| • QUARTERLY REPORT OF FORM 10-Q • MAY 2012 CLEARWIRE / SPRINT AMENDMENT, DATED AS OF MAY 15, 2012, TO THE 4G MVNO AGREEMENT DATED AS OF NOVEMBER 28, 2008 BETWEEN CLEARWIRE COMMUNICATIONS LLC, COMCAST MVNO II, LLC, TWC WIRELESS, LLC BHN SPECTRUM INVESTMENTS, LLC AND SPRINT SPECTRUM L.P • CERTIFICATION OF CHIEF EXECUTIVE OFFICER REQUIRED BY RULE 13A-14(B) OR RULE 15D-14(A) AND SECTION 302 OF THE SARBANES OXLEY ACT OF 2002 • CERTIFICATION OF CHIEF FINANCIAL OFFICER REQUIRED BY RULE 13A-14(B) OR RULE 15D-14(A) AND SECTION 302 OF THE SARBANES OXLEY ACT OF 2002 • CERTIFICATION OF CHIEF EXECUTIVE OFFICER REQUIRED BY RULE 13A-14(B) OR RULE 15D-14(A) AND SECTION 906 OF THE SARBANES OXLEY ACT OF 2002 • CERTIFICATION OF CHIEF FINANCIAL OFFICER REQUIRED BY RULE 13A-14(B) OR RULE 15D-14(A) AND SECTION 906 OF THE SARBANES OXLEY ACT OF 2002 • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-Q
______________________________________ Commission file number 001-34196 Clearwire Corporation (Exact name of registrant as specified in its charter)
1475 120th AVE. NE BELLEVUE, WASHINGTON 98005 (425) 216-7600 ______________________________________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that registrant was required to submit and post such files.) Yes þ No o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ The number of shares outstanding of the registrant's Class A common stock as of July 24, 2012, was 542,094,806. The number of shares outstanding of the registrant's Class B common stock as of July 24, 2012 was 917,116,026. CLEARWIRE CORPORATION AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q For The Quarter Ended June 30, 2012 Table of Contents
PART I - FINANCIAL INFORMATION
CLEARWIRE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands, except par value) (Unaudited)
See accompanying notes to unaudited condensed consolidated financial statements. 2 CLEARWIRE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data) (Unaudited)
See accompanying notes to unaudited condensed consolidated financial statements. 3 CLEARWIRE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (In thousands) (Unaudited)
See accompanying notes to unaudited condensed consolidated financial statements. 4 CLEARWIRE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
See accompanying notes to unaudited condensed consolidated financial statements. 5 CLEARWIRE CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (In thousands) (Unaudited) Six Months Ended June 30, 2012 and 2011
See accompanying notes to unaudited condensed consolidated financial statements. 6 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements contained in our 2011 Annual Report on Form 10-K. In the opinion of management, all adjustments consisting of normal recurring accruals necessary for a fair presentation have been included. The results for the three and six months ended June 30, 2012 and 2011 do not necessarily indicate the results that may be expected for the full year. We are a leading provider of fourth generation, or 4G, wireless broadband services. We build and operate next generation mobile broadband networks that provide high-speed mobile Internet and residential Internet access services in communities throughout the country. Our current 4G mobile broadband network operates on the Worldwide Interoperability of Microwave Access technology 802.16e standard, which we refer to as mobile WiMAX. As of June 30, 2012, we offered our services in 88 markets in the United States covering an estimated 136 million people, including an estimated 134 million people covered by our 4G mobile broadband networks in 71 markets. Our 4G mobile broadband network provides a connection anywhere within our coverage area. In our current 4G mobile broadband markets in the United States, we offer our services through retail channels and through our wholesale partners. Sprint Nextel Corporation, which we refer to as Sprint, accounts for primarily all of our wholesale revenues to date, and offers services in each of our 4G markets. In addition to Sprint and our other existing wholesale partners, we have also recently entered into wholesale arrangements with Simplexity, FreedomPop, Leap Wireless, and Jolt Mobile. We are currently focused on growing our revenue by continuing to build our wholesale business and leveraging our retail business, reducing expenses, and seeking additional capital for our current business and the development of our network. Over the long term, we will need to expand our revenue base by increasing sales to our existing wholesale partners and by adding additional wholesale partners with substantial offload data capacity needs. To be successful with either, we believe it is necessary that we deploy Long Term Evolution, or LTE, technology, which is currently being adopted by most wireless operators in the United States as their next generation wireless technology. By deploying LTE, we believe that we will be able to take advantage of our leading spectrum position, which includes approximately 160 MHz of spectrum on average in the 100 largest markets in the United States, to offer offload data capacity to existing and future mobile broadband service providers for resale to their customers on a cost effective basis. As of June 30, 2012, we believe that we had sufficient cash to fund the near-term liquidity needs of our business for at least the next 12 months based on the cash and short term investments we had on hand as of the end of the quarter, the ongoing impact of our cost containment efforts, the cash we expect to receive for our mobile WiMAX services from our retail business and from Sprint under the agreement signed with them in November 2011, which we refer to as the November 2011 4G MVNO Amendment (See Note 17, Related Party Transactions, for further information) and other wholesale partners, and the cash we expect to spend under our current LTE deployment plans. We do not expect our operations to generate cumulative positive cash flows during the next twelve months. If our business fails to perform as we expect or if we incur unforeseen expenses, we may be required to raise additional capital in the near term to fund our current business. Also, we will need to raise substantial additional capital to fund our business and meet our financial obligations beyond the next 12 months. If we are unable to raise sufficient additional capital to meet our funding needs on acceptable terms in a timely manner, or we fail to generate sufficient additional revenue from our wholesale and retail businesses to meet our obligations over the long term, our business prospects, financial condition and results of operations will likely be materially and adversely affected, and we will be forced to consider all available alternatives.
The condensed consolidated financial statements have been prepared in accordance with accounting principals generally accepted in the United States of America, which we refer to as U.S. GAAP, and pursuant to the rules and regulations of the Securities and Exchange Commission, which we refer to as the SEC. The same accounting policies are followed for preparing the quarterly and annual financial information unless otherwise disclosed in the notes below. Revenue Recognition - We primarily earn revenue by providing access to our high-speed wireless networks. In our 4G mobile broadband markets, we offer our services through retail channels and through our wholesale partners. Sprint, our largest wholesale 7 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) customer, accounts for primarily all of our wholesale revenue to date, and comprises approximately 36% of total revenues during the three and six months ended June 30, 2012. Revenue consisted of the following (in thousands):
In November 2011, we entered into the November 2011 4G MVNO Amendment with Sprint under which, among other things, Sprint will pay us $925.9 million for unlimited 4G mobile WiMAX services for resale to its retail subscribers in 2012 and 2013, approximately two-thirds of which is payable for service provided in 2012, and the remainder for service provided in 2013. Of the $925.9 million, $175.9 million will be paid as an offset to principal and interest due under a $150.0 million promissory note issued by us to Sprint in January 2012. Of the amount due, $900.0 million is being recognized on a straight-line basis over 2012 and 2013 and the remaining $25.9 million is being recorded as an offset to the interest cost associated with the promissory note. See Note 17, Related Party Transactions, for further information on the provisions of this agreement. Wholesale revenue for the three and six months ended June 30, 2012 is comprised of the current period portion of the revenue recognized on a straight-line basis from the November 2011 4G MVNO Amendment. For 2011, the majority of our wholesale revenues were derived from our agreement with Sprint signed in April 2011. Under that agreement, revenues were earned as Sprint utilized our network, with usage-based pricing that included volume discounts. In addition to revenues earned during that period, wholesale revenues for the second quarter of 2011 included revenue of approximately $16.1 million attributable to services provided in the first quarter of 2011, and approximately $12.8 million of a $28.2 million settlement amount which relates to wholesale services provided in 2010. The following accounting policies were adopted in the six months ended June 30, 2012: In May 2011, the Financial Accounting Standards Board, which we refer to as the FASB, issued new accounting guidance amending fair value measurement to achieve common fair value measurement and disclosure requirements in U.S. GAAP, and International Financial Reporting Standards. We adopted the new accounting guidance on January 1, 2012. As the new accounting guidance primarily amended the disclosure requirements related to fair value measurement, the adoption did not have any impact on our financial condition or results of operations. In June 2011, the FASB issued new accounting guidance on the presentation of other comprehensive income, which was subsequently revised in December 2011. The new guidance eliminates the current option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity. Instead, an entity has the option to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. We adopted the new accounting guidance on January 1, 2012 which resulted in reporting the components of comprehensive loss in the Consolidated Statements of Comprehensive Loss, rather than in the Consolidated Statements of Stockholders' Equity, as previously reported.
In connection with our ongoing cost savings initiatives, since the beginning of 2011, a total of approximately 5,800 unutilized tower leases have either been terminated or when early termination was not available under the terms of the lease, we advised our landlords of our intention not to renew. In connection with this lease termination initiative, we incurred lease termination costs and recognized a cease-to-use tower lease liability based on the remaining lease rentals (including contractual rent escalations) for leases subject to termination actions, reduced by estimated sublease rentals that could be reasonably obtained. In addition to charges related to payment of lease termination costs, during the second quarter of 2012, based on sublease activity to date, we eliminated the remaining estimated sublease rental income from the liability computation and fully incorporated contractual rent escalations resulting in an increase to the liability of approximately $25.0 million. The charge for lease termination activities is net of previously recorded deferred rent liabilities associated with these leases and includes cancellation fees. In addition, where our current contract requires us to continue payments for certain executory costs for the remaining terms of these leases, we have 8 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) accrued a liability for such costs. See Note 5, Property, Plant and Equipment, for a description of the write down of costs for projects classified as construction in progress related to the above leases. Charges by type of cost and reconciliation of the associated accrued liability were as follows (in thousands):
For the three and six months ended June 30, 2012, $31.9 million and $42.8 million, respectively were recorded as Cost of goods and services and network costs and $2.6 million and $3.5 million, respectively, were recorded as Selling, general and administrative expenses. For the three and six months ended June 30, 2011, $14.4 million and $16.5 million, respectively, were recorded as Cost of goods and services and network costs and $5.3 million and $9.8 million, respectively, were recorded as Selling, general and administrative expenses.
Investments as of June 30, 2012 and December 31, 2011 consisted of the following (in thousands):
We owned Auction Market Preferred securities issued by a monoline insurance company which were perpetual and did not have a final stated maturity. Our Auction Market Preferred securities were fully written down and had no carrying value at December 31, 2011. During the first quarter of 2012, we sold the Auction Market Preferred securities and recorded a gain of $3.3 million to Other income (expense), net on the condensed consolidated statements of operations representing the total proceeds received. We no longer own any collateralized debt obligations or Auction Market Preferred securities. 9 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Property, plant and equipment, which we refer to as PP&E, as of June 30, 2012 and December 31, 2011 consisted of the following (in thousands):
We have entered into lease arrangements related to our network construction and equipment that meet the criteria for capital leases. At June 30, 2012 and December 31, 2011, we have recorded capital lease assets with an original cost of $81.2 million within Network and base station equipment. Construction in progress is primarily composed of costs incurred during the process of completing network projects not yet placed in service. The balance at June 30, 2012 included $20.7 million of costs related to completing network projects not yet placed in service, $62.0 million of network and base station equipment not yet assigned to a project and $16.1 million of costs related to information technology, which we refer to as IT, and other corporate projects. Charges associated with Property, plant and equipment We assess our assets classified as PP&E and evaluate for losses related to (1) shortage, or loss incurred in deploying such equipment, (2) reserve for excessive and obsolete equipment not yet deployed in the network, and (3) abandonment of network and corporate projects no longer expected to be deployed. In addition to charges incurred in the normal course of business, this assessment includes evaluating the impact of changes in our business plans and strategic network plans on those assets. During the six months ended June 30, 2012, we solidified our LTE network architecture, including identifying the sites at which we expect to overlay LTE technology in the first phase of our deployment. Any projects that are not required to deploy LTE technology at those sites, or that are no longer viable due to the development of the LTE network architecture, were abandoned and the related costs written down. In addition, any network equipment not required to support our network deployment plans or sparing requirements were also written down to estimated salvage value. During the six months ended June 30, 2011, in connection with our plan to deploy LTE alongside our existing WiMAX network and the shift in management's strategic network deployment plans to focus on areas with high usage concentration, any projects that no longer fit within the deployment plans were abandoned and the related costs were written down to salvage value. Additionally, in connection with our cost savings initiatives, we continually review our tower leases and evaluate whether such towers fit within management's deployment plans. In connection therewith, certain tower leases have been terminated, and when early termination was not available under the terms of the lease, we advised our landlords of our intention not to renew. The costs for projects included in construction in progress related to leases for which we have initiated such terminations were written down. See Note 3, Charges Resulting from Cost Savings Initiatives, for a discussion of the costs associated with lease terminations. 10 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) We incurred the following charges associated with PP&E for the three and six months ended June 30, 2012 and 2011 (in thousands):
(1) Included in Cost of goods and services and network costs on the condensed consolidated statements of operations.
During the first quarter of 2012, as a result of Sprint's announcement that it plans to decommission its iDEN network, we evaluated the remaining useful lives of our Network and base station equipment co-located at iDEN sites identified by Sprint to be decommissioned. We concluded that, for certain of the Network and base station equipment at these sites, it is not likely that we would continue to operate our equipment at the current location once Sprint decommissions its site. Therefore, we determined the useful lives of the Network and base station equipment at these sites should be accelerated beginning in the first quarter of 2012 from a weighted-average remaining useful life of approximately 5 years to approximately 1 - 2 years based on the expected date of decommissioning. We will continue to monitor the estimated useful lives of our network assets as our plans continue to evolve. Any further adjustments to those lives would likely result in increased depreciation expense in future periods.
Owned and leased spectrum licenses as of June 30, 2012 and December 31, 2011 consisted of the following (in thousands):
11 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) As of June 30, 2012, future amortization of spectrum licenses, spectrum leases and prepaid lease costs (excluding pending spectrum and spectrum transition costs) is expected to be as follows (in thousands):
We expect that all renewal periods in our spectrum leases will be renewed by us, and the costs to renew to be immaterial.
Other intangible assets as of June 30, 2012 and December 31, 2011 consisted of the following (in thousands):
As of June 30, 2012, the future amortization of other intangible assets is expected to be as follows (in thousands):
We evaluate all of our patent renewals on a case by case basis, based on renewal costs. 12 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Current liabilities Current liabilities consisted of the following (in thousands):
Other long-term liabilities Other long-term liabilities consisted of the following (in thousands):
(1) See Note 17, Related Party Transactions, for further detail regarding deferred revenue balances with related parties.
Clearwire Corporation, which we refer to as Clearwire or the Company, holds no significant assets other than its equity interests in Clearwire Communications LLC, which we refer to as Clearwire Communications. Clearwire Communications is treated as a partnership for United States federal income tax purposes and therefore does not pay United States federal income tax. As a result, any current and deferred tax consequences, including for Clearwire, arise at the partner level. Other than the balances associated with the non-United States operations, the only temporary difference for Clearwire is the basis difference associated with our investment in the partnership. We have recognized a deferred tax liability for this basis difference. Our deferred tax assets primarily represent net operating loss carry-forwards associated with Clearwire's operations prior to the formation of the Company on November 28, 2008 and the portion of the partnership losses allocated to Clearwire after the formation of the Company. A portion of our deferred tax assets will be realized through schedulable reversing deferred tax liabilities, however all of the net operating losses incurred on or before December 13, 2011 are limited under Section 382 and a portion cannot be realized within 13 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) the carry-forward period. Net operating losses incurred after December 13, 2011 are not subject to limitation under Section 382. As it relates to the United States tax jurisdiction, we determined that our temporary taxable difference associated with our investment in Clearwire Communications will not completely reverse within the carry-forward period of the net operating losses. The portion of such temporary difference that will reverse within the carry-forward period of the net operating losses represents relevant future taxable income. Management has reviewed the facts and circumstances, including the history of net operating losses and projected future tax losses, and determined that it is appropriate to record a valuation allowance against the portion of our deferred tax assets that are not deemed realizable. The income tax benefit reflected in our condensed consolidated statements of operations primarily reflects United States deferred taxes net of certain state taxes.
Long-term debt at June 30, 2012 and December 31, 2011 consisted of the following (in thousands):
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(3) As of June 30, 2012, par amount of approximately $101.1 million is secured by assets classified as Network and base station equipment. (4) Included in Other current liabilities on the consolidated balance sheets. 14 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
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2016 Senior Secured Notes — In January 2012, Clearwire Communications completed an offering of senior secured notes with a par value of $300.0 million, due 2016 and bearing interest at 14.75%, which we refer to as the 2016 Senior Secured Notes. Clearwire Communications received proceeds of $294.8 million, net of debt issuance costs, from the offering. The 2016 Senior Secured Notes provide for bi-annual payments of interest in June and December. The holders of the 2016 Senior Secured Notes have the right to require us to repurchase all of the notes upon the occurrence of specific kinds of changes of control at a price of 101% of the principal plus any unpaid accrued interest to the repurchase date. Under certain circumstances, Clearwire Communication will be required to use the net proceeds from the sale of assets to make an offer to purchase the 2016 Senior Secured Notes at an offer price equal to 100% of the principal amount plus any unpaid accrued interest. Our payment obligations under the 2016 Senior Secured Notes are guaranteed by certain domestic subsidiaries on a senior basis and secured by certain assets of such subsidiaries on a first-priority lien basis. The 2016 Senior Secured Notes contain limitations on our activities, which among other things include incurring additional indebtedness and guarantee indebtedness; making distributions or payment of dividends or certain other restricted payments or investments; making certain payments on indebtedness; entering into agreements that restrict distributions from restricted subsidiaries; selling or otherwise disposing of assets; merger, consolidation or sales of substantially all of our assets; entering transactions with affiliates; creating liens; issuing certain preferred stock or similar equity securities and making investments and acquiring assets. Exchangeable Notes Transaction — During the first quarter of 2012, Clearwire and Clearwire Communications entered into securities purchase agreements with certain institutional investors, which we refer to as the Exchange Transaction, pursuant to which Clearwire issued 38.0 million shares of Clearwire's Class A common stock, which we refer to as Class A Common Stock, for an aggregate price of $83.5 million, which we refer to as the Purchase Price, and Clearwire Communications repurchased $100.0 million in aggregate principal amount of its 8.25% exchangeable notes due 2040, which we refer to as the Exchangeable Notes, for a total price equal to the Purchase Price. Clearwire used the proceeds of the sale of the Class A Common Stock to contribute to Clearwire Communications to allow it to retire $100.0 million in aggregate principal amount of its Exchangeable Notes, plus accrued but unpaid interest, held by the institutional investors. Due to the significant discount resulting from the recognition of the exchange options as a separate derivative liability upon the issuance of the Exchangeable Notes, extinguishment of the Exchangeable Notes in the Exchange Transaction resulted in a loss of $10.1 million recorded in Other income (expense), net on the condensed consolidated statements of operations. 15 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Future Payments — For future payments on our long-term debt see Note 13, Commitments and Contingencies. Interest Expense — Interest expense included in our condensed consolidated statements of operations for the three and six months ended June 30, 2012 and 2011, consisted of the following (in thousands):
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The holders’ exchange rights contained in the Exchangeable Notes constitute embedded derivative instruments that are required to be accounted for separately from the debt host instrument at fair value. As a result, upon the issuance of the Exchangeable Notes, we recognized exchange options, which we refer to as Exchange Options, with an estimated fair value of $231.5 million as a derivative liability. As a result of the Exchange Transaction, $100.0 million in par value of the Exchange Notes were retired and the related Exchange Options, with a notional amount of 14.1 million shares, were settled at fair value. The Exchange Options are indexed to Class A Common Stock, have a notional amount of 88.9 million and 103.0 million shares at June 30, 2012 and December 31, 2011, respectively, and mature in 2040. See Note 10, Long-term Debt, Net, for further information on the Exchange Transaction. We do not apply hedge accounting to the Exchange Options. Therefore, gains and losses due to changes in fair value are reported in our condensed consolidated statements of operations. At June 30, 2012 and December 31, 2011, the Exchange Options’ estimated fair value of $889,000 and $8.2 million, respectively, was reported in Other current liabilities on our condensed consolidated balance sheets. For the three months ended June 30, 2012 and 2011, we recognized gains of $10.7 million and $115.4 million, respectively, from the changes in the estimated fair value in Gain on derivative instruments in our condensed consolidated statements of operations. For the six months ended June 30, 2012 and 2011, we recognized gains of $5.8 million and $88.6 million, respectively, from the changes in the estimated fair value in Gain on derivative instruments in our condensed consolidated statements of operations. See Note 12, Fair Value, for information regarding valuation of the Exchange Options.
The following is a description of the valuation methodologies and pricing assumptions we used for financial instruments measured and recorded at fair value on a recurring basis in our financial statements and the classification of such instruments pursuant to the valuation hierarchy. Cash Equivalents and Investments Where quoted prices for identical securities are available in an active market, we use quoted market prices to determine the fair value of investment securities and cash equivalents, and they are classified in Level 1 of the valuation hierarchy. Level 1 securities include U.S. Government Treasury Bills, actively traded U.S. Government Treasury Notes and money market mutual funds for which there are quoted prices in active markets or quoted net asset values published by the money market mutual fund and supported in an active market. Investments are classified in Level 2 of the valuation hierarchy for securities where quoted prices are available for similar investments in active markets or for identical or similar investments in markets that are not active and we use "consensus pricing" from independent external valuation sources. Level 2 securities include U.S. Government Agency Discount Notes and U.S. Government Agency Notes. 16 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) Derivatives The Exchange Options are classified in Level 3 of the valuation hierarchy. To estimate the fair value of the Exchange Options, we use an income approach based on valuation models, including option pricing models and discounted cash flow models. We maximize the use of market-based observable inputs in the models and develop our own assumptions for unobservable inputs based on management estimates of market participants’ assumptions in pricing the instruments. We use a trinomial option pricing model to estimate the fair value of the Exchange Options. The inputs include the contractual terms of the instrument and market-based parameters such as interest rate forward curves, stock price and dividend yield. A level of subjectivity is applied to estimate our stock price volatility input. The stock price volatility used in computing the fair value of the Exchange Options at June 30, 2012 and December 31, 2011 of 40% is based on our historical stock price volatility giving consideration to our estimates of market participant adjustments for general market conditions as well as company-specific factors such as market trading volume and our expected future performance. Holding all other pricing assumptions constant, an increase or decrease of 10% in our estimated stock volatility at June 30, 2012 could result in a loss of $2.7 million, or a gain of $889,000, respectively. The following table summarizes our financial assets and liabilities by level within the valuation hierarchy at June 30, 2012 (in thousands):
The following table summarizes our financial assets and liabilities by level within the valuation hierarchy at December 31, 2011 (in thousands):
17 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table presents the change in Level 3 financial assets and liabilities measured on a recurring basis for the three months ended June 30, 2012 (in thousands):
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The following table presents the change in Level 3 financial assets and liabilities measured on a recurring basis for the three months ended June 30, 2011 (in thousands):
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The following table presents the change in Level 3 financial assets and liabilities measured on a recurring basis for the six months ended June 30, 2012 (in thousands):
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18 CLEARWIRE CORPORATION AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - (Continued) The following table presents the change in Level 3 financial assets and liabilities measured on a recurring basis for the six months ended June 30, 2011 (in thousands):
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The following is the description of the fair value for financial instruments we hold that are not subject to fair value recognition. Debt Instruments The senior secured notes maturing in 2015, which we refer to as the 2015 Senior Secured Notes, the 2016 Senior Secured Notes, the second-priority secured notes, which we refer to as the Second-Priority Secured Notes, and the Exchangeable Notes are classified as Level 2 of the valuation hierarchy. To estimate the fair value of the 2015 Senior Secured Notes, the 2016 Senior Secured Notes, the Second-Priority Notes and the Exchangeable Notes, we used the average indicative price from several market makers. To estimate the fair value of the vendor financing notes, which we refer to as the Vendor Financing Notes, we used an income approach based on the contractual terms of the notes and market-based parameters such as interest rates. As a result, they are classified in Level 3 of the valuation hierarchy. A level of subjectivity is applied to estimate the discount rate used to calculate the present value of the estimated cash flows. The following table presents the carrying value and the approximate fair value of our outstanding debt instruments at June 30, 2012 and December 31, 2011 (in thousands):
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