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Executives

Amy Wakeham

Stewart Douglas Hutcheson - Chief Executive Officer and Director

R. Perley McBride - Chief Financial Officer and Executive Vice President

Jerry Elliott

Analysts

Simon Flannery - Morgan Stanley, Research Division

Richard H. Prentiss - Raymond James & Associates, Inc., Research Division

James G. Moorman - S&P Capital IQ Equity Research

David W. Barden - BofA Merrill Lynch, Research Division

Amir Rozwadowski - Barclays Capital, Research Division

Philip Cusick - JP Morgan Chase & Co, Research Division

Leap Wireless International (LEAP) Q2 2013 Earnings Call August 1, 2013 5:00 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter 2013 Leap Wireless International Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded today, Thursday, August 1, 2013. I would now like to turn the presentation over to the host of today's call, Ms. Amy Wakeham, Vice President of Investor Relations and Corporate Communications. Please proceed.

Amy Wakeham

Great. Thank you. Good afternoon, everyone, and welcome to Leap's Second Quarter Conference Call. Joining me on our call today are Doug Hutcheson, Leap's Chief Executive Officer; Perley McBride, Leap's Chief Financial Officer; and Jerry Elliott, Leap's Chief Operating Officer. Following our prepared marks, the operator will come back on the line for the Q&A portion of the call. All of our earnings materials including earnings release, presentation and conference call replay will be available on the Investor Relations section of our corporate website. You can also find a reconciliation of our non-GAAP measures to the most directly comparable GAAP measure in the notes to the financial statements in today's earnings release or on the Financial Reports page of the website. As a reminder, statements about expected future events and financial results are forward-looking and subject to risks and uncertainties. Our actual results may differ. Please refer to the risk factors detailed in our SEC filings for further discussion. With that, I'll go ahead and turn the call over to Doug.

Stewart Douglas Hutcheson

Good afternoon, and thanks for joining us today. Before we discuss our Q2 results, I'd like to take a moment and comment on another significant event at the company. As I'm sure you know, we entered into an agreement on July 12 to be acquired by AT&T. Leap's stockholders will receive $15 per share in cash and a contingent value right or CVR entitling them to a pro rata share of any net proceeds received from the sale of the 700 Mhz "A Block" spectrum in Chicago. We negotiated a transaction structure that included the CVR approach because we believe the value of our 700 Mhz license is impaired due to interference and interoperability issues and that a near-term sale of the license would not achieve optimal value for our stockholders.

A company will represent Leap's stockholder interest and will continue to control the 700 Mhz license and will work to eliminate interference and interoperability issues. The CVR is described in greater detail on the preliminary proxy statement we filed on Tuesday with the SEC.

We're excited about the merger, which will give Cricket customers access to AT&T's 4G LTE network and expand Cricket's presence to additional U.S. cities. We believe the combination of the 2 companies will result in increased competition, better device choices, improved customer care and a significantly enhanced mobile Internet experience for consumers seeking affordable, value-rich wireless service. Of course, the transaction is subject to regulatory review and other customary closing conditions.

The purpose of today's call is to discuss our operational and financial results and as such, we won't be commenting or answering questions during this call on the proposed merger. However, I would like to direct you to our filings with the SEC and FCC and to our corporate website where we have posted additional information, including our preliminary proxy statement and investor FAQs regarding the transaction. Until such time that a transaction may close, it's business as usual at Leap, our operational strategy remains the same and we continue to focus on delivering a better customer experience, retaining and expanding our current customer base and attracting postpaid customers in making smart investments.

On the customer experience front, we're pleased to report that the initiatives we're pursuing are beginning to yield results. According to J.D. Power's report released just today, Cricket received the second-highest ranking for overall customer care among all noncontract carriers. Although there is much work left to be done, this recognition affirms we're on the right path to improve the customer experience we provide.

We're competing vigorously in the dynamic wireless space and have recently taken steps to further advance our competitive position. Our enhanced phone payment plan offers customers more flexible purchase options, providing even more opportunity to get the handset they really want. We've also introduced a completely new interface for our innovative Muve Music service, which significantly enhances the user experience and ease-of-use. We're encouraged by the early results and we're seeing and looking forward to pressing forward in the quarters to come.

Before I turn the call over to Perley to discuss our operational and financial results, I'd like to thank our employees, dealer partners and our suppliers for their support as we continue to advance our strategy and work to complete the proposed transaction. Perley?

R. Perley McBride

Thank you, Doug, and good afternoon, everyone. Our second quarter results reflect the impact of the increasingly competitive wireless environment and while we continue to take steps to drive our business forward, customer activity remains challenged. We also continue to be focused on effectively managing our cash resources.

Let's turn to Slide 7 and I'll walk you through our operational and financial results. Customer activity in the second quarter reflects the seasonality of the business. The tough competitive environment in which we operate, the continued decline in our PAYGo daily and broadband products, which now represent only 4% of the customer base, higher device selling prices and fewer reactivations. In the second quarter, our average device selling price to new customers increased 57% year-over-year. We believe that higher device prices drive increased customer survival. However, we also recognize that high device prices present a barrier to many customers, especially in the prepaid space. We recently launched an improved phone payment plan and are investing to drive customer awareness in this industry-changing program that will give customers the flexibility to pay for handsets at the point of sale or over time.

Turning to Slide 8. Our core wireless churn reflects typical seasonal increases. We continue to make investments that we believe will improve customer loyalty and increased customer survival and are seeing the results through lower deactivations in the second quarter. These improvements were offset by a decrease in the number of reactivating customers. As we work to further improve customer retention, changes were recently made to our sales compensation plans to ensure even more focus is placed on the customer experience and retention.

On Slide 9, we experienced another increase in Q2 ARPU, primarily driven by the reduction in PAYGo daily and broadband customers, as well as continued improvements in the mix of higher value plans and additional service fees. To compete more vigorously, we recently introduced some lower-priced service plans in many of our markets, which may impact ARPU in future quarters.

Moving to CCU on Slide 10, on a year-over-year and quarter-over-quarter basis, the increase in CCU is primarily driven by the decrease in our customer base. Product costs are also higher due to an increase in customers on Muve Music rate plans. At the end of Q2 2013, approximately 37% of our customers were on a Muve Music service plan compared to 10% in Q2 2012, and 32% in Q1 2013. We also made several changes to our dealer compensation to incentivize focus on customer longevity, which resulted in increased CCU.

On a quarter-over-quarter basis, we also experienced seasonally higher roaming costs. Cost management continues to be a focus, but we expect that heightened competition and the actions we have and are taking to protect our customer base and distribution will place additional pressure on CCU. Additionally, we recently introduced some aggressive device pricing and expanded data allotments in our service plans, which we expect may result in an increase in upgrades and data costs in the third quarter.

Turning to CPGA on Slide 11, on a year-over-year basis, CPGA increased by 31% primarily due to the decrease in gross activations driven by intensified competition and higher device selling prices. As we have said over the past several quarters, we are focused on acquiring the right customer and the result may be lower gross add volumes. We continue to believe that addressing consumer desire for high-end devices by improving the selection of devices we offer customers, including the most popular smartphones, will result in higher value customers that stay with us longer. As discussed earlier, we recently introduced industry-changing phone payment plans, which we believe will bring the out-the-door cost of higher-end devices into an affordable range for many more consumers. We expect this, along with other promotions, will drive improvements to gross activations and have invested marketing and advertising in the third quarter to drive consumer awareness.

Turning to our second quarter financial results on Slide 12. On a year-over-year basis, service revenues declined 10%. However, our focus on the higher-end devices drove an improvement in equipment revenues of nearly 40%. As a result, total revenues declined by 7% year-over-year and quarter-over-quarter. As mentioned previously, we remain focused on improving our cost structure, but we will continue to protect our customer base and distribution. The year-over-year improvement in free cash flow was primarily driven by lower capital spending, and we are free cash flow positive for Q2 and year-to-date when excluding the $43 million of early debt prepayment premium. We do continue to enhance our network to provide customers with better coverage and capacity for data services, and we currently cover approximately 21 million POPs with LTE network technology. We previously considered covering up to an additional 10 million POPs in 2013. However, we have recently adjusted our plans to forecast on delivering cost-effective LTE services to existing markets instead of a significant expansion of new LTE services. As a result, we are adjusting our 2013 CapEx guidance to a range of $150 million to $200 million.

To update everyone on our Apple purchase commitment, we purchased approximately 1/2 of our first year minimum purchase commitment through June 2013. Due to our efforts to expand sales volume for the iPhone, we have not been required to purchase additional handsets to meet the first year commitment.

To conclude and set the tone for the second half of the year, we remain focused on acquiring and keeping customers, protecting and enabling our distribution and making smart investments. With that, let me turn it back to the operator for the Q&A portion of the call.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Simon Flannery with Morgan Stanley.

Simon Flannery - Morgan Stanley, Research Division

So can you just give a little bit of color on the capital spending? Obviously, it's come down but you've been at a very low run rate in the first half. Is -- what are the projects that are going to require? I mean, it looks like you're going to be doing something like $100 million, so it's sort of doubled the run rate in the second half versus the first half, and yet I hear you saying that your LTE footprint is going to be constrained here. So perhaps you could just give a bit more color, is $150 million at the low end still, potentially too high? And then if you had any stats on the number of customers actually on LTE now in your base and any usage patterns you are seeing?

R. Perley McBride

Simon, it's Perley. I'll take the first half, and I'll let Jerry talk about our customers on LTE. But as far as capital spending, our current plan is that, that range does hold, the -- we have a number of data coverage and expansion initiatives underway currently in the company across the -- clear across the country. So we are expecting as those ramp up and come to full speed, that we will be coming in somewhere around the -- somewhere in the range that we gave. The -- what we've seen in our data, as you can imagine across the country, is consumers are consuming more and more data and we've had to obviously, increase the coverage and capabilities of our data networks. So that's where a lot of our capital is going, as well as investing, continuing to invest in back office projects with respect to improving the customer experience, and in areas from that perspective.

Jerry Elliott

Simon, it's Jerry. The LTE customer base continues to grow. We've not ever released how many 4G LTE customers we've got, but it continues to grow pretty nicely. And I think we've introduced more 4G handsets this summer and will continue into the fall and obviously, into the next year, so that base will continue to grow. The usage from a 4G customer is about twice that,that the usage is about twice what it is for a 3G customer. So we definitely see what everybody else sees in terms of we give people more capability. They use it. And part of the -- one of the things we've done to address kind of the increasing data usage is we've doubled the size of our data buckets before throttling kicks in. So that's just recently launched across the company. But I think our story on data usage is the same as everybody else across the country.

Stewart Douglas Hutcheson

And the last piece, Simon, I -- there are some things that may create additional thoughts on where capital goes. We're early on in WiFi offload as an example. And so we have some things that we're looking at to compress. We're going to be doing some upgrades on some of our video capabilities to manage that. So we're going to watch that number closely. And as we advance, see how do we balance the increased data usage that we're seeing with techniques that we can use to try and compress that and see if we can manage our numbers to the most effective outcome over time.

Operator

And our next question comes from Rick Prentiss with Raymond James.

Richard H. Prentiss - Raymond James & Associates, Inc., Research Division

A couple of -- well, first, congrats on the pending transaction. Two questions, if I could. There's been a flurry of M&A in the wireless space out there. But there's also been a flurry of new plans for customers to think about how to buy stuff. What is your view of what's happening in the marketplace and how the customers and consumers are looking at it?

Jerry Elliott

Hey, Rick, it's Jerry. Yes, I mean, we -- it's interesting. The industry has always been incredibly competitive, but it seems like the velocity and intensity of the competition certainly increased over the last 2 or 3 months with the -- whether its new rate plans or 0-down for an entire phone line up from one of the carriers and lots of action around trade-in programs. So it's really interesting. I mean, I think the 2 largest companies in the industry continue to perform really well and continue to garner the subscribers and the cash flow, and there's 2 other players that continue to do things that it's very difficult to understand from an economic perspective, and they're interestingly calling other people industry names. But I don't know if they're ever going to be able to make any money at what they're doing. So if all you want to do is grab market share and you just want to, just grab customers regardless of profitability, then that's one approach.

Richard H. Prentiss - Raymond James & Associates, Inc., Research Division

Okay. And the second question, obviously, AT&T has said they want to keep the Cricket brand. So it's nice to see that we'd have some legs beyond it. But my question is what has been the reaction from your dealer channel as far as the acquisition? How are they feeling?

Jerry Elliott

Oh, gosh, the dealer channel is euphoric. I mean, they're extremely happy. They're going to get a really robust 4G network across the country, a customer care organization that, in that same J.D. Power study that Doug cited earlier, AT&T, was the winner on customer care for postpaid carriers. And then obviously, the advertising and marketing machine that they've got, and keeping the Cricket brand name and expanding into additional cities and other markets is something that's not only an exciting opportunity for our distribution, our dealers, but it's really exciting for a lot of our sales force as well internally. So it's been a hugely positive thing for both the internal sales force as well as the dealer distribution to partners.

Operator

Our next question comes from the line of James Moorman with S&P Capital IQ.

James G. Moorman - S&P Capital IQ Equity Research

Just in terms of -- with MetroPCS and T-Mobile talking about expanding markets, how do you kind of plan on reacting to that as they do come into more and more of your markets? And I don't know if this -- it's kind of interrelated in your strategy, but you announced a new financing program. Now what do you see doing -- that you're going to be doing with this new program, that you kind of missed on in the last program?

Jerry Elliott

So the Metro has launched in 12 or 13 of our markets already. They've made a public announcement about that I guess a week or 2, so, ago. So they have launched in a number of our markets. We're assuming they'll continue to expand into more of our markets, and we look forward to the opportunity to do the same thing next year. So it's an industry that's always been extremely competitive as I've mentioned to Rick a minute ago. I think it seems to be getting even more competitive, and the velocity of the competition seems to be increasing. But I think that overall, the -- we're doing a lot of things, not only in response to more competition, but generally just to improve our business performance. The phone payment plans are a big thing for us. We've seen a great start and uptake on that. The -- a number of competitive actions that Perley mentioned around pricing, actions that we've taken on handsets and rate plans. And then I think we continue to improve the quality of our handsets, not only in the folks that -- the OEMs that we work with, but just the performance of the handsets themselves. They're as good a device as anybody in the industry has got. And we've got all the same device as anybody has got at this point. So we fully expected them to come into all of our markets many months ago. We planned ahead for that, and we welcome healthy competition.

Stewart Douglas Hutcheson

Just to give some color on the phone payment plans, what the -- what our current -- the current offering is really, it's a 3-tier offering that's basically focused on attracting the postpaid consumer. Our existing offer was one that was a really more of a rent-to-own products. We had kind of a 3-tiered offering now that's really focused on the postpaid consumer and also allows us to finance the unbanked consumer as well. So we believe it's a more robust program that can catch a broader part of the U.S. population and really has -- we'll have a particular way to allow a postpaid consumer to pay for a handset over time, if they don't want to pay for all upfront, and at very, very attractive rates. And our lead offer is the 0% rate. So...

Stewart Douglas Hutcheson

And when we launched the initial program, that was really what was available. The company has worked with other providers to put out now this broader program that allows us to meet the needs of approximately 90% of the customer base. And so we're pleased and it's early but we've had, I think, reactions to that program that are real positive. So we look forward to seeing how we do in building the program over the next 6 months.

Operator

And our next question comes from David Barden with Bank of America.

David W. Barden - BofA Merrill Lynch, Research Division

Just a first on the financial side, could you guys remind us or share with us kind of what roaming costs and partnerships you have now and obviously, there's a moment in time at some point in the future where that could change. It's going to have some ramifications and fallout for other guys. It will be helpful to kind of get an understanding of how that is working today. And then a second question is just we keep talking about how robust the competition is, maybe Jerry, and how it's accelerating its velocity. But it really seems like and one of the problems is that no one has been able to really stand out with some kind of product or brand in a significant or extended kind of way. And I guess it will be helpful just to kind of get a sense of -- now you've been there for a year and you're kind of watching this or maybe Doug, too. Like what is possible to be done to differentiate your product enough that you could command an economic value for your product in a sustained kind of way? Or is it just not possible right now in this climate to make money in the prepaid business because there's just too many people and it's going to require incremental consolidation or shaking out strategically?

Stewart Douglas Hutcheson

Let me take a shot. We don't release details on our roaming, and let us take a look on that. But I don't think we're in a position to give a lot of detail on that right now. And then we don't have specific comments on what we think a standout product would be going forward, and so we'll revert on it at a later time on that. But I don't have anything to add right now.

Operator

And your next question comes from the line of Amir Rozwadowski with Barclays.

Amir Rozwadowski - Barclays Capital, Research Division

Just a bit more on the competitive landscape. As you mentioned, we've seen some interesting moves by some of the competitors in recent months, and particularly if you look at some of the pricing plans that are put in the marketplace, there does seem to be an optically be a blending of what we would might consider traditional postpaid-type plans versus traditional prepaid-type plans. And as you folks have invested in your LTE network and have improved sort of the portfolio of devices that you're providing to the marketplace, have you seen increased willingness of the subscribers who have been on what we would consider traditional postpaid plans transitioning and finding sort of a more attractive value proposition with respect to some of your service offerings in the market?

Stewart Douglas Hutcheson

Yes, the last time -- I think on our last call, we released, 2/3 of our customers come to us from postpaid carriers. And we don't have an update specifically for that. In a fair sense, that's where the largest part of the market segment is and we'll continue to press ahead with our strategy, as Perley and Jerry both highlighted of attracting postpaid customers. We'll continue to work on doing that. In addition, the customer base we serve and have served well over the years, the financing programs, the things that we have done allow particularly, the new programs, really allow us to provide opportunities for them to get into better handsets and it provided a series of structure, a structured financing alternatives for them that we're real pleased with, and we'll look forward to see how they progress.

Operator

And our last question comes from the line of Phil Cusick with JPMorgan.

Philip Cusick - JP Morgan Chase & Co, Research Division

Doug, it's been a heck of a run. I wonder if you could just help us with the status of that 700 Mhz license. What's the impairment in that market and what's the situation for getting that cleaned up?

Stewart Douglas Hutcheson

Yes, we actually provided information in our proxy around that. I think we'll be back with more information specifically on where things are in the coming quarters. I think that there is some general information available about the 700 A band that's out there on where the interference is on that and we look forward to clearing that. We'll provide more information in the coming months. So thank you.

Amy Wakeham

Great. Thanks for joining us, everyone, on our call this afternoon. We look forward to updating you on our progress on our next quarterly conference call. Any further questions regarding our operational and financial results can be directed to the Investor Relations department. Questions regarding our proposed merger with AT&T are just in the FAQs posted on the IR section of our corporate website. Operator?

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.

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