Leap Wireless International Management Discusses Q2 2012 Results - Earnings Call Transcript

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Leap Wireless International (LEAP) Q2 2012 Earnings Call August 6, 2012 5:00 PM ET


Ladies and gentlemen, thank you for standing by. Welcome to the Second Quarter 2012 Leap Wireless International Earnings Conference Call. [Operator Instructions] I would now like to turn the presentation over to the host for today's call, Ms. Amy Wakeham, Vice President of Investor Relations and Corporate Communications. Please proceed.

Amy Wakeham

Yes. Thanks, George. Good afternoon, everyone. Thanks for joining us, and welcome to Leap's Second quarter 2012 Conference Call. This call, along with the presentation slides, is being webcast live and together with our earnings release, will be available on our corporate website shortly after the completion of the live call. The results and data we discuss today reflect the consolidated results of Leap, its subsidiaries and joint venture partners for the periods indicated. We will discuss certain non-GAAP measures. For a reconciliation of our non-GAAP measures to the most directly comparable GAAP measures, please see the notes to the financial statements in today's earnings release, or visit our Financial Reports page on our 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 materially. Please refer to the risk factors detailed in our SEC filings for further discussions. For anyone listening to a taped or webcast replay or viewing a written transcript of our second quarter call, please note that all information presented is current only as of today's date, August 6, 2012. The company disclaims any duty or obligation to update any forward-looking information, whether as a result of new information, future events or otherwise.

On the call today to discuss our second quarter results are Doug Hutcheson, Leap's President and Chief Executive Officer; and Jerry Elliott, Leap's Chief Financial Officer. Following our prepared remarks, the call operator will come back on the line for the Q&A portion of the call, and then Doug will return for a few closing remarks.

I'd now like to turn the call over to Doug.

Stewart Douglas Hutcheson

Welcome, and thank you for joining us today. Over the past several months, Leap has been planning and implementing a transition in our business that we believe is fundamentally necessary and will significantly advance our strategy, strengthen our competitiveness and improve our financial performance. This transition is based upon 2 elements: First, over the second half of this year, we will introduce a number of new products, plans and services, and we'll make changes to improve customer experience. Second, we have been looking and continue to look at all options to drive free cash flow, improve margins and optimize the value of our lower performing assets. To some extent, second quarter's results reflect and we expect third quarter results will reflect that we're already in the middle of this transition. Operationally, customer additions did not meet our expectations for reasons we'll explain later in the call. On the financial side, our progress has produced some of the best results in terms of OIBDA and margins, although more progress is essential on this front.

We'll discuss those results in detail shortly, but before I do, I'd like to take a step back to provide you with an overview of how we're looking at our business and responding to the evolving marketplace. As you know, 2 years ago, we refocused our business to provide attractive all-inclusive plans with sophisticated devices such as smartphones and advanced services such as Muve Music that operate over a fast nationwide network. Following that transition, we made dramatic improvements in the business and we continue to believe that it's fundamentally the right strategy. In fact, while we're making some important refinements to our strategy, a lot of what we're seeing in the marketplace is telling us that we're on the right path and need to keep moving forward, albeit with improved execution.

Over the coming weeks, you're going to see a significant upgrade of our higher ARPU service plans to provide more alternatives and value at different price points. We'll also be making improvements to our customer experience and adding more high-quality desirable handsets. Looking to the holidays, you will see the introduction of 4G devices and services as we expand our 4G network capabilities. We also intend to focus on maintaining our competitive position for entry-level customers by expanding our lifeline programs to provide attractive programs to financially challenged consumers, importantly, without meaningfully discounting the overall profitability around these plans. At the same time, we remain focused on improving cash flows and financial performance. We are tightening our focus in our national retail channels, limiting the number of doors and focusing our marketing spend. In addition, we're reducing 2012 capital expenditures by approximately $80 million, principally by managing 3G network capacity investments.

Also, as we roll out LTE, we are continuing to explore cost effective ways to deliver 4G services, including by deploying facilities-based coverage and by entering into partnerships and joint ventures with other carriers. We're also expanding a review of alternatives to drive cash flow and realize value from our assets.

Let me now provide a little more detail regarding our operational results. As I said, second quarter results reflect a quarter of transition. However, net customer additions did not meet our expectations. In general, second quarters are weaker, and we've seen that across the industry. In this economy, that impact was magnified. In addition, promotional activities to drive gross additions that we implemented to bridge the transition did not perform as we expected.

Gross additions were also impacted by device selection and certain device quality issues regarding some of our more popular devices. While these issues have or are being addressed, they caused some impact during the quarter to gross additions, churn and CPGA. While we had substantial handsets supply throughout the quarter, certain popular handsets were not -- either not available for sale because of quality issues or did not meet changes in customer needs over time. In some cases, this required the company to meet customer demand with more expensive devices, increasing our subsidy expense. We are in discussions with these suppliers and expect significant steps to be taken on their part or they may be, among other things, eliminated from our device portfolio. Also as in previous quarters, we've continued to focus our efforts away from the broadband products so we can use the 3G network capacity for higher value services.

I will discuss churn on the next slide, but it was few a tips [ph] higher than we expected. However, our core voice churn year-over-year was essentially flat. Therefore, when the expected decline of broadband customers is considered, most of the year-over-year reduction in voice customer additions is attributable to the lower gross additions we saw during the quarter. These factors together resulted in net customer additions that did not meet our expectations.

Turning to Slide 8, while consolidated churn was higher than we expected, our in-footprint churn excluding national retail was flat year-over-year at approximately 3.4%. There are 2 factors on churn which we'd like to discuss in more detail: First, overall churn in Q2 was higher than expected due to fallout from some national retail channels that was not acceptable. I'll discuss the details of some of the actions we're taking to ensure we will move towards more attractive national retail customer activity in a few minutes. Second, in the second quarter like every quarter, we ran a variety of retention programs to extend the life of certain customers or handsets. During the quarter, certain new retention programs that we ran for select customers did not work as we anticipated and we eliminated them. But these programs put some pressure on ARPU this quarter and we expect they will also put some pressure on churn next quarter as well. As we look at Q3 '12, we expect churn to be near or higher than Q2 '12 churn, reflecting the pattern of churn being highest in the third quarter and some pressures from the Q2 retention activities. After which, we expect it will moderate as a result of the initiatives we'll discuss next.

Let me now give you more details on the changes we're making to address the evolving marketplace, changes that you'll see roll out over the next few weeks. As I said earlier, our strategy of switching to providing high quality, more desirable devices has been successful as we've seen growth in our unit margins. We continue to see the increasing role devices play for customers and the effect they have on their carrier decision, which is prompting us to be very active in modifying our device selection. In June, we're very proud to become the first prepaid carrier to offer the iPhone, which was a major milestone for us. Results are early, and we will update in the coming quarters. We're also now putting more energy into emphasizing the middle and higher range of our smartphones because customers don't just want a smartphone, they want one with better capabilities, including a richer data experience. Over the next 6 months, we expect to introduce up to 10 new devices.

As I said earlier, our strategy to provide our higher ARPU customers with unique and high value -- our strategy is to provide our higher ARPU customers with unique and high value service plans. For example, in July, we provided broadband customers the ability to buy additional data capacity on demand in concert with our tiered service plans. Customer can now buy an additional 1 gigabit of full speed data for $10. Later this quarter, we will introduce our first major service plan update in 2 years, and we'll provide customers with competitive plans that include the features they want. In addition, we'll also be expanding the role of new Muve Music. We will provide more details at launch, but we believe this -- we can build further on the unique differentiation this product provides.

At the lower end of the range, we will continue to expand our lifeline offerings. Lifeline gives customers up to $13.50 discount on any rate plan, and across the industry, it has been popular. We have over 350,000 customers on lifeline, and Q2 was our best quarter to date for this service offering. Currently, we provide this service across 81 million covered POPs, and by the end of the year, we expect to have rolled it out to over 90 million covered POPs.

Clearly, device quality and capability, along with coverage and value of the service plans, are important parts of the customer experience we provide. But we've also been improving other aspects of our customers' experience over the past year, such as improving our call center operational strategy, increasing web and self-care, and expanding the number of dealer locations that offer service. That said, we've had instances where quality of the uniformity of the products has been unsatisfactory or inadequate to meet our customers' requirements, and we must eliminate the issues that prevent us from satisfying our customers. We're driving to improve quality and uniformity of every customer experience across all touch points, including company stores, dealer partners and national retail as the top company-wide initiative. To that end, the company compensation across all channels will be substantially based on providing an effective customer experience that meets the value our customers desire.

Since our national retail launch in Q3, we've been carefully monitoring customer activity and channel performance. As a result, we now have a good sense as to what can work, and more importantly, what we expect will not work. If you recall, we had previously provided a cautionary first half outlook and said we would come back with more details after we gained additional experience in the national retail channel. This caution has been borne out as we see overall performance across the channel that must be improved. We believe this channel has significant potential, but we're making an important pivot in the strategy and considerably refining our approach. What we've determined about this channel is we'll focus on a limited set of higher volume retailers that have wireless as an important part of their business. Aligning with this type of retailer aligns all the parties in providing a quality customer experience that should result in lower churn customers. Going forward, we will be focusing on a smaller number of more effective channels. I want to emphasize our commitment to these retailers.

We're also working to ensure we deliver customer experience through national retail that is similar to the experience we provide to our traditional customers. One of the important steps to this end will be conforming our pricing across all our channels as part of the new rate plan rollout, which we expect will provide a more uniform experience. By year end, we expect to have about 8,000 total national retail doors, which is a much tighter focus than we've previously forecast. This will reduce significantly our national retail spending in the second half of the year.

On a separate note, we have periodically informed you about our status relative to the wholesale minimum revenue commitment. Due to certain provisions in the wholesale agreement, we do not believe the company is obligated to meet this commitment in 2012, although we expect to satisfy a significant majority of it in any event. Sprint has not agreed with our position and we are in discussions with them.

Turning to Slide 12, let me give you an update on where we are with 4G. The availability to -- of 4G to prepaid customers is rolling out as we had predicted and we continue to believe we're positioned with regard to the timing of our 4G rollout. The investments we made in 3G mean all our customers have access to a high-speed nationwide network and we can introduce 4G on a timescale in a cost that works well for us. We expect to offer LTE across 21 million covered POPs by year-end 2012. Additionally, we expect to have 3 LTE devices available by year-end. Looking forward, we expect to offer LTE products and services across at least 2/3 of our network footprint over the next 2 to 3 years and are exploring opportunities to more efficiently deploy capital in collaboration with others. Based on the activity we've already completed, we expect that CapEx per covered POP to deploy LTE will be less than $10, on track with our initial outlook.

Now I'd like to hand the call over to Jerry to discuss the financial results.

Jerry Elliott

Well, thank you, Doug, and good afternoon, everybody. Thank you for joining us for what's my first earnings call here at Leap. As Doug has been talking about, and I want to reiterate to everybody, our results for the second quarter are not acceptable. Going forward, we cannot keep doing the same things and simply try harder, but instead, we have to take specific and significant actions to increase our margins and be on a clearly demonstrable path to free cash flow, realize the value of our assets and return to growth over time.

We've been talking about 2 actions that are immediate evidence that we are serious about generating free cash flow: reducing our spending on our MVNO and a 13% reduction on our CapEx guidance for this year. We also have to be obsessed with improving our customer experience and our employee experience. I'll be happy to talk more about free cash flow in the Q&A, but the key takeaway for all of our employees, vendors, other commercial partners, investors and analysts that it is not business as usual here.

So let's get into the specifics of our second quarter results and outlook for the rest of this year. On Slide 14, you can see that service revenue increased by $47 million or 7% over last year because of continued customer growth and a 4% increase in ARPU. We had about 6 million average subs in the second quarter, up from about 5.8 million a year ago. And within our customer base, we benefited from an increase in the number of customers on a $55 or higher rate plan and a decline in the number of customers on a $45 or lower rate plan. Because of lower price points and lower gross additions, our equipment revenue declined $21 million year-over-year and $16 million sequentially.

Adjusted OIBDA increased 19% year-over-year because of our revenue growth and increased 46% sequentially from the first quarter, primarily due to lower gross additions and because subsidy expense decreased $60 million. If you exclude the OIBDA impact of $10 million in the quarter from our MVNO business, our OIBDA would have been 25% higher year-over-year. So adjusted OIBDA margins showed very good improvement, up 260 basis points year-over-year and 850 basis points sequentially.

The last item on this page, free cash flow, you can see that we spent $111 million of cash in the quarter. The year-over-year change in free cash flow was primarily due to stocking the iPhone toward the end of June. Cash CapEx for the quarter was $119 million compared to cash CapEx of $93 million in the second quarter of last year. As I talked about earlier, our free cash flow has to change and we expect to burn less cash in the second half of this year than the first half.

Before I talk about second quarter ARPU on Slide 15, please remember that the company has enjoyed several quarters of both sequential ARPU and year-over-year ARPU growth. ARPU has grown more than 12% since the third quarter of 2010 when we moved to all-inclusive rate plants. In the second quarter, ARPU increased nearly $1.50 year-over-year as the percentage of our customers on a $55 or higher rate plan is now 49% compared to 47% in the first quarter of this year and 27% a year ago. On a sequential basis, ARPU declined $0.95 from the first quarter, and while we do continue to see increases in our build ARPU because of the mix shift toward higher value rate plans, this was more than offset by an increase in the number of pay-as-you-go subscribers who did not top up their monthly or daily service plan; and at the end of June, we had 23% more customers who were past their monthly renewal payment date but who had not yet paid their bill. We obviously had no revenue associated with these customers, but they were still within their applicable grace period for payment, and so were included in the denominator of the ARPU calculation, therefore, depressing our ARPU. This elevated nonpayment activity did continue in July, but we've seen more normal customer behavior so far in August.

Service revenue was also impacted by a quarter-over-quarter increase in service credits as a result of some of the retention programs that Doug talked about earlier. Looking ahead, we do expect ARPU to improve in the third quarter.

On Page 16, you can see that cash cost per user increased by $1.08 over last year because of higher product costs, startup and transition costs associated with changing our primary supply chain logistics vendor and upfront expenses incurred related to cost reduction efforts. The year-over-year CCU increase were partially offset by decreases in customer care costs as we've improved customer self-service functionality that has reduced calls to our call centers and helped enable much better first call resolution. On a sequential basis, CCU decreased by $1.64 as a result of the decrease in upgrade activity.

In the first quarter of this year, approximately 13% of subscribers upgraded, and that number dropped to 9% in the second quarter, which was about the same as last year. We expect CCU to increase in the third quarter due to seasonal roaming expense increases and because more customers will have Muve Music on their handsets. While these increases are expected, as I discussed and as I'll keep talking about, we're going to reduce our spending and improve our margins over time.

On to Slide 17. You can see that CPGA increased year-over-year because of lower gross adds and costs associated with our national retail sales channel. These costs were de minimis in the second quarter of 2011 because we didn't launch nationwide in the big box retailers until late last year. The sequential increase in CPGA of $68 was primarily caused by the decline in gross additions. Importantly, excluding our national retail business, all of the components of CPGA, subsidy, sales and marketing, went down both year-over-year and sequentially, and we expect CPGA to continue to decline in the third quarter.

Moving on to Slide 18. As we've already talked about, we reduced our CapEx spending for the rest of this year and the reduction is primarily related to our 3G network and there'll be very limited impact to LTE. We had $525 million of cash at the end of June and expect that we will receive more than $100 million of additional cash when our spectrum exchange with Verizon closes later this year. Also, our first significant debt maturity is $250 million in July of 2014. We expect that we'll be refinancing our debt well before their maturities, and then our drive to free cash flow will strengthen our balance sheet and financial flexibility, as well as decrease our leverage. I also want to point out that we believe the market value of our wireless licenses after we give effect to our pending spectrum transactions is around $3 billion. Our markets do not all operate with the same cash flow characteristics, and our results in some markets may not reflect the most attractive or efficient return on those assets. As part of our review of the business, we're evaluating all alternatives to drive cash flow and value from those assets.

I just want to close my part of the presentation by reemphasizing to all of our employees, business partners, analysts and investors that it's not business as usual here and that we are completely focused on creating shareholder value. We believe we'll create value by investing for growth in 4G in ways that have the highest and most probable returns on investment, while at the same time being focused, rigorous, disciplined and critical with how we spend both our time and our money. Whether it's capital or operating expenses, it's all cash. And all of our time and money investments and activities have to be judged by cash on cash returns, and therefore, free cash flow.

I'd like to now turn the call back to the operator for the Q&A.

Question-and-Answer Session


[Operator Instructions] And our first question comes from the line of Phil Cusick from JPMorgan.

Philip Cusick - JP Morgan Chase & Co, Research Division

I guess let's start with the ARPU. Can you talk about the retention issues in the second quarter and how that affected ARPU? And Bill, I believe you said that ARPU should rebound in the third quarter. Maybe we could just start there.

Stewart Douglas Hutcheson

Yes, Phil. We implemented some -- this new retention programs. We always run retention programs every quarter. We implemented some new retention programs, and when we do those, they tend towards being very selective. We focus them on a set of characteristics that -- or a set of customers that have a certain set of characteristics, and what we saw was some customers that weren't eligible for the program decide to wait to see if they were. And that's why we saw the spike, as Jerry said, the spike we saw in hotlines. That has cleared as we moved into August. We eliminated the programs as soon as we saw the behavior change. We eliminated the programs. So we think we're on track to see that ARPU number come back as we look -- as we move into third quarter.

Philip Cusick - JP Morgan Chase & Co, Research Division

And the other side, if you look at the non-pay denominator, should we look for this -- a big PAYGo churn number in the third quarter, so sort of an extra disconnect level, as these non-pay customers roll off? And can you...

Stewart Douglas Hutcheson

Yes, the -- we're going to -- I don't know that we're going to see a further increase in that number. I'll have -- we should check. I don't think we're expecting further large increase in that number. What you should expect with PAYGo is it's going to get focused on the -- a few of the national retailers that we've seen really are trying to do a good job with it. And so you'll see us retract out of some of the doors that we're concerned about, where they're headed, focus on a smaller set of doors, as we said, and get their performance to be more attractive over time.


Our next question comes from the line of Simon Flannery with Morgan Stanley.

Simon Flannery - Morgan Stanley, Research Division

I wanted to follow up on the out-of-region strategy. I think, Jerry, you mentioned the deal with Sprint. I think it's $75 million this year, $300 million over the course of the agreement. Can you just talk about the state of negotiations there? And is it just a timing issue that you believe you don't need to spend the money? Or is there some ability here to change -- get out of the full $300 million? And then on the non-pays, is that primarily due to this discount retention offers? Or do you think there are some macro factors at play there as well?

Jerry Elliott

Good questions. I'll take the Sprint question first. So as Doug talked about, we don't believe we have any obligation with respect to the commitment for 2012. That being said, we are spending a significant amount of money with them during 2012. In terms of going forward, I honestly don't want to get into that in terms of where we think our obligations might or might not be for 2013 and beyond. We're having discussions with Sprint, as Doug talked about, and I'd rather just let that play out. And we'll certainly update folks as we go along and we -- we're able to talk about that more. With respect to the decrease -- or the increase, excuse me, in the nonpaying customers, yes, I mean, I -- it certainly had something to do with the promotional activity in the second quarter. I also think that there's some element of customer behavior that we had trained in past quarters in terms of people expecting significant discounts and retention activities as we got really close to the end of the quarter. When we did not do that, I think a lot of people were holding out, waiting for us to do it or hoping we would do it. And I think not doing it is just one of the many steps we're taking to get to more profitable customers and more cash flow in the company.

Simon Flannery - Morgan Stanley, Research Division

And not really any change in the macroeconomic environment?

Stewart Douglas Hutcheson

We saw -- we did see some overall slowness, Simon. I think you've seen that across the entire industry. And I think the area that we're a little bit more focused on that was on the front door. And I pointed that out, that we saw -- most of the issues that we saw in that [ph] in the second quarter was front door related. We had -- we did -- as we said we would in the last call, we did give a little bit more -- we went through some revised promotions. So we didn't drive some of the activities as hard. And we really are doing that because we believe the new rate plans and the new devices that we're launching are going to be at -- much more appealing and try and drive customers to come because of the value. The other piece that we're real focused on is at the beginning of the year, I think we had 20 million-or-so markets that had the availability of the Lifeline program. And as of now, we're at 80 million. We're tracking towards a higher number. And we really have seen pressure at the lower end of our business as the free phones and free services have come along. We've seen those other -- those offers from some of the MVNOs and other carriers make some -- get some traction. And we're now at the point where our rollout is complete, and we've seen a really major acceleration of that. During the quarter, we moved up to over 350,000. That's almost a tripling or more than a tripling of where we were in prior quarter. So I think that's the other thing that we want to focus on, and driving gross adds is now -- we have a program in that area that doesn't involve us giving away phones or get -- overly discounting the service. We're really going to use the Lifeline program to allow us to keep our pricing attractive to us and our unit margins up and provide value to the customer.


Our next question comes from the line of the Rick Prentiss with Raymond James.

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

A couple of questions. Follow-up on a couple of those. It seems, first, that the wireless industry in the U.S., the gross add pool is shrinking. It doesn't seem to be as many people. Definitely postpaid but seems maybe on the prepaid side, too, not as many available. So maybe just give some comments from your side, if you think that is the case? And then on the Lifeline program, are people coming into the store and then you check their ability to qualify for that? There's been obviously a lot of regulatory changes in the Lifeline program. So I'm just trying to think of how you guys kind of target that.

Stewart Douglas Hutcheson

Sure, so let me maybe start with the second question and come back to the first. We actually -- the sales process that we have is we actually -- they apply to us, and then before they move all the way into the program, that we reach state approval. So the application is completed and it's processed, and then they step on to the program as a result of being qualified. We led -- or were a leader -- let me say that differently. We were a leader in trying to drive the regulatory changes that happened. So we feel like we were very participative. You'll see that we were pretty active in the comment process and believe that the direction that the industry is trying to go to, we're at a leading point on that, which is not as dominant with these free phones and free service. We're really trying to provide customers a phone that meets all of their needs. And we've seen customers -- as we've launched that, we're seeing a nice response to it.

Jerry Elliott

The -- can I just jump in on that, Doug? On the Lifeline, Rick, just to give you a little bit more color, so people come into the store, they apply for the Lifeline program and then every state is different in terms of determining eligibility for Lifeline subsidy support. And so some states are automated and it goes really fast, and some states actually are still paper based and so it doesn't go nearly as fast. So it's really state-by-state on exactly how the registration and application process is handled.

Stewart Douglas Hutcheson

The other side, Rick, is this. The gross add pool is shrinking. We believe that there's a lot of customers that are currently in the postpay environment, that to the degree we get the right rate plans and devices and customer experience that are going to find the value that we bring is really attractive. And so our job is to sit there and focus on making sure that the way we go to market on that really provides those customers an alternative at the higher end. But at the other end, we've been real focused on again trying to make sure that we have competitive products that aren't discounting ARPU. We really are resisting -- we certainly, as we reported, had some pressure this quarter, and we're not happy with the results. But the flip side of it is we're not going to go discounting ARPU. We watched the industry go through that cycle previously, and we think the right thing to do is focus on driving value at the customers at appropriate ARPUs. And so we're going to keep our head down and we're looking forward to putting out the new services and such that I talked. You'll see those coming -- be coming out between now and the end of the quarter.

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

Are you going to keep it fairly simple, though, and not have a ton of price plans? So some -- in the past, your simplicity has been part of the selling point.

Stewart Douglas Hutcheson

Yes, we are going to keep it simple. And the -- what we're going to do is we will not have a large number of plans. So we will be working on keeping it simple.


Our next question comes from the line of Tim Horan with Oppenheimer.

Timothy K. Horan - Oppenheimer & Co. Inc., Research Division

So just 2 of them. Do you think maybe the Lifeline service is starting to cannibalize your low end a little bit, maybe not just yours but some of the competitors' out there? And I guess who are you really seeing now the pressure from at the low end? And then just on the strategy front, could you just summarize kind of where the 2-or-so or 3 areas maybe of focus on the strategy at this point? I know you're -- it sounds like you're deemphasizing MVNO, but are there other areas you're deemphasizing and other areas you really want to focus on?

Jerry Elliott

I can take the first part of that, and I'm sure Doug and I will both have thoughts on the second question you had, Tim. We don't think Lifeline is cannibalizing any of our low-end customers. We actually really like the longevity and churn characteristics of Lifeline customers. They're really attractive. In terms of the competition, it's a bunch of people that -- some of which you heard of, many of which may haven't heard of. There's a lot of activity on that low end. We think as the next few quarters go on and kind of a recertification of some of the providers happens from -- both at state -- at the state level, that some of those are going to fade away, quite honestly. And other of them, I have no idea how they make money. So there'll be a limit on how long they can survive. So we actually think that Lifeline's quite accretive to the business, and we think there's a lot of runway to go. As Doug mentioned, we think there's -- we're going to have about 90 million POPs covered by the end of the year. We've got 350,000 subs on Lifeline now, and we think there's plenty of room to run there. And it's one of the real areas of focus for the company going forward. Doug, if you want to start on the strategy, I can...

Stewart Douglas Hutcheson

Yes, and there's -- on the strategy, I think I would emphasize 2 key things on that. The first is the progress we've -- that we have made in moving towards richer rate plans, it's -- we're at now, when we talked to people 2 years ago about making this transition, I think if we had said we'd be at 50%, I think it would have been difficult to -- for people to grasp. But here we are at 50% of our customers on higher-value rate plans, and I think the idea that this transition is going to continue in the industry is clear. And we're going to drive into those rate plans the differentiators that we have, which is the value that we bring. You'll see us work on how we bundle in other things that we know consumers want and continue to stay focused on driving attractive ARPUs. The point I want to stress on that is not only do these higher-ARPU customers have more attractive unit margins, so do the Lifeline customers, as you compare that. So both things that we're focused on strategically are picking the customer segments where the unit margins are the most attractive. The other part is -- that Jerry highlighted and -- as a company, is we are going to take a series of steps to get -- drive cash flow. And so you saw that evidenced by really looking and scrutinizing even more some of the capital expenditures that we've got. You will see us keep heading pretty hard towards LTE. We have a build-out schedule that we're working towards that supports getting to the 2/3. But you'll watch us really focus on driving our network base, that -- our network base to continue to provide it. But we're struck. And I've said this before that we're really -- there's hundreds of millions of dollars of synergies and network efficiencies there. And so we're also looking to, as I've spoken publicly a few times, how do we collaborate to get at those synergies to do things more efficiently and have been, and expect to, continue to be looking at all the alternatives to get that done appropriately. We'll really drive that value to our shareholders.


Our next question comes from the line of James Moorman with S&P IQ (sic) [S&P Capital IQ].

James G. Moorman - S&P Equity Research

First, in terms of your LTE appointment where you've pulled back probably about 4 million from 25 to 21, is that just part of the cash flow initiative? Or is there a strategic reason for pulling back on those 4 million this year? And then also back on the Lifeline issue, you said it differs from state to state in terms of the process, whether it's paper forms or other. Has there been a change since they put in the new regulations in May and June that you've seen? Has -- is it taking longer to add customers to this -- to the Lifeline?

Jerry Elliott

I can talk about the LTE. And the answer is no, we're not pulling back on. It's simply a timing change. One of the markets that we had originally been planning for late 2012 is going to go forward with the build. It'll just be first half of 2013. So that's the difference between 21 million and 25 million. On the Lifeline, I mean, I can't say we've seen any material change in May or June since -- in terms of processing since the changes. Again, I -- from my perspective, the big difference is whether it's an automated database that the state uses to match up applications, or whether we're doing things like, not just us but everybody in a state, having to fax in paper applications and then some states quite -- take quite a bit longer than others to actually process those applications. So I think, not just for us but for the Lifeline product as an asset class, as you will, for the whole industry, we have to keep pushing the states to get more and more automated because some of them currently take entirely too long from a customer perspective.


Our next question comes from the line of Jonathan Chaplin with Credit Suisse.

Jonathan Chaplin - Crédit Suisse AG, Research Division

Two quick questions, if I may. First, Jerry, I'm wondering whether it makes sense to look at the business in a slightly different fashion. We've always thought that one of the biggest challenges you have is not having enough scale within your 100 million POPs to really generate an attractive amount of free cash flow. Does it make sense to turn the whole business into an MVNO and sell off the licenses for $3 billion? If you were to do that, how much CapEx would you be able to get rid of? Would it be accretive to free cash flow and then it -- separate to that -- separate to the business, have $3 billion of licenses you can sell? And leaving aside my crazy idea, my second question is on CapEx. What's changed in your view of the business since the beginning of the year when you set a CapEx budget that you don't have to spend as much on your 3G network, on capacity, as you thought you would have to? Because it seems like high-end rate plans, which probably correlate well with smartphones, and usage are probably growing at a cracking rate. So how is it that you were able to spend less on capacity?

Jerry Elliott

Thanks for the questions. In terms of turning the entire business into an MVNO and sell off the $3 billion of spectrum, if we weren't clear, let me be as clear as I can possibly be. We are looking at every available option for creating value in our markets, for driving cash flow at higher levels in our markets. Whether or not that turns the entire company into an MVNO, I don't want to get into what we're looking at, but I just want to make sure everybody understands. We're looking at everything we can think of to create value in this business. In terms of the CapEx, I -- Doug may be able to comment from a historical perspective. I can only comment from the time I got here, which is there were a few drivers in the reduction. And from my perspective, one is certainly the lower-than-expected subscriber counts certainly had something to do with it. A lot of -- secondly, a lot of thinking about how we would configure our network from a capacity and coverage standpoint regardless of the lower-than-expected subscriber accounts played a big role. And then thirdly, I think a lot more rigor and discipline around where we spend our money and what kind of returns we expect from our investments is also one of the key contributors to change in the CapEx guidance.


Our next question comes from the line of David Barden with Bank of America.

David W. Barden - BofA Merrill Lynch, Research Division

So Jerry, you're crystal clear. You're looking at every available option. It'll be helpful to kind of -- for us on the other side of the table to kind of hear what the options are. The -- when I heard it at the beginning, it sounded like maybe you were looking at maybe selling off an underperforming market here or there or some other assets or things like that. But, I mean, what is the magnitude of what we're talking about? Are we talking about selling the company? Are we talking about restructuring the company? Are we talking about selling licenses or sale leasebacks? I mean, how significant should we be really thinking about this? Is the objective function of your role now to be getting the stock price up? Is that kind of what we're thinking about? The second question I would have is in the quarter, it kind of sounded like it was a perfect storm. The promotions weren't working, the retentions weren't working, the devices weren't working, the national big box program wasn't really working. And we're kind of in this middle of this transitional process, and we're trying to get the business to kind of be coming back. So with respect to kind of management's focus on all these things that kind of went wrong in the quarter, what are we going to see you guys knocking off first, second, third into the third and the fourth quarter so we can kind of anticipate how this turnaround happens?

Jerry Elliott

Yes, thanks, Dave. And I'm sure Doug can talk about sort of what we're doing in terms of what didn't go right in the second quarter. From the strategy perspective, I wouldn't eliminate anything right now from what we're thinking about. So you can -- we can all create our own menus and choices. I guess I'd like to think that everywhere I've been, I've been there to create shareholder value. So I don't think anything's changed in terms of what my role is and what my responsibility is. So as we talked about earlier, the way we think we create value is investing in 4G for growth in the right ways and at the right places and the right times to create that growth. And at the same time, the rest of the business has to produce greater cash flow, and we have to realize the value of our assets that we've got. So there's nothing that you can think of that you should eliminate right now from the list of possibilities. We prefer to always control our own destiny and worry about ourselves and what others might do later. So we're going to be taking a lot of steps to control our own destiny and run the business far more profitably. And hopefully, that results in value creation.

Stewart Douglas Hutcheson

And then on the operational side, we have had to put a lot -- clamp down, I think would be the right way, on a number of different fronts. And I think we had areas that we're already seeing progress that we're updating you. An example with that is as we look forward, I think you'll see a nice recovery on the ARPU, as an example. We've discussed that. I believe that once we get the new rate plans and the devices out there, that we'll put -- you'll start to see some strengthening in gross add volumes, which is -- we're very focused on that. And so I think you'll see us get those 2 things as our primary focus. On the operations of the business, I think Jerry, who I have been real pleased, has brought a partner in that can give a lot more focus on the details with me on -- in how these things get executed, and I think that you'll see the business start to build strength as we look ahead.

With that, thanks, Jerry, and thanks all. Let me conclude by reiterating that we are focused on making these changes to deliver improved operational and financial performance. Some of the actions have already been taken, and there are more to come. Operationally, we're improving our customer offerings by adding attractive, sophisticated devices and providing improved plans with features customers want. We're all driving hard to improve customer service, all of which we believe will drive growth. At the same time, as our results are already showing, we will look at all options to improve free cash flow and margins, drive stronger business performance and better manage our investments and optimize our underperforming assets. We continue to believe that we're fundamentally on the right track and that we can leverage our position as a low-cost leader in wireless to provide excellent value to our customers and improve value to our shareholders. As we continue to move through this transition phase, you can expect to see a number of announcements from us, and we also expect to provide additional updates to analysts/investors this fall. With that, I'd like to thank you for your time today and thank you. And I look forward to talking to you again soon.


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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