Clearwire Q1 2008 Earnings Call Transcript

Executives

Hope F. Cochran - Vice President - Finance, Treasurer

Perry S. Satterlee - President, Chief Operating Officer; President and CEO of Clearwire U.S.

Dr. John Saw - Vice President, Chief Technology Officer

John A. Butler - Chief Financial Officer

Benjamin G. Wolff - Chief Executive Officer, Director

Analysts

Rick Prentiss - Raymond James

Eric Caner

Phil Cusick - Bear Stearns

Michael Rollins - Citigroup

Clearwire Corporation (CLWR) Q1 2008 Earnings Call May 12, 2008 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the quarter one 2008 Clearwire Corporation earnings conference call. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, Ms. Hope Cochran, Vice President of Finance and Treasurer. Please proceed.

Hope F. Cochran

Good afternoon. I’m Hope Cochran, Vice President of Finance and Treasurer for Clearwire and I’d like to welcome you to our first quarter 2008 results conference call. Joining me this afternoon are Perry Satterlee, President and Chief Operating Officer; John Saw, our Chief Technology Officer; and John Butler, our Chief Financial Officer. Our Chief Executive Officer, Ben Wolff, will be joining us for the question-and-answer session.

This afternoon’s call is scheduled to conclude at approximately 2:45 p.m. Pacific Time. Today’s call is being webcast on the Clearwire investor relations website and will be archived on that site and available for replay shortly after we conclude.

We released our earnings earlier this afternoon and hopefully you’ve had an opportunity to read the press release, which provides detailed financial information on Clearwire Corporation’s 2008 first quarter results.

Before I turn the call over to Perry, let me briefly state our Safe Harbor disclaimer: today’s call may contain forward-looking statements reflecting management’s beliefs and assumptions concerning future events based on currently available information. Forward-looking statements include, among other things, our future financial and operating performance and financial condition, including projections and guidance for 2008 and subsequent periods, subscriber growth, network development and launch plans, and the need for additional financing.

Listeners are cautioned not to put undue reliance on any forward-looking statements as they are not a guarantee of future performance and remain subject to a number of uncertainties and other factors that could cause actual results to differ materially from forecasts.

Please refer to our press release and our filings with the SEC for more information on these risk factors.

Additionally, a reconciliation of any non-GAAP financial measures discussed on this call can be found in our press release.

At this time, I’d like to turn the call over to Clearwire's President and Chief Operating Officer, Perry Satterlee.

Perry S. Satterlee

Thank you, Hope and thank you to everyone on the call for joining us today as we discuss Clearwire's first quarter 2008 financial and operating results. During last quarter’s call, Ben Wolff, our CEO, discussed several key areas of focus for this year -- deploying mobile WiMAX technology, driving improvements in the operating and financial performance of the business, and balancing our growth opportunities with the challenging economic and financial environment. I am pleased to report that we believe we are making good progress in all of these areas and we will be sharing some of the highlights with you today during today’s call.

To start, our progress in Clearwire's first mobile WiMAX market, Portland, Oregon, is on track. Site development is on schedule to meet our targeted launch date and the first rounds of testing on the Wave 2 software load for Motorola are exceeding our performance objectives.

Development of the remaining pops in the additional three WiMAX markets, Las Vegas, Atlanta, and Grand Rapids, are also on track. We are poised to make service available in these three markets by the end of the year, taking into account the timing of the close of the combination with Sprint and the acquisition of interim financing.

In addition to the aforementioned markets, we have approximately 30 million more mobile WiMAX pops at some stage of development. We have more than 2,500 sites leased and ready to construct, which when completed will double the number of sites on air today. This state of deployment readiness allows us to accelerate our launch schedule. In a few minutes, John Saw will provide more color on the progress that we are making in our Portland market, as well as the developments in the WiMAX ecosystem.

Our first quarter results were consistent with expectations and we remain well-positioned to achieve our plan for the year. Clearwire ended the first quarter with approximately 443,000 consolidated subscribers, which reflects an increase of 72% from the first quarter of 2007. Consolidated revenue grew 76% from the same period last year, driven by subscriber growth, relatively stable pricing, and the adoption of additional services. Most importantly, we made progress driving profitability in our operating markets. We ended the quarter with a total of 27 markets achieving market EBITDA positive and the initial 25 markets as a group posting a 21% market EBITDA margin.

Our ongoing subscriber and revenue growth, as well as the expanding profit margins in our initial markets continue to validate the business model that we have been executing since day one.

While the fiscal losses arising from the ongoing investment in our network build continue to increase, these losses are consistent with the long-term business model. Simply put, we will take a sustained period of investment and negative cash flow to build out our network and begin producing operating profits. However, in contrast to the capital intensive nationwide cellular build-outs of the 90s, we believe our planned capital outlay and negative cash flows will prove to be far more efficient and modest.

While our accumulated losses to date are slightly over $1 billion, this pales in comparison to the losses incurred by our wireless predecessors prior to reaching cash flow break-even. As most of you know, I was at Nextel and the COO of Nextel Partners. The combination of both companies to build a nationwide footprint had peak negative cash flow estimated at $18 billion.

We believe the evolution of wireless broadband technology and the migration to an all IP network is giving Clearwire and its shareholders a much more efficient use of capital. Following the closing of the combination with Sprint and the new investments from our strategic investors, we expect the funding gap required to complete a nationwide build-out to be approximately $2 billion to $2.3 billion.

Compare that outlay to the more than $16 billion that our major competitors just spent for new spectrum designated in part for the deployment of a next generation network, and this is all before a single dollar of CapEx or OpEx is spent.

We believe Clearwire represents one of the most cost-efficient nationwide deployments while producing one of the most capable wireless networks to date.

Now to tell us more about mobile WiMAX and the progress we are making, I would like to turn the call over to our Chief Technology Officer, Dr. John Saw.

Dr. John Saw

Thank you, Perry. I am pleased to report to you that our Portland mobile WiMAX network trial continues to progress on schedule. Most importantly, the mobile WiMAX technology that we plan to deploy continues to exceed our expectations.

We have entered an important phase in our WiMAX rollout plan. Our 145 square mile beta coverage area that we demonstrated during our January investor day has now been converted to a production network. The training wheels are coming off as we prepare the Portland network for commercial launch.

Concurrently, we are also acquiring, developing, and constructing additional sites in our Portland network to cover the remainder of the city and surrounding areas as we move towards a soft launch in Portland later in the year. To date, more than 70% of our WiMAX sites in Portland are in construction or on air.

As part of our conversion to a production network, we have recently upgraded our network software to meet the latest Wave 2 profile of the mobile WiMAX standard. The Wave 2 release will deliver more features and capabilities to our network, including advanced antenna processing.

One of the key benefits of Wave 2 is the capacity and coverage enhancements that are enabled by multiple in, multiple out antenna schemes, commonly known as MIMO Matrix A and MIMO Matrix B. To date, early field test results of MIMO have been very positive. We have seen measurable performance improvements in coverage with MIMO A and in capacity improvements with MIMO B. MIMO A will be particularly helpful to enhance coverage, including in-building coverage at the cell address. We are also pleased to see significant throughput improvements delivered by MIMO B.

In recent dry tests, we have observed throughput increases of more than 50% when compared to previous tests conducted on non-MIMO B systems.

We expect that these MIMO enhancements will greatly improve our customers’ mobile broadband experience, far beyond what is achievable by any other wireless network in service today. This is great news for both our shareholders and our customers.

Consistent with the way that we have launched markets using our pre-WiMAX technology, we plan to continue to thoroughly stress test the new WiMAX platform in Portland with friendly customers during our soft launch phase.

Once we have soaked in the Portland network for several months, we expect to launch the other three markets. As described in our investor day presentation, before we move to broader nationwide deployment, we intend to launch Atlanta, Las Vegas, and Grand Rapids, each of which will cover different market densities, topographies, demographics, and competitive landscapes, so that we can incorporate the lessons learned into the broader launch of mobile WiMAX in our markets throughout the country.

Obviously the availability and breadth of mobile WiMAX devices is a critical path item for us to launch WiMAX. Let me take a moment to update you on that front.

Clearwire's mobile WiMAX device roadmap and the overall development of the WiMAX ecosystem are quite healthy. We continue to work with our silicon and device OEM partners to deliver residential modems and a suite of mobile devices for our lead WiMAX markets.

We are pleased with the product performance and early form factors that our vendors are delivering, starting with USB dongles and express cut modems. Our engineers are working closely with these vendors on performance tuning and interoperability testing to ensure high performance quality in our lead markets. Certainly one of the focus areas in the WiMAX launch is managing the coordination of interoperability testing amongst device vendors and infrastructure supplies.

We have also started testing Intel-based WiMAX embedded laptop notebooks and the first set of the new mobile Internet devices from Nokia, specifically the Nokia N810 Internet Tablet WiMAX Edition. Embedded devices will become a very important sales channel for WiMAX and we are very excited to see the emergence of these devices in field testing.

In summary, we believe that our WiMAX infrastructure and device development are progressing nicely. We are well past the technology evaluation stage for WiMAX and are scaling into a production environment. With our upcoming combination with Sprint’s 4G assets, we expect to cover 120 million to 140 million people by the end of 2010. By the end of 2009, we expect to have 60 million to 80 million people covered.

Looking back, it has taken mobile WiMAX about three years from when the standard was ratified in 2005 to the start of the commercial ramp today. In all my years in wireless, I believe that this has been one of the fastest ramps of a new wireless technology from standardization to commercial ramp. It will be interesting to see if LTE can keep up with this three-year cycle, assuming that LTE Release 8 actually closes this year.

In addition to having to work out the kinks in the technology and to growing an LTE ecosystem, prospective LTE operators will still need to solve a number of significant challenges. The first is the massive back-haul capacity upgrades needed for existing 2G and 3G towers, which were originally designed for narrowband voice. No one talks much about this but LTE will need much more than a couple of T1 lines supporting many of the 2G, 3G sites today.

The second challenge lies in a misconception that LTE is a simple upgrade from 3G systems. It is not. Most 2G/3G cellular sites are not upgradeable to LTE and will require an expansive forklift upgrade.

Last but not least, prospective LTE operators will need to either find new spectrum or reform existing bands in order to find enough white channels to launch a truly broadband network.

Now I will turn it back to Perry.

Perry S. Satterlee

Thank you, John. We believe that our recent announcement to combine Clearwire and Sprint’s 4G assets to form a new wireless communications company is a tremendous opportunity for the entire Clearwire team, our shareholders, partners, and customers. We expect the transaction to close during the fourth quarter of 2008. In the meantime, we will continue to be prudent with the use of our cash resources. We will moderate the growth rate of our net subscriber additions and emphasize margin improvements and financial performance in our operating markets as we plan for their eventual conversion to WiMAX. This will require careful management of subscriber growth in these markets to ensure a solid return on the cost of customer acquisitions against the cost of converting those customers before the WiMAX upgrade.

The net result of these efforts will enable our company to meet our current expectations and guidance while positioning us to more efficiently transition to the future state as a wireless broadband service provider.

At this time, I would like to highlight some more details of Clearwire's strong operating results for the first quarter.

Consolidated net subscriber additions in Q1 were approximately 48,000, bringing the total number of subscribers to 443,000, representing a 72% year-over-year growth and a 12% from last quarter. Penetration in our markets that have been in operation for more than 12 months continues to increase steadily. We ended the first quarter with nearly one-third of the group at 15% or greater household penetration and more than two-thirds of the group were more than 10%.

Our quarterly net adds and our overall subscriber growth were in line with the upswing of the seasonal trend that we have observed in our business over the past few years. As we have stated previously, we have continued our focus on driving profitability in our markets and we have taken steps to ensure that we maintain quality subscriber growth in the face of increasing competition and the headwinds of a tightening economy. Thereby, year-over-year net add growth in Q2 and Q3 will be lower than in past periods. Having said, that it’s important to note that we expect to achieve our original guidance of 510,000 to 530,000 subscribers at the end of 2008.

In Q1, consolidated ARPU was $36.86, representing an increase of $1.06 during the same period in 2007 and a sequential quarterly increase of $0.77. As we discussed in our last earnings call, we employed introductory promotions during the latter part of Q4 which extended into the early part of Q1 and helped further drive subscriber growth.

The year-over-year increase in ARPU is due to the discontinuance of holiday promotions for new customers and the increased revenues from our international markets. Our focus on long-term pricing stability has yield a sustained ARPU base rate that reflects the premium our simple, portable, and reliable residential broadband services are able to garner in a highly competitive marketplace.

We believe ARPU growth will continue to be driven by premium plan loading, which was more than 80% in Q1, and the increased adoption of multiple services by our customers as we evolve our marketing and distribution in preparation for Clearwire's WiMAX offering.

Consolidated CPGA for Q1 was $393, representing a decrease from $477 in the previous quarter and up from $343 from the same period last year. The year-over-year increase in consolidated CPGA was driven in part by international markets, which have ramped to a normal spending level over the last few quarters but started 2007 with unusually low sales and marketing expenses.

During Q1, domestic CPGA declined from $486 in Q4 to $396 as the sustained marketing activity that began in 2007, which included TV advertising, led to increased productivity, especially in our larger metropolitan markets. The efficiency gained from our market push were coupled with overarching efforts to drive profitability through our continued management of sales and marketing spend.

Consolidated churn in Q1 was 2.2% compared to 2.4% last quarter and 1.6% during the same period in 2007. Domestic churn was 2% for the quarter, which is down sequentially from 2.1% last quarter but is up from the 1.5% during the same period in 2007.

International churn was 3.7% for the quarter, which is down sequentially from 4.9% last quarter and up from 2.4% for the same period in 2007. In response to the consumer credit issues in the marketplace, Clearwire tightened its credit standards in late 2007, which is paying dividends within our newer subscriber base. However, expect that churn will rise slightly over the next two quarters due to a seasonal increase in moves and slight increase in non-pay.

Our domestic initial markets are prime examples of our ability to balance growth and modulate spend in order to achieve profitability. Year over year, the total subscribers of these markets increased by 29% to more than 226,000, which equates to an average household penetration level of nearly 13%. This group of markets achieved market EBITDA positive in Q207 and have continued to demonstrate its overall performance in both margins and operating metrics.

As a whole, this group attained a 21% market EBITDA margin for the quarter, which is nearly double from the 11% in Q4. In addition to its impressive market EBITDA margin expansion, the other key metrics in this group, including CPGA and ARPU, continue to outperform the company as a whole.

The financial and operational performance of the initial 25 markets serves as a blueprint for our operating markets to reach profitability. We believe they are a direct illustration of how all of our markets will efficiently scale in costs and effectively drive additional revenue while managing growth.

With the critical mass that our markets have built, they are well-positioned to continue to grow ARPU through base marketing of the Clearwire product portfolio. By leveraging our existing customer relationships, markets should be able to cost-effectively penetrate the customer base with VOIP and PC card services. For example, in the first quarter, the majority of VOIP sales in the initial 25 markets were made to existing customers.

Penetration of additional services is a critical growth component in our operating markets. The following is an update on the performance of the individual products that are included in Clearwire's multi-service offering.

During Q1, we launched VOIP service in three additional markets, bringing the total number of markets selling VOIP to 44. We ended the quarter with more than 14,000 VOIP subscribers, which represents quarter over quarter growth rate of nearly 50%.

During Q1, VOIP services represented 10% of our residential broadband sales in the 44 markets that currently provide this offering. This represents a product mix that is consistent with the previous quarter and our long-term business plan.

Q1 marks the first full quarter of PC card availability following the launch of the product in October of 2007. During the quarter, we increased our focus on the Soho and MSB segment by offering businesses a new way to untether their workforce and increase productivity. We have made compelling headway into a number of business accounts during the quarter. For example, the City of Lubbock recently purchased more than 100 PC cards. Jason [Golzer], Director of IT, said: “Clearwire has completely transformed the way we do business in Lubbock, whether we are cutting down our repair time or reducing costs by monitoring our different applications. The speeds are unmatched by any other wireless broadband product in our marketplace.”

We believe this is a great example of how our PC card performance will enable the mobile workforce to improve their effectiveness.

As we increased the dedicated media and marketing for the PC card during Q1, we identified that the express card form factor was impacting the efficiency of our distribution efforts. Given that the major retailers have shifted their inventory to the PC cards utilizing the express card -- PCs utilizing the express card, we are now targeting the business segment to sell our current form factor. We will broaden to the consumer segment as the express card becomes widely available in our markets in late Q2 to early Q3.

While the express card isn’t currently available, we believe we have made good progress in building the awareness and distribution from Clearwire's PC card offering and have exited the first quarter with PC card sales at 5% of residential gateway sales.

Of the new PC card activations during Q1, more than 40% were purchased with our residential gateway service. Our success in combining the PC card with our residential gateway services serves as a foundation for the breadth of mobile offerings that will be available in the mobile WiMAX product set and it represents an important step in the evolution of our home and away service offering.

And now I’d like to turn it over to our Chief Financial Officer, John Butler.

John A. Butler

Thank you, Perry. Now turning our attention to the financials, on a consolidated basis, service revenue for the quarter grew by approximately 76% to $51.5 million, compared to approximately $29.3 million during the same quarter of ’07. The substantial increase in revenue was driven by the continued rapid growth of our subscriber base, which grew 72% versus last year’s first quarter, as well as the growth of our new products and services, particularly our VOIP product.

Over the past 12 months, we’ve added a net total of nearly 185,000 subscribers, bringing our total subscriber count to approximately 443,000 at the end of the first quarter. In the first quarter alone, we had over 48,000 net subscriber additions.

Now let’s review the expense drivers for the quarter -- on a consolidated basis, first quarter gross margins in dollar terms were slightly above the same period last year. However, in percentage terms, the gross margins for the 2008 first quarter were 26% versus 43% in last year’s first quarter. The gross margin deterioration in the quarter was primarily due to the cumulative effect of the Q4 and early Q1 sales promotion, an increase in the cost of service related to the markets launched in the second half of ’07, and the significant number of towers leased and ready for equipment in preparation for a rapid 2009 deployment.

We expect gross margins to increase in the second quarter as the newly launched markets begin to scale. SG&A expenses were $99.1 million for the quarter versus $68.7 million in the first quarter of ’07. The largest components of SG&A are headcount and CPGA, both of which are higher than the year-ago quarter, primarily in support of the market expansion, higher gross add volumes, and increased call center activity during the past year. However, it is important to note the consolidated headcount is down by nearly 6.3% from fourth quarter ’07 levels and would have decreased even further if we excluded new roles necessitated by the mobile WiMAX deployments, new portal rollout, and other activities as we continue to focus on automating and driving costs out of the business.

We ended the first quarter with approximately 1,863 partners. Our EBITDA loss for the first quarter was $121.9 million, compared to $70 million in the same quarter of ’07. On a sequential basis, the first quarter EBITDA loss has been reduced by approximately 9% from our fourth quarter ’07 loss. This occurred as a result of our slowdown in market deployment and focus on driving profitability.

As with any asset intensive start-up and consistent with the experience at [Macau] Cellular, Nextel, and Nextel Partners, as our network footprint expands our losses will increase, as a result of fixed network components that are required to build a wireless network. This is the same pattern that all wireless carriers have faced during the build-out phase and is expected to resume in Clearwire once we begin to accelerate the mobile WiMAX deployments later in the year.

Our CapEx in the first quarter came in at $53.1 million versus $74.4 million in the year-ago quarter. The reduce CapEx in the quarter reflects our decision to modulate our rate of growth to conserve cash while continuing to prepare for our planned mobile WiMAX launches later in the year.

Let’s move the discussion to our more mature initial 25 markets. As we’ve detailed previously, these markets provide a better understanding of how the business is operating, which is exclusive of the construction and development business, where new market launches and related capital investments tend to distort our consolidated results from quarter to quarter.

As Perry mentioned earlier, during the second half of 2007 we began to increase our focus on driving profitability rather than increasing market share. We ended the first quarter in our initial markets with 226,000 subscribers, representing an increase of 29% versus the same quarter last year. This strong subscriber growth, along with growth in new product sales and other initiatives, drove 38% revenue growth as service revenue rose to $24.9 million compared to $18.1 million in the same period last year. Gross margins were 77% for the quarter, up from 72% in the same period in 2007.

With improving scale and a large percentage of incremental revenue dollars falling straight to the bottom line, the initial market’s EBITDA continued its steady progress, moving to a margin of 21% versus slightly negative in the prior year. We believe that the performance in our initial markets validates our strategic investments in spectrum assets, new market development, and corresponding increased level of operating losses that come along with any construction and development business. This premise is further validated by the 2006 markets, which are now beginning to turn market EBITDA positive and the 2007 markets, which appear to be on a similar trajectory.

And with that, I’ll turn the call back to Perry.

Perry S. Satterlee

Thank you, John. I would like to close by saying that we are truly at the cusp of a transformative and revolutionary period in the development of our company. Over the past three years, we have demonstrated that our fast, simple, portable, and reliable wireless broadband service has mass market appeal.

We have executed against our plan, which shows a clear path to the profitability in our business model. With these achievements and experience to guide us, we will hit the ground running as we embark on our new vision to transform the way that people make use of the full capabilities of the Internet. We believe we are building one of the most capable wireless broadband networks ever conceived.

And with that, we’ll turn the call over for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Rick Prentiss of Raymond James. Please proceed.