining if certain triggering events have occurred, including significant decreases in the market value of certain assets, significant changes in the manner in which an asset is used, significant changes in the legal climate or business climate that could affect the value of an asset, or current period or continuing operating or cash flow losses or projections that demonstrate continuing losses associated with certain assets used for the purpose of producing revenue that might be an indicator of impairment.  When we perform the SFAS 144 impairment tests, we identify the appropriate asset group to be our network system, which includes the grouping of all our assets required to operate our portion of the Nextel Digital Mobile Network and provide service to our customers.  We based this conclusion of asset grouping on the revenue dependency, operating interdependency and shared costs to operate our network.  Thus far, we believe none of the above factors has occurred and therefore have not recorded any impairment charges.

 

9



 

Stock-Based Compensation

 

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.”  This statement amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. We continue to apply the intrinsic value method for stock-based compensation to employees prescribed by Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees” and have provided the disclosures required by SFAS No. 148.

 

As required by SFAS No. 148, had compensation cost been determined based upon the fair value of the awards granted during second quarter 2003 and 2002, our net loss and basic and diluted loss per share would have increased to the pro forma amounts indicated below:

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(in thousands, except per share amounts)

 

Net loss, as reported

 

$

(108,917

)

$

(73,997

)

$

(158,106

)

$

(164,729

)

Add:  stock-based employee compensation expense included in reported net income

 

218

 

2,865

 

481

 

5,756

 

Deduct:  total stock-based employee compensation expense determined under fair-value-based method for all awards

 

(6,428

)

(8,742

)

(13,443

)

(17,534

)

Pro forma net loss

 

$

(115,127

)

$

(79,874

)

$

(171,068

)

$

(176,507

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted loss per share

 

 

 

 

 

 

 

 

 

As reported

 

$

(0.44

)

$

(0.31

)

$

(0.64

)

$

(0.68

)

Pro forma

 

$

(0.46

)

$

(0.33

)

$

(0.69

)

$

(0.73

)

 

 

 

 

 

 

 

 

 

 

Weighted average fair value per share of options granted

 

$

3.81

 

$

.3.32

 

$

4.58

 

$

5.56

 

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model as prescribed by SFAS No. 148 using the following assumptions:

 

Expected stock price volatility

 

80%

Risk-free interest rate

 

3.8%

Expected life in years

 

6 years

Expected dividend yield

 

0.00%

 

The Black-Scholes option-pricing model requires the input of subjective assumptions and does not necessarily provide a reliable measure of fair value.

 

Asset Retirement Obligations

 

During 2003, we adopted SFAS No. 143, “Accounting for Asset Retirement Obligations” (“SFAS No. 143”), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement obligations (“ARO”).  Under the scope of this pronouncement, we have ARO associated with removal of equipment from cell sites and towers that we lease from third parties.  Adoption of SFAS No. 143 did not materially impact our financial position or results of operation.

 

Recently Issued Accounting Pronouncements

 

In November 2002, the EITF issued a final consensus on Issue 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.”  Issue 00-21 provides guidance on how and when to recognize revenues on arrangements requiring delivery of more than one product or service.  Issue 00-21 is effective prospectively for arrangements entered into during fiscal periods beginning after June 15, 2003.  Companies may also elect to apply the provisions of Issue 00-21 to existing arrangements and record the income statement impact as a cumulative effect of a change in accounting principle.

 

Under the provisions of Staff Accounting  Bulletin, or SAB, No. 101, “Revenue Recognition in  Financial Statements,” we accounted for the sale of our phone equipent and the subsequent service to the customer as a single unit of accounting due to the fact that our wireless service is essential to the functionality of our phones. Accordingly, we recognized revenue from the phone

 

10



 

equipment sales and an equal amount of the cost of phone equipment revenues over the expected customer relationship period, when title to the phone passed to the customer. Under  EITF Issue No. 00-21, we no longer need to consider whether a customer is able to realize utility from the phone in the  absence of the undelivered service. Based on this fact and the fact that we meet the criteria stipulated in EITF Issue No. 00-21, we  have concluded that EITF Issue No. 00-21 requires us to account for the sale of a phone as a unit of accounting separate from the subsequent service to the customer.  Accordingly, we will recognize revenue from phone equipment sales and the related cost of phone equipment revenues when title to the  phone equipment passes to the customer for all arrangements entered into beginning in the third quarter 2003.

 

We adopted EITF Issue 00-21 on July 1, 2003  and elected to apply the provisions to our existing customer  arrangements. The cumulative effect of adopting EITF 00-21 did not  materially impact the statement of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidated of Variable Interest Entities, an Interpretation of ARB No. 51.”  This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation.  The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003.  The application of this Interpretation is not expected to have a material effect on our financial statements.  The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that we would consolidate or disclose information about variable interest entities when the Interpretation becomes effective.  We do not believe that we have any existing variable interest entities that will require consolidation.

 

In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  This statement establishes standards for how an issuer classifies and measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer.  This statement is effective for all freestanding financial instruments entered into or modified after May 31, 2003; otherwise it is effective at the beginning of the first interim period beginning after June 15, 2003.  We have identified that our mandatorily redeemable preferred stock is within the scope of this statement and will be reclassified to long-term debt and the mandatorily redeemable preferred stock dividends will be recorded as interest expense beginning July 1, 2003.

 

4.  PROPERTY, PLANT AND EQUIPMENT

 

 

 

June 30,
2003

 

December 31,
2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Building and improvements

 

$

7,807

 

$

7,101

 

Equipment

 

1,092,566

 

1,016,492

 

Furniture and Fixtures

 

95,170

 

85,345

 

 

 

 

 

 

 

Less:  accumulated depreciation and amortization

 

(286,712

)

(222,107

)

 

 

 

 

 

 

Subtotal

 

908,831

 

886,831

 

 

 

 

 

 

 

Construction in progress

 

114,722

 

113,245

 

 

 

 

 

 

 

Total property and equipment

 

$

1,023,553

 

$

1,000,076

 

 

5.  NON-CURRENT PORTION OF LONG-TERM DEBT

 

 

 

June 31,
2003

 

December 31,
2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

 

 

Bank Credit Facility — Term B Loan, interest at our option, calculated on Administrative Agent’s alternate base rate or reserve adjusted London Interbank Offered Rate (“LIBOR”)

 

$

173,250

 

$

173,687

 

Bank Credit Facility — Term C Loan, interest at our option, calculated on Administrative Agent’s alternate base rate or reserve adjusted LIBOR

 

148,188

 

149,625

 

Bank Credit Facility — Term D Loan, interest at our option, calculated on Administrative Agent’s alternate base rate or reserve adjusted LIBOR

 

50,000

 

50,000

 

14% Senior Redeemable Discount Notes due 2009, net of unamortized discount of $1.8 million at June 30, 2003 and $67.1 million at December 31, 2002

 

21,312

 

425,861

 

11% Senior Notes due 2010, interest payable semi-annually in cash and in arrears

 

390,000

 

390,000

 

12½% Senior Notes due 2009, net of $12.8 million and $13.4 million discount at June 30, 2003 and December 31, 2002, respectively, interest payable semi-annually in cash and in arrears

 

212,187

 

211,572

 

1½% Convertible Senior Notes due 2008, interest payable semi-annually in cash and in arrears

 

175,000

 

 

81/8% Senior Notes due 2011, interest payable semi-annually in cash and in arrears

 

450,000

 

 

Capital lease obligations

 

22,611

 

23,855

 

 

 

 

 

 

 

Total long-term debt

 

$

1,642,548

 

$

1,424,600

 

 

11



 

Our outstanding senior unsecured notes contain certain covenants that limit, among other things, our ability to: (i) pay dividends, redeem capital stock or make certain other restricted payments or investments, (ii) incur additional indebtedness or issue preferred equity interests, (iii) merge, consolidate or sell all or substantially all of our assets, (iv) create liens on assets and (v) enter into certain transactions with affiliates or related persons. As of June 30, 2003, we were in compliance with all of our required covenants.

 

Our Term Loans contain financial covenants requiring us to maintain (i) certain defined ratios of senior debt and total debt to EBITDA as defined in our credit facility, (ii) a minimum interest coverage ratio, (iii) a minimum fixed charge coverage ratio, (iv) a maximum leverage ratio and (v) minimum service revenues, subscriber units and covered population equivalents. As of June 30, 2003, we were in compliance with all of our required covenants.

 

14% Senior Redeemable Discount Notes

 

From May 13, 2003 through June 4, 2003, we purchased approximately $86.1 million (principal amount at maturity) of our 14% senior discount notes due 2009 for $87.9 million in open-market purchases, resulting in a loss of $9.6 million for early retirement of debt for the three months ended June 30, 2003.  The purchases were made with a portion of proceeds from our sale in May and June 2003 of the 1½% convertible senior notes.

 

On June 11, 2003, we commenced a tender offer and consent solicitation relating to all of our outstanding 14% senior discount notes.  The tender offer expired on July 10, 2003 and we received the consents necessary to amend the indenture governing the 14% senior discount notes to eliminate substantially all restrictive covenants and certain event of default provisions.  As of June 30, 2003, we had purchased approximately $375.8 million (principal amount at maturity) from the tender offer for our 14% senior discount notes for $398.1 million, resulting in a loss of approximately $51.7 million for early retirement of debt for the three months ended June 30, 2003.   The purchases were made with a portion of proceeds from our sale in June 2003 of the 81/8% senior notes.

 

The aggregate accreted value of the 14% senior discount notes outstanding as of June 30, 2003 will increase at a rate of 14%, compounded semi-annually, to a final accreted value equal to a principal amount of $23.1 million as of February 2004.  Thereafter, the 14% senior discount notes bear interest at a rate of 14% per annum payable semi-annually in cash in arrears, with the interest payments payable from August 1, 2004 through February 2009 when the 14% senior discount notes mature and become due.

 

1½% Convertible Senior Notes

 

In May and June 2003, we issued an aggregate principal amount of $175.0 million of 1½% convertible senior notes due November 15, 2008 in private placements.  The 1½% senior convertible notes are convertible into shares of our Class A common stock at a conversion rate of 131.9087 shares per $1,000 principal amount of notes, or $7.58 per share subject to adjustment. Interest will accrue at the rate of 1½% per annum, which interest is to be paid semi-annually on May 15 and November 15 of each year, commencing November 15, 2003.  We subsequently filed a registration statement with the SEC to register the resale of the 1½% senior convertible notes and the shares of our Class A common stock into which the 1½% senior convertible notes are convertible.

 

The 1½% senior convertible notes are senior unsecured debt and rank on parity with all of our other existing and future

 

12



 

senior unsecured debt and prior to all of our subordinated debt.  Neither we nor any of our subsidiaries are subject to any financial covenants under the indenture governing the 1½% senior convertible notes.  In addition, neither we nor any of our subsidiaries are restricted under the indenture governing the 1½% senior convertible notes from paying dividends, incurring debt, or issuing or repurchasing our securities.  We may not redeem the notes in whole or in part at our option prior to maturity.  In the event of a fundamental change as defined in the indenture relating to the 1½% senior convertible notes, each holder of 1½% senior convertible notes will have the right to require us to repurchase all or part of such holder’s 1½% senior convertible notes at a price equal to 100% of the aggregate principal amount of the 1½% senior convertible notes repurchased, plus accrued and unpaid interest on the 1½% senior convertible notes repurchased to the date of repurchase.

 

81/8% Senior Notes

 

On June 23, 2003, we issued $450.0 million of 81/8% senior notes due July 1, 2011 in a private placement.  We intend to exchange all of the 81/8% senior notes for registered notes having the same financial terms and covenants as the privately placed notes.  Interest will accrue at the rate of 81/8% per annum, payable semi-annually on January 1 and July 1 of each year, commencing on January 1, 2004.  The proceeds from this offering were used primarily to fund the purchase of the 14% senior discount notes in our tender offer.

 

The 81/8% senior notes represent our senior unsecured obligations, and rank equally in right of payment to all existing and future senior unsecured obligations including our existing senior notes, and will rank senior in right of payment to all existing and future subordinated obligations.

 

We may redeem the 81/8% senior notes, in whole or in part, at any time on or after July 1, 2007.  If we choose this optional redemption, we are required to redeem the 81/8% senior notes at the redemption prices (expressed as percentages of principal amount) set forth below, plus an amount in cash equal to all accrued and unpaid interest and liquidated damages, if any, to the redemption date, if redeemed during the twelve-month period beginning on July 1 of each of the years set forth below.

 

Year

 

Percentage

 

2007

 

104.063

%

2008

 

102.031

%

2009 and thereafter

 

100.000

%

 

Prior to July 1, 2006, we may redeem up to 35% of the aggregate principal amount of notes issued under the indenture at a redemption price of 108.125% of the principal amount of the notes redeemed, plus accrued and unpaid interest and additional interest, if any, to the redemption date with the net cash proceeds of one or more public equity offerings; provided that at least 65% of the notes issued remain outstanding immediately after the occurrence of such redemption and the redemption occurs within 60 days of such sale.

 

The 81/8% senior notes contain certain restrictions that limit our and our subsidiaries’ ability to (i) incur additional debt, (ii) pay dividends, acquire our shares, make certain investments or redeem outstanding debt which is subordinate in right of payment to the 81/8% senior notes, (iii) designate unrestricted subsidiaries, (iv) enter into transactions with affiliates, (v) engage in any business other than telecommunications, (vi) create liens, (vii) pay dividends, make loans or advances to our subsidiaries or transfer any of our property or assets to our subsidiaries, (viii) issue or sell shares of capital stock of our subsidiaries; and (ix) sell assets.

 

6. COMMITMENTS AND CONTINGENCIES

 

Legal Proceedings

 

On December 5, 2001, a purported class action lawsuit was filed against us, two of our executive officers and four of the underwriters involved in our initial public offering. It was filed on behalf of all persons who acquired our common stock between February 22, 2000 and December 6, 2000 and initially named as defendants us, John Chapple, our President, Chief Executive Officer and Chairman of the Board, John D. Thompson, our Chief Financial Officer and Treasurer, and the underwriters involved in our initial public offering. Mr. Chapple and Mr. Thompson have been dismissed from the lawsuit without prejudice. The complaint seeks recessionary and/or compensatory damages. We dispute the allegations of the complaint that suggest any wrongdoing on our part or by our officers, and we intend to defend the action vigorously.

 

13



 

On June 8, 2001 a purported class action lawsuit was filed against Nextel Partners, Inc. as well as several other wireless carriers and manufacturers of wireless telephones. The complaint alleges that the defendants, among other things, manufactured and distributed wireless telephones that cause adverse health effects.  On or about March 5, 2003, the multi-district litigation (MDL) court granted the defendants’ consolidated motion to dismiss the plaintiffs’ claims on preemption grounds.  The plaintiffs have appealed the MDL court order.  We dispute the allegations of the complaint, will vigorously defend against the action, and intend to seek indemnification from the manufacturers of the wireless telephones if necessary.

 

On April 1, 2003, a purported class action lawsuit was filed in the District Court of Hidalgo County, Texas against us, Nextel Communications, and Nextel West Corp.  The lawsuit is captioned Rolando Prado vs. Nextel Communications, Nextel West Corp and Nextel Partners, Cause No. C-695-03-B.  On May 2, 2003, a purported class action lawsuit was filed in the Circuit Court of Shelby County for the Thirtieth Judicial District at Memphis, Tennessee against us, Nextel Communications and Nextel West Corp.  The lawsuit is captioned Steve Strange vs. Nextel Communications, Nextel West Corp. and Nextel Partners, Civil Action No. 01-002520-03.  On May 3, 2003, a purported class action lawsuit was filed in the Circuit Court of the Second Judicial Circuit in and for Leon County, Florida against us, Nextel and Nextel South Corp.  The lawsuit is captioned Christopher Freeman and Susan and Joseph Martelli vs. Nextel Communications, Nextel Partners Operating Corp. and Nextel South Corp., Case No. 03-CA1065.  These complaints allege that we falsely and deceptively increased our prices for wireless service.  Plaintiffs seek to enjoin such practices and seek a refund of monies paid by the class based on the alleged deception.  Plaintiffs also seek attorneys’ fees, expenses and, if permitted, punitive damages.  We believe the allegations are groundless and will vigorously defend against these actions.

 

We are subject to other claims and legal actions that may arise in the ordinary course of business. We do not believe that any of these other pending claims or legal actions or the items discussed above will have a material effect on our financial position or results of operations.

 

7.  RELATED PARTY TRANSACTIONS

 

Motorola Purchase Agreements

 

Pursuant to the equipment purchase agreements between us and Motorola, who currently holds approximately 5.2% of our outstanding common stock, Motorola provides the iDEN infrastructure and subscriber handset equipment to us throughout our markets.  We expect to continue to rely on Motorola for the manufacture of a substantial portion of our handset equipment as well as the equipment necessary to construct our portion of the Nextel Digital Mobile Network for the foreseeable future. The equipment purchase agreements govern our rights and obligations regarding purchases of handset equipment and system infrastructure equipment manufactured by Motorola and others.

 

For the three months ended June 30, 2003 and 2002, we purchased approximately $46.5 million and $54.3 million, respectively, and $90.5 million and $85.1 million for the six months ended June 30, 2003 and 2002, respectively, of infrastructure and other equipment, handsets, warranties and services from Motorola.

 

Nextel Operating Agreements

 

We, along with our operating subsidiary,  entered into a joint venture agreement dated January 29, 1999 with Nextel WIP, who currently holds approximately 31.5% of our outstanding common stock and with whom one of our directors is affiliated. The joint venture agreement, along with other operating agreements between Nextel WIP and us, defines the relationships, rights and obligations between the parties and governs the build-out and operation of our portion of the Nextel Digital Mobile Network and the transfer of licenses from Nextel WIP to us. Our roaming agreement with Nextel WIP provides that each party pays the other company’s monthly roaming fees in an amount based on the actual system minutes used by our respective customers when they are roaming on the other party’s network. For the three months ended June 30, 2003 and 2002 we earned approximately $26.9 million and $20.0 million, respectively, and for the six months ended June 30, 2003 and 2002 we earned approximately $49.9 million  and $35.3 million, respectively, from Nextel customers roaming on our system, which is included in our service revenues.

 

During the three months ended June 30, 2003 and 2002, recorded as part of cost of service revenues, we paid Nextel WIP $24.0 million and $21.2 million, respectively, and for the six months ended June 30, 2003 and 2002 we paid Nextel WIP $43.8 million and $37.0 million, respectively, for services such as specified telecommunications switching services, charges for our customers roaming on Nextel’s system and other support costs.

 

14



 

During the first half of 2003 Nextel continued to provide certain services to us for which we pay a fee based on their cost.  These services are limited to Nextel telemarketing and customer care, fulfillment, activations and billing for the national accounts. For the three months ended June 30, 2003 and 2002, we were charged approximately $996,000 and $736,000, respectively, and $2.2 million and $1.7 million for the six months ended the same periods, respectively, for these services.  Nextel WIP also provided us access to certain back office and information systems platforms on an ongoing basis. For the three months ended June 30, 2003 and 2002, we were charged approximately $1.0 million and $512,000, respectively, and $2.3 million and $837,000 for the six months ended June 30, 2003 and 2002, respectively, for these services. The costs for all of these services are included in selling, general and administrative expenses.

 

In the event of a termination of the joint venture agreement, Nextel WIP could, in certain circumstances, purchase or be forced to purchase all of our outstanding common stock. In such event, Nextel WIP, at its option, would be entitled to pay the purchase price therefor in cash or in shares of Nextel common stock.  The circumstances that could trigger these rights and obligations include, without limitation, termination of our operating agreements with Nextel WIP, a change of control of Nextel or a failure by us to make certain required changes to our business.

 

Business Relationship

 

In the ordinary course of business, we have engaged the services of and leased tower space from a company whose stockholder, president, chief executive officer and chairman of the board of directors is one of our directors.  For the three months ended June 30, 2003 and 2002, we paid this company $2.9 million and $2.3 million, respectively, and $5.2 million and $5.0 million for the six months ended June 30, 2003 and 2002, respectively, for these services and tower leases.

 

Donaldson, Lufkin & Jenrette Securities Corporation and Credit Suisse First Boston have served as initial purchasers of our senior notes and senior discount notes and received customary discounts and commissions in connection with each such offering. Donaldson, Lukfin & Jenrette Securities Corporation also acted as our financial advisor and as arranger, and DLJ Capital Funding, Inc., an affiliate of Donaldson, Lufkin & Jenrette Securities Corporation, acted as syndication agent, under our credit facility, and received customary fees and reimbursements in connection therewith. DLJ Merchant Banking and certain related parties, all of which are affiliates of Donaldson, Lufkin & Jenrette Securities Corporation, currently own approximately 11.4% of our outstanding common stock through their affiliate, Credit Suisse First Boston, and are represented on our board of directors. Donaldson, Lufkin & Jenrette Securities Corporation was a co-lead manager of the initial public offering of our Class A Common Stock, and we may from time to time enter into other investment banking relationships with it or one of our affiliates. The aggregate amount of all fees paid to the Credit Suisse and the DLJ Entities in connection with the capitalization transactions for both the three and six months ended June 30, 2003 and 2002 is approximately $4.5 million and $437,500, respectively.

 

Subsequent Events

 

From July 1, 2003 through July 11, 2003, we repurchased approximately $16.5 million (principal amount at maturity) of our 14% senior discount notes for cash.

 

On August 6, 2003 we closed a private placement of $125 million of 1½% senior convertible notes due 2008. The offering of these notes was made to qualified institutional buyers as defined in Rule 144A of the Securities Act.  At the option of the holders, the notes are convertible at an initial conversion rate of 78.3085 shares of our Class A common stock per $1,000 principal amount of notes, which represents a conversion price of $12.77 per share of Class A common stock.   Interest will accrue at the rate of 1½% per annum, payable semi-annually in arrears in cash on May 15 and November 15 of each year, commencing on November 15, 2003.  The proceeds from this offering will be used for general corporate purposes, including, but not limited to, general working capital and opportunistic repurchases of currently outstanding notes.

 

15



 

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

 

Some statements and information contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” are not historical facts but are forward-looking statements. For a discussion of these forward-looking statements and of important factors that could cause results to differ materially from the forward-looking statements, see “Forward-Looking Statements” and “Risk Factors” below.

 

Please read the following discussion together with our 2002 annual report on Form 10-K along with the Selected Consolidated Financial Data, the consolidated financial statements and the related notes included elsewhere in this report.

 

Overview

 

We provide digital mobile communications services using the Nextel brand name in mid-sized and tertiary markets throughout the United States. We offer digital cellular services; Direct Connect® (the long-range digital walkie-talkie service); wireless data services, including email; text messaging; and Nextel Online Services®, which provide wireless access to the Internet,  an organization’s internal databases and other applications. We hold licenses for wireless frequencies in markets where approximately 53 million people, or Pops, live and work. We have constructed and operate a digital mobile network compatible with the digital mobile network constructed and operated by Nextel Communications, Inc. (“Nextel”) in targeted portions of these markets, including 13 of the top 100 metropolitan statistical areas and 57 of the top 200 metropolitan statistical areas in the United States ranked by population. Our combined Nextel Digital Mobile Network constitutes one of the largest fully integrated digital wireless communications systems in the United States, currently covering 198 of the top 200 metropolitan statistical areas in the United States.

 

We offer a package of wireless voice and data services under the Nextel brand name targeted primarily to business users. We currently offer the following four services, fully integrated and accessible through a single wireless handset:

 

                  digital mobile telephone service, including advanced calling features such as speakerphone, conference calling, voicemail, call forwarding and additional line service;

 

                  Direct Connect, sometimes referred to as the long-range walkie-talkie feature, which allows customers to contact each other instantly on private one-to-one calls on a nationwide basis or on group calls involving up to 100 custmers in the same geographic region;

 

                  two-way messaging, which allows customers to receive and send short numeric and text messages from their handset; and

 

                  Internet services, marketed as Nextel Online Services, which provide customers with Internet-ready handsets access to the World Wide Web and web-based applications such as email, address books, calendars and advanced Java™ enabled business applications.

 

As of June 30, 2003, we had approximately 1,053,600 digital subscribers. Our subscriber base grew 52% compared to June 30, 2002, when we had an ending subscriber count of approximately 691,600.  Our network provides coverage to approximately 37 million Pops, which include the markets in Alabama, Arkansas, Florida, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Minnesota, Mississippi, Nebraska, New York, North Dakota, Pennsylvania, Tennessee, Texas, Virginia, Vermont, West Virginia and Wisconsin.  We launched two additional markets during second quarter 2003, one in Augusta, Georgia that launched on May 8, 2003 and the other in Burlington, Vermont that launched June 25, 2003.

 

Other accomplishments during second quarter 2003 include:

 

Enhancements to Nationwide Direct Connect:

                  In April 2003, Phase I of a two-phase enhancement to Nationwide Direct Connect was completed in all of our markets allowing our customers and Nextel customers traveling to a market outside of their local calling area to use Direct Connect in the visited market and to communicate instantly with our customers and Nextel customers that reside in or who have traveled to that market.

 

                  In June 2003, Phase II of the Nationwide Direct Connect enhancement was launched.  With the Nationwide Direct Connect (“NDC”) feature, our customers and Nextel customers are able to use the Push to Talk SM long-range digital walkie-talkie capability anywhere in the continental United States and Hawaii on the Nextel

 

16



 

Digital Mobile Network with any other Nextel subscriber.  The rollout to all of our markets and Nextel’s markets was completed at the end of July 2003.

 

Debt Refinancing and Debt Repurchases:

                  During May and June 2003 we closed a private placement of $175.0 million of 1½% convertible senior notes.  We used a portion of the proceeds from this offering to purchase approximately $86.1 million (principal amount at maturity) of our 14% senior discount notes for cash in open-market purchases.

 

                  During June we commenced a tender offer and consent solicitation relating to all of our outstanding 14% senior discount notes.  As of June 30, 2003, we had repurchased $375.8 million (principal amount at maturity) of our 14% senior discount notes for cash in our tender offer.  We also closed a private placement of $450 million 81/8% senior notes due 2011, and the proceeds from the offering were used primarily to fund the purchase of the 14% senior discount notes in our tender offer.

 

Selected Consolidated Financial Data

 

We have summarized below our historical consolidated financial data as of and for the three and six months ended June 30, 2003 and 2002. The historical operating data presented below for the same periods are derived from our records.

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(in thousands, except per share amounts)
(unaudited)

 

Consolidated Statements of Operations Data:

 

 

 

 

 

 

 

 

 

Operating revenues:

 

 

 

 

 

 

 

 

 

Service revenues (1)

 

$

226,507

 

$

153,418

 

$

427,049

 

$

281,082

 

Equipment revenues (1)

 

7,762

 

7,668

 

15,029

 

13,155

 

Total revenues

 

234,269

 

161,086

 

442,078

 

294,237

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of service revenues (excludes depreciation of $32,558, $23,531, $64,135 and $45,644, respectively)

 

77,492

 

66,350

 

149,073

 

127,779

 

Cost of equipment revenues (1)

 

23,333

 

23,637

 

44,935

 

43,170

 

Selling, general and administrative

 

98,734

 

76,846

 

187,369

 

146,916

 

Stock-based compensation (primarily selling, general and administrative related)

 

218

 

2,865

 

481

 

5,756

 

Depreciation and amortization

 

33,488

 

23,532

 

65,994

 

45,647

 

Total operating expenses

 

233,265

 

193,230

 

447,852

 

369,268

 

Income (loss) from operations

 

1,004

 

(32,144

)

(5,774

)

(75,031

)

Other income (expense):

 

 

 

 

 

 

 

 

 

Interest expense, net

 

(39,104

)

(42,158

)

(79,397

)

(80,157

)

Interest income

 

481

 

2,084

 

1,282

 

4,517

 

Loss on early extinguishment of debt

 

(68,082

)

 

(68,127

)

 

Total other income (expense)

 

(106,705

)

(40,074

)

(146,242

)

(75,640

)

Loss before deferred income tax provision

 

(105,701

)

(72,218

)

(152,016

)

(150,671

)

Deferred income tax provision

 

(3,216

)

(1,779

)

(6,090

)

(14,058

)

Net loss

 

(108,917

)

(73,997

)

(158,106

)

(164,729

)

Mandatorily redeemable preferred stock dividends

 

(1,092

)

(970

)

(2,141

)

(1,899

)

Loss attributable to common stockholders

 

$

(110,009

)

$

(74,967

)

$

(160,247

)

$

(166,628

)

 

 

 

 

 

 

 

 

 

 

Loss per share attributable to common stockholders, basic and diluted

 

$

(0.44

)

$

(0.31

)

$

(0.64

)

$

(0.68

)

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares outstanding, basic and diluted

 

250,960

 

244,375

 

250,718

 

244,245

 

 

17



 

 

 

As of June 30,
2003

 

As of
December 31,
2002

 

 

 

(dollars in thousands)
(unaudited)

 

Consolidated Balance Sheet Data:

 

 

 

 

 

Cash and cash equivalents, and short-term investments (2)

 

$

207,823

 

$

195,029

 

Property, plant and equipment, net

 

1,023,553

 

1,000,076

 

FCC operating licenses, net

 

368,958

 

348,440

 

Total assets

 

1,803,779

 

1,735,925

 

Current liabilities

 

135,086

 

161,567

 

Long-term debt

 

1,642,548

 

1,424,600

 

Series B mandatorily redeemable preferred stock

 

37,112

 

34,971

 

Total stockholders’ equity (deficit)

 

(74,898

)

76,379

 

Total liabilities and stockholders’ equity

 

$

1,803,779

 

$

1,735,925

 

 

 

 

 

 

 

 

 

As of June 30,
2003

 

As of June 30,
2002

 

 

 

(dollars in thousands)
(unaudited)

 

Other Data:

 

 

 

 

 

Covered Pops (end of period) (millions)

 

37

 

36

 

Subscribers (end of period)

 

1,053,600

 

691,600

 

 

 

 

 

 

 

Statement of Cash Flows Data:

 

 

 

 

 

Net cash used from operating activities

 

$

(20,659

)

$

(93,789

)

Net cash used from investing activities

 

$

(106,319

)

$

(150,038

)

Net cash provided from financing activities

 

$

131,884

 

$

51,727

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(dollars in thousands)
(unaudited)

 

Other Data:

 

 

 

 

 

 

 

 

 

Adjusted EBITDA(3)

 

$

34,710

 

$

(5,747

)

$

60,701

 

$

(23,628

)

Net capital expenditures(4)

 

$

32,913

 

$

81,704

 

$

88,666

 

$

139,076

 

 


(1)          Effective January of 2000, we changed our revenue recognition policy for activation fees (included in service revenues) and equipment (phones) revenues in accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 101 (SAB 101), “Revenue Recognition in Financial Statements.” See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for a more detailed description of the impact of our adoption of this policy.

 

(2)          Short-term investments include marketable securities and corporate commercial paper with original purchase maturities greater than three months.

 

(3)          The term EBITDA refers to a financial measure that is defined as earnings (loss) before interest, taxes, depreciation and amortization; we use the term “Adjusted EBITDA” to reflect that our financial measure also excludes cumulative effect of change in accounting principle, loss from disposal of assets, gain (loss) from early extinguishment of debt and stock-based compensation.  Adjusted EBITDA is commonly used to analyze companies on the basis of leverage and liquidity.  However, Adjusted EBITDA is not a measure determined under GAAP in the United States of America and may not be comparable to similarly titled measures reported by other companies.  Adjusted EBITDA should not be construed as a substitute for operating income or as a better measure of liquidity than cash flow from operating activities, which are determined in accordance with GAAP.  We have presented Adjusted EBITDA to provide additional information with respect to our ability

 

18



 

to meet future debt service, capital expenditure and working capital requirements.  The following schedule reconciles Adjusted EBITDA to net cash provided by (used in) operating activities reported on our Consolidated Statements of Cash Flows, which we believe is the most directly comparable GAAP measure:

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(dollars in thousands)

 

Net cash provided by (used in) operating activities (as reported on Consolidated Statements of Cash Flows)

 

$

(16,321

)

$

(35,066

)

$

(20,659

)

$

(93,789

)

Adjustments to reconcile to Adjusted EBITDA:

 

 

 

 

 

 

 

 

 

Cash paid interest expense, net of capitalized amount

 

29,774

 

19,776

 

51,359

 

48,105

 

Interest income

 

(481

)

(2,084

)

(1,282

)

(4,518

)

Change in working capital and other

 

21,738

 

11,627

 

31,283

 

26,573

 

Adjusted EBITDA income (loss)

 

$

34,710

 

$

(5,747

)

$

60,701

 

$

(23,629

)

 

(4)          Net capital expenditures exclude capitalized interest and are offset by net proceeds from the sale and lease-back transactions of telecommunication towers and related assets to third parties accounted for as operating leases. Net capital expenditures as defined are not a measure determined under GAAP in the United States of America and may not be comparable to similarly titled measures reported by other companies.  Net capital expenditures should not be construed as a substitute for capital expenditures reported on the Consolidated Statements of Cash Flows, which is determined in accordance with GAAP. We report net capital expenditures in this manner because we believe it reflects the net cash used as defined by us for capital expenditures and to satisfy the reporting requirements for our debt covenants. The following schedule reconciles net capital expenditures to  capital expenditures  reported on our  Consolidated  Statements of Cash Flows, which we believe is the most directly comparable GAAP measure:

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures (reported on Consolidated Statements of Cash Flows)

 

$

19,557

 

$

81,988

 

$

84,824

 

$

148,054

 

Less: cash paid portion of capitalized interest

 

(355

)

(627

)

(676

)

(1,103

)

Less:  cash proceeds from sale and lease-back transactions accounted for as operating leases

 

(5,358

)

(785

)

(6,250

)

(1,848

)

Change in capital expenditures accrued or unpaid

 

19,069

 

1,128

 

10,768

 

(6,027

)

Net capital expenditures

 

$

32,913

 

$

81,704

 

$

88,666

 

$

139,076

 

 

19



 

RESULTS OF OPERATIONS

 

Three Months Ended June 30, 2003 Compared to Three Months Ended June 30, 2002

 

Revenues

 

Our primary sources of revenues are service revenues and equipment revenues. Service revenues increased 48% to $226.5 million for the three-month period ended June 30, 2003 as compared to $153.4 million for the same period in 2002. Our service revenues consist of charges to our customers for airtime usage and monthly network access fees from providing integrated wireless services within our territory, particularly mobile telephone and two-way radio dispatch services. Service revenues also include roaming revenues from Nextel subscribers using our portion of the Nextel Digital Mobile Network.  Roaming revenues for the second quarter of 2003 accounted for approximately 12% of our service revenues, as compared to 13% in the same period in 2002.  Although we continue to see growth in roaming revenues due to an increase in coverage and on-air cell sites, we expect roaming revenues as a percentage of our service revenues to continue to decline due to the anticipated revenue growth that we expect to achieve from our own customer base.

 

The following table shows the impact of our accounting policy whereby we defer activation fees and equipment revenue and related costs over a three-year period for the three months ended June 30, 2003 and 2002.  For a discussion of this accounting policy, please see “Critical Accounting Policies – Revenue Recognition.”

 

 

 

Three Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Service revenues billed or accrued

 

$

227,081

 

$

154,436

 

Activation fees deferred

 

(1,688

)

(1,664

)

Previously deferred activation fees recognized

 

1,114

 

646

 

Total service revenues reported

 

$

226,507

 

$

153,418

 

 

 

 

 

 

 

Equipment revenues billed

 

11,040

 

$

10,262

 

Equipment revenues deferred

 

(9,919

)

(7,163

)

Previously deferred equipment revenues recognized

 

6,641

 

4,569

 

Total equipment revenues reported

 

$

7,762

 

$

7,668

 

 

 

 

 

 

 

Cost of equipment revenues billed

 

$

27,185

 

$

27,249

 

Cost of equipment revenues deferred

 

(11,607

)

(8,827

)

Previously deferred cost of equipment revenues recognized

 

7,755

 

5,215

 

 

 

 

 

 

 

Total cost of equipment revenues reported

 

$

23,333

 

$

23,637

 

 

Equipment revenues reported for second quarter 2003 were $7.8 million as compared to $7.7 million reported for the same period in 2002, representing an increase of 1.3%, primarily due to an increase in our subscriber base.  Our equipment revenues consist of revenues received for wireless telephones and accessories purchased by our subscribers.

 

Total revenues increased 45% to $234.3 million for the three months ended June 30, 2003 as compared to $161.1 million generated in the same period in 2002.  This growth in revenues was due to the increase in our subscriber base from our existing markets in addition to launching the Augusta, Georgia and Burlington, Vermont markets during the second quarter of 2003.  We expect our revenues to continue to increase as we add more subscribers and continue to introduce new products to our customers.  However, although we anticipate continued growth in our revenues in 2003, we have launched all of our markets and we therefore do not expect to continue to experience revenue growth rates of the same magnitude as we have experienced in the past when we were launching new markets on a continuous basis.

 

For second quarter 2003, our average monthly revenue per unit, or ARPU, was $66, which was a decrease of $3 compared to second quarter 2002. We attribute the decrease in ARPU to an increase in competitive pricing plans and growth in the number of government segment subscribers, offset by additional usage of features such as voice mail, short message services, Nextel Online Services

 

20



 

and Nextel Worldwide roaming products. We expect to continue to achieve ARPU levels above the industry average and anticipate our ARPU to be in the mid to high $60s for the remainder of 2003.  The following table sets forth our revenues and ARPU:

 

Revenues

 

 

 

For the Three
Months Ended
June 30,
2003

 

% of
Consolidated
Revenues

 

For the Three
Months Ended
June 30,
2002

 

% of
Consolidated
Revenues

 

 

 

(dollars in thousands, except for ARPU)

 

Service and roaming revenues

 

$

226,507

 

97

%

$

153,418

 

95

%

Equipment revenues

 

7,762

 

3

%

7,668

 

5

%

Total revenues

 

$

234,269

 

100

%

$

161,086

 

100

%

ARPU(1)

 

$

66

 

 

 

$

69

 

 

 

 


(1)                                  ARPU is an industry term that measures total service revenues per month from our subscribers divided by the average number of subscribers in commercial service during the period.  ARPU, itself, is not a measurement determined under GAAP in the United States of America and may not be similar to ARPU measures of other companies; however, ARPU uses GAAP measures as the basis for calculation.  We believe that ARPU provides useful information concerning the appeal of our rate plans and service offerings and our performance in attracting high value customers.  The following schedule reflects the ARPU calculation and provides a reconciliation of service revenues used for the ARPU calculation to service revenues reported on our Consolidated Statements of Operations, which we believe is the most directly comparable GAAP measure to the service revenues measure used for the ARPU calculation:

 

 

 

For the Three Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(dollars and units in thousands, except for ARPU)

 

Service revenues (as reported on Consolidated Statements of Operations)

 

$

226,507

 

$

153,418

 

Add:  activation fees deferred and recognized for SAB No. 101

 

574

 

1,018

 

Less:  roaming revenues and other revenues

 

(26,917

)

(20,218

)

Service revenues for ARPU

 

$

200,164

 

$

134,218

 

 

 

 

 

 

 

Average units (subscribers)

 

1,005

 

653

 

ARPU

 

$

66

 

$

69

 

 

Cost of Service Revenues

 

Cost of service revenues consists primarily of network operating costs, which include site rental fees for cell sites and switches, utilities, maintenance and interconnect and other wireline transport charges. Cost of service revenues also includes the amounts we must pay Nextel WIP when our customers roam onto Nextel’s portion of the Nextel Digital Mobile Network.  These expenses depend mainly on the number of operating cell sites, total minutes of use and the mix of minutes of use between interconnect and Direct Connect.  The use of Direct Connect is more efficient than interconnect and, accordingly, relatively less costly to provide.

 

For the three months ended June 30, 2003, our cost of service revenues was $77.5 million as compared to $66.4 million for the same period in 2002, representing an increase of 17%.  The increase in costs was primarily the result of bringing on-air approximately 467 additional cell sites since June 30, 2002, as well as an increase in airtime usage, both of which resulted in higher network operating costs. Increased airtime usage resulted both from the growth in the number of customers from 2002 as well as from the increased average minutes of use per customer. We saw an increase in average minutes of use per subscriber, which was 678 average monthly minutes per subscriber for second quarter 2003.  This is an increase of approximately 11% as compared to 609 average monthly minutes of use per subscriber for the same period in 2002.  We expect cost of service revenues to increase as we place more cell sites in service and the usage of minutes increase as our customer base grows.  However, we expect our cost of service revenues per average minute of use to decrease as economies of scale continue to be realized.

 

21



 

Cost of Equipment Revenues

 

Cost of equipment revenues includes the cost of the subscriber wireless telephones and accessories sold by us. As reflected in the following table, our cost of equipment revenues for the three-month period ended June 30, 2003 was $23.3 million as compared to $23.6 million for the same period in 2002. The decrease in costs was related mostly to a decline in the average per unit cost of phones sold, offset by the increase in the volume of phones sold to new subscribers.  The table below reflects the cost of equipment revenues taking into account the effect of SAB No. 101.

 

 

 

For the Three Months Ended June 31,

 

 

 

2003

 

2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Cost of equipment revenues:

 

 

 

 

 

Cost of equipment revenues billed

 

$

27,185

 

$

27,249

 

Cost of equipment revenues deferred (effect of SAB No. 101).

 

(11,607

)

(8,827

)

Previously deferred cost of equipment revenues recognized (effect of SAB No. 101)

 

7,755

 

5,215

 

Total cost of equipment revenues reported

 

$

23,333

 

$

23,637

 

 

Due to the unique “push to talk” functionality of our handsets, the cost of our equipment tends to be higher than that of our competitors.  As part of our business plan, we often offer our equipment at a discount or as part of a promotion as an incentive to our customers to commit to contracts for our higher priced service plans and to compete with the lower priced competitor handsets. Therefore, we believe these amounts best represent the economics and actual cash subsidy on equipment costs.  As a result, the table below shows that the gross subsidy (without the effect of SAB No. 101) between equipment revenues and cost of equipment revenues was a loss of $16.1 million for second quarter 2003, as compared to a loss of $17.0 million for the same period in 2002.  We expect to continue to employ these discounts and promotions in an effort to grow our subscriber base. Therefore, for the foreseeable future, we expect that cost of equipment revenues will continue to exceed our equipment revenues.

 

 

 

For the Three Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Equipment revenues billed

 

$

11,040

 

$

10,262

 

Cost of equipment revenues billed

 

(27,185

)

(27,249

)

Total gross subsidy for equipment

 

$

(16,145

)

$

(16,987

)

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses consist of sales and marketing expenses, expenses related to customer care services and general and administrative costs. For the three months ended June 30, 2003, selling, general and administrative expenses were $98.7 million as compared to $76.8 million for the same period in 2002, representing an increase of 29%.

 

Sales and marketing expenses increased as a result of:

 

                  higher expenses for commissions related to a greater proportion of sales received from indirect distribution channels;

 

                  increased sales and marketing activities, including advertising expenses aimed to grow our customer base; and

 

                  start-up costs related to opening approximately 20 new retail stores.

 

General and administrative costs relate to corporate personnel including tax, legal, planning, human resources, information technology, treasury, accounting, service and repair expenses and costs incurred in connection with our customer care center operations.

 

Our general and administrative costs increased as a result of:

 

22



 

                  increasing staff and operating expenses for our customer care service centers in Las Vegas, Nevada and Panama City Beach, Florida to support  our growing customer base; and

 

                  additional billing, collection, customer retention, and service and repair expenses related costs to support a larger and growing customer base.

 

As we continue to grow our customer base and expand our operations, we expect our sales and marketing expenses and general and administrative costs to continue to increase, but at a slower rate than our customer growth due to efficiencies we are able to implement.  Overall, we expect our acquisition costs per new customer to decrease as we continue to increase the amount of sales from our low cost distribution channels, including our retail stores and web-based distribution channels, decrease equipment subsidies and increase the productivity of our direct sales representatives.  During third and fourth quarter 2003, we expect to see a decline in acquisition costs per new customer since we will not be launching as many new retail stores and as we continue to decrease equipment subsidies and improve our direct sales productivity.

 

Stock-Based Compensation Expense

 

For the three-month period ended June 30, 2003 and 2002, we recorded stock-based compensation expense associated with our grants of restricted stock and employee stock options of approximately $218,000 and $2.9 million, respectively. This is a non-cash expense.  Subject to our mandatory adoption of any future accounting pronouncements, we expect stock-based compensation expense to continue to decrease as the options and restricted stock continue to vest.

 

Depreciation and Amortization Expense

 

For the second quarter ended June 30, 2003, our depreciation and amortization expense was $33.5 million compared to $23.5 million for the same period in 2002, representing an increase of 43%.  The $10.0 million increase related primarily to depreciating wireless network assets for the new switches in Iowa and Florida put in operation in 2002 and for the 467 additional cell sites placed in service since June 30, 2002, along with furniture and equipment purchased for our offices and new retail stores.  We expect depreciation to continue to increase due to the additional cell sites we plan to place in service.

 

Interest Expense and Interest Income

 

Interest expense, net of capitalized interest, declined $3.1 million from $42.2 million for the three-month period ended June 30, 2002 to $39.1 million for the three months ended June 30, 2003, representing a decrease of 7%.  This reduction was due mostly to recording a non-cash fair market value gain of approximately $796,000 for the three months ended June 30, 2003 for our interest rate swap agreements compared to approximately a $2.0 million non-cash fair market value loss for the same period in 2002. Additionally, we had less interest expense related to our 14% senior notes due to our repurchases of these notes during the second quarter.

 

For the three months ended June 30, 2003, interest income was $481,000, as compared to $2.1 million for the same period in 2002. This decrease was due to a decline in interest rates on our short-term investments and a reduction in our cash and short-term investment balance as a result of expenditures related to the network build-out.

 

Net Loss

 

For the three months ended June 30, 2003, we had a net loss attributable to common stockholders of approximately $110.0 million compared to a net loss of $75.0 million for the same period in 2002, representing an increase of 47%. The $110.0 million net loss includes a $68.1 million loss for early retirement of debt related to retiring $461.9 million (principal amount at maturity) of our 14% senior discount note due 2009 notes for cash. Of the $68.1 million loss for early retirement of debt, $61.2 million represents the premium paid to retire the notes (which is cash) and $6.9 million relates to the write-off of the deferred financing costs for the 14% senior discount notes.

 

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

 

Revenues

 

Service revenues increased 52% to $427.0 million for the six months ended June 30, 2003 as compared to $281.1 million for the six months ended June 30, 2002. Roaming revenues for the six months ended June 30, 2003 accounted for approximately 11.7% of our service revenues, as compared to 12.5% for the same period in 2002.

 

23



 

The following table shows the impact of our accounting policy whereby we defer activation fees and equipment revenue and related costs over a three-year period for the six months ended June 30, 2003 and 2002.

 

 

 

For the Six Months Ended

 

 

 

June 30, 2003

 

June 30, 2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

Service revenues billed or accrued

 

$

428,245

 

$

283,000

 

Activation fees deferred

 

(3,319

)

(3,069

)

Previously deferred activation fees recognized

 

2,123

 

1,151

 

Total service revenues reported

 

$

427,049

 

$

281,082

 

 

 

 

 

 

 

Equipment revenues billed

 

$

22,101

 

$

19,367

 

Equipment revenues deferred

 

(19,947

)

(14,700

)

Previously deferred equipment revenues recognized

 

12,875

 

8,488

 

Total equipment revenues reported

 

$

15,029

 

$

13,155

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

Cost of equipment revenues

 

$

53,203

 

$

51,300

 

Cost of equipment revenues deferred

 

(23,266

)

(17,769

)

Previously deferred cost of equipment revenues recognized

 

14,998

 

9,639

 

Total cost of equipment revenues reported

 

$

44,935

 

$

43,170

 

 

Equipment revenues reported for the six months ended June 30, 2003 were $15.0 million as compared to $13.2 million reported for the same period in 2002, representing an increase of $1.8 million, or 14%, due to an increase in our subscriber base.

 

Total revenues increased 50% to $442.1 million for the six months ended June 30, 2003 as compared to $294.2 million generated in the same period in 2002. This growth in revenues was due to launching new markets in Augusta, Georgia during May 2003 and Burlington, Vermont during June 2003 along with increased revenues from existing markets.

 

For the six months ended June 30, 2003 our ARPU was $65, which is a $3 decline compared to the six months ended June 30, 2002. We attribute the decrease in ARPU to the maturity of our markets and an increase in competitive pricing plans, offset by an increase in the minutes used by our customers and additional usage of features such as voice mail, short message services and, to a lesser extent, Nextel Wireless Web services and Nextel Worldwide roaming products. The following table sets forth our revenues and ARPU:

 

Revenues

 

 

 

For the Six
Months Ended
June 30,
2003

 

% of
Consolidated
Revenues

 

For the Six
Months Ended
June 30,
2002

 

% of
Consolidated
Revenues

 

 

 

(dollars in thousands, except for ARPU)

 

Service and roaming revenues

 

$

427,049

 

97

%

$

281,082

 

96

%

Equipment revenues

 

15,029

 

3

%

13,155

 

4

%

Total revenues

 

$

442,078

 

100

%

$

294,237

 

100

%

ARPU(1)

 

$

65

 

 

 

$

68

 

 

 

 


(1)                                  ARPU is an industry term that measures total service revenues per month from our subscribers divided by the average number of subscribers in commercial service during the period.  ARPU, itself, is not a measurement determined under GAAP in the United States of America and may not be similar to ARPU measures of other companies; however, ARPU uses GAAP measures as the basis for calculation.  We believe that ARPU provides useful information concerning the appeal of our rate plans and service offering and our performance in attracting high value customers.  The following schedule reflects the ARPU calculation and provides a reconciliation of service revenues used for the ARPU calculation to service revenues reported on our Consolidated Statements of Operations, which we believe is the most directly comparable GAAP measure to the service revenues measure used for the ARPU calculation:

 

24



 

 

 

For the Six Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(dollars and units in thousands, except
for ARPU)

 

Service revenues (as reported on Consolidated Statements of Operations)

 

$

427,049

 

$

281,082

 

Add:  activation fees deferred and recognized for SAB No. 101

 

1,196

 

1,918

 

Less:  roaming revenues and other revenues

 

(49,866

)

(35,756

)

Service revenues for ARPU

 

$

378,379

 

$

247,244

 

 

 

 

 

 

 

Average units (subscribers)

 

963

 

604

 

ARPU

 

$

65

 

$

68

 

 

Cost of Service Revenues

 

For the six months ended June 30, 2003, our cost of service revenues was $149.1 million as compared to $127.8 million for the same period in 2002, representing an increase of 17%. The increase in costs was primarily the result of bringing on-air approximately 467 additional cell sites since June 30, 2002, as well as an increase in airtime usage from 574 average monthly minutes of use per subscriber for the six months ended June 30, 2002 to 641 average monthly minutes of use per subscriber for the six months ended June 30, 2003. Increased airtime usage resulted from the 52% growth in the number of customers from 2002 along with the 12% increase in average minutes of use per subscriber per month.

 

Cost of Equipment Revenues

 

Our cost of equipment revenues for the six months ended June 30, 2003 was $44.9 million as compared to $43.2 million for the same period in 2002.  The increase in costs was related mostly to the growth in number of subscribers.  The table below reflects the cost of equipment revenues taking into account the effect of SAB No. 101.

 

 

 

For the Six Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Cost of equipment revenues:

 

 

 

 

 

Cost of equipment revenues billed

 

$

53,203

 

$

51,300

 

Cost of equipment revenues deferred (effect of SAB No. 101).

 

(23,266

)

(17,769

)

Previously deferred cost of equipment revenues recognized (effect of SAB No. 101)

 

14,998

 

9,639

 

Total cost of equipment revenues reported

 

$

44,935

 

$

43,170

 

 

Due to the unique “push to talk” functionality of our handsets, the cost of our equipment tends to be higher than that of our competitors.  As part of our business plan, we often offer our equipment at a discount or as part of a promotion as an incentive to our customers to commit to contracts for our higher priced service plans and to compete with the lower priced competitor handsets. Therefore, we believe these amounts best represent the economics and actual cash subsidy on equipment costs.  As a result, the table below shows that the gross subsidy (without the effect of SAB No. 101) between equipment revenues and cost of equipment revenues was a loss of $31.1 million for six months ended June 30, 2003, as compared to a loss of $31.9 million for the same period in 2002.  We expect to continue to employ these discounts and promotions in an effort to grow our subscriber base. Therefore, for the foreseeable future, we expect that cost of equipment revenues will continue to exceed our equipment revenues.

 

 

 

For the Six Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(in thousands)

 

 

 

 

 

 

 

Equipment revenues billed

 

$

22,101

 

$

19,367

 

Cost of equipment revenues billed

 

(53,203

)

(51,300

)

Total gross subsidy for equipment

 

$

(31,102

)

$

(31,933

)

 

25



 

Selling, General and Administrative Expenses

 

For the six months ended June 30, 2003, selling, general and administrative expenses were $187.4 million as compared to $146.9 million for 2002, representing an increase of 28%.  The increase was due to an increase in sales and marketing activities to grow our customer base, higher commission expense related to a larger proportion of sales from the indirect sales channel,

start-up costs for opening new retail stores, and additional billing, collection, customer retention, customer care and service and repair costs to support a larger and growing customer base.

 

Stock-Based Compensation Expense

 

For the six months ended June 30, 2003 and 2002, we recorded stock-based compensation expense associated with our grants of restricted stock and employee stock options of approximately $481,000 and $5.8 million, respectively.

 

Depreciation and Amortization Expense

 

For the six months ended June 30, 2003, our depreciation and amortization expense was $66.0 million as compared to $45.6 million for the same period in 2002, representing an increase of 45%. The $20.4 million increase related primarily to depreciating the wireless network assets for the 467 additional cell sites placed in service since June 30, 2002, along with furniture and equipment purchased to set up new retail stores.

 

Interest Expense and Interest Income

 

Interest expense, net of capitalized interest, declined from $80.2 million for the six months ended June 30, 2002 to $79.4 million for the six months ended June 30, 2003, representing a decrease of 1%.  This reduction was due mostly to recording a non-cash fair market value gain of approximately $1.4 million for the six months ended June 30, 2003 for our interest rate swap agreements compared to approximately a $593,000 non-cash fair market value loss for the same period in 2002.

 

For the six months ended June 30, 2003, interest income was $1.3 million as compared to $4.5 million for the same period in 2002, representing a decrease of  $3.2 million or 71%. This decrease was due to a decline in interest rates on our short-term investments and a reduction in our cash balance as a result of expenditures related to the network build-out.

 

Net Loss

 

For the six months ended June 30, 2003, we had a net loss attributable to common stockholders of approximately $160.2 million as compared to a net loss of $166.6 million for 2002, representing a decline of $6.4 million or 4%. The $160.2 million net loss includes a $68.1 million loss for early retirement of the 14% senior discount notes, of which $61.2 million represents the premium paid to retire the notes (which is cash) and $6.9 million represents the write-off of the related deferred financing costs.

 

Liquidity and Capital Resources

 

As of June 30, 2003, our cash and cash equivalents and short-term investments balance was approximately $207.8 million, an increase of $95.2 million compared to the balance of $112.6 million at the end of March 31, 2003.  In addition, we have access to an undrawn line of credit of $100 million for a total liquidity position of $307.8 million as of June 30, 2003.  The increase in our liquidity position from March 31, 2003 is a result of a series of refinancing transactions described below that were completed during the second quarter of 2003.

 

                  On May 13, 2003, we closed a private placement of $150 million of 1½% senior convertible notes due 2008.  On June 11, 2003, we closed a private placement of an additional $25 million of these notes (increasing total gross proceeds to $175 million) pursuant to the exercise of an over-allotment option held by the initial purchasers of these notes.

 

                  From May 13, 2003 through June 4, 2003, we retired approximately $86.1 million (principal amount at maturity) of our 14% senior discount notes due 2009 for $87.9 million for cash in open-market purchases.

 

                  On June 11, 2003, we commenced a tender offer and consent solicitation relating to all of our outstanding 14% senior discount notes.  From June 11, 2003 through June 30, 2003, we repurchased approximately $375.8 million (principal amount at maturity) of our 14% senior discount notes for $398.1 million.

 

26



 

                  On June 23, 2003, we closed a private placement of $450 million of 81/8% senior notes due 2011.  The proceeds from the offering were primarily used to fund the repurchase of the 14% senior discount notes.

 

Statement of Cash Flows Discussion:

 

 

 

For the Six Months Ended June 30,

 

 

 

2003

 

2002

 

$ Change

 

% Change

 

Net cash used from operating activities

 

$

(20,659

)

$

(93,789

)

$

73,130

 

78

%

Net cash used from investing activities

 

$

(106,319

)

$

(150,038

)

$

43,719

 

29

%

Net cash provided from financing activities

 

$

131,884

 

$

51,727

 

$

80,157

 

155

%

 

For the six months ended June 30, 2003, we used $20.7 million in cash for operating activities, as compared to $93.8 million used for the same period in 2002. The $73.1 million decrease in the net use of funds was due to an increase in service revenues from customers, a decline in our accounts receivable balance from customers through increased collection activity and a reduction in telephone and accessory inventory on-hand, offset by an increased use of funds for operating activities and related production costs for our billing system, network operating costs for additional sites placed in service, and increased marketing and sales activities.

 

Net cash used in investing activities for the six-month period ended June 30, 2003 was $106.3 million compared to $150.0 million for the same period in 2002. The $43.7 million decrease in net cash used in investing activities was primarily due to:

 

                  a $63.2 million decrease in capital expenditures;

                  a $20.8 million decrease in  FCC licenses acquired; offset by

                  a $40.3 million increase in net cash purchases (proceeds) of short-term investments.

 

We anticipate our total capital spending for 2003 to be approximately  $190 million, which is a $10 million decrease from our first quarter 2003 forecast of $200 million primarily as the result of technology improvements employed by network equipment.  Through June 30, 2003, we have decreased our forecast for capital requirements by a total of $20.0 million since our initial forecast of $210.0 million given at the beginning of 2003.

 

Net cash provided from financing activities for the six months ended June 30, 2003 totaled $131.9 million, which increased $80.2 million compared to $51.7 million for the same period in 2002.  As discussed above, we completed a series of refinancing transactions during the second quarter 2003 which helped to provide funds from financing activities and improved our overall liquidity position.   The net cash provided from financing activities was primarily due to the following:

 

                  our receipt of $612.2 million net proceeds from the sale of senior convertible notes and senior notes as described above,

                  our use of $486.1 million for the purchase and retirement of $461.9 million (principal amount at maturity) of our 14% senior discount notes;

                  our receipt of $6.3 million proceeds from sale of towers; and

                  our use of $1.1 million for the payment of capital lease obligations.

 

Capital Needs and Funding Sources:

 

Our primary liquidity needs arise from the capital requirements necessary to expand and enhance coverage in our existing markets that are part of the Nextel Digital Mobile Network.  Other liquidity needs include the future acquisition of additional frequencies, the installation of new or additional switch equipment and the introduction of new technology and services. Without limiting the foregoing, we expect capital expenditures to include, among other things, the purchase of switches, base radios, transmission towers and antennae, radio frequency engineering, and cell site construction.

 

We believe that our existing cash and cash equivalents and short-term investments balance and access to our line of credit, as necessary, plus the recently completed convertible debt financing described below under the heading “Recent Developments” will provide sufficient funds to finance our capital needs and working capital requirements as well as provide the necessary funds to acquire any additional FCC licenses through 2004, which we expect to be our first full year of positive free cash flow.  Please see   “–Free Cash Flow” below for more information regarding our use of free cash flow as a non-GAAP financial measure.

 

27



 

To the extent we are not able to generate positive cash from operating activities, we will be required to use more of our available liquidity to fund operations or we would require additional financing.  We may be unable to raise additional capital on acceptable terms, if at all.  Furthermore, our ability to generate positive cash from operating activities is dependent upon the amount of revenue we receive from customers, operating expenses required to provide our service, the cost of acquiring and retaining customers and our ability to continue to grow our customer base.

 

Additionally, to the extent we decide to expand our digital mobile network or deploy next generation technologies, we would require additional financing to fund these projects.  In the event that additional financing is necessary, such financing may not be available to us on satisfactory terms, if at all, for a number of reasons, including, without limitation, restrictions in our debt instruments on our ability to raise additional funds, conditions in the economy generally and in the wireless communications industry specifically, and other factors that may be beyond our control.  To the extent that additional capital is raised through the sale of equity or securities convertible into equity, the issuance of such securities could result in the dilution of our stockholders.

 

Free Cash Flow

 

We define free cash flow as net cash provided by (used in) operating activities less capital expenditures and payments for FCC licenses.  Free cash flow is not a measurement determined under GAAP in the United States of America and may not be similar to free cash flow measures of other companies.  We believe that free cash flow provides useful information to investors, analysts and our management about the amount of cash our business is generating after interest payments and reinvestments in the business, which may be used to fund scheduled debt maturities and other financing activities, including refinancings and early retirement of debt.  Free cash flow is most directly comparable to the GAAP measure of net cash provided by (used in) operating activities reported on our Consolidated Statements of Cash Flows.  The following schedule reconciles free cash flow to net cash provided by (used in) operating activities:

 

 

 

For the Six Months Ended June 30,

 

 

 

2003

 

2002

 

 

 

(dollars in thousands)

 

 

 

 

 

 

 

Net cash provided by (used in) operating activities (as reported on our Consolidated Statements of Cash Flows)

 

$

(20,659

)

$

(93,789

)

Less:  capital expenditures

 

(84,824

)

(148,054

)

Less:  FCC licenses

 

(13,607

)

(34,416

)

Free cash flow (negative)

 

$

(119,090

)

$

(276,259

)

 

Although we have stated that we expect to be free cash flow positive for the full year 2004, we are currently unable to provide a quantitative reconciliation of free cash flow to net cash provided by (used in) operating activities for the full year 2004 because significant GAAP information relating to 2004 fiscal periods that would be necessary to determine our anticipated 2004 net cash provided by (used in) operating activities, including net loss, interest, taxes, depreciation and amortization, is currently not available or ascertainable with the requisite specificity without unreasonable effort.

 

The following table provides details regarding our contractual obligations subsequent to June 30, 2003:

 

 

 

Payments due by Period
(in thousands)

 

 

 

 

 

Contractual Obligations

 

2003

 

2004

 

2005

 

2006

 

2007

 

Thereafter

 

Total

 

Long-term debt

 

$

1,250

 

$

3,750

 

$

3,750

 

$

3,750

 

$

151,469

 

$

1,457,136

 

$

1,621,105

 

Capital lease obligations

 

1,503

 

3,208

 

3,499

 

3,817

 

4,163

 

9,492

 

25,682

 

Redeemable preferred stock

 

 

 

 

 

 

82,107

 

82,107

 

Operating leases

 

37,466

 

72,338

 

59,749

 

39,681

 

25,743

 

54,203

 

289,180

 

Purchase obligations

 

3,917

 

7,000

 

500

 

 

 

 

11,417

 

Total contractual obligations

 

$

44,136

 

$

86,296

 

$

67,498

 

$

47,248

 

$

181,375

 

$

1,602,938

 

$

2,029,491

 

 

Included in the “Purchase obligations” caption above are minimum amounts due under our most significant agreements for telecommunication services required for back-office support.  Amounts actually paid under some of these agreements may be higher due to variable components of these agreements. In addition to the amounts reflected in the table, we expect to pay significant amounts to Motorola for infrastructure, handsets and related services in future years.  Potential amounts payable to Motorola are not shown above due to the uncertainty surrounding the timing and extent of these payments.  See Note 7 in the Notes to the Consolidated Condensed Financial Statements appearing in this Form 10-Q for amounts paid to Motorola for the three-month period ended June 30, 2003

 

28



 

and 2002 and Note 11 in the Notes to the Consolidated Financial Statements in our 2002 Annual Report on Form 10-K for 2002, 2001 and 2000.  In addition, please see “Recent Developments” below for a description of our recent convertible senior note financing; the table above does not reflect this transaction.

 

Sources of Funding

 

To date, third-party financing activities have provided all of our funding. As of June 30, 2003 these financings totaled approximately $2.3 billion and included:

 

                  proceeds from cash equity contributions of $202.8 million in January 1999;

 

                  the offering of 14% senior discount notes for initial proceeds of $406.4 million in January 1999, less $191.2 million for the partial redemption of these notes in April 2000, $86.1 million for open-market repurchases of notes during May and June 2003, and $375.8 million (principal amount at maturity) as of June 30, 2003 for the repurchase of notes pursuant to a tender offer commenced in June 2003;

 

                  term loans incurred in the aggregate principal amount of $375.0 million in January and September 1999 and January 2002;

 

                  the contribution by Nextel WIP of FCC licenses valued at $178.3 million, in exchange for class B common stock and Series B preferred stock in January and September 1999 and September 2000;

 

                  the contribution by Motorola of a $22.0 million credit to use against our purchases of Motorola-manufactured infrastructure equipment in exchange for Class A common stock, all of which had been used by December 31,1999;

 

                  net proceeds from the sale of Class A common stock in our initial public offering of $510.8 million in February 2000;

 

                  the offering of 11% senior notes for $200 million in March 2000;

 

                  the offering of an additional $200 million in 11% senior notes in July 2000;

 

                  the offering of 12 ½% senior discount notes for $210.4 million in December 2001;

 

                  net proceeds totaling $28.0 million from the sale of switches in Kentucky and Florida in July and October 2002;

 

                  cancellation of existing indebtedness in November and December 2002 and January and February 2003 in the aggregate amount of $45.0 million (principal amount at maturity) in exchange for the issuance of shares of our Class A common stock;

 

                  the offering of 1½% senior convertible notes for $150.0 million in May 2003 and an additional $25.0 million in June 2003 pursuant to the exercise of an over-allotment option held by the initial purchasers of the notes; and

 

                  the offering of 81/8% senior notes for $450.0 million in June 2003.

 

Nextel Partners Operating Corp., one of our wholly owned subsidiaries, entered into a credit facility in January 1999 with a syndicate of banks and other financial institutions led by Donaldson, Lufkin & Jenrette Securities Corporation, as arranger, DLJ Capital Funding, as syndication agent, and Bank of Montreal, as administrative agent. This credit facility was amended and restated in September 1999 and further amended on March 10, 2000, January 25, 2001, January 21, 2002 and April 17, 2003. On April 17, 2003, we amended our existing credit facility, including our related guaranty and pledge agreement, to permit the issuance of additional unsecured debt, subject to the terms and conditions of the credit facility and our related guaranty and pledge agreement.  On February 5, 2002, we closed the transaction to amend our existing $425 million credit facility to provide for an additional $50 million term D loan.  Currently, the credit facility, as amended, includes a $175 million term B loan, a $150 million term C loan, a $50 million term D loan and a $100 million reducing revolving credit facility. The credit facility may not exceed $475 million. The $175 million term B loan matures on January 29, 2008, and the $150 million term C and $50 million term D

 

29



 

loans mature on July 29, 2008. The revolving credit facility will terminate on January 29, 2007. As of June 30, 2003, $374.6 million of term loans were outstanding and no amounts were outstanding under the $100 million revolving credit facility.

 

The term B, C and D loans all bear interest, at our option, at the administrative agent’s alternate base rate or reserve-adjusted London Interbank Offering Rate (“LIBOR”) plus, in each case, applicable margins. The applicable margin for the term B loan is 4.75% over LIBOR and 3.75% over the base rate of the higher of 0.5% per annum above the latest federal funds rate or the prime rate. The applicable margin for the term C and D loans is 4.25% over LIBOR and 3.25% over the base rate. For the revolving credit facility, the initial applicable margin is 4.25% over LIBOR and 3.25% over the base rate until consolidated EBITDA, as defined by the Bank Credit Agreement, is positive, at which time the applicable margin will be initially 4.0% over LIBOR and 3.0% over the base rate and thereafter will be determined on the basis of the ratio of total debt to annualized EBITDA and will range between 2.25% and 3.75% over LIBOR and between 1.25% and 2.75% over the base rate. As of June 30, 2003, the interest rates on the $175 million term B loan, the $150 term C loan and the $50 million term D loan were 6.02%, 5.39% and 5.60%, respectively.

 

Borrowings under the term loans are secured by a first priority pledge of all assets of our subsidiaries and a pledge of their capital stock. The credit facility contains financial and other covenants customary for the wireless industry, including limitations on our ability to incur additional debt, create liens on assets or enter into significant transactions and covenants relating to minimum service revenues, subscriber units and covered Pops. The credit facility also contains covenants requiring that we maintain certain defined financial ratios and meet operational targets for service revenues, subscriber units and network coverage. As of June 30, 2003, we were in compliance with all covenants associated with this credit facility and anticipate remaining in compliance with these covenants for the foreseeable future.

 

Our 14% senior discount notes due February 1, 2009 were sold in January 1999. The notes were issued at a discount to their aggregate principal amount at maturity and generated aggregate gross proceeds to us of approximately $406.4 million. In July 1999 we exchanged these notes for registered notes having the same financial terms and covenants as the notes issued in January 1999. Cash interest will not accrue on the notes prior to February 1, 2004. On April 18, 2000, we redeemed 35% of the accreted value of these outstanding notes for approximately $191.2 million with proceeds from our initial public offering. The redemption payment of $191.2 million included $167.7 million of these outstanding notes plus a 14% premium of approximately $23.5 million. In November and December 2002 we exchanged approximately $27.0 million (principal amount at maturity) of the notes for shares of our Class A common stock and again in January and February 2003 exchanged an additional $8.0 million (principal amount at maturity) of the notes for shares of our Class A common stock.  From May 13, 2003 through June 4, 2003, we purchased approximately $86.1 million (principal amount at maturity) of the notes outstanding for $87.9 million.  On June 11, 2003 we commenced a tender offer that expired July 11, 2003 to purchase all of the remaining notes outstanding, which through June 30, 2003 we purchased approximately $375.8 million (principal amount at maturity) of the 14% senior discount notes for $398.1 million.  Subsequent to June 30, 2003 through July 11, 2003 we purchased an additional $16.5 million (principal amount at maturity) of the 14% senior discount notes for $17.5 million, leaving approximately $6.1 million of the 14% senior discount notes outstanding as of July 31, 2003.  The notes still outstanding will accrete in value representing the amortization of original issue discount at a rate of 14%, compounded semiannually, to an aggregate principal amount of $6.5 million by February 1, 2004.  As of June 30, 2003, the accreted value of the outstanding 14% senior discount notes was approximately $21.3 million.

 

On March 10, 2000, we issued $200 million of 11% senior notes due 2010, and on July 27, 2000, we issued an additional $200 million of 11% senior notes, each in a private placement. We subsequently exchanged all of the March 2000 and July 2000 notes for registered notes having the same financial terms and covenants as the privately placed notes. In November 2002 we exchanged $10.0 million (principal amount at maturity)  of the notes for shares of our Class A common stock.  Interest accrues for these notes at the rate of 11% per annum, payable semiannually in cash in arrears on March 15 and September 15 of each year.

 

On December 4, 2001 we issued in a private placement $225 million of 12½% senior discount notes due 2009. These notes were issued at a discount to their aggregate principal amount at maturity and generated aggregate gross proceeds to us of approximately $210.4 million. We subsequently exchanged all of these 12½% senior discount notes for registered notes having the same financial terms as the privately placed notes.  Interest accrues for these notes at the rate of 12½% per annum commencing on May 15, 2002, payable semiannually in cash in arrears on May 15 and November 15 of each year.

 

On May 13, 2003 we closed a private placement of $150 million of 1½% senior convertible notes due 2008.  On June 11, 2003, we closed a private placement of an additional $25 million of these notes pursuant to the exercise of an over-allotment option held by the initial purchases of these notes increasing the total proceeds to $175 million.  At the option of the holders, the notes are convertible at an initial conversion rate of 131.9087 shares of our class A common stock per $1,000 principal amount of notes, which represents a conversion price of $7.58 per share of Class A common stock.  Interest accrues for these notes at the rate of 1½% per annum commencing on November 15, 2003, payable semiannually in cash in arrears on May 15 and November 15 of each year.

 

30



 

On June 23, 2003, we issued $450 million of 81/8% senior notes due 2011 in a private placement.  We intend to exchange all of the 81/8% senior notes for registered notes having the same financial terms and covenants as the privately placed notes.  Interest will accrue at the rate of 81/8% per annum, payable semi-annually on January 1 and July 1 of each year, commencing on January 1, 2004.  The proceeds from this offering were used primarily to fund the purchase of the 14% senior discount notes in our tender offer.

 

As discussed in more detail in “Risk Factors,” if we fail to satisfy the financial covenants and other requirements contained in our credit facility and the indentures governing our outstanding notes, our debts could become immediately payable at a time when we are unable to pay them, which could adversely affect our liquidity and financial condition.

 

In the future, we may opportunistically engage in additional debt-for-equity exchanges or repurchase additional outstanding notes if the financial terms are sufficiently attractive.

 

Recent Developments

 

From July 1, 2003 through July 11, 2003, we repurchased approximately $16.5 million (principal amount at maturity) of our 14% senior discount notes for cash.

 

On August 6, 2003 we closed a private placement of $125 million of 1½% senior convertible notes due 2008.  The offering of these notes was made to qualified to institutional buyers as defined in Rule 144A of the Securities Act.  At the option of the holders, the notes are convertible at an initial conversion rate of 78.3085shares of our Class A common stock per $1,000 principal amount of notes, which represents a conversion price of $12.77 per share of Class A common stock.   Interest will accrue at the rate of 1½% per annum, payable semi-annually in arrears in cash on May 15 and November 15 of each year, commencing on November 15, 2003.  The proceeds from this offering will be used for general corporate purposes, including but not limited to general working capital and opportunistic repurchases of currently outstanding notes.

 

Critical Accounting Policies

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities in the consolidated condensed financial statements and accompanying notes.  The SEC has defined a company’s most critical accounting policies as the ones that are most important to the portrayal of the company’s financial condition and results of operations, and which require the company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.  Based on this definition, we have identified the critical accounting policies and judgments addressed below.  We also have other key accounting policies, which involve the use of estimates, judgments and assumptions.  For additional information see Note 3 “Significant Accounting Policies” in Item 1 of Part I, “Financial Statements (Unaudited)” of this Form 10-Q, and Note 1 “Operations and Significant Accounting Policies” in Item 8 of Part II, “Financial Statements and Supplementary Data,” of our Annual Report on Form 10-K for the year ended December 31, 2002.  Although we believe that our estimates and assumptions are reasonable, they are based upon information presently available.  Actual results may differ significantly from these estimates under different assumptions or conditions.

 

Revenue Recognition

 

We recognize service revenue for access charges and other services charged at fixed amounts ratably over the service period, net of credits and adjustments for service discounts.  These discounts typically relate to promotional service campaigns in which customers will receive a monthly discount on their service plan for a limited period depending on the features of the rate plan.  Additionally, for situations where customers may have a billing dispute, coverage dispute or service issue we may grant a one-time credit or adjustment to the customer’s bill.  We recognize excess usage and long distance revenue at contractual rates per minute as minutes are used.  To account for the service revenues, including adjustments and discounts, that are unbilled at month-end, we make an estimate of unbilled service revenue from the end of the billed service period to the end of the month.  This estimate, which is subjective, is based on a number of factors including:  the increase in net subscribers, number of business days from the billed service period to the end of the month and the average revenue per subscriber, after taking partial billing periods into consideration.  This estimate is accrued monthly and reversed the following month when the actual service period is billed again.

 

Equipment revenues include sale of phone and accessory equipment.  We recognize revenue for phone equipment on a straight-line basis over three years, starting when the customer takes title.  The decision to defer these phone equipment revenues is further described in the following paragraph.  For sale of accessory equipment, we recognize revenue when title passes, which is upon shipping the accessory to the customer.

 

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In accordance with Staff Accounting Bulletin 101 (SAB No.  101), “Revenue Recognition in Financial Statements,” our activation fees and phone revenues are deferred and recognized over three years. The decision to defer these revenues is based on the conclusion that while the service contract and the phone equipment revenues are a multiple element arrangement, the elements of the arrangement should not be accounted for separately.   The key factor in our conclusion is that our wireless service is essential to the functionality of the phone, due to the fact that our phones, which have a unique “push to talk” feature, can only be used on our digital network. Concurrently, the related costs for the phone equipment are deferred solely to the extent of deferred revenues. The direct and incremental phone costs in excess of revenues generated from phone sales are expensed in addition to the amortization of the deferred costs.

 

Accounts Receivable

 

Accounts receivable are recorded at the invoiced amount and include late payment fee charges for unpaid balances.  The allowance for doubtful accounts is our best estimate of the amount of probable credit losses that will occur in our existing accounts receivable balance.  We review our allowance for doubtful accounts monthly.  We determine the allowance based on the age of the balances and our experience of collecting on certain account types such as corporate, small business, government or other various classifications.  Account balances are charged off against the allowance after all means of collection have been exhausted internally and the potential for recovery is considered remote or delegated to a third-party collection agency.

 

Capitalization and Depreciation of Fixed Assets

 

We are inherently capital intensive due to the build out of the digital network.  Thus, we record our system (digital network) and non-system fixed assets, including improvements that extend useful lives, at cost, while maintenance and repairs are charged to operations as incurred. Depreciation and amortization are computed using the straight-line method based on industry average estimated useful lives of up to 31 years for cell site shelters, three to ten years for digital mobile network equipment, and three to seven years for furniture and fixtures. Leasehold improvements are amortized over the shorter of the respective lives of the leases or the useful lives of the improvements.

 

Construction in progress includes costs of labor (internal and external), materials, transmission and related equipment, engineering, site design, interest and other costs relating to the construction and development of our digital mobile network.  Assets under construction are not depreciated until placed into service.  In capitalizing costs related to the construction of the digital network, we include costs that are required to activate the mobile network.

 

FCC Licenses

 

FCC operating licenses are recorded at historical cost. Our FCC licenses and the requirements to maintain the licenses are similar to other licenses granted by the FCC, including PCS and cellular licenses, in that they are subject to renewal after the initial 10-year term. Historically, the renewal process associated with these FCC licenses has been perfunctory. The accounting for these licenses has historically not been constrained by the renewal and operational requirements.

 

On January 1, 2002, we implemented SFAS No. 142, "Goodwill and Other Intangible Assets."   SFAS No. 142 requires the use of a non-amortization approach to account for purchased goodwill and certain intangibles. Under a non-amortization approach, goodwill and certain intangibles are not amortized into results of operations, but instead are reviewed for impairment, at least annually, and written down as a charge to results of operations only in the periods in which the recorded value of goodwill and certain intangibles exceeds fair value. We have determined that FCC licenses have indefinite lives; therefore, as of January 1, 2002 we no longer amortize the cost of these licenses.  We performed asset impairment analyses on our FCC licenses in accordance with SFAS No. 142 as of January 1, 2002 for the transition and the annual assessment during the fourth quarter of 2002 and determined there has been no impairment related to our FCC licenses.  For our impairment analysis, we used the aggregate of all our FCC licenses, which constitutes the footprint of our portion of the Nextel Digital Mobile Network, as the unit of accounting for our FCC licenses based on the guidance in Emerging Issues Task Force, or EITF, Issue No. 02-7, “Unit of Accounting for Testing Impairment Indefinite-Lived Intangible Assets.”

 

As a result of the adoption of SFAS No. 142, we recorded a non-cash charge to our income tax provision of $12.3 million at the end of the first quarter of 2002 to increase the valuation allowance related to our net operating loss.  This charge is required because we have significant deferred tax liabilities related to FCC licenses.  Historically, we did not need a valuation allowance for the portion of our net operating loss equal to the amount of license amortization expected to occur during the carry forward period of our net operating loss.  Since we ceased amortizing licenses for financial statement purposes on January 1, 2002, we can no longer estimate the amount, if any, of deferred tax liabilities related to our FCC licenses which will reverse during the net operating loss carry forward period.  Accordingly, we increased the valuation allowance upon the adoption of SFAS No. 142 and continue to increase the valuation allowance with a corresponding deferred tax provision as the deferred tax liabilities related to FCC license amortization

 

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increase.  For the three months ended June 30, 2003 and 2002, the deferred tax provision attributable to FCC licenses was $3.2 million and $1.8 million, respectively, and for the six months ended the same periods it was $6.1 million and $14.1 million, respectively.

 

Impairment of Long-Lived Assets

 

Our long-lived assets consist principally of property, plant and equipment.  It is our policy to assess impairment of long-lived assets pursuant to SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."  This includes determining if certain triggering events have occurred, including significant decreases in the market value of certain assets, significant changes in the manner in which an asset is used, significant changes in the legal climate or business climate that could affect the value of an asset, or current period or continuing operating or cash flow losses or projections that demonstrate continuing losses associated with certain assets used for the purpose of producing revenue that might be an indicator of impairment.  When we perform the SFAS No. 144 impairment tests, we identify the appropriate asset group to be our network system, which includes the grouping of all our assets required to operate our portion of the Nextel Digital Mobile Network and provide service to our customers.  We based this conclusion of asset grouping on the revenue dependency, operating interdependency and shared costs to operate our network.  Thus far, we believe none of the above factors has occurred and therefore have not recorded any impairment charges.

 

Asset Retirement Obligations

 

During 2003, we adopted SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143"), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement obligations ("ARO").  Under the scope of this pronouncement, we have ARO associated with removal of equipment from cell sites and towers that we lease from third parties.  Adoption of SFAS No. 143 did not materially impact our financial position or results of operation.

 

Recently Issued Accounting Pronouncements

 

In November 2002, the EITF issued a final consensus on Issue 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables.”  Issue 00-21 provides guidance on how and when to recognize revenues on arrangements requiring delivery of more than one product or service.  Issue 00-21 is effective prospectively for arrangements entered into in fiscal periods beginning after June 15, 2003.  Companies may also elect to apply the provisions of Issue 00-21 to existing arrangements and record the income statement impact as a cumulative effect of a change in accounting principle.

 

Under the provisions of Staff Accounting  Bulletin, or SAB, No. 101, “Revenue Recognition in  Financial Statements,” we accounted for the sale of our  phone equipent and the subsequent service to the customer as a single  unit of accounting due to the fact that our wireless service is  essential to the functionality of our phones. Accordingly, we  recognized revenue from the phone equipment sales and an equal amount of the cost of phone equipment revenues over the expected customer relationship period, when title to the phone passed to the customer.  Under EITF Issue No. 00-21, we no longer need to consider whether a customer is able to realize utility from the phone in the absence of the undelivered service. Based on this fact and the fact that we meet the criteria stipulated in EITF Issue No. 00-21, we have concluded that EITF Issue No. 00-21 requires us to account for the sale of a phone as a unit of accounting separate from the subsequent service to the customer.  Accordingly, we will recognize revenue from phone equipment sales and the related cost of phone equipment revenues when title to the phone equipment passes to the customer for all arrangements entered into beginning in the third quarter 2003.

 

We adopted EITF Issue 00-21 on July 1, 2003  and elected to apply the provisions to our existing customer  arrangements. The cumulative effect of adopting EITF 00-21 did not  materially impact the statement of operations.

 

In January 2003, the FASB issued Interpretation No. 46, “Consolidated of Variable Interest Entities, an Interpretation of ARB No. 51.”  This Interpretation addresses the consolidation by business enterprises of variable interest entities as defined in the Interpretation.  The Interpretation applies immediately to variable interests in variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003.  The application of this Interpretation is not expected to have a material effect on our financial statements.  The Interpretation requires certain disclosures in financial statements issued after January 31, 2003 if it is reasonably possible that we will consolidate or disclose information about variable interest entities when the Interpretation becomes effective.  We do not believe that we have any existing variable interest entities that will require consolidation.

 

In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.”  This statement establishes standards for how an issuer classifies and

 

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measures in its statement of financial position certain financial instruments with characteristics of both liabilities and equity.  It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances) because that financial instrument embodies an obligation of the issuer.  This statement is effective for all freestanding financial instruments entered into or modified after May 31, 2003; otherwise it is effective at the beginning of the first interim period beginning after June 15, 2003.  We have identified that our mandatorily redeemable preferred stock is within the scope of this statement and will be reclassified as long-term debt, and the mandatorily redeemable preferred stock dividends will be recorded as interest expense beginning July 1, 2003.

 

Related Party Transactions

 

Motorola Purchase Agreements

 

Pursuant to the equipment purchase agreements between us and Motorola, who currently holds approximately 5.2% of our outstanding common stock, Motorola provides the iDEN infrastructure and subscriber handset equipment to us throughout our markets. We expect to continue to rely on Motorola for the manufacture of a substantial portion of our handset equipment as well as the equipment necessary to construct our portion of the Nextel Digital Mobile Network for the foreseeable future. The equipment purchase agreements govern our rights and obligations regarding purchases of handset equipment and system infrastructure equipment manufactured by Motorola and others.

 

For the three months ended June 30, 2003 and 2002, we purchased approximately $46.5 million and $54.3 million, respectively, and $90.5 million and $85.1 million for the six months ended June 30, 2003 and 2002, respectively, of infrastructure and other equipment, handsets, warranties and services from Motorola.

 

Nextel Operating Agreements

 

We, along with our operating subsidiary, entered into a joint venture agreement dated January 29, 1999 with Nextel WIP, who currently holds approximately 31.5% of our outstanding common stock and with whom one of our directors is affiliated. The joint venture agreement, along with other operating agreements between Nextel WIP and us, defines the relationships, rights and obligations between the parties and governs the build-out and operation of our portion of the Nextel Digital Mobile Network and the transfer of licenses from Nextel WIP to us.  Our roaming agreement with Nextel WIP provides that each party pays the other company’s monthly roaming fees in an amount based on the actual system minutes used by our respective customers when they are roaming on the other party’s network. For the three months ended June 30, 2003 and 2002 we earned approximately $26.9 million and $20.0 million, respectively, and for the six months ended June 30, 2003 and 2002 we earned approximately $49.9 million and $35.3 million, respectively, from Nextel customers roaming on our system, which is included in our service revenues.

 

During the three months ended June 30, 2003 and 2002, recorded as part of cost of service revenues, we paid Nextel WIP $24.0 million and $21.2 million, respectively, and for the six months ended June 30, 2003 and 2002 we paid Nextel WIP $43.8 million and $37.0 million, respectively, for services such as specified telecommunications switching services, charges for our customers roaming on Nextel’s system and other support costs.

 

During the first half of 2003 Nextel  continued to provide certain services to us for which we pay a fee based on  their cost. These services are limited to Nextel telemarketing and customer care, fulfillment, activations and billing for the national accounts. For the three months ended June 30, 2003 and 2002, we were charged approximately $996,000 and $736,000, respectively, and $2.2 million and $1.7 million for the six months ended the same periods, respectively, for these services.  Nextel WIP also provided us access to certain back office and information systems platforms on an ongoing basis. For the three months ended June 30, 2003 and 2002, we were charged approximately $1.0 million and $512,000, respectively, and $2.3 million and $837,000 for the six months ended June 30, 2003 and 2002, respetively, for these services. The costs for all of these services are included in selling, general and administrative expenses.

 

In the event of a termination of the joint venture agreement, Nextel WIP could, in certain circumstances, purchase or be forced to purchase all of our outstanding common stock.  In such event, Nextel WIP, at its option, would be entitled to pay the purchase price therefore in cash or in shares of Nextel common stock.  The circumstances that could trigger these rights and obligations include, without limitation, termination of our operating agreements with Nextel WIP, a change of control of Nextel or a failure by us to make certain required changes to our business.

 

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Business Relationship

 

In the ordinary course of business, we have engaged the services of and leased tower space from a company whose stockholder, president, chief executive officer and chairman of the board of directors is one of our directors.  For the three months ended June 30, 2003 and 2002, we paid this company $2.9 million and $2.3 million, respectively, and $5.2 million and $5.0 million for the six months ended June 30, 2003 and 2002, respectively, for these services and tower leases.

 

Donaldson, Lufkin & Jenrette Securities Corporation and Credit Suisse First Boston have served as initial purchasers of our senior notes and senior discount notes and received customary discounts and commissions in connection with each such offering. Donaldson, Lukfin & Jenrette Securities Corporation also acted as our financial advisor and as arranger, and DLJ Capital Funding, Inc., an affiliate of Donaldson, Lufkin & Jenrette Securities Corporation, acted as syndication agent, under our credit facility, and received customary fees and reimbursements in connection therewith. DLJ Merchant Banking and certain related parties, all of which are affiliates of Donaldson, Lufkin & Jenrette Securities Corporation, currently own approximately 11.4% of our outstanding common stock through their affiliate, Credit Suisse First Boston, and are represented on our board of directors. Donaldson, Lufkin & Jenrette Securities Corporation was a co-lead manager of the initial public offering of our Class A Common Stock, and we may from time to time enter into other investment banking relationships with it or one of our affiliates. The aggregate amount of all fees paid to the Credit Suisse and the DLJ Entities in connection with the capitalization transactions for both the three and six months ended June 30, 2003 and 2002 is approximately $4.5 million and $437,500, respectively.

 

RISK FACTORS

 

The following risk factors and other information included in this Quarterly Report on Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected.

 

We have a history of operating losses, expect to continue to incur operating losses in the future and may not be able to generate the earnings necessary to fund our operations, sustain the continued growth of our business or repay our debt obligations.

 

We did not commence commercial operations until January 29, 1999, and the portion of the Nextel Digital Mobile Network we began operating on that date only had a few months of operating history. Since then, we have had a history of operating losses, and, as of June 30, 2003, we had an accumulated deficit of approximately $1.1 billion. We expect to continue to incur operating losses and to generate negative cash flow from operating activities at least through 2003. We cannot assure you that we will become profitable or sustain profitability in the future. If we fail to achieve significant and sustained growth in our revenues and earnings from operations, we will not have sufficient cash to fund our current operations, sustain the continued growth of our business or repay our debt obligations. In addition, the slowdown in the U.S. economy generally has added economic and consumer uncertainty that could adversely affect our revenue growth. Our failure to fund our operations or continued growth would have an adverse impact on our financial condition, and our failure to make any required payments would result in defaults under all of our debt agreements, which could result in the cessation of our business.

 

If Nextel experiences financial or operational difficulties, our business may be adversely affected.

 

Our business plan depends, in part, on Nextel continuing to build and sustain customer support of its brand and the Motorola iDEN technology. If Nextel encounters financial problems or operating difficulties relating to its portion of the Nextel Digital Mobile Network or experiences a significant decline in customer acceptance of its products or the Motorola iDEN technology, our affiliation with and dependence on Nextel may adversely affect our business, including the quality of our services, the ability of our customers to roam within the entire network and our ability to attract and retain customers. Additional information regarding Nextel, its domestic digital mobile network business and the risks associated with that business can be found in Nextel’s Annual Report on Form 10-K for the year ended December 31, 2002, as well as Nextel’s other filings made under the Securities Act of 1933 and the Securities Exchange Act of 1934 (SEC file number 0-19656).

 

Our highly leveraged capital structure and other factors could limit our ability to obtain additional financing and our growth opportunities.

 

The total of our non-current portion of our outstanding debt and mandatorily redeemable preferred stock outstanding was approximately $1.6 billion as of June 30, 2003 and greatly exceeds the level of our revenues and stockholders’ equity.  As of June 30, 2003, the non-current portion of total long-term debt outstanding included  $371.4 million outstanding under our credit facility, $21.3 million of 14% senior discount notes outstanding at their accreted value, $390.0 million of 11% senior notes outstanding, $212.2 million of 12½% senior discount notes outstanding at their accreted value, $175.0 million 1½% convertible senior notes, $450.0 million 81/8% senior notes and $22.6 million of capital lease obligations. We also had approximately $37.1 million of mandatorily redeemable preferred stock outstanding, including accrued dividends. In aggregate, this indebtedness represented approximately 105% of our total book capitalization at that date.

 

Our large amount of outstanding indebtedness, and the fact that we may need to incur additional debt in the future, could significantly impact our business for the following reasons:

 

                                          it limits our ability to obtain additional financing, if needed, to continue the build-out of or implement any enhancement of our portion of the Nextel Digital Mobile Network including any enhanced iDEN services to expand wireless voice capacity, enhanced data services or potential “third generation” or “3G” mobile wireless services, to

 

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cover our cash flow deficit or for working capital, other capital expenditures, debt service requirements or other purposes;

 

                                          we must dedicate a substantial portion of our operating cash flow to fund interest expense on our credit facility and other indebtedness, reducing funds available for our build-out, operations or other purposes;

 

                                          we are vulnerable to interest rate fluctuations because our credit facility term loan bears interest at variable rates; and

 

                                          it limits our ability to compete with competitors who are not as highly leveraged, especially those who may be able to price their service packages at levels below those, which we can or are willing to match.

 

Our ability to make payments on our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Based on our current level of operations and anticipated cost savings and operating improvements, we believe our cash flow from operations, available cash and available borrowings under our credit facility will be adequate to meet our estimated capital requirements to build out our portion of the Nextel Digital Mobile Network using the current 800 MHz iDEN system until we become free cash flow positive, which we anticipate will not occur before 2004.  See “—Liquidity and Capital Resources” for more information regarding our use of free cash flow as a non-GAAP measure.

 

We cannot be sure, however, that our business will generate sufficient cash flow from operations, that currently anticipated cost savings and operating improvements will be realized on schedule or that future borrowings will be available to us under our credit facility in an amount sufficient to enable us to pay our indebtedness, our obligations under our credit facility or our existing senior discount notes and senior notes, or to fund our other liquidity needs. In addition, if our indebtedness cannot be repaid at maturity or refinanced, we will not be able to meet our obligations under our debt agreements, which could result in the cessation of our business.

 

If we default on our debt or if we were liquidated, the value of our assets may not be sufficient to satisfy our obligations.  We have a significant amount of intangible assets, such as licenses granted by the FCC.  The value of these licenses will depend significantly upon the success of our business and the growth of the SMR and wireless communication industry in general.

 

General conditions in the wireless communications industry or specific competitors’ results, including potential slowing of new subscriber additions, declining ARPU or increased customer dissatisfaction, may adversely affect the market price of our Class A common stock and, as a result, could impair our ability to raise additional capital through the sale of our equity or debt securities.  In addition, the fundraising efforts of Nextel or any of its affiliates may also adversely affect our ability to raise additional funds.

 

Under certain circumstances, Nextel WIP has the ability to purchase, and a majority of our Class A stockholders can cause Nextel WIP to purchase, all of our outstanding Class A common stock.

 

Under our restated certificate of incorporation and our operating agreements, in certain circumstances and subject to certain limitations, Nextel WIP has the ability to purchase, or to cause and fund redemption by us of, all of the outstanding shares of our Class A common stock.  In addition, under the provisions of our restated certificate of incorporation, upon the occurrence of certain events, the holders of a majority of our outstanding Class A common stock can require Nextel WIP to purchase, or cause and fund a redemption by us of, all of the outstanding shares of our Class A common stock.  The circumstances that could trigger Nextel WIP’s purchase right include the occurrence of January 29, 2008 (subject to certain postponements by our board of directors); a failure by us to implement certain required changes to our business; a failure by Nextel WIP to fund certain changes to the digital transmission technology; or termination of our operating agreements with Nextel WIP as a result of our breach.  The circumstances that could trigger our stockholders’ put right include a change of control of Nextel; failure by us in certain circumstances to implement changes to our business; or termination of our operating agreements with Nextel WIP as a result of a breach by Nextel WIP.

 

Any failure to integrate our portion of the Nextel Digital Mobile Network with Nextel’s portion effectively or on schedule would have an adverse effect on our results of operations.

 

Pursuant to our operating agreements with Nextel WIP, Nextel WIP provides us with important services and assistance, including a license to use the Nextel brand name and the sharing of switches that direct calls to their destinations. Any interruption in the provision of these services could delay or prevent the successful integration of our portion of the Nextel Digital Mobile Network with Nextel’s portion, which is essential to the overall success of our business.

 

Moreover, our business plan depends on our ability to implement integrated customer service, network management and billing systems with Nextel’s systems to allow our respective portions of the Nextel Digital Mobile Network to operate together, and

 

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provide our and Nextel’s customers with seamless service. Integration requires that numerous and diverse computer hardware and software systems work together. Any failure to integrate these systems effectively or on schedule may have an adverse effect on our results of operations.

 

Difficulties in constructing and operating our portion of the Nextel Digital Mobile Network could increase the estimated costs and delay the continued expansion of the network, which would adversely affect our ability to generate revenue.

 

The continued operation of our portion of the Nextel Digital Mobile Network involves a high degree of risk. Before we are able to build additional cell sites in our markets to expand coverage, fill in gaps in coverage or increase capacity, we will need to:

 

                                          select and acquire appropriate sites for our transmission equipment, or cell sites;

 

                                          purchase and install low-power transmitters, receivers and control equipment, or base radio equipment;

 

                                          build out the physical infrastructure;

 

                                          obtain interconnection services from local telephone service carriers on a timely basis; and

 

                                          test the cell site.

 

Our ability to perform these necessary steps successfully may be hindered by, among other things, any failure to:

 

                                          lease or obtain rights to sites for the location of our base radio equipment;

 

                                          obtain necessary zoning and other local approvals with respect to the placement, construction and modification of our facilities;

 

                                          acquire additional necessary radio frequencies from third parties or exchange radio frequency licenses with Nextel WIP;

 

                                          commence and complete the construction of sites for our equipment in a timely and satisfactory manner; and

 

                                          obtain necessary approvals, licenses and permits from federal, state and local agencies, including land use regulatory approvals and approval from the Federal Aviation Administration and Federal Communications Commission with respect to the transmission towers that we will be using.

 

Before fully implementing our portion of the Nextel Digital Mobile Network in a new market area or expanding coverage in an existing market area, we must complete systems design work, find appropriate sites and construct necessary transmission structures, receive regulatory approvals, free up frequency channels now devoted to non-digital transmissions and begin systems optimization. These processes may take weeks or months to complete and may be hindered or delayed by many factors, including unavailability of antenna sites at optimal locations, land use and zoning controversies and limitations of available frequencies. In addition, we may experience cost overruns and delays not within our control caused by acts of governmental entities, design changes, material and equipment shortages, delays in delivery and catastrophic occurrences. Any failure to construct our portion of the Nextel Digital Mobile Network on a timely basis may affect our ability to provide the quality of services in our markets consistent with our current business plan, and any significant delays could have a material adverse effect on our business.

 

If we do not offer services that Nextel WIP requires us to offer or we fail to meet performance standards, we risk termination of our agreements with Nextel WIP, which would eliminate our ability to carry out our current business plan and strategy.

 

Our operating agreements with Nextel WIP require us to construct and operate our portion of the Nextel Digital Mobile Network to specific standards, and to offer certain services by Nextel and its domestic subsidiaries. Our failure to satisfy these obligations could constitute a material default under the operating agreements that would give Nextel WIP the right to terminate these agreements, and would terminate our right to use the Nextel brand. The non-renewal or termination of the Nextel WIP operating agreements would eliminate our ability to carry out our current business plan and strategy and would adversely affect our financial condition.

 

We may be required to implement material changes to our business operations to the extent these changes are adopted by Nextel, which may not be beneficial to our business.

 

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If Nextel adopts material changes to its operations, our operating agreements with Nextel WIP give it the right to require us to make similar changes to our operations. The failure to implement required changes could, under certain circumstances, trigger the ability of Nextel WIP to terminate their operating agreements with us, which could result in the adverse effects described above. Even if the required change is beneficial to Nextel, the effect on our business may vary due to differences in markets and customers. We cannot assure you that such changes would not adversely affect our business plan.

 

The transmission technology used by us and Nextel is different from that used by most other wireless carriers, and, as a result, we might not be able to keep pace with industry standards if more widely used technologies advance.

 

The Nextel Digital Mobile Network uses scattered, non-contiguous radio spectrum near the frequencies used by cellular carriers. Because of their fragmented character, these frequencies traditionally were only usable for two-way radio calls, such as those used to dispatch taxis and delivery vehicles. Nextel became able to use these frequencies to provide a wireless telephone service competitive with cellular carriers only when Motorola developed a proprietary technology it calls "iDEN." We, Nextel, and Southern LINC are currently the only major U.S. wireless service providers utilizing iDEN technology on a nationwide basis, and iDEN phones are not currently designed to roam onto other domestic wireless networks.

 

Our operating agreements with Nextel WIP require us to use the iDEN technology in our system and prevent us from adopting any new communications technologies that may perform better or are available at a lower cost without Nextel WIP’s consent.

 

Future technological advancements may enable other wireless technologies to equal or exceed our current levels of service and render iDEN technology obsolete. If Motorola is unable to upgrade or improve iDEN technology or develop other technology to meet future advances in competing technologies on a timely basis, or at an acceptable cost, because of the restrictive provisions in our operating agreements with Nextel WIP, we will be less able to compete effectively and could lose customers to our competitors, all of which would have an adverse effect on our business and financial condition.

 

We are dependent on Motorola for telecommunications equipment necessary for the operation of our business, and any failure of Motorola to perform would adversely affect our operating results.

 

Motorola is currently our sole-source supplier of transmitters used in our network and wireless telephone equipment used by our customers, and we rely, and expect to continue to rely, on Motorola to manufacture a substantial portion of the equipment necessary to construct our share of the Nextel Digital Mobile Network. We expect that for the next few years, Motorola, and other manufacturers who are licensed by Motorola, will be the only manufacturers of wireless telephones that are compatible with the Nextel Digital Mobile Network. If Motorola becomes unable to deliver such equipment, or refuses to do so on reasonable terms, then we may not be able to service our existing subscribers or add new subscribers and our business would be adversely affected. Motorola and its affiliates engage in wireless communications businesses and may in the future engage in additional businesses that do or may compete with some or all of the services we offer. We cannot assure you that any potential conflict of interest between us and Motorola will not adversely affect our ability to obtain equipment in the future. In addition, the failure by Motorola to deliver necessary technology improvements and enhancements and system infrastructure and subscriber equipment on a timely, cost-effective basis would have an adverse effect on our growth and operations. We generally have been able to obtain adequate quantities of base radios and other system infrastructure equipment from Motorola, and adequate volumes and mix of wireless telephones and related accessories from Motorola, to meet subscriber and system loading rates, but we cannot be sure that equipment quantities will be sufficient in the future. Additionally, in the event of shortages of that equipment, our agreements with Nextel WIP provide that available supplies of this equipment would be allocated proportionately between Nextel and us.

 

Costs and other aspects of a future deployment of advanced digital technology could adversely affect our operations and growth.

 

Based on our current outlook and the current outlook of Nextel, we anticipate eventually deploying advanced digital technology that will allow high capacity wireless voice and high-speed data transmission, and potentially other advanced digital services.  The technology that we would deploy to provide these types of broadband wireless services is sometimes referred to as third-generation or “3G.”  We and Nextel are focusing activities on maximizing our ability to offer 3G capabilities while continuing to fully utilize our iDEN digital mobile network.  Significant capital expenditures would be required in implementing this 3G technology, and we cannot assure you that we will have the financial resources necessary to fund these expenditures or, if we do implement this technology, that it would provide the advantages that we would expect.  Moreover, it may be necessary to acquire additional frequencies to implement 3G technologies, and we cannot be sure that we will be able to obtain such spectrum on reasonable terms, if at all.  The actual amount of the funds required to finance and implement this technology may significantly exceed our current estimate.  Further, any future implementation could require additional unforeseen capital expenditures in the event of unforeseen delays, cost overruns, unanticipated expenses, regulatory changes, engineering design changes, equipment unavailability and technological or other complications.  In addition, there are several types of 3G technologies that may not be fully compatible

 

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with each other or with other currently deployed digital technologies.  If the type of technology that we either choose to deploy or are required to deploy to maintain compatibility with the technology chosen by Nextel does not gain widespread acceptance or perform as expected, or if our competitors develop 3G technology that is more effective or economical than ours, our business would be adversely affected.

 

We may not be able to obtain additional spectrum, which may adversely impact our ability to implement our business plan.

 

We may seek to acquire additional spectrum, including through participation as a bidder or member of a bidding group in government-sponsored auctions of spectrum. We may not be able to accomplish any spectrum acquisition or the necessary additional capital for that purpose may not be available on acceptable terms, or at all. If sufficient additional capital is not available, to the extent we are able to complete any spectrum acquisition, the amount of funding available to us for our existing businesses would be reduced. Even if we are able to acquire spectrum, we may still require additional capital to finance the pursuit of any new business opportunities associated with our acquisitions of additional spectrum, including those associated with the potential provision of any new "third-generation" or "3G" wireless services. This additional capital may not be available.

 

Our future performance will depend on our and Nextel’s ability to succeed in the highly competitive wireless communications industry.

 

Our ability to compete effectively with established and prospective wireless communications service providers depends on many factors, including the following:

 

                                          If the wireless communications technology that we and Nextel use does not continue to perform in a manner that meets customer expectations, we will be unable to attract and retain customers. Customer acceptance of the services we offer is and will continue to be affected by technology-based differences and by the operational performance and reliability of system transmissions on the Nextel Digital Mobile Network. If we are unable to address and satisfactorily resolve performance or other transmission quality issues as they arise, including transmission quality issues on Nextel’s portion of the Nextel Digital Mobile Network, we may have difficulty attracting and retaining customers, which would adversely affect our revenues.

 

                                          If either personal communication services or cellular operators provide two-way radio dispatch services in the future, our competitive advantage of being uniquely able to combine that service with our mobile telephone service would be impaired. Further, some of our competitors have attempted to compete with Direct Connect by offering unlimited mobile-to-mobile calling plan features and reduced rate calling plan features for designated small groups. If these calling plan modifications are perceived by our existing and potential customers as viable substitutes for our differentiated services, our business may be adversely affected.

 

                                          Because the Nextel Digital Mobile Network does not currently provide roaming or similar coverage on a nationwide basis that is as extensive as is available through most cellular and personal communication services providers, we may not be able to compete effectively against those providers. In addition, some of our competitors provide their customers with handsets with both digital and analog capability, which expands their coverage, while we have only digital capability. We cannot be sure that we, either alone or together with Nextel, will be able to achieve comparable system coverage or that a sufficient number of customers or potential customers will be willing to accept system coverage limitations as a trade-off for our multi-function wireless communications package.

 

                                          Neither we nor Nextel has the extensive direct and indirect channels of distribution for the Nextel Digital Mobile Network products and services that are available to some of our competitors. The lack of these distribution channels could adversely affect our operating results. Although we have recently launched a pilot program to expand our distribution channels to include retail locations, we cannot assure you that this program will be successful.  Moreover, many of our competitors have established extensive networks of retail locations, including locations dedicated solely to their products, and multiple distribution channels and therefore have access to more potential customers than we do.

 

                                          Because of their greater resources, some of our competitors may be able to offer services to customers at prices that are below the prices that we can offer for comparable services. If we cannot, as a result, compete effectively based on the price of our service offerings, our revenues and growth may be adversely affected.

 

                                          The wireless telecommunications industry is experiencing significant technological change. Our digital technology could become obsolete. We rely on digital technology that is not compatible with, and that competes with, other forms of digital and non-digital voice communication technology. Competition among these differing technologies

 

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can result in the following: segment the user markets, which could reduce demand for specific technologies, including our technology; reduce the resources devoted by third-party suppliers, including Motorola, which supplies all of our current digital technology, to developing or improving the technology for our systems; and adversely affect market acceptance of our services.

 

                                          We offer our subscribers access to digital two-way mobile data and Internet connectivity under the brand name Nextel Online. We cannot be sure that these services will continue to perform satisfactorily, be utilized by a sufficient number of our subscribers or produce sufficient levels of customer satisfaction or revenue. Because we have less spectrum than some of our competitors, and because we have elected to defer the implementation of “third generation” or “3G” services, any digital two-way mobile data and Internet connectivity services that we may offer could be significantly limited compared to those services offered by other wireless communications providers with larger spectrum positions. The success of these new services will be jeopardized if: we are unable to offer these new services profitably; these new service offerings adversely impact the performance or reliability of the Nextel Digital Mobile Network; we, Nextel or third-party developers fail to develop new applications for our customers; or we otherwise do not achieve a satisfactory level of customer acceptance and utilization of these services.

 

                                          We expect that as the number of wireless communications providers in our market areas increases, including providers of both digital and analog services, our competitors’ prices in these markets will decrease. We may encounter further market pressures to reduce our digital mobile network service offering prices; restructure our digital mobile network service offering packages to offer more value; or respond to particular short-term, market-specific situations, for example, special introductory pricing or packages that may be offered by new providers launching their services in a particular market. A reduction in our pricing would likely have an adverse effect on our revenues and operating results.

 

                                          Because of the numerous features we offer, our mobile handsets are, and are likely to remain, significantly more expensive than mobile analog telephones and are, and are likely to remain, somewhat more expensive than digital cellular or personal communication services telephones that do not incorporate a comparable multi-function capability. The higher cost of our equipment may make it more difficult or less profitable to attract customers who do not place a high value on our unique multi-service offering. This may reduce our growth