UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
-------------------------------------------------
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
----------------------- ------------------------
Commission file number 1-04721
---------------------------------------------------------
SPRINT CORPORATION
--------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
KANSAS 48-0457967
-------------------------------------- ------------------------------------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
P.O. Box 7997, Shawnee Mission, Kansas 66207-0997
-------------------------------------- ------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (913) 624-3000
----------------------------
--------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last
report)
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 these reports), and (2) has been subject to these filing
requirements for the past 90 days.
Yes X No
----------- -------
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
----------- -------
COMMON SHARES OUTSTANDING AT October 31, 2004:
FON COMMON STOCK
Series 1 1,385,221,790
Series 2 85,745,926
TABLE OF CONTENTS
Page
Reference
Part I - Financial Information
Item 1. Sprint Corporation Financial Statements
Consolidated Financial Statements
Consolidated Statements of Operations 1
Consolidated Statements of Comprehensive Income (Loss) 2
Consolidated Balance Sheets 3
Consolidated Statements of Cash Flows 5
Consolidated Statement of Shareholders' Equity 6
Condensed Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations 24
Item 3. Quantitative and Qualitative Disclosures about Market Risk 42
Item 4. Controls and Procedures 43
Part II - Other Information
Item 1. Legal Proceedings 44
Item 2. Changes in Securities 44
Item 3. Defaults Upon Senior Securities 45
Item 4. Submission of Matters to a Vote of Security Holders 45
Item 5. Other Information 46
Item 6. Exhibits 46
Signature 48
Exhibits
(12) Computation of Ratios of Earnings to Fixed Charges
(31) (a) Certification of Chief Executive Officer Pursuant to
Securities Exchange Act of 1934 Rule 13a-14(a)
(b) Certification of Chief Financial Officer Pursuant to Securities Exchange
Act of 1934 Rule 13a-14(a)
(32) (a) Certification of Chief Executive Officer Pursuant to
18 U.S.C. Section 1350, As Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
(b) Certification of Chief Financial Officer Pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
Part I.
Item 1.
SPRINT CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
(millions, except per share data)
Quarters Ended Year-to-Date
September 30, September 30,
--- ------------------------------- -- -------------------------------
2004 2003 2004 2003
(as restated) (as restated)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net Operating Revenues $ 6,922 $ 6,714 $ 20,498 $ 19,516
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Operating Expenses
Costs of services and products 3,190 3,034 9,415 8,766
Selling, general and administrative 1,666 1,644 4,984 4,894
Depreciation and amortization 1,222 1,243 3,687 3,715
Restructuring and asset impairments 3,559 1,223 3,685 1,581
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Total operating expenses 9,637 7,144 21,771 18,956
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Operating Income (Loss) (2,715) (430) (1,273) 560
Interest expense (305) (341) (947) (1,071)
Premium on early retirement of debt (38) (2) (58) (21)
Other income (expense), net 13 4 (17) (78)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Loss from continuing operations before
income taxes (3,045) (769) (2,295) (610)
Income tax benefit 1,135 273 846 211
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Loss from Continuing Operations (1,910) (496) (1,449) (399)
Discontinued operation, net - (1) - 1,321
Cumulative effect of change in accounting
principle, net - - - 258
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net Income (Loss) (1,910) (497) (1,449) 1,180
Earnings allocated to participating
securities (3) - (9) -
Preferred stock dividends paid (2) (2) (5) (5)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Earnings (Loss) Applicable to Common Stock
$ (1,915) $ (499) $ (1,463) $ 1,175
--- ------------- -- -------------- -- ------------- --- -------------
Diluted Earnings(Loss) per Common Share
Continuing operations $ (1.32) $ (0.35) $ (1.02) $ (0.29)
Discontinued operation - - - 0.93
Cumulative effect of change in
accounting principle, net - - - 0.18
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Total $ (1.32) $ (0.35) $ (1.02) $ 0.83
--- ------------- -- -------------- -- ------------- --- -------------
Diluted weighted average common shares 1,450.6 1,419.6 1,433.8 1,413.1
--- ------------- -- -------------- -- ------------- --- -------------
Basic Earnings (Loss) per Common Share
Continuing operations $ (1.32) $ (0.35) $ (1.02) $ (0.29)
Discontinued operation - - - 0.93
Cumulative effect of change in
accounting principle, net - - - 0.18
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Total $ (1.32) $ (0.35) $ (1.02) $ 0.83
--- ------------- -- -------------- -- ------------- --- -------------
Basic weighted average common shares 1,450.6 1,419.6 1,433.8 1,413.1
--- ------------- -- -------------- -- ------------- --- -------------
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).
SPRINT CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Loss) (Unaudited)
(millions)
Quarters Ended Year-to-Date
September 30, September 30,
--- ------------------------------- -- -------------------------------
2004 2003 2004 2003
(as restated) (as restated)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net Income (Loss) $ (1,910) $ (497) $ (1,449) $ 1,180
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Other Comprehensive Income (Loss)
Unrealized holding gains on securities 14 4 19 44
Income tax expense (4) (2) (6) (17)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net unrealized holding gains on securities
during the period 10 2 13 27
Reclassification adjustment for gains on
securities included in net income
(loss) - (3) (2) (6)
Income tax benefit - 1 1 3
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net reclassification adjustment for gains
included in net income - (2) (1) (3)
Foreign currency translation adjustments
24 - 24 (1)
Income tax expense (9) - (9) -
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net foreign currency translation adjustment
15 - 15 (1)
Unrealized losses on qualifying cash
flow hedges - (4) (3) (34)
Income tax benefit - 1 1 13
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Net unrealized losses on qualifying cash
flow hedges during the period - (3) (2) (21)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Total other comprehensive income (loss) 25 (3) 25 2
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Comprehensive Income (Loss) $ (1,885) $ (500) $ (1,424) $ 1,182
--- ------------- -- -------------- -- ------------- --- -------------
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).
SPRINT CORPORATION
CONSOLIDATED BALANCE SHEETS
(millions)
September 30, December 31,
2004 2003
(Unaudited)
-------------------------------------------------------------------------------------------------------------------------
Assets
Current assets
Cash and equivalents $ 4,016 $ 2,424
Accounts receivable, net of allowance for doubtful accounts of
$271 and $276 3,207 2,876
Inventories 691 582
Prepaid expenses 300 279
Other 414 450
-------------------------------------------------------------------------------------------------------------------------
Total current assets 8,628 6,611
Gross property, plant and equipment 42,949 53,994
Accumulated depreciation (20,590) (26,893)
-------------------------------------------------------------------------------------------------------------------------
Net property, plant and equipment 22,359 27,101
Intangibles
Goodwill 4,401 4,401
Spectrum licenses 3,386 3,385
Other intangibles 69 32
-------------------------------------------------------------------------------------------------------------------------
Total intangibles 7,856 7,818
Accumulated amortization (8) (3)
-------------------------------------------------------------------------------------------------------------------------
Net intangibles 7,848 7,815
Other assets 944 1,148
-------------------------------------------------------------------------------------------------------------------------
Total $ 39,779 $ 42,675
-----------------------------------
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).
SPRINT CORPORATION
CONSOLIDATED BALANCE SHEETS (continued)
(millions, except per share data)
September 30, December 31,
2004 2003
(Unaudited)
-------------------------------------------------------------------------------------------------------------------------
Liabilities and Shareholders' Equity
Current liabilities
Current maturities of long-term debt $ 1,414 $ 594
Accounts payable 2,176 2,197
Accrued interconnection costs 445 503
Accrued taxes 466 407
Advance billings 626 572
Accrued restructuring costs 160 117
Payroll and employee benefits 416 683
Accrued interest 276 378
Other 1,014 1,025
-------------------------------------------------------------------------------------------------------------------------
Total current liabilities 6,993 6,476
Noncurrent liabilities
Long-term debt and capital lease obligations 16,038 16,841
Equity unit notes - 1,725
Deferred income taxes 857 1,725
Postretirement and other benefit obligations 1,397 1,572
Other 1,070 976
-------------------------------------------------------------------------------------------------------------------------
Total noncurrent liabilities 19,362 22,839
Redeemable preferred stock 247 247
Shareholders' equity
Common stock
FON, par value $2.00 per share, 3,000.0 shares authorized, 1,470.3 and
904.3 shares issued and outstanding 2,941 1,809
PCS, par value $1.00 per share, 4,000.0 shares authorized, 0 and 1,035.4
shares issued and outstanding - 1,035
Capital in excess of par or stated value 11,956 10,084
Retained earnings (deficit) (1,024) 906
Accumulated other comprehensive loss (696) (721)
-------------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 13,177 13,113
-------------------------------------------------------------------------------------------------------------------------
Total $ 39,779 $ 42,675
-----------------------------------
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).
SPRINT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(millions)
------------------------------------------------------------------ ----------------- ----------------------------------
Year-to-Date September 30, 2004 2003
(as restated)
------------------------------------------------------------------ ----------------- ----------------- ----------------
Operating Activities
Net income (loss) $ (1,449) $ 1,180
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Discontinued operation, net - (1,321)
Cumulative effect of change in accounting principle, net - (258)
Depreciation and amortization 3,687 3,715
Deferred income taxes (879) 442
Net losses on write-down of assets 3,540 1,568
Changes in assets and liabilities:
Accounts receivable, net (331) 44
Inventories and other current assets (153) 174
Accounts payable and other current liabilities (138) (1,226)
Noncurrent assets and liabilities, net (2) (148)
Other, net 251 190
------------------------------------------------------------------------------------ --- ------------- -- -------------
Net cash provided by operating activities of continuing operations 4,526 4,360
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Investing Activities
Capital expenditures (2,642) (2,333)
Investments in debt securities (121) -
Proceeds from debt securities 237 (91)
Other, net (26) 65
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Net cash used by investing activities of continuing operations (2,552) (2,359)
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Financing Activities
Proceeds from debt - 44
Payments on debt (1,685) (2,386)
Proceeds from common stock issued 1,802 6
Dividends paid (485) (343)
Other, net (14) 14
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Net cash used by financing activities of continuing operations (382) (2,665)
------------------------------------------------------------------------------------ --- ------------- -- -------------
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Cash from discontinued operations - 2,230
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Increase in Cash and Equivalents 1,592 1,566
Cash and Equivalents at Beginning of Period 2,424 1,035
------------------------------------------------------------------ --- ------------- --- ------------- -- -------------
Cash and Equivalents at End of Period $ 4,016 $ 2,601
--- ------------- -- -------------
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).
SPRINT CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (Unaudited)
(millions)
Year-to-Date September 30, 2004
------------------------------------------------------------------------------------------------------------------------
Capital in Accumulated
FON PCS Excess of Retained Other
Common Common Par or Earnings Comprehensive
Stock Stock Stated Value (Deficit) Loss Total
------------------------------------------------------------------------------------------------------------------------
Beginning 2004 balance $ 1,809 $ 1,035 $ 10,084 $ 906 $ (721) $ 13,113
Net loss - - - (1,449) - (1,449)
Common stock dividends - - - (480) - (480)
Preferred stock dividends - - (5) - - (5)
FON Series 1 common stock issued 95 - 1,783 - - 1,878
PCS Series 1 common stock issued - 2 7 - - 9
Stock-based compensation expense - - 102 - - 102
Conversion of PCS common stock
into FON common stock 1,037 (1,037) - - - -
Other, net - - (15) (1) 25 9
------------------------------------------------------------------------------------------------------------------------
September 30, 2004 balance $ 2,941 $ - $ 11,956 $ (1,024) $ (696) $ 13,177
--------------------------------------------------------------------------------------
Shares Outstanding
------------------------------------------------------------
Beginning 2004 balance 904.3 1,035.4
FON Series 1 common stock issued 47.5 -
PCS Series 1 common stock issued - 1.6
Conversion of PCS common stock
into FON common stock 518.5 (1,037.0)
------------------------------------------------------------
September 30, 2004 balance 1,470.3 -
--------------------------
See accompanying Condensed Notes to Consolidated Financial Statements (Unaudited).
PART I.
Item 1.
SPRINT CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
The information in this Form 10-Q has been prepared according to Securities and
Exchange Commission (SEC) rules and regulations. In our opinion, the
consolidated interim financial statements reflect all adjustments, consisting
only of normal recurring accruals, needed to fairly present Sprint Corporation's
consolidated financial position, results of operations, cash flows and
comprehensive income.
Certain information and footnote disclosures normally included in consolidated
financial statements prepared according to accounting principles generally
accepted in the United States have been condensed or omitted. As a result, you
should read these financial statements along with Sprint Corporation's 2003 Form
10-K/A. Operating results for the 2004 year-to-date period do not necessarily
represent the results that may be expected for the year ending December 31,
2004.
--------------------------------------------------------------------------------
1. Basis of Consolidation and Presentation
--------------------------------------------------------------------------------
Consolidation and Comparative Presentation
The consolidated financial statements include the accounts of Sprint, its wholly
owned subsidiaries and subsidiaries it controls. Investments in entities in
which Sprint exercises significant influence, but does not control, are
accounted for using the equity method. See Note 4 for additional information.
The consolidated financial statements are prepared using accounting principles
generally accepted in the United States. These principles require management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities, and the
reported amounts of revenues and expenses. Actual results could differ from
those estimates.
Certain prior-year amounts have been reclassified to conform to the current-year
presentation. These reclassifications had no effect on the net results of
operations or shareholders' equity as previously reported.
Classification of Operations
Sprint is a global communications company and a leader in integrating
long-distance, local service, and wireless communications. Sprint is also one of
the largest carriers of Internet traffic using its tier one Internet Protocol
(IP) network and is a leader in providing high-speed wireless data services.
Sprint's business is divided into three segments: Wireless, Local and Long
distance operations.
Change in Depreciable Life
As of January 1, 2004, Sprint re-evaluated the depreciable lives of certain
network assets. The depreciable life of certain high-capacity transmission
equipment was extended from eight years to twelve years. This extension in life
decreased the 2004 third quarter and 2004 year-to-date depreciation expense in
Long distance by approximately $24 million and $73 million, respectively.
--------------------------------------------------------------------------------
2. Recombination of Tracking Stock
--------------------------------------------------------------------------------
On April 23, 2004, Sprint recombined its two tracking stocks. Each share of PCS
common stock automatically converted into 0.5 shares of FON common stock. As of
April 23, 2004, the FON Group and the PCS Group no longer exist, and FON common
stock represents all of the operations and assets of Sprint, including Wireless,
Local and Long distance operations. This event is reflected in the presentation
of these financial statements.
Shareholders' Equity
The conversion of PCS common stock into FON common stock resulted in an increase
in FON common stock outstanding of 518.5 million shares as of April 23, 2004.
Although Sprint's Articles of Incorporation continue to authorize PCS common
stock following the conversion of PCS common stock, Sprint's board of directors
adopted a resolution prohibiting the issuance of any shares. Sprint intends to
submit to a vote of stockholders an amendment to the Articles to delete
references to the PCS common stock at its next annual meeting of stockholders.
Earnings Per Share
All per share amounts have been restated, for all periods presented, to reflect
the recombination of the FON common stock and PCS common stock as of the
earliest period presented at an identical conversion ratio (0.50). The
conversion ratio was also applied to dilutive PCS Group securities (mainly stock
options, employee stock purchase plan shares, convertible preferred stock, and
restricted stock units) to determine diluted weighted average shares on a
consolidated basis.
Following is earnings per share information for the FON Group and the PCS Group.
These amounts reflect the restatement discussed in Note 3.
Quarter Ended Year-to-Date
------------------------------ ------------------------------
FON Group PCS Group FON Group PCS Group
Periods Ended September 30, 2003 (as restated) (as restated)
------------------------------ ------------------------------
(millions, except earnings per share data)
Loss from Continuing Operations $ (432) $ (64) $ (63) $ (336)
Discontinued operation, net (1) - 1,321 -
Cumulative effect of change in accounting
principle, net - - 258 -
------------- -------------- ------------- --------------
Net Income (Loss) (433) (64) 1,516 (336)
Preferred stock dividends (paid) received 2 (4) 6 (11)
------------- -------------- ------------- --------------
Earnings (Loss) Applicable to Common Stock $ (431) $ (68) $ 1,522 $ (347)
------------- -------------- ------------- --------------
Diluted Earnings (Loss) per Common Share(1)
Continuing operations $ (0.48) $ (0.07) $ (0.07) $ (0.34)
Discontinued operation - - 1.47 -
Cumulative effect of change in accounting
principle, net - - 0.29 -
------------- -------------- ------------- --------------
Total $ (0.48) $ (0.07) $ 1.69 $ (0.34)
------------- -------------- ------------- --------------
Diluted weighted average common shares 903.0 1,033.1 899.9 1,026.6
------------- -------------- ------------- --------------
Basic Earnings (Loss) per Common Share
Continuing operations $ (0.48) $ (0.07) $ (0.07) $ (0.34)
Discontinued operation - - 1.47 -
Cumulative effect of change in accounting
principle, net - - 0.29 -
------------- -------------- ------------- --------------
Total $ (0.48) $ (0.07) $ 1.69 $ (0.34)
------------- -------------- ------------- --------------
Basic weighted average common shares 903.0 1,033.1 899.9 1,026.6
------------- -------------- ------------- --------------
(1) As the effects of including dilutive FON Group and PCS Group securities
were antidilutive, they were not included in the diluted weighted average
common shares outstanding for the FON Group and PCS Group, nor were they
included in the calculation of diluted earnings per share.
--------------------------------------------------------------------------------
3. Restatement of Previously Issued Financial Statements
--------------------------------------------------------------------------------
During a review of internal controls relating to its capital assets, Sprint
identified, in the 2004 third quarter, a calculation error that had resulted,
since 1999, in the overstatement of interest capitalized during the construction
of its Wireless capital assets, with a corresponding understatement of interest
expense. The error subsequently resulted in an overstatement of depreciation
expense after the associated capital assets were placed in service. While Sprint
believes the impacts of this calculation error are not material to any
previously issued financial statement, Sprint determined that this calculation
error was most appropriately corrected through restatement of previously issued
financial statements.
The impacts of this restatement on the financial statements for the quarter and
year-to-date periods ended September 30, 2003 are summarized below (in millions,
except per share information):
Statement of Operations Data: Quarter Ended Year-to-Date
-------------------------------------- --------------------------------------
Periods Ended Previously As Previously As
September 30, 2003 Reported Adjustment Restated Reported Adjustment Restated
-------------------------------------- --------------------------------------
Operating income (loss) $ (438) $ 8 $ (430) $ 536 $ 24 $ 560
Interest expense 335 6 341 1,052 19 1,071
Loss from continuing
operations (497) 1 (496) (402) 3 (399)
Net income (loss) (498) 1 (497) 1,177 3 1,180
Diluted earnings (loss) per
common share(1) (0.35) - (0.35) 0.83 - 0.83
Basic earnings (loss) per
common share(1) (0.35) - (0.35) 0.83 - 0.83
Statement of Cash Flows Data: Nine Months Ended September 30, 2003
--------------------------------------
Previously As
Reported Adjustment Restated
--------------------------------------
Net cash provided by operating
activities of continuing
operations $ 4,379 $ (19) $ 4,360
Capital expenditures 2,352 (19) 2,333
Increase in Cash and
Equivalents 1,566 - 1,566
(1) On April 23, 2004 Sprint recombined its two tracking stocks. Each share of
PCS common stock automatically converted into 0.5 shares of FON common
stock. All per share amounts have been restated to reflect the
recombination of the FON common stock as of the earliest period presented
at an identical conversion ratio (0.5). The conversion ratio was also
applied to dilutive PCS Group securities (mainly stock options, employee
stock purchase plans, convertible preferred stock and restricted stock
units) to determine diluted weighted average shares on a consolidated
basis.
Following are the impacts of the restatements on previously reported information
for the FON Group and the PCS Group:
Quarter Ended Year-to-Date
-------------------------------------- --------------------------------------
Periods Ended Previously As Previously As
September 30, 2003 Reported Adjustment Restated Reported Adjustment Restated
-------------------------------------- --------------------------------------
FON Net income (loss) $ (433) $ - $ (433) $ 1,516 $ - $ 1,516
Diluted earnings (loss) per
FON common share (0.48) - (0.48) 1.69 - 1.69
Basic earnings (loss) per FON
common share (0.48) - (0.48) 1.69 - 1.69
PCS Net loss (65) 1 (64) (339) 3 (336)
Diluted loss per PCS common
share (0.07) - (0.07) (0.34) - (0.34)
Basic loss per PCS common share
(0.07) - (0.07) (0.34) - (0.34)
--------------------------------------------------------------------------------
4. Investments
--------------------------------------------------------------------------------
At September 30, 2004, Sprint carried $424 million in investment asset value:
$70 million was included in "Current assets--other" and $354 million in "Other
assets" on the Consolidated Balance Sheets.
At December 31, 2003, Sprint carried $548 million in investment asset value:
$125 million was included in "Current assets--other" and $423 million in "Other
assets" on the Consolidated Balance Sheets.
Specific investment types and the related carrying amounts include:
Investments in Debt Securities
During the second half of 2003, Sprint invested in marketable debt securities.
Interest on these investments is reinvested and recognized in "Other, net" in
the Consolidated Statements of Operations. Sprint recognized approximately $2
million of interest income on these investments in the 2004 third quarter and $6
million in the 2004 year-to-date period. Accumulated unrealized holding losses
were immaterial at the end of September 30, 2004 and at December 31, 2003. At
September 30, 2004, investments in marketable debt securities totaled $608
million of which $70 million was included in "Current assets - Other" and $117
million, with maturities of less than five years, was included in "Other assets"
on the Consolidated Balance Sheets. The remaining $421 million have original or
remaining maturities at purchase of less than 90 days and were included in "Cash
and equivalents."
At December 31, 2003, investments in marketable debt securities totaled $503
million of which $125 million was included in "Current assets - Other" and $177
million was included in "Other assets" on the Consolidated Balance Sheets. The
remaining $201 million had original or remaining maturities at purchase of less
than 90 days and were included in "Cash and equivalents."
Investments in Equity Securities
The cost of investments in marketable equity securities, primarily made up of
EarthLink common stock, was $134 million at September 30, 2004 and December 31,
2003. Accumulated unrealized holding gains were $50 million (net of $29 million
tax) and $38 million (net of $23 million tax) at September 30, 2004 and December
31, 2003, respectively. These gains were included in "Accumulated other
comprehensive loss" on the Consolidated Balance Sheets.
At September 30, 2004, Sprint held 18.9 million shares of EarthLink common
stock, which were reflected in "Other assets" on the Consolidated Balance
Sheets. These shares were hedged with variable prepaid forward contracts,
maturing from November 2004 to November 2005. See Note 14 for additional
information.
Equity Method Investments
At September 30, 2004 and at December 31, 2003, investments accounted for using
the equity method consisted primarily of Sprint's investment in Virgin Mobile
USA, LLC (Virgin Mobile USA). These investments were reflected in "Other assets"
on the Consolidated Balance Sheets. Certain other equity method investments were
carried at zero value.
Virgin Mobile USA
Sprint's investment in Virgin Mobile USA was $19 million at September 30, 2004
and $41 million at December 31, 2003. Sprint determined that Virgin Mobile USA
is not a variable interest entity and therefore carries it as an equity
investment.
This joint venture with the Virgin Group was originally entered into in the 2001
fourth quarter to market wireless services, principally to youth and pre-pay
segments. Virgin Mobile USA launched services in June 2002. In the 2002 second
quarter, Sprint entered into a new agreement with Virgin Group for funding of
Virgin Mobile USA. Under the terms of the agreement, Sprint agreed to fund up to
$150 million, with the majority in the form of discounted network services and
the remainder in cash, and the Virgin Group agreed to fund up to $150 million in
cash. Sprint has satisfied 100% of this cash funding commitment and 100% of the
network services contribution through September 30, 2004. Additionally, in the
2003 third quarter, Sprint's board of directors authorized additional cash
funding for the joint venture in the amount of $30 million, all of which had
been provided to the joint venture as of September 30, 2004.
Sprint's board of directors authorized additional funding to the joint venture
of approximately $22 million in the 2004 first quarter, and approximately $13
million in the 2004 second quarter. A loan facility for these funds is in place
with the venture and the available line of credit remains undrawn.
In the 2003 third quarter, a Sprint subsidiary agreed to guarantee a $20 million
term-loan facility entered into by Virgin Mobile USA to fund working capital
needs. The facility expires on December 31, 2004. If required to perform, Sprint
would acquire Virgin Mobile USA's subscriber base. The fair value of this
guarantee was recorded in "Current liabilities - Other" on the Consolidated
Balance Sheets in the amount of $5 million.
Combined, unaudited, summarized financial information (100% basis) of entities
accounted for using the equity method was as follows:
Quarters Ended Year-to-Date
September 30, September 30,
-- ------------------------------- --- ------------------------------
2004 2003 2004 2003
------------------------------------------ -- ------------- --- ------------- --- ------------- -- -------------
(millions)
Results of operations
Net operating revenues $ 302 $ 221 $ 891 $ 568
-- ------------- --- ------------- --- ------------- -- -------------
Operating loss $ (29) $ (63) $ (85) $ (177)
-- ------------- --- ------------- --- ------------- -- -------------
Net loss $ (24) $ (77) $ (107) $ (163)
-- ------------- --- ------------- --- ------------- -- -------------
Equity in net losses of affiliates $ (8) $ (17) $ (30) $ (45)
-- ------------- --- ------------- --- ------------- -- -------------
--------------------------------------------------------------------------------
5. Asset Retirement Obligations
--------------------------------------------------------------------------------
Sprint adopted Statement of Financial Accounting Standard (SFAS) No. 143,
Accounting for Asset Retirement Obligations, on January 1, 2003. This standard
provides accounting guidance for legal obligations associated with the
retirement of long-lived assets that result from the acquisition, construction
or development and (or) normal operation of that asset. According to the
standard, the fair value of an asset retirement obligation (ARO liability)
should be recognized in the period in which (1) a legal obligation to retire a
long-lived asset exists and (2) the fair value of the obligation based on
retirement cost and settlement date is reasonably estimable. Upon initial
recognition of the ARO liability, the related asset retirement cost should be
capitalized by increasing the carrying amount of the related long-lived asset.
Sprint's network is primarily located on owned and leased property and utility
easements. In Long distance and Local operations, a majority of the leased
property has no requirement for remediation at retirement. The leased property
of the Wireless operation has potential remediation requirements. Sprint expects
to maintain its property as a necessary component of infrastructure required to
maintain operations or FCC licensing. Sprint has recorded the liability
presently required for the ultimate satisfaction of these requirements, and this
amount is immaterial.
Adoption of SFAS No. 143 affected the cost of removal historically recorded by
Local operations. Consistent with regulatory requirements and industry practice,
Local historically accrued costs of removal in its depreciation reserves. These
costs of removal do not meet the SFAS No. 143 definition of an ARO liability.
Upon adoption of SFAS No. 143, Sprint recorded a reduction in its historical
depreciation reserves of approximately $420 million to remove the accumulated
excess cost of removal, resulting in a cumulative effect of change in accounting
principle credit, net of tax, in the Consolidated Statements of Operations of
$258 million.
--------------------------------------------------------------------------------
6. Restructuring and Asset Impairment
--------------------------------------------------------------------------------
Organizational Realignment
In the 2003 fourth quarter, Sprint initiated a company-wide effort to realign
internal resources to enhance our focus on the needs and preferences of two
distinct consumer types - business and individuals. This business transformation
initiative is enabling the enterprise to more effectively and efficiently use
its asset portfolio to create customer-focused solutions. One of the goals of
this initiative is to create a more efficient cost structure. As decisions are
made to meet this specific goal (Organizational Realignment), charges are
recognized for severance costs associated with work force reductions.
The decisions made in the 2003 fourth quarter and 2004 first quarter are
expected to result in the involuntary separation of approximately 2,550
employees. The decisions made in the 2004 second quarter to consolidate call
center activity and respond to the continued competitive pressures in the
long-distance market are expected to result in the involuntary separation of
approximately 2,350 additional employees. As of September 30, 2004,
approximately 4,200 separations have been completed. In October 2004, Sprint
announced strategic plans that will result in additional work force reductions
of up to 1,000 employees achieved through attrition, voluntary and involuntary
separations.
Sprint has recognized $144 million in pre-tax charges for the Organizational
Realignment associated with severance benefits and currently expects the
aggregate pre-tax charges will not exceed $175 million. Actions associated with
these decisions should be completed in the first half of 2005.
Other Restructuring Activity
In the 2003 fourth quarter, Sprint announced the termination of the development
of a new billing platform (PCS Billing Platform Termination). This decision
resulted in pre-tax charges of $351 million in the 2003 fourth quarter. The
charge for asset impairments was $339 million and the remaining $12 million was
accrued for other contractual obligations. In the 2004 third quarter, Sprint
recorded an expense reduction of $2 million as a result of finalizing the
contractual obligations associated with this action.
In the 2003 second quarter, Sprint announced the wind-down of its Web Hosting
business. Restructurings of other Long distance operations also occurred in the
continuing effort to create a more efficient cost structure (Web Hosting
Wind-down). These decisions resulted in pre-tax charges of $376 million in 2003
and $62 million in the 2004 year-to-date period. The aggregate charge for asset
impairments was $316 million, the aggregate charge for employee terminations was
$14 million and the remaining $108 million was for facility lease terminations.
In connection with the Web Hosting wind-down, Sprint may incur additional
charges for facility lease terminations in subsequent periods. The severance
charges are associated with the involuntary employee separation of approximately
600 employees. As of September 30, 2004, substantially all of the employee
separations have been completed. Sprint has recognized $438 million in pre-tax
charges and expects the aggregate pre-tax charge to be approximately $440
million.
The 2004 activity is summarized as follows:
------------------------------------ --- ------------------- ---------------------------------- --- ------------------
2004 Activity
----------------------------------
December 31, 2003 Restructuring Cash September 30,
Liability Balance Charge Payments 2004 Liability
Balance
------------------------------------ --- ------------------- -- -------------- --- ------------ --- ------------------
(millions)
Restructuring Events
Organizational Realignment
Severance $ 54 $ 85 $ 81 $ 58
PCS Billing Platform Termination
Other exit costs 12 (2) 10 -
Web Hosting Wind-down
Severance 6 - 3 3
Other exit costs 45 62 8 99
------------------------------------ --- ------------------- -- -------------- --- ------------ --- ------------------
Total $ 117 $ 145 $ 102 $ 160
--- ------------------- -- -------------- --- ------------ --- ------------------
Asset Impairments
Sprint determined that business conditions and events occurring in the 2004
third quarter and impacting its Long distance operations constituted a
"triggering event" requiring an evaluation of the recoverability of the Long
distance long-lived assets pursuant to SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.
The industry-wide business conditions and events included the continuing impacts
of the highly-competitive long distance market, the related aggressive pricing,
recent changes in the regulatory climate negatively impacting the long-term
ability of Long distance to bridge the last mile in the consumer and small
business market segments, product substitution and customers' accelerated
demands for cost-effective, advanced, IP-driven telecommunications solutions
requiring transparent wireline and wireless connectivity.
In light of these industry-wide business conditions and events, Sprint
reevaluated its strategy and financial forecasts in the 2004 third quarter.
Sprint intends to focus sales efforts and resources on being a leader
in telecommunications solutions, by emphasizing (1) integrate-able products and
telecommunications solutions, such as wireless-enabled and IP-driven, and (2)
markets in which Sprint can leverage its unique portfolio of wireless and
wireline assets.
Evaluations of asset recoverability are performed at the lowest asset or asset
group level for which identifiable cash flows are largely independent of the
cash flows of other assets or asset groups. Due to the integrated nature of the
Long distance network, Sprint conducted its testing of the asset group at the
Long distance entity level (excluding assets held for sale), as this is the
lowest level for which identifiable cash flows are available. Further, it was
concluded that the fiber-optic backbone constituted the primary asset of the
Long distance asset group. Accordingly, cash flows were projected over the
remaining useful life of the fiber-optic backbone. These cash flow projections
reflect estimated future operating results, considering all relevant
circumstances and events, and estimated capital expenditures required to
maintain, but not to increase, the service potential of the asset group. The
resulting undiscounted future cash flows were less than the carrying value of
the Long distance asset group, requiring that the asset group be reduced to fair
value.
The fair value of the asset group was determined by discounting the cash flow
projections at a 10% discount rate, reflecting a risk-adjusted weighted average
cost of capital. The resulting fair value of the asset group required a $3.52
billion pre-tax non-cash impairment charge, reducing the net carrying value of
Long distance property, plant and equipment by about 60%, to $2.29 billion at
September 30, 2004.
In October 2004, Sprint completed the sale of its wholesale Dial IP business for
$34 million. These assets were classified as held for sale at September 30,
2004, and an associated pre-tax non-cash charge of $21 million was recorded in
the 2004 third quarter to adjust the carrying value of these assets to fair
value.
In the 2003 third quarter, Sprint recorded a pre-tax, non-cash charge of $1.2
billion related to the write-down in the fair value of its MMDS spectrum.
Sprint's ongoing evaluation of business use for this asset resulted in a
decision to end pursuit of a residential fixed wireless strategy. This decision
required a revaluation of the fair value of the asset.
This fair value was based on recent sales prices for similar assets. Sprint is
now focusing its efforts on a broad range of alternative strategies. Sprint is
continuing to optimize its spectrum portfolio, is monitoring technology and
industry developments, and is involved in efforts to achieve favorable
regulatory rulings with respect to this spectrum.
In the 2003 first quarter, Sprint recorded a charge for asset impairment of $10
million. This charge was associated with the termination of a software
development project.
--------------------------------------------------------------------------------
7. Long-term Debt and Capital Lease Obligations
--------------------------------------------------------------------------------
In August 2004, Sprint purchased $516 million of its senior notes before their
scheduled maturities. These notes had interest rates ranging from 6.0% to 6.9%
and maturity dates ranging from 2007 to 2028. Sprint recorded a premium of $38
million and $3 million of unamortized debt costs and fees associated with this
repayment.
In September 2004, Sprint paid $13 million of its capital lease obligations
before their scheduled maturities.
--------------------------------------------------------------------------------
8. Equity Unit Notes
--------------------------------------------------------------------------------
In the 2001 third quarter, Sprint completed a registered offering of 69 million
equity units, each with a stated amount of $25. Net proceeds from the issuance
were approximately $1.7 billion after deducting the underwriting discount and
other offering expenses.
Each equity unit initially consisted of a corporate unit. Each corporate unit
consisted of a forward purchase contract and a $25 principal amount of senior
notes (Notes) of Sprint's wholly owned subsidiary, Sprint Capital Corporation.
The corporate unit could be converted by the holder into a treasury unit
consisting of the forward purchase contract and a treasury portfolio of
zero-coupon U.S. treasury securities by substituting the treasury securities for
the Notes. The underlying Notes or treasury portfolio were pledged to Sprint to
secure the holder's obligations under the forward purchase contract.
Forward Purchase Contracts
As a component of the equity units, the forward purchase contracts originally
obligated the holders to purchase, and obligated Sprint to sell, on August 17,
2004, a variable number of newly issued shares of PCS common stock, ranging from
approximately 58 million to 70 million shares depending on the market price of
PCS common stock. As a result of the recombination of PCS common stock and FON
common stock on April 23, 2004, the forward purchase contracts obligated the
holders to purchase, and Sprint to sell, a variable number of shares of newly
issued FON common stock, ranging from approximately 29 million to 35 million
shares. These forward purchase contracts included a provision permitting the
equity unit holders to benefit from or "participate" in any dividends declared
on the common stock during the contract period. On August 17, 2004, the forward
purchase contracts were settled by the issuance of approximately 35 million
shares of FON common stock in exchange for $1.725 billion in cash.
Notes
The Notes originally had an interest rate of 6% per annum, payable quarterly in
arrears.
In May 2004, Sprint purchased $750 million principal amount of the Notes before
their scheduled maturity. Sprint recorded costs of $29 million consisting of a
$20 million premium and $9 million of unamortized debt costs associated with
this prepayment.
In May 2004, Sprint successfully remarketed approximately $940 million principal
amount of the Notes. The interest rate on the Notes was reset to 4.78% effective
May 24, 2004. The remarketed Notes will mature August 17, 2006. The remaining
$35 million principal amount of outstanding Notes was retained by the holders of
those Notes. These Notes were also reset to the new interest rate.
Following the remarketing of the Notes, the Notes were no longer pledged to
secure the obligations under the purchase contracts. Proceeds received by the
previous Note holders from the remarketing were used by the collateral agent to
purchase other securities that were pledged as security.
As of September 2004, the remarketed notes are included in "Long-term debt and
capital lease obligations" on the Consolidated Balance Sheets.
--------------------------------------------------------------------------------
9. Earnings Per Share
--------------------------------------------------------------------------------
Dilutive securities did not have a dilutive effect on earnings per share because
Sprint incurred a loss from continuing operations in all periods presented.
Options have been granted with exercise prices which are currently higher than
market prices. These options are considered antidilutive. Sprint's antidilutive
securities totaled 87.7 million shares in the 2004 third quarter and 89.4
million shares in the 2004 year-to-date period compared to 105.2 million and
117.9 million shares in the same 2003 periods.
--------------------------------------------------------------------------------
10. Stock-based Compensation
--------------------------------------------------------------------------------
Effective January 1, 2003, Sprint adopted SFAS No. 123, Accounting for
Stock-Based Compensation (SFAS No. 123), as amended by SFAS No. 148, Accounting
for Stock-Based Compensation - Transition and Disclosure, using the prospective
method. Upon adoption, Sprint began expensing the fair value of stock-based
compensation for all grants, modifications or settlements made on or after
January 1, 2003 using the Black-Scholes-Merton model. The following table
illustrates the effect on net income and earnings per share of stock-based
compensation included in net income and the effect on net income and earnings
per share for grants issued on or before December 31, 2002, had Sprint applied
the fair value recognition provisions of SFAS No. 123.
Quarters Ended Year-to-Date
September 30, September 30,
-- --------------------------- - ---------------------------
2004 2003 2004 2003
(as restated) (as restated)
---------------------------------------------------- -- ----------- -- ------------ - ------------ - ------------
(millions, except per share data)
Net income (loss), as reported $ (1,910) $ (497) (1,449) 1,180
Add: Stock-based employee compensation expense
included in reported net income, net of related
tax effects 22 10 65 25
Deduct: Total stock-based employee compensation
expense determined under fair value based
method for all awards, net of related tax
effects (27) (33) (92) (126)
---------------------------------------------------- -- ----------- -- ------------ - ------------ - ------------
Pro forma net income (loss) $ (1,915) $ (520) $ (1,476) $ 1,079
-- ----------- -- ------------ - ------------ - ------------
Earnings (loss) per common share:
Basic - as reported $ (1.32) $ (0.35) $ (1.02) $ 0.83
-- ----------- -- ------------ - ------------ - ------------
Basic - pro forma $ (1.32) $ (0.37) $ (1.04) $ 0.76
-- ----------- -- ------------ - ------------ - ------------
Diluted - as reported $ (1.32) $ (0.35) $ (1.02) $ 0.83
-- ----------- -- ------------ - ------------ - ------------
Diluted - pro forma $ (1.32) $ (0.37) $ (1.04) $ 0.76
-- ----------- -- ------------ - ------------ - ------------
Sprint recognized pre-tax charges of $19 million in the 2004 third quarter, $62
million in the 2004 year-to-date period, $14 million in the 2003 third quarter,
and $23 million in the 2003 year-to-date period related to stock-based grants
issued after December 31, 2002 and grants of restricted stock made in 2002 and
previous years.
Sprint recognized pre-tax charges of $15 million in the 2004 third quarter and
$40 million in the 2004 year-to-date period of non-cash expense related to the
recombination of FON common stock and PCS common stock on April 23, 2004. The
charges primarily reflect application of stock option expensing to PCS stock
options granted before January 1, 2003, as required by SFAS No. 123. Sprint
expects to recognize about $100 million of non-cash pre-tax expense related to
the conversion of PCS stock options into FON stock options through 2006, with
not more than $55 million recognized in 2004, not more than $43 million in 2005,
and the remaining amount in 2006.
In the 2003 second quarter, Sprint recognized pre-tax charges of $15 million of
non-cash expense in connection with separation agreements agreed to by Sprint
and William T. Esrey, former chairman and chief executive officer; Ronald T.
LeMay, former president and chief operating officer; and J. Richard Devlin,
former executive vice president--general counsel, external affairs and corporate
secretary. The charges were associated with accounting for modifications which
accelerated vesting and extended exercise periods of stock options granted in
prior periods, as required by SFAS No. 123. Most of the FON stock options had
exercise prices that were approximately two times the market price at the
modification date, while most of the PCS stock options had exercise prices that
were approximately five times the market price at the modification date.
--------------------------------------------------------------------------------
11. Employee Benefit Information
--------------------------------------------------------------------------------
The net periodic benefit cost consisted of the following:
Pension Benefits Other Postretirement
Benefits
--------------------------- ---------------------------
Quarters Ended Quarters Ended
September 30, September 30,
---------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------
Service cost $ 29 $ 25 $ 4 $ 2
Interest cost 63 59 18 15
Expected return on plan assets (75) (80) (1) (1)
Amortization of transition (asset) obligation (1) - - (1)
Amortization of prior service cost 4 3 (13) (11)
Amortization of net loss 25 9 13 5
-------------------------------------------------------------------------------------------------------------
Net benefit expense $ 45 $ 16 $ 21 $ 9
------------------------------------------------------------
Pension Benefits Other Postretirement
Benefits
--------------------------- ---------------------------
Year-to-Date Year-to-Date
September 30, September 30,
---------------------------------------------------------
2004 2003 2004 2003
-------------------------------------------------------------------------------------------------------------
Service cost $ 100 $ 89 $ 11 $ 10
Interest cost 187 176 48 47
Expected return on plan assets (227) (218) (2) (2)
Amortization of transition (asset) obligation (2) (2) (1) (1)
Amortization of prior service cost 12 11 (37) (33)
Amortization of net loss 67 25 30 20
-------------------------------------------------------------------------------------------------------------
Net benefit expense $ 137 $ 81 $ 49 $ 41
------------------------------------------------------------
Sprint contributed $300 million to the pension trust in January 2004.
In the 2004 first quarter, Sprint amended certain retiree medical plans to
standardize the plan design effective January 1, 2005, eliminating differences
in benefit levels. These amendments decreased the accumulated postretirement
benefit obligation (APBO) related to other postretirement benefits by
approximately $35 million, and decreased the 2004 net benefit expense by $5
million, of which approximately $1 million was recognized in the 2004 third
quarter and approximately $4 million in the year-to-date period.
As a result of these amendments, Sprint also recognized the effects of the 2003
Medicare Prescription Drug, Improvement and Modernization Act (the Act). The Act
contains a subsidy to employers who provide prescription drug coverage to
retirees that is actuarially equivalent to Medicare Part D. Analysis of Sprint's
retiree prescription drug claims data determined that Sprint's retiree
prescription drug benefit was actuarially equivalent. In estimating the effects
of the Act, estimates of participation rates and per capita claims costs were
not changed. The effect of recognizing the federal subsidy related to the Act in
the 2004 first quarter was a $73 million reduction in the APBO, a $3 million
reduction in the net benefit cost in the 2004 third quarter and a $9 million
reduction in the net benefit cost in the year-to-date period. Sprint has
accounted for its retiree medical benefit plan in accordance with Financial
Accounting Standards Board Staff Position No. 106-2.
--------------------------------------------------------------------------------
12. Litigation, Claims and Assessments
--------------------------------------------------------------------------------
In March 2004, eight purported class action lawsuits relating to the
recombination of the tracking stocks were filed against Sprint and its directors
by holders of PCS common stock. Seven of the lawsuits were consolidated in the
District Court of Johnson County, Kansas. The eighth, pending in New York, has
been voluntarily stayed. The consolidated lawsuit alleges breach of fiduciary
duty in connection with allocations between the FON Group and the PCS Group
before the recombination of the tracking stocks and breach of fiduciary duty in
the recombination. The lawsuit seeks to rescind the recombination and monetary
damages. All defendants have denied plaintiffs' allegations and intend to
vigorously defend this matter.
A number of putative class action cases that allege Sprint failed to obtain
easements from property owners during the installation of its fiber optic
network have been filed in various courts. Several of these cases sought
certification of nationwide classes, and in one case, a nationwide class was
certified. However, a nationwide settlement of these claims was approved by the
U.S. District Court for the Northern District of Illinois, which enjoined all
other similar cases. Objectors appealed the preliminary approval order and
injunction to the Seventh Circuit Court of Appeals. In October, 2004, the
Seventh Circuit Court of Appeals vacated the nationwide class and the injunction
and remanded the case to the trial court for further proceedings. In 2001,
Sprint accrued for the estimated settlement costs of these suits.
In 2003, several putative class action lawsuits were filed in the U.S. District
Court for the District of Kansas by participants in the Sprint Retirement
Savings Plan, the Sprint Retirement Savings Plan for Bargaining Unit Employees
and the Centel Retirement Savings Plan for Bargaining Unit Employees. The
complaints, which name Sprint, the committees that administer the plans, and
various current and former directors and officers as defendants, have been
consolidated before one judge. The consolidated lawsuit alleges that defendants
breached their fiduciary duties to the plans and violated the ERISA statutes by
making the company contribution in FON common stock and PCS common stock and
including FON common stock and PCS common stock among the more than thirty
investment options offered to plan participants. The lawsuit seeks to recover
any decline in the value of FON common stock and PCS common stock during the
class period. All defendants have denied plaintiffs' allegations and intend to
vigorously defend this matter.
In 2003, a series of putative class action lawsuits were filed by shareholders
against Sprint, certain current and former officers and directors, and its
former auditor, Ernst & Young (EY). The lawsuits alleged that Sprint's financial
statements were misleading as a result of failure to disclose personal tax
strategies utilized by senior executives of Sprint and allegedly sponsored by
EY, and that EY was not independent. The cases were consolidated into a single
proceeding in the U.S. District Court for the District of Kansas, and in April
2004, the court dismissed those allegations on defendants' motion and dismissed
EY with prejudice, but permitted plaintiffs to amend their complaint against
other defendants. Plaintiffs filed an amended complaint alleging that Sprint's
2001 and 2002 proxy statements were misleading because they described new
employment agreements entered into with senior executives without disclosing
that the board allegedly was considering terminating those same executives. The
lawsuit seeks to recover any decline in the value of FON common stock and PCS
common stock during the class period. In September, 2004, the court denied
defendants' motion to dismiss these new allegations, and the parties have
stipulated that the case can proceed as a class action. All defendants have
denied plaintiffs' allegations and intend to vigorously defend this matter.
Various other suits, proceedings and claims, including purported class actions,
typical for a business enterprise, are pending against Sprint.
While it is not possible to determine the ultimate disposition of each of these
proceedings and whether they will be resolved consistent with Sprint's beliefs,
Sprint expects that the outcome of such proceedings, individually or in the
aggregate, will not have a material adverse effect on the financial condition or
results of operations of Sprint or its business segments.
--------------------------------------------------------------------------------
13. Income Taxes
--------------------------------------------------------------------------------
The differences that caused Sprint's effective income tax rates to vary from the
35% federal statutory rate for income taxes related to continuing operations
were as follows:
Year-to-Date
September 30,
-----------------------------------
2004 2003
(as restated)
------------------------------------------------------------- -- -------------- --- -------------
(millions)
Income tax benefit at the federal statutory rate $ 803 $ 214
Effect of:
State income taxes, net of federal income tax effect 48 (2)
Other, net (5) (1)
------------------------------------------------------------- -- -------------- --- -------------
Income tax benefit $ 846 $ 211
-- -------------- --- -------------
Effective income tax rate 36.9% 34.6%
-- -------------- --- -------------
--------------------------------------------------------------------------------
14. Accounting for Derivative Instruments
--------------------------------------------------------------------------------
Risk Management Policies
Sprint's derivative instruments include interest rate swaps, stock warrants,
variable prepaid forward contracts, credit forward contracts, and foreign
currency forward and option contracts. Sprint's derivative transactions are used
principally for hedging purposes and comply with board-approved policies. Senior
finance management receives frequent status updates of all outstanding
derivative positions.
Sprint enters into interest rate swap agreements to manage exposure to interest
rate movements and achieve an optimal mixture of floating and fixed-rate debt
while minimizing liquidity risk. Interest rate swap agreements that are
designated as fair value hedges effectively convert Sprint's fixed-rate debt to
a floating rate through the receipt of fixed-rate amounts in exchange for
floating-rate interest payments over the life of the agreement without an
exchange of the underlying principal amount. Interest rate swap agreements
designated as cash flow hedges reduce the impact of interest rate movements on
future interest expense by effectively converting a portion of its floating-rate
debt to a fixed rate.
In certain business transactions, Sprint is granted warrants to purchase the
securities of other companies at fixed rates. These warrants are supplemental to
the terms of the business transactions and are not designated as hedging
instruments.
Sprint enters into variable prepaid forward contracts which reduce the
variability in expected cash flows related to a forecasted sale of the
underlying equity securities held as available for sale.
Sprint enters into fair value hedges through credit forward contracts which
hedge changes in fair value of certain debt issues.
Sprint's foreign exchange risk management program focuses on reducing
transaction exposure to optimize consolidated cash flow. Sprint enters into
forward and option contracts in foreign currencies to reduce the impact of
changes in foreign exchange rates. Sprint's primary transaction exposure results
from net payments made to and received from overseas telecommunications
companies for completing international calls made by Sprint's domestic customers
and the operation of its international subsidiaries.
Interest Rate Swaps
The interest rate swaps met all the required criteria under derivative
accounting rules for the assumption of perfect effectiveness resulting in no
recognition of changes in their fair value in earnings during the life of the
swap. Sprint held only fair-value hedges during 2003 and in the period ending
September 30, 2004.
Sprint recorded a $1 million decrease as of September 30, 2004 resulting from
changes in the fair value of the interest rate swaps. The decrease in value for
these swaps has been recorded in "Other non-current assets" on the Consolidated
Balance Sheets. As the swaps have been deemed perfectly effective, an offset was
recorded to the underlying long-term debt.
Stock Warrants
The stock warrants are not designated as hedging instruments and changes in the
fair value of these derivative instruments are recognized in earnings during the
period of change.
Sprint's net derivative gains on stock warrants were immaterial in both the 2004
third quarter and 2004 year-to-date period.
Net Purchased Equity Options
The net purchased equity options embedded in variable prepaid forward contracts
are designated as cash flow hedges.
The impact to other comprehensive income in the 2004 third quarter was
immaterial. Sprint has recorded a $2 million after-tax decrease for the 2004
year-to-date period resulting from losses on these cash flow hedges. The changes
in other comprehensive income are included in "Net unrealized losses on
qualifying cash flow hedges" in the Consolidated Statements of Comprehensive
Income.
Credit Forward Contracts
Sprint held fair value hedges in credit forward contracts during the 2003 first
quarter to hedge changes in fair value of certain debt issues. As there is high
correlation between the credit forward contracts and the debt issues being
hedged, fluctuations in the value of the credit forward contracts are generally
offset by changes in the fair value of the debt issues. A nominal amount was
recorded in Sprint's Consolidated Statements of Operations in the 2003 first
quarter on this investment. The contracts matured in the 2003 third quarter.
Foreign Currency Forward and Option Contracts
Foreign currency forward and option contracts held during the periods were not
designated as hedges as defined in SFAS No. 133 and changes in the fair value of
these derivative instruments are recognized in earnings during the period of
change. The activity associated with these contracts was immaterial in all
periods presented.
Concentrations of Credit Risk
Sprint's accounts receivable are not subject to any concentration of credit
risk. Sprint controls credit risk of its interest rate swap agreements and
foreign currency contracts through credit approvals, dollar exposure limits and
internal monitoring procedures. In the event of nonperformance by the
counterparties, Sprint's accounting loss would be limited to the net amount it
would be entitled to receive under the terms of the applicable interest rate
swap agreement or foreign currency contract. However, Sprint does not anticipate
nonperformance by any of the counterparties to these agreements.
--------------------------------------------------------------------------------
15. Discontinued Operation
--------------------------------------------------------------------------------
In the 2003 first quarter, Sprint sold its directory publishing business to R.H.
Donnelley for $2.23 billion in cash. The sale closed on January 3, 2003.
The pre-tax gain recognized in the 2003 year-to-date period was $2.14 billion,
$1.32 billion after-tax. In the 2003 third quarter, Sprint recognized a loss of
$1 million primarily related to a state tax rate true-up.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets, Sprint has presented the directory publishing business as a
discontinued operation in the consolidated financial statements. Included in
"Discontinued Operations, net" in the 2003 year-to-date Consolidated Statements
of Operations was $5 million of "Net operating revenues" and "Income from
continuing operations before income taxes."
--------------------------------------------------------------------------------
16. Other Financial Information
--------------------------------------------------------------------------------
Supplemental Cash Flows Information
Sprint's net cash paid (received) for interest and income taxes was as follows:
Year-to-Date
September 30,
-- ------------- -- -------------
2004 2003
(as restated)
--------------------------------------------------- -- ------------- -- -------------
(millions)
Interest (net of capitalized interest) $ 1,039 $ 1,137
-- ------------- -- -------------
Income taxes $ (42) $ 70
-- ------------- -- -------------
Sprint's non-cash activities included the following:
Year-to-Date
September 30,
-- ------------- -- -------------
2004 2003
--------------------------------------------------- -- ------------- -- -------------
(millions)
Common stock issued:
Sprint's employee benefit stock plans $ 53 $ 51
-- ------------- -- -------------
Settlement of shareholder suit $ 5 $ -
-- ------------- -- -------------
--------------------------------------------------------------------------------
17. Segment Information
--------------------------------------------------------------------------------
Sprint is divided into three main lines of business: Wireless, Local and Long
distance. Other consists primarily of wholesale distribution of
telecommunications products.
Sprint manages its segments to the operating income (loss) level of reporting.
Items below operating income (loss) are managed at a corporate level. The
reconciliation from operating income to net income is shown on the face of the
Consolidated Statements of Operations in the consolidating information.
Segment financial information was as follows:
----------------------------------------------------------------------------------------------------------------
Corporate
Quarters Ended Long and
September 30, Wireless Local Distance Other(1) Eliminations(2) Consolidated
----------------------------------------------------------------------------------------------------------------
(millions)
2004
Net operating revenues $ 3,760 $ 1,496 $ 1,808 $ 217 $ (359) $ 6,922
Affiliated revenues 3 54 168 134 (359) -
Operating income (loss) 451 411 (3,570) (5) (2) (2,715)
2003 (as restated)
Net operating revenues $ 3,340 $ 1,527 $ 1,977 $ 220 $ (350) $ 6,714
Affiliated revenues 2 40 167 141 (350) -
Operating income (loss) 303 463 (1,185) (7) (4) (430)
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Corporate
Year-to-Date Long and
September 30, Wireless Local Distance Other(1) Eliminations(2) Consolidated
----------------------------------------------------------------------------------------------------------------
(millions)
2004
Net operating revenues $ 10,811 $ 4,512 $ 5,593 $ 638 $ (1,056) $ 20,498
Affiliated revenues 9 163 503 381 (1,056) -
Operating income (loss) 1,146 1,302 (3,698) (16) (7) (1,273)
2003 (as restated)
Net operating revenues $ 9,383 $ 4,585 $ 6,028 $ 617 $ (1,097) $ 19,516
Affiliated revenues 7 158 530 402 (1,097) -
Operating income (loss) 730 1,378 (1,514) (23) (11) 560
----------------------------------------------------------------------------------------------------------------
(1) In the 2003 first quarter, Sprint closed the sale of its directory
publishing business to R.H. Donnelley for $2.23 billion in cash. Operations
of the directory publishing business are reported as a discontinued
operation for all periods presented. See Note 15 for additional
information.
(2) Revenues eliminated in consolidation consist principally of access charged
to Long distance by Local, equipment purchases from the wholesale
distribution business, interexchange services provided to Local, long
distance services provided to Wireless for resale to Wireless customers and
for internal business use, Caller ID services provided by Local to Wireless
and Local handset purchases from Wireless.
Net operating revenues by product and services were as follows:
----------------------------------------------------------------------------------------------------------------------
Quarters Ended Long
September 30, Wireless Local Distance Other(1) Eliminations(2)Consolidated
----------------------------------------------------------------------------------------------------------------------
(millions)
2004
Voice $ - $ 1,105 $ 1,131 $ - $ (196) $ 2,040
Data - 214 427 - (16) 625
Internet - - 180 - (3) 177
Wireless services 3,760 - - - (3) 3,757
Other - 177 70 217 (141) 323
----------------------------------------------------------------------------------
Total net operating revenues $ 3,760 $ 1,496 $ 1,808 $ 217 $ (359) $ 6,922
----------------------------------------------------------------------------------
2003
Voice $ - $ 1,152 $ 1,243 $ - $ (188) $ 2,207
Data - 187 463 - (16) 634
Internet - - 233 - (2) 231
Wireless services 3,340 - - - (2) 3,338
Other - 188 38 220 (142) 304
----------------------------------------------------------------------------------
Total net operating revenues $ 3,340 $ 1,527 $ 1,977 $ 220 $ (350) $ 6,714
----------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------------
Year-to-Date Long
September 30, Wireless Local Distance Other(1) Eliminations(2)Consolidated
----------------------------------------------------------------------------------------------------------------------
(millions)
2004
Voice $ - $ 3,388 $ 3,481 $ - $ (581) $ 6,288
Data - 614 1,317 - (54) 1,877
Internet - - 617 - (10) 607
Wireless services 10,811 - - - (9) 10,802
Other - 510 178 638 (402) 924
----------------------------------------------------------------------------------
Total net operating revenues $ 10,811 $ 4,512 $ 5,593 $ 638 $ (1,056) $ 20,498
----------------------------------------------------------------------------------
2003
Voice $ - $ 3,500 $ 3,780 $ - $ (588) $ 6,692
Data - 536 1,391 - (58) 1,869
Internet - - 721 - (25) 696
Wireless services 9,383 - - - (7) 9,376
Other - 549 136 617 (419) 883
----------------------------------------------------------------------------------
Total net operating revenues $ 9,383 $ 4,585 $ 6,028 $ 617 $ (1,097) $ 19,516
----------------------------------------------------------------------------------
(1) In the 2003 first quarter, Sprint closed the sale of its directory
publishing business to R.H. Donnelley for $2.23 billion in cash. Operations
of the directory publishing business are reported as a discontinued
operation for all periods presented. See Note 15 for additional
information.
(2) Revenues eliminated in consolidation consist principally of access charged
to Long distance by Local, equipment purchases from the wholesale
distribution business, interexchange services provided to Local, long
distance services provided to Wireless for resale to Wireless customers and
for internal business use, Caller ID services provided by Local to Wireless
and Local handset purchases from Wireless. The decline in the Internet
elimination in the year-to-date periods is driven by the termination of the
Web Hosting business in the 2003 second quarter.
--------------------------------------------------------------------------------
18. Recently Issued Accounting Pronouncements
--------------------------------------------------------------------------------
In March 2004, the EITF of the Financial Accounting Standards Board reached a
consensus on EITF No. 03-6, Participating Securities and the Two-Class Method
under SFAS No. 128, Earnings Per Share (EITF No. 03-6). This guidance requires
that the rights of securities to participate in the earnings of an enterprise
must be reflected in the reporting of earnings per share. Sprint's equity unit
purchase contracts met the "participating security" qualifications outlined in
the guidance, because the purchase contracts included a provision permitting the
equity unit holders to benefit from or "participate" in any dividends declared
on the common stock during the contract period.
Sprint adopted EITF No. 03-6 in the 2004 second quarter. Prior to April 23,
2004, the equity unit forward purchase contracts were tied only to the PCS
common stock which had no earnings upon which to declare dividends. Upon
recombination and until settlement in August 2004, the equity unit purchase
contracts participated in the earnings of FON common stock. The proportionate
share of earnings attributable to these securities was $3 million, net of tax,
in the 2004 third quarter and $9 million in the year-to-date period. This
attribution was reflected as "Earnings allocated to participating securities" on
the face of the Consolidated Statements of Operations.
--------------------------------------------------------------------------------
19. Subsequent Event
--------------------------------------------------------------------------------
Dividend Declaration
On October 11, 2004, Sprint's board of directors declared a dividend of 12.5
cents per share on the FON common stock to shareholders of record at the close
of business, December 9, 2004. The dividend will be paid December 30, 2004.
Part I.
Item 2.
SPRINT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
--------------------------------------------------------------------------------
Forward-looking Information
--------------------------------------------------------------------------------
Sprint includes certain estimates, projections and other forward-looking
statements in its reports and in other publicly available material. Statements
regarding expectations, including performance assumptions and estimates relating
to capital requirements, as well as other statements that are not historical
facts, are forward-looking statements.
These statements reflect management's judgments based on currently available
information and involve a number of risks and uncertainties that could cause
actual results to differ materially from those in the forward-looking
statements. With respect to these forward-looking statements, management has
made assumptions regarding, among other things, customer and network usage,
customer growth and retention, pricing, operating costs, the timing of various
events and the economic environment.
Future performance cannot be ensured. Actual results may differ materially from
those in the forward-looking statements. Some factors that could cause actual
results to differ include:
o the effects of vigorous competition and the overall demand for
Sprint's service offerings in the markets in which Sprint operates;
o the costs and business risks associated with providing new services
and entering new markets;
o adverse change in the ratings afforded our debt securities by ratings
agencies;
o the ability of Wireless to continue to grow and improve profitability;
o the ability of Local and Long distance to maintain cash flow
generation;
o the effects of mergers and consolidations within the
telecommunications industry and unexpected announcements or
developments from others in the telecommunications industry;
o the uncertainties related to bankruptcies affecting the
telecommunications industry;
o the impact of financial difficulties of third-party affiliates on
Wireless network coverage;
o the uncertainties related to Sprint's investments in networks, systems
and other businesses;
o the uncertainties related to the implementation of Sprint's business
strategies, including our initiative to realign services to enhance
the focus on business and consumer customers;
o the impact of new, emerging and competing technologies on Sprint's
business;
o unexpected results of litigation filed against Sprint;
o the risk of equipment failure, natural disasters, terrorist acts, or
other breaches of network or information technology security;
o the possibility of one or more of the markets in which Sprint competes
being impacted by changes in political or other factors such as
monetary policy, legal and regulatory changes, or other external
factors over which Sprint has no control; and
o other risks referenced from time to time in Sprint's filings with the
Securities and Exchange Commission (SEC).
The words "estimate," "project," "forecast," "intend," "expect," "believe,"
"target," "providing guidance" and similar expressions are intended to identify
forward-looking statements. Forward-looking statements are found throughout
Management's Discussion and Analysis. The reader should not place undue reliance
on forward-looking statements, which speak only as of the date of this report.
Sprint is not obligated to publicly release any revisions to forward-looking
statements to reflect events after the date of this report or unforeseen events.
Sprint provides a detailed discussion of risk factors in various SEC filings,
including its 2003 Form 10-K/A, and you are encouraged to review these filings.
--------------------------------------------------------------------------------
Overview
--------------------------------------------------------------------------------
Sprint is a global communications company and a leader in integrating wireless,
local service and long-distance communications. Sprint is also one of the
largest carriers of Internet traffic using its tier one Internet Protocol
network and is a leader in providing high-speed wireless data services.
Sprint operates a 100% digital PCS wireless network with licenses to provide
service to the entire United States population, including Puerto Rico and the
U.S. Virgin Islands, using a single frequency band and a single technology.
Wireless, together with third party affiliates, operates PCS systems in over 300
metropolitan markets, including the 100 largest U.S. metropolitan areas, and
reaches a quarter billion people. Combined with our wholesale and affiliate
partners, Wireless served more than 23 million subscribers at the end of the
2004 third quarter. Sprint currently serves approximately 7.7 million access
lines in its franchise territories in 18 states. Additionally, Sprint provides
local service using its facilities, leased facilities or unbundled network
elements provided by other carriers in a total of 36 states and the District of
Columbia. Sprint has ceased proactively marketing residential local service
using a platform of unbundled elements, often referred to as UNE-P, and seeks to
provide new local service selectively to small business customers who seek this
service from Long distance. Sprint intends to continue serving existing
customers. Sprint is the nation's third-largest provider of long-distance
services, based on revenues, and operates nationwide, all-digital long distance
and tier one Internet Protocol (IP) networks. Sprint is selling into the cable
telephony market through arrangements with cable companies that resell Sprint
long distance service and/or use Sprint back office systems and network assets
in support of their local telephone service provided over cable facilities.
Sprint operates in an industry that has been and continues to be subject to
consolidation and dynamic change. Therefore, Sprint routinely reassesses its
business strategies. Due to changes in telecommunications, including
bankruptcies, over-capacity and a highly competitive pricing environment in all
telecommunications sectors, Sprint has taken actions to appropriately allocate
capital and other resources to enable sustaining cash contribution. Sprint
routinely assesses the implications of these actions on its operations and these
assessments may continue to impact the future valuation of its long-lived
assets.
As part of its overall business strategy, Sprint regularly evaluates
opportunities to expand and complement its business and may at any time be
discussing or negotiating a transaction that, if consummated, could have a
material effect on its business, financial condition, liquidity or results of
operations. Sprint is currently in active discussions regarding strategic
alternatives related to its owned Wireless communications towers, and expects to
reach any conclusions regarding these alternatives in the 2004 fourth quarter or
in the 2005 first quarter.
In the 2003 first quarter, Sprint sold its directory publishing business to R.H.
Donnelley for $2.23 billion in cash.
Business Transformation
Currently, Sprint's operations are divided into three lines of business:
Wireless, Local and Long distance operations.
In the 2003 fourth quarter, Sprint undertook an initiative to realign internal
resources (Organizational Realignment). This effort was implemented to enhance
our focus on the needs and preferences of two distinct consumer types -
businesses and individuals. This effort is enabling Sprint to more effectively
and efficiently use its portfolio of assets to create customer-focused
communications solutions. Throughout 2004, management anticipates continuing to
make decisions using the current segmentation, taking into consideration the
re-aligned customer-focused approach.
In furtherance of the goals of the realignment initiative, efforts are underway
to improve Sprint's productivity through:
o Consolidating systems and eliminating redundancies
o Automation
o Process re-engineering
o E-enablement
o Organizational redesign and streamlining
These efforts have resulted and could continue to result in decisions requiring
restructuring charges and asset impairments over the next several years.
Elimination of Tracking Stocks
On April 23, 2004, Sprint recombined its two tracking stocks. Each share of PCS
common stock automatically converted into 0.5 shares of FON common stock. As of
April 23, 2004, the FON Group and the PCS Group no longer exist, and FON common
stock represents all of the operations and assets of Sprint, including Wireless,
Local and Long distance.
Impairment of Long Distance Assets
Sprint determined that business conditions and events occurring in the 2004
third quarter and impacting its Long distance operations constituted a
"triggering event" requiring an evaluation of the recoverability of the Long
distance long-lived assets pursuant to SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets.
The industry-wide business conditions and events included the continuing impacts
of the highly-competitive long distance market, the related aggressive pricing,
recent changes in the regulatory climate negatively impacting the long-term
ability of Long distance to bridge the last mile in the consumer and small
business market segments, product substitution and customers' accelerated
demands for cost-effective, advanced, IP-driven telecommunications solutions
requiring transparent wireline and wireless connectivity.
In light of these industry-wide business conditions and events, Sprint
reevaluated its strategy and financial forecasts in the 2004 third quarter.
Sprint intends to focus sales efforts and resources on being a leader
in telecommunications solutions, by emphasizing (1) integrate-able products and
telecommunications solutions, such as wireless-enabled and IP-driven, and (2)
markets in which Sprint can leverage its unique portfolio of wireless and
wireline assets.
Evaluations of asset recoverability are performed at the lowest asset or asset
group level for which identifiable cash flows are largely independent of the
cash flows of other assets or asset groups. Due to the integrated nature of the
Long distance network, Sprint conducted its testing of the asset group at the
Long distance entity level (excluding assets held for sale), as this is the
lowest level for which identifiable cash flows are available. Further, it was
concluded that the fiber-optic backbone constituted the primary asset of the
Long distance asset group. Accordingly, cash flows were projected over the
remaining useful life of the fiber-optic backbone. These cash flow projections
reflect estimated future operating results, considering all relevant
circumstances and events, and estimated capital expenditures required to
maintain, but not to increase, the service potential of the asset group. The
resulting undiscounted future cash flows were less than the carrying value of
the Long distance asset group, requiring that the asset group be reduced to fair
value.
The fair value of the asset group was determined by discounting the cash flow
projections at a 10% discount rate, reflecting a risk-adjusted weighted average
cost of capital. The resulting fair value of the asset group required a $3.52
billion pre-tax non-cash impairment charge, reducing the net carrying value of
Long distance property, plant and equipment by about 60%, to $2.29 billion at
September 30, 2004.
In October 2004, Sprint completed the sale of its wholesale Dial IP business for
$34 million. These assets were classified as held for sale at September 30,
2004, and an associated pre-tax non-cash charge of $21 million was recorded in
the 2004 third quarter to adjust the carrying value of these assets to fair
value.
Restatement of Previously Issued Financial Statements
During a review of internal controls relating to its capital assets, Sprint
identified, in the 2004 third quarter, a calculation error that had resulted,
since 1999, in the overstatement of interest capitalized during the construction
of its Wireless capital assets, with a corresponding understatement of interest
expense. The error subsequently resulted in an overstatement of depreciation
expense after the associated capital assets were placed in service. While Sprint
believes the impacts of this calculation error are not material to any
previously issued financial statement, Sprint determined that this calculation
error was most appropriately corrected through restatement of previously issued
financial statements. The following discussion reflects this restatement. See
Note 3 of the Condensed Notes to Consolidated Financial Statements for
additional information.
--------------------------------------------------------------------------------
Results of Operations
--------------------------------------------------------------------------------
Consolidated
Quarters Ended Year-to-Date
September 30, September 30,
----------------------------------- ----------------------------------
2004 2003 2004 2003
(as restated) (as restated)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
(millions)
Net operating revenues $ 6,922 $ 6,714 $ 20,498 $ 19,516
--- ------------- -- -------------- -- ------------- --- -------------
Loss from continuing operations $ (1,910) $ (496) $ (1,449) $ (399)
--- ------------- -- -------------- -- ------------- --- -------------
Net operating revenues increased 3.1% in the 2004 third quarter and 5% in the
2004 year-to-date period compared to the same 2003 periods reflecting growth in
Wireless revenues partially offset by declining Long distance and Local
revenues.
Sprint recorded a loss from continuing operations of $1.9 billion in the 2004
third quarter and $1.4 billion in the 2004 year-to-date period that includes the
after-tax impacts of the items discussed below.
In the 2004 third quarter, loss from continuing operations includes a total $2.3
billion asset impairment charge related to Sprint's Long distance property,
plant and equipment. Additionally, Sprint recorded a $13 million restructuring
charge related to Sprint's Organizational Realignment and the termination of its
Web Hosting business. Also included in the loss from continuing operations was a
$25 million charge associated with the early retirement of $516 million of
senior notes.
The 2004 year-to-date loss from continuing operations also includes a $77
million restructuring charge related to Sprint's Organizational Realignment and
the termination of its Web Hosting business as well as an $18 million charge
associated with the early retirement of $750 million of equity unit notes. These
charges were partially offset by a $9 million benefit resulting from the receipt
of the final payment of a bankruptcy settlement with MCI (WorldCom).
In the 2003 third quarter, loss from continuing operations included a $777
million charge related to the impairment of Sprint's MMDS spectrum licenses in
accordance with SFAS No. 142, Goodwill and Other Intangibles, resulting from a
decision to no longer pursue a residential fixed wireless strategy.
Additionally, Sprint recorded an $11 million insurance recovery related to the
derivative action and securities class action suit discussed below, a $1 million
charge related to Web Hosting wind-down activities, and a $1 million net premium
primarily related to the early retirement of Local debt.
The 2003 year-to-date loss from continuing operations also includes a $22
million charge in connection with the separation agreements agreed to by Sprint
and three former executive officers and a $218 million charge related to winding
down the Web Hosting business. Additionally, the year-to-date period includes a
$32 million charge to settle derivative action and securities class action
litigation, a $12 million charge reflecting the premiums paid on debt tender
offers, and a $6 million charge associated with the termination of a software
development project.
--------------------------------------------------------------------------------
Segmental Results of Operations
--------------------------------------------------------------------------------
Wireless
Wireless operates a 100% digital PCS wireless network with licenses to provide
service to the entire United States population, including Puerto Rico and the
U.S. Virgin Islands, using a single frequency band and a single technology.
Wireless, together with third party affiliates, operates PCS systems in over 300
metropolitan markets, including the 100 largest U.S. metropolitan areas, and
reaches a quarter billion people. Combined with our wholesale and affiliate
partners, Wireless served more than 23 million subscribers at the end of the
2004 third quarter. Wireless provides nationwide service through a combination
of:
o operating its own digital network in major U.S. metropolitan areas
using code division multiple access (CDMA), which is a digital
spread-spectrum wireless technology that allows a large number of
users to access a single frequency band by assigning a code to all
transmission bits, sending a scrambled transmission of the encoded
information over the air and reassembling the speech and data into its
original format,
o affiliating with other companies that use CDMA, mainly in and around
smaller U.S. metropolitan areas,
o roaming on other providers' analog cellular networks using multi-mode
and multi-band handsets, and
o roaming on other providers' digital networks that use CDMA.
Wireless subscribers can use their phones through roaming agreements in
countries other than the United States, including areas of:
o Asia Pacific, including China, Guam, Hong Kong and New Zealand,
o Canada and Mexico,
o Central and South America, including Argentina, Bolivia, Chile,
Colombia, Ecuador, Guatemala, Paraguay and Uruguay, and
o Most major Caribbean Islands.
Sprint's third generation (3G) capability allows more efficient utilization of
the network when voice calls are made using 3G-enabled handsets. It also
provides enhanced data services. The service, marketed as "Sprint PCS VisionSM,"
allows consumer and business subscribers to use their Vision-enabled PCS devices
to exchange instant messages, exchange personal and corporate e-mail, take, send
and receive pictures, play games with full-color graphics and polyphonic sounds
and browse the Internet wirelessly with speeds up to 144 kbps (with average
speeds of 50 to 70 kbps).
Sprint is continuing to execute its plans for faster wireless data speeds by
deploying Evolution Data Optimized (EV-DO) technology across the Sprint
Nationwide PCS Network. With average user speeds of 300-500 kilobits per second
and peak rates of up to 2.4 Megabits per second for downloads, EV-DO will
accelerate mobile-device data speeds up to 10 times faster than on our current
network. In addition this technology is expected to deliver superior application
and service performance on EV-DO-capable handsets and laptops equipped with
EV-DO-enabled Sprint PCS Connection Cards(TM). Additional traffic volumes
related to EV-DO may require future capital expenditures to acquire additional
spectrum in certain markets.
Wireless supplements its own network through affiliation arrangements with other
companies that use CDMA. Under these arrangements, these companies offer
wireless services using Sprint's spectrum under the Sprint brand name on CDMA
networks built and operated at their own expense. Sprint has amended its
existing agreements with a majority of its affiliates to provide for a
simplified pricing mechanism, as well as refining and changing various business
processes. The amended agreements cover nearly 70% of the subscribers served by
all affiliates. The agreements provide simplified and predictable long-term
pricing for service bureau fees and stability to the rates charged for
inter-area service fees. In addition, the agreements settled all significant
outstanding disputes with these affiliates.
One affiliate, which has not agreed to amend its existing agreement with us, has
filed suit against us. This same affiliate and some other affiliates are
disputing and refusing to pay amounts owed to Sprint. Reserves have been
established that are expected to provide for the ultimate resolution of these
disputes. Wireless may incur additional expenses to ensure that service is
available to its subscribers in the areas served by its affiliates. If any of
the PCS affiliates cease operations, Wireless may incur roaming charges in areas
where service was previously provided by the affiliates and costs to meet FCC
buildout and renewal requirements, as well as experience lower revenues.
Wireless also provides services to companies that resell wireless services to
their subscribers on a retail basis under their own brand using the Sprint
Nationwide PCS Network. These companies bear the costs of acquisition, billing
and customer service. In June 2002, Virgin Mobile USA, LLC, a joint venture
between Sprint and the Virgin Group, launched services targeting youth and
pre-pay segments. Sprint also has a multi-year, exclusive wholesale agreement
with Qwest Communications (Qwest) whereby Qwest wireless subscribers use
Sprint's national PCS network and have access to Sprint-branded PCS Vision data
services. Qwest began adding new subscribers under this agreement in the 2004
first quarter. In the 2004 second quarter, existing subscribers began
transitioning to Sprint's network and this transition is expected to be
substantively complete by the 2005 first quarter.
Selected Operating Results
---------------------------------------------------------------------
Quarters Ended
September 30, Variance
---------------------------------- -------------------------------
2004 2003 $ %
(millions) (as restated)
---------------------------------------------- ---------------- ----------------- -- ------------- -----------------
Net operating revenues
Service $ 3,244 $ 2,900 $ 344 11.9%
Equipment 350 340 10 2.9%
Wholesale, affiliate and other 166 100 66 66.0%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total net operating revenues 3,760 3,340 420 12.6%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating expenses
Costs of services and products 1,768 1,628 140 8.6%
Selling, general and administrative 908 789 119 15.1%
Depreciation and amortization 630 620 10 1.6%
Restructuring and asset impairment 3 - 3 NM
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total operating expenses 3,309 3,037 272 9.0%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating income $ 451 $ 303 $ 148 48.8%
-- ------------- -- -------------- -- -------------
Capital expenditures $ 603 $ 485 $ 118 24.3%
-- ------------- -- -------------- -- -------------
NM = Not meaningful
Selected Operating Results
---------------------------------------------------------------------
Year-to-Date
September 30, Variance
---------------------------------- -------------------------------
2004 2003 $ %
(millions) (as restated)
---------------------------------------------- ---------------- ----------------- -- ------------- -----------------
Net operating revenues
Service $ 9,285 $ 8,309 $ 976 11.7%
Equipment 1,115 845 270 32.0%
Wholesale, affiliate and other 411 229 182 79.5%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total net operating revenues 10,811 9,383 1,428 15.2%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating expenses
Costs of services and products 5,245 4,597 648 14.1%
Selling, general and administrative 2,487 2,217 270 12.2%
Depreciation and amortization 1,914 1,829 85 4.6%
Restructuring and asset impairment 19 10 9 90.0%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total operating expenses 9,665 8,653 1,012 11.7%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating income $ 1,146 $ 730 $ 416 57.0%
-- ------------- -- -------------- -- -------------
Capital expenditures $ 1,670 $ 1,192 $ 478 40.1%
-- ------------- -- -------------- -- -------------
Net Operating Revenues
Quarters Ended Year-to-Date
September 30, September 30,
----------------------------------- ----------------------------------
2004 2003 2004 2003
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Direct subscribers (millions) 17.3 15.5 17.3 15.5
--- ------------- -- -------------- -- ------------- --- -------------
Average monthly service revenue
per user (ARPU) $ 63 $ 63 $ 62 $ 61
--- ------------- -- -------------- -- ------------- --- -------------
Subscriber churn rate 2.7% 2.7% 2.6% 2.7%
--- ------------- -- -------------- -- ------------- --- -------------
Average monthly service revenue per user (ARPU), calculated on our direct
subscriber base, is computed by dividing wireless service revenues by weighted
average monthly wireless subscribers to measure revenue on a per user basis.
This is a measure which uses GAAP as the basis for the calculation. ARPU, which
is used by most wireless companies, is a method of valuing recurring subscriber
revenue and is used by analysts and investors to compare relative value across
the wireless industry.
Net operating revenues include service revenues from the direct subscriber base,
revenues from sales of handsets and accessory equipment, and revenues from our
wholesale and affiliate partners. Service revenues consist of monthly recurring
charges, usage charges and miscellaneous fees such as directory assistance,
operator-assisted calling, handset insurance and late payment charges. Service
revenues increased 12% in the 2004 third quarter and in the 2004 year-to-date
period from the same 2003 periods reflecting an increase in the number of
subscribers, increased revenues from data services, and subscriber elections to
add services to their base plans. These increases were partially offset by lower
overage charges from usage-based plans. Average monthly usage in the 2004 third
quarter was approaching 17 hours per month, an increase of approximately three
hours when compared to the 2003 third quarter. In the 2004 third quarter, 56% of
new direct subscribers chose to include PCS Vision in their service package. At
the end of the period approximately 42% of the subscriber base included data
services in their wireless plan compared to approximately 33% at the end of the
2003 third quarter.
Wireless had 429,000 direct net additions in the 2004 third quarter, ending the
period with approximately 17.3 million subscribers compared to approximately
15.5 million subscribers at the end of the 2003 third quarter. Wholesale
partners added 422,000 subscribers in the third quarter of 2004, ending the
period with approximately 2.8 million subscribers. Wholesale end of period
subscribers do not include certain Qwest subscribers that are generating revenue
on the network but have not yet completed the entire back office transition
necessary to be recorded in the subscriber count. The Wireless affiliates added
101,000 subscribers in the third quarter of 2004, ending the period with
approximately 3.1 million subscribers. This brings the total number of
subscribers served on the Wireless and affiliate networks, including direct,
affiliate and wholesale subscribers, to more than 23 million at the end of the
2004 third quarter.
Subscriber churn, which is calculated on our direct subscriber base, is computed
by dividing the subscribers who discontinued Sprint PCS service by the weighted
average subscribers for the period. This is an operational measure which is used
by most wireless companies as a method of estimating the life of the subscriber.
Analysts and investors primarily use churn to compare relative value across the
wireless industry. The subscriber churn rate was 2.7% for both the 2004 and 2003
third quarter periods. Viewed sequentially, 2004 third quarter churn increased
from 2.3% in the 2004 second quarter. Involuntary churn rose from a seasonally
low second quarter level.
Revenues from sales of handsets and accessories, including new subscribers and
upgrades, were approximately 9.3% of net operating revenues in the 2004 third
quarter compared to 10.2% for the same 2003 period. This decline was mainly due
to higher rebates, partially offset by higher retail prices, as well as higher
net operating revenues. These revenues were at 10.3% of net operating revenues
in the 2004 year-to-date period compared to 9.0% for the same 2003 period. This
increase was mainly due to higher subscriber additions and higher retail prices,
which was partially offset by higher rebates. As part of Wireless marketing
plans, handsets, net of rebates, are normally sold at prices below the cost.
Wholesale, affiliate and other revenues consist primarily of net revenues
retained from Wireless subscribers residing in affiliate territories, and
revenues from the sale of Wireless services to companies that resell those
services to their subscribers on a retail basis. These revenues represented 4.4%
of net operating revenues in the 2004 third quarter and 3.8% in the 2004
year-to-date period compared to 3.0% and 2.4% for the same 2003 periods. These
increases mainly reflect net additions to the affiliate and wholesale customer
base.
Costs of Services and Products
Costs of services and products mainly include handset and accessory costs,
switch and cell site expenses, customer service costs and other network-related
costs. These costs increased 9% in the 2004 third quarter and 14% in the 2004
year-to-date period from the same 2003 periods. These increases were primarily
due to network support of a larger subscriber base, higher minutes of use,
expanded network coverage, initial costs associated with customer service
co-sourcing arrangements, and incremental hurricaine-related costs of $14
million in the 2004 third quarter. Equipment costs also increased due to higher
direct gross additions and handset upgrades. These increases were somewhat
offset by decreases in information technology expense due to operational
efficiencies. Handset and equipment costs were 37.4% of total costs of services
and products in the 2004 third quarter and 39.2% in the 2004 year-to-date period
compared to 41.1% and 39.0% for the same 2003 periods. Costs of services and
products were 47.0% of net operating revenues in the 2004 third quarter and
48.5% in the 2004 year-to-date period compared to 48.7% and 49.0% for the same
2003 periods.
Selling, General and Administrative
Selling, General and Administrative (SG&A) expense mainly includes sales and
marketing costs to promote and sell products and services, as well as related
salary and benefit costs. SG&A expense increased 15% in the 2004 third quarter
and 12% in the 2004 year-to-date period from the same 2003 periods reflecting an
increase in sales and distribution costs primarily driven by higher direct gross
additions and an increase in the number of owned retail stores. In the 2004
third quarter, an adjustment of $26 million was recorded to reflect an updated
analysis of cell site acquisition and development. Marketing costs also
contributed to the year-to-date increase as a significant campaign was launched
in the 2004 second quarter to reposition the Sprint PCS(R) brand. This increase
was offset by a decline in bad debt expense due to improved cash collections.
SG&A expense was 24.1% of net operating revenues in the 2004 third quarter and
23.0% in the 2004 year-to-date period compared to 23.6% for the same 2003
periods. Bad debt expense as a percentage of net operating revenues was 1.7% in
the 2004 third quarter and 1.4% in the 2004 year-to-date period compared to 2.3%
for the same 2003 periods. Reserve for bad debt as a percent of outstanding
accounts receivable was 6.4% at the end of the 2004 third quarter and 7.3% at
year-end 2003. This improvement was mainly driven by improved cash collections.
Depreciation and Amortization
Estimates and assumptions are used both in setting depreciable lives and testing
for recoverability. Assumptions are based on internal studies of use, industry
data on lives, recognition of technological advancements and understanding of
business strategy. Depreciation expense consists mainly of depreciation of
network assets.
Depreciation and amortization expense increased 2% in the 2004 third quarter and
5% in the 2004 year-to-date period from the same 2003 periods due to an increase
in the network asset investment during 2003 and the 2004 year-to-date period.
Depreciation and amortization expense was 16.8% of net operating revenues in the
2004 third quarter and 17.7% in the 2004 year-to-date period compared to 18.6%
and 19.5% for the same 2003 periods.
Restructuring and Asset Impairment
In the 2004 third quarter, Wireless recorded a $3 million restructuring charge
representing severance costs associated with Sprint's Organizational
Realignment. Restructuring charges associated with these events totaled $19
million in the 2004 year-to-date period.
In the first quarter of 2003, Wireless recorded a charge of $10 million
associated with the termination of a software development project.
Local
Local consists mainly of regulated local phone operations serving approximately
7.7 million access lines in 18 states. Local provides voice and data services,
including digital subscriber line (DSL), for customers within its franchise
territories, access by phone customers and other carriers to the local network,
nationwide long-distance services to residential customers in its franchise
territories, sales of telecommunications equipment, and other services within
specified calling areas to residential and business customers. Local provides
wireless services and video services to customers in its franchise territories
through agency relationships.
Selected Operating Results
---------------------------------------------------------------------
Quarters Ended
September 30, Variance
----------------------------------- -------------------------------
(millions) 2004 2003 $ %
--------------------------------------------- ----------------- ----------------- -- ------------- -----------------
Net operating revenues
Voice $ 1,105 $ 1,152 $ (47) (4.1)%
Data 214 187 27 14.4%
Other 177 188 (11) (5.9)%
--------------------------------------------- --- ------------- -- -------------- -- -------------
Total net operating revenues 1,496 1,527 (31) (2.0)%
--------------------------------------------- --- ------------- -- -------------- -- -------------
Operating expenses
Costs of services and products 499 491 8 1.6%
Selling, general and administrative 311 304 7 2.3%
Depreciation and amortization 272 269 3 1.1%
Restructuring 3 - 3 NM
--------------------------------------------- --- ------------- -- -------------- -- -------------
Total operating expenses 1,085 1,064 21 2.0%
--------------------------------------------- --- ------------- -- -------------- -- -------------
Operating income $ 411 $ 463 $ (52) (11.2)%
--- ------------- -- -------------- -- -------------
Operating margin 27.5% 30.3%
--- ------------- -- --------------
Capital expenditures $ 257 $ 269 $ (12) (4.5)%
--- ------------- -- -------------- -- -------------
NM = Not meaningful
Selected Operating Results
----------------------------------------------------------------------
Year-to-Date
September 30, Variance
----------------------------------- -------------------------------
(millions) 2004 2003 $ %
--------------------------------------------- ----------------- ----------------- -- ------------- -----------------
Net operating revenues
Voice $ 3,388 $ 3,500 $ (112) (3.2)%
Data 614 536 78 14.6%
Other 510 549 (39) (7.1)%
--------------------------------------------- --- ------------- -- -------------- -- -------------
Total net operating revenues 4,512 4,585 (73) (1.6)%
--------------------------------------------- --- ------------- -- -------------- -- -------------
Operating expenses
Costs of services and products 1,412 1,467 (55) (3.7)%
Selling, general and administrative 967 935 32 3.4%
Depreciation and amortization 811 805 6 0.7%
Restructuring 20 - 20 NM
--------------------------------------------- --- ------------- -- -------------- -- -------------
Total operating expenses 3,210 3,207 3 0.1%
--------------------------------------------- --- ------------- -- -------------- -- -------------
Operating income $ 1,302 $ 1,378 $ (76) (5.5)%
--- ------------- -- -------------- -- -------------
Operating margin 28.9% 30.1%
--- ------------- -- --------------
Capital expenditures $ 713 $ 839 $ (126) (15.0)%
--- ------------- -- -------------- -- -------------
NM = Not meaningful
Net Operating Revenues
Net operating revenues decreased 2% in both the 2004 third quarter and the 2004
year-to-date period from the same 2003 periods. The quarterly and year-to-date
declines were driven by lower voice revenue and declines in equipment sales
somewhat offset by growth in data revenue. Local ended the 2004 third quarter
with approximately 7.7 million switched access lines, a 2.7% decrease during the
past 12 months. The reduction in access lines was driven principally by wireless
substitution, losses to competitive local providers, and hurricane-related
disconnects in the third quarter. The reduction in access lines is expected to
continue, although Sprint expects its ongoing rate of line loss to be less than
the loss rates experienced by major urban carriers. On a voice-grade equivalent
basis, which includes both traditional switched services and high capacity
lines, voice-grade equivalents grew 8% during the past 12 months. This growth
reflects growth in DSL, as well as many business customers switching from
individual lines to high capacity dedicated circuits.
Voice Revenues
Voice revenues, derived from local exchange services, long-distance revenue and
switched access revenue, decreased 4% in the 2004 third quarter and 3% in the
2004 year-to-date period from the same 2003 periods due to a decrease in access
lines. The third quarter decline was also impacted by $14 million due to an
unfavorable FCC ruling associated with an interstate access pricing dispute that
arose in the early 1990's. Additionally, FCC-allowable cost recoveries
associated with local number portability ceased in February 2004 and recoveries
for the cost of pooling telephone numbers among carriers ceased in July 2004.
These declines were partially offset by the Wireless local number portability
recoveries which began in July 2004. While consumer long-distance revenues had a
slight increase in the quarter due to growth in the Unlimited Long Distance
product, they declined in the year-to-date period. Voice revenues partially
benefited in the 2004 year-to-date period from a retroactive access billing
adjustment with a third-party carrier recorded during the 2004 second quarter.
Data Revenues
Data revenues are mainly derived from DSL, local data transport services, and
special access. Data revenues increased 14% in the 2004 third quarter and 15% in
the 2004 year-to-date period compared to the same 2003 periods driven by strong
growth in DSL lines. Local ended the 2004 third quarter with 432,000 DSL lines
in service, an increase of 64% compared to the year ago period.
Other Revenues
Other revenues decreased 6% in the 2004 third quarter and 7% in the 2004
year-to-date period from the same 2003 periods principally driven by lower
equipment sales.
Costs of Services and Products
Costs of services and products include costs to operate and maintain the local
network and costs of equipment sales. These costs increased 2% in the 2004 third
quarter and decreased 4% in the 2004 year-to-date period compared to the same
2003 periods. The year-to-date decrease was mainly driven by general expense
controls and lower costs associated with equipment sales, somewhat offset by
higher pension costs. In the quarter, these declines were more than offset by
hurricane-related expenses of $23 million. Costs of services and products were
33.4% of net operating revenues in the 2004 third quarter and 31.3% in the 2004
year-to-date period compared to 32.2% and 32.0% for the same periods a year ago.
Selling, General and Administrative
SG&A expense increased 2% in the 2004 third quarter and 3% in the 2004
year-to-date period compared to the same 2003 periods. The increase was
primarily due to higher pension costs, stock-based compensation and $7 million
of hurricane-related expenses partially offset by general expense controls. SG&A
expense was 20.8% of net operating revenues in the 2004 third quarter and 21.4%
in the 2004 year-to-date period compared to 19.9% and 20.4% for the same periods
a year ago. SG&A includes charges for estimated bad debt expense. The reserve
for bad debts requires management's judgment and is based on customer specific
indicators, as well as historical trending, industry norms, regulatory decisions
and recognition of current market indicators about general economic conditions.
Bad debt expense as a percentage of net revenues was 1.3% in both the 2004 third
quarter and the 2004 year-to-date period compared to 1.6% and 1.4% in the same
periods a year ago. Reserve for bad debt as a percent of outstanding accounts
receivable was 8.9% at the end of the 2004 third quarter and 8.5% at year-end
2003.
Depreciation and Amortization
Estimates and assumptions are used in setting depreciable lives and testing for
recoverability. Assumptions are based on internal studies of use, industry data
on lives, recognition of technological advancements and understanding of
business strategy. Depreciation expense increased 1% in both the 2004 third
quarter and the 2004 year-to-date period compared to the same 2003 periods.
Depreciation expense was 18.2% of net operating revenues in the 2004 third
quarter and 18.0% in the 2004 year-to-date period compared to 17.6% for both
periods a year ago.
Restructuring and Asset Impairment
In the 2004 third quarter, Local recorded a $17 million restructuring charge
representing severance costs associated with Sprint's Organizational
Realignment. Restructuring charges associated with these events totaled $20
million in the 2004 year-to-date period.
Long distance
Long distance provides a broad suite of communications services targeted to
domestic business and residential customers, multinational corporations and
other communications companies. These services include domestic and
international voice; data communications using various protocols, such as
Internet Protocol (IP) and frame relay (a data service that transfers packets of
data over Sprint's network), and managed network services. Long distance is
selling into the cable telephony market through arrangements with cable
companies that resell Sprint long distance service and/or use Sprint back office
systems and network assets in support of their local telephone service provided
over cable facilities. In addition, Long distance provides international data
communications, and provides local service using Sprint's facilities, leased
facilities or unbundled network elements provided by other carriers in a total
of 36 states and the District of Columbia.
Sprint determined that business conditions and events occurring in the 2004
third quarter and impacting its Long distance operations constituted a
"triggering event" requiring an evaluation of the recoverability of the Long
distance long-lived assets pursuant to SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. The industry-wide business
conditions and events included the continuing impacts of the highly-competitive
long distance market, the related aggressive pricing, recent changes in the
regulatory climate negatively impacting the long-term ability of Long distance
to bridge the last mile in the consumer and small business market segments,
product substitution and customers' accelerated demands for cost-effective,
advanced, IP-driven telecommunications solutions requiring transparent wireline
and wireless connectivity. In light of these industry-wide business conditions
and events, Sprint reevaluated its strategy and financial forecasts in the 2004
third quarter. The resulting evaluation of the recoverability of the Long
distance long-lived assets required a $3.52 billion pre-tax non-cash impairment
charge, reducing the net carrying value of Long distance property, plant and
equipment by about 60%, to $2.29 billion at September 30, 2004.
Selected Operating Results
---------------------------------------------------------------------
Quarters Ended
September 30, Variance
---------------------------------- -------------------------------
(millions) 2004 2003 $ %
---------------------------------------------- ---------------- ----------------- -- ------------- -----------------
Net operating revenues
Voice $ 1,131 $ 1,243 $ (112) (9.0)%
Data 427 463 (36) (7.8)%
Internet 180 233 (53) (22.7)%
Other 70 38 32 84.2%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total net operating revenues 1,808 1,977 (169) (8.5)%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating expenses
Costs of services and products 1,085 1,061 24 2.3%
Selling, general and administrative 421 526 (105) (20.0)%
Depreciation and amortization 319 352 (33) (9.4)%
Restructuring and asset impairment 3,553 1,223 2,330 NM
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total operating expenses 5,378 3,162 2,216 70.1%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating loss $ (3,570) $ (1,185) $ (2,385) NM
-- ------------- -- -------------- -- -------------
Capital expenditures $ 71 $ 75 $ (4) (5.3)%
-- ------------- -- -------------- -- -------------
NM = Not meaningful
Selected Operating Results
---------------------------------------------------------------------
Year-to-Date
September 30, Variance
---------------------------------- -------------------------------
(millions) 2004 2003 $ %
---------------------------------------------- ---------------- ----------------- -- ------------- -----------------
Net operating revenues
Voice $ 3,481 $ 3,780 $ (299) (7.9)%
Data 1,317 1,391 (74) (5.3)%
Internet 617 721 (104) (14.4)%
Other 178 136 42 30.9%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total net operating revenues 5,593 6,028 (435) (7.2)%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating expenses
Costs of services and products 3,233 3,231 2 0.1%
Selling, general and administrative 1,452 1,664 (212) (12.7)%
Depreciation and amortization 960 1,076 (116) (10.8)%
Restructuring and asset impairment 3,646 1,571 2,075 NM
---------------------------------------------- -- ------------- -- -------------- -- -------------
Total operating expenses 9,291 7,542 1,749 23.2%
---------------------------------------------- -- ------------- -- -------------- -- -------------
Operating loss $ (3,698) $ (1,514) $ (2,184) NM
-- ------------- -- -------------- -- -------------
Capital expenditures $ 191 $ 230 $ (39) (17.0)%
-- ------------- -- -------------- -- -------------
NM = Not meaningful
Net Operating Revenues
Net operating revenues decreased 9% in the 2004 third quarter and 7% in the 2004
year-to-date periods from the same 2003 periods. The revenue decline in nearly
all categories was due to the competitive pricing environment in the
long-distance business.
Voice Revenues
Voice revenues decreased 9% in the 2004 third quarter and 8% in the 2004
year-to-date period from the same 2003 periods due to a decline in retail
business and consumer voice revenues resulting from wireless, e-mail and instant
messaging substitution, aggressive competition from Regional Bell Operating
Companies (RBOCs) for consumer and small business customers and aggressive
pricing by traditional interexchange carriers and the RBOCs for enterprise
customers. Minute volume increased 14% in the 2004 third quarter and 12% in the
2004 year-to-date period compared to the same 2003 periods. Voice revenues
generated from the provision of services to Wireless and Local represented 13.1%
of total voice revenues in the 2004 third quarter and 12.6% in the 2004
year-to-date period compared to 11.9% and 11.8% in the same 2003 periods.
Data Revenues
Data revenues decreased 8% in the 2004 third quarter and 5% in the 2004
year-to-date period from the same 2003 periods. The year-to-date decrease was
driven by declines in frame relay and private line services partially offset by
an increase in asynchronous transfer mode (ATM) and managed network services.
ATM revenues in the 2004 third quarter were flat and managed network services,
frame relay and private line services declined from the 2003 third quarter.
Internet Revenues
Internet revenues decreased 23% in the 2004 third quarter and 14% in the 2004
year-to-date period from the same 2003 periods. The decline was mainly driven by
a decrease in Dial IP and Web Hosting services, somewhat offset by an increase
in dedicated IP. Sprint made the decision to exit the Web Hosting business in
the 2003 second quarter. In the 2004 third quarter, a large Dial IP contract
expired. In October 2004, Sprint completed the sale of its wholesale Dial IP
business for $34 million. These assets were classified as held for sale at
September 30, 2004, and an associated pre-tax non-cash charge of $21 million was
included in the 2004 third quarter impairment charge.
Other Revenues
Other revenues increased 84% in the 2004 third quarter and 31% in the 2004
year-to-date period from the same 2003 periods. The increase was primarily due
to higher equipment sales and government services.
Costs of Services and Products
Costs of services and products include interconnection costs paid to local phone
companies, other domestic service providers and foreign phone companies to
complete calls made by Long distance's domestic customers, costs to operate and
maintain our long-distance networks, and costs of equipment sales. These costs
increased 2% in the 2004 third quarter compared to the same 2003 period, but
were flat in the 2004 year-to-date period from the same 2003 period. The
increase is primarily attributable to higher volumes. On a year-to-date basis,
the increase was offset by renegotiated access rate agreements and initiatives
to reduce access unit costs. Costs of services and products for Long distance
were 60.0% of net operating revenues in the 2004 third quarter and 57.8% in the
2004 year-to-date period compared to 53.7% and 53.6% for the same periods a year
ago. These increases reflect the competitive pricing environment of the
long-distance business and an increasing mix of lower priced affiliate volumes.
Selling, General and Administrative
SG&A expenses decreased 20% in the 2004 third quarter and 13% in the 2004
year-to-date period from the same 2003 periods. The decline was due to
restructuring efforts and general cost controls. SG&A expense was 23.3% of net
operating revenues in the 2004 third quarter and 26.0% in the 2004 year-to-date
period compared to 26.6% and 27.6% for the same periods a year ago.
SG&A includes charges for estimated bad debt expense. The reserve for bad debts
requires management's judgment and is based on customer specific indicators, as
well as historical trending, industry norms, regulatory decisions and
recognition of current market indicators about general economic conditions. Bad
debt expense as a percentage of net revenues was 0.9% in the 2004 third quarter
and 1.9% in the 2004 year-to-date period compared to 0.8% and 1.7% for the same
2003 periods. Reserve for bad debt as a percent of outstanding accounts
receivable was 10.0% at the end of the 2004 third quarter and 11.0% at year-end
2003.
Depreciation and Amortization
Estimates and assumptions are used both in setting depreciable lives and testing
for recoverability. Assumptions are based on internal studies of use, industry
data on lives, recognition of technological advancements and understanding of
business strategy. Depreciation expense decreased 9% in the 2004 third quarter
and 11% in the year-to-date period from the same periods a year ago primarily
driven by a decreased asset base due to the asset impairments associated with
the wind-down of the Web Hosting business announced in the 2003 second quarter,
as well as the extension of the depreciable life of certain high-capacity
transmission equipment from eight years to twelve years due to slower
anticipated evolution of technology and limited physical deterioration. This
extension in life decreased the 2004 third quarter and year-to-date depreciation
expense in Long distance by approximately $25 million and $74 million,
respectively.
As a result of the impairment of its property, plant and equipment in the 2004
third quarter, Long distance depreciation expense will decline beginning in the
2004 fourth quarter. The 2004 fourth quarter decline is expected to be
approximately $190 million. Depreciation expense was 17.6% of net operating
revenues in the 2004 third quarter and 17.2% in the 2004 year-to-date period
compared to 17.8% and 17.9% for the same periods a year ago.
Restructuring and Asset Impairment
In the 2004 third quarter, Long distance recorded a total $3.54 billion asset
impairment charge related to its property, plant and equipment.
In the 2004 third quarter, Long distance recorded a $13 million restructuring
charge representing severance costs associated with Sprint's Organizational
Realignment and the wind-down of the Web Hosting business. Restructuring charges
associated with these events totaled $106 million in the 2004 year-to-date
period.
In the 2003 third quarter, the FON Group recorded a pre-tax, non-cash charge of
$1.2 billion related to the write-down in the fair value of its MMDS spectrum.
Sprint's ongoing evaluation of business use for this asset resulted in a
decision to end pursuit of a residential fixed wireless strategy. This decision
required a revaluation of the fair value of the asset.
In the 2003 second quarter, a $348 million charge was recorded in connection
with Sprint's announcement of the wind-down of its Web Hosting business. The
charge for asset impairments was $337 million. The remaining $11 million was
accrued for employee terminations in connection with the wind-down of the Web
Hosting business, as well as restructurings of other global markets division
operations in the continuing effort to create a more efficient cost structure.
In the 2003 third quarter, an additional $2 million charge was recorded related
to employee terminations.
--------------------------------------------------------------------------------
Nonoperating Items
--------------------------------------------------------------------------------
Interest Expense
Interest expense decreased $36 million in the 2004 third quarter and $124
million in the 2004 year-to-date period compared to the same periods a year ago.
These decreases are primarily due to reductions in Sprint's outstanding debt.
Sprint's effective interest rate on long-term debt was 6.9% in the 2004 third
quarter compared to 7.0% in the 2003 third quarter. The lower effective interest
rate is primarily due to fair value interest rate swaps on $1 billion of
long-term debt that were entered into during the third quarter of 2003. At
September 30, 2004, the average floating rate of interest on the swapped debt
was 4.7%, while the average coupon on the underlying debt was 7.2%. Interest
costs on short-term borrowings and interest costs on deferred compensation plans
have been excluded so as not to distort the effective interest rate on long-term
debt.
Premium on Early Retirement of Debt
In the third quarter of 2004, Sprint recorded a premium of $38 million due to
early retirement of $516 million of its long-term senior notes. These notes had
interest rates ranging from 6% to 6.9% and maturity dates ranging from 2007 to
2028.
In May 2004, Sprint recorded a premium of $20 million due to early retirement of
$750 million of senior notes related to the equity units. The notes had an
interest rate of 6% and a maturity date of August 17, 2006.
In March 2003, Sprint completed a tender offer to purchase $442 million
principal amount of current senior notes before their scheduled maturity. The
notes had an interest rate of 5.7% and a maturity date of November 15, 2003. A
premium of $6 million was paid as part of the tender offer.
Also in March 2003, Sprint completed a tender offer to purchase $635 million
principal amount of its long-term senior notes before their scheduled maturity.
The notes had an interest rate of 5.9% and a maturity date of May 1, 2004. A
premium of $13 million was paid as part of the tender offer.
Other Income (Expense), net
Other income (expense), net consisted of the following:
Quarters Ended Year-to-Date
September 30, September 30,
----------------------------------- ----------------------------------
2004 2003 2004 2003
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
(millions)
Dividend and interest income $ 19 $ 17 $ 36 $ 38
Equity in net losses of affiliates (8) (17) (30) (45)
Amortization of debt costs (6) (11) (27) (26)
Royalties 4 3 11 10
Litigation settlement - 17 - (33)
Tracking stock recombination
advisory fees - - (15) -
Other, net 4 (5) 8 (22)
--------------------------------------------- --- ------------- -- -------------- -- ------------- --- -------------
Total $ 13 $ 4 $ (17) $ (78)
--- ------------- -- -------------- -- ------------- --- -------------
Equity in net losses of affiliates was driven by Sprint's investment in Virgin
Mobile USA, in all periods presented.
Amortization of debt costs includes the recognition of $3 million of deferred
costs associated with the prepayment of $516 million in senior notes in the 2004
third quarter and $9 million of deferred debt costs associated with the
prepayment of $750 million of equity unit notes in the 2004 second quarter.
Royalties are payments made to Sprint by Call-Net equaling 2.5% of Call-Net
gross revenues from telecommunication services.
In the 2003 first quarter, Sprint recorded a $50 million charge to settle
shareholder litigation. In the 2003 third quarter, Sprint recorded a $17 million
credit from an insurance recovery related to this action.
In the 2004 first quarter, Sprint recorded $15 million in advisory fees relating
to the tracking stock recombination.
Income Taxes
See Note 13 of the Condensed Notes to Consolidated Financial Statements for
information about the differences that caused the effective income tax rates to
vary from the federal statutory rate for income taxes related to continuing
operations.
Discontinued Operation, Net
In the 2002 third quarter, Sprint reached a definitive agreement to sell its
directory publishing business to R.H. Donnelley for $2.23 billion in cash. The
sale closed on January 3, 2003.
The pretax gain recognized in the 2003 year-to-date period was $2.14 billion,
$1.32 billion after-tax. In the 2003 third quarter, Sprint recognized a loss of
$1 million primarily related to a state tax rate true-up.
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets, Sprint has presented the directory publishing business as a
discontinued operation in the consolidated financial statements.
Cumulative Effect of Change in Accounting Principle, Net
In the 2003 first quarter, Sprint adopted SFAS No. 143, Accounting for Asset
Retirement Obligations. Upon adoption of SFAS No. 143, Sprint recorded a
reduction in Local's depreciation reserves to remove previously accrued costs of
removal. Historically, Local accrued costs of removal in its depreciable rate, a
practice consistent with regulatory requirements and others in the industry.
These costs of removal do not meet the standard's definition of an asset
retirement obligation liability. This one-time benefit of approximately $420
million resulted in a cumulative effect of change in accounting principle
credit, net of tax, in the Consolidated Statements of Operations of $258
million.
--------------------------------------------------------------------------------
Financial Condition
--------------------------------------------------------------------------------
Sprint's consolidated assets of $39.8 billion reflect a decrease of $2.9 billion
in the 2004 year-to-date period. Cash and equivalents increased $1.6 billion as
cash provided by operations and proceeds from the equity unit forward purchase
contract settlement exceeded capital expenditures, debt, and dividend payments.
Accounts receivable, net, increased $331 million due to the higher wireless
subscriber base. Net property, plant, and equipment decreased $4.7 billion due
to the total $3.54 billion impairment of Sprint's Long distance property, plant
and equipment as well as depreciation expense that exceeded capital expenditures
by $1.0 billion for the 2004 year-to-date period.
Investments in debt securities, included in both other current and other
noncurrent assets, have declined by $116 million as proceeds from maturities and
called securities have been reinvested in cash equivalents.
--------------------------------------------------------------------------------
Liquidity and Capital Resources
--------------------------------------------------------------------------------
Sprint's board of directors exercises discretion regarding the liquidity and
capital resource needs of its business segments. This includes the ability to
prioritize the use of capital and debt capacity, to determine cash management
policies and to make decisions regarding the timing and amount of capital
expenditures.
Operating Activities
Sprint's operating cash flows of $4.5 billion increased $166 million in the 2004
year-to-date period from the same 2003 period. This growth is driven by higher
wireless revenues and various company-wide cost containment initiatives somewhat
offset by declining wireline revenues and higher consolidated working capital
requirements.
Investing Activities
Sprint's cash flows used by investing activities totaled $2.6 billion in the
2004 year-to-date period compared to $2.4 billion in the same 2003 period.
Capital expenditures account for the majority of Sprint's investing activities.
Wireless capital expenditures were incurred mainly to maintain and enhance
network reliability and upgrade capabilities for providing new products and
services. Local incurred capital expenditures to accommodate voice grade
equivalent growth, expand capabilities for providing enhanced services, convert
our network from circuit to packet switching, continue the build-out of
high-speed DSL services, meet regulatory requirements, and replace network and
support assets. Long distance capital expenditures were incurred mainly to
maintain network reliability and upgrade capabilities for providing new products
and services. The overall increase in capital expenditures in 2004 was driven by
higher Wireless spending, somewhat offset by Local and Long distance spending
reductions.
Financing Activities
Sprint's cash flows used by financing activities totaled $382 million in the
2004 year-to-date period and $2.7 billion in the same 2003 period. In 2004,
financing activities include $1.8 billion of proceeds from the issuance of
common stock mainly from the settlement of the equity unit forward purchase
contracts. Financing activities also include a $1.7 billion reduction of debt in
the 2004 year-to-date period compared with a reduction of $2.4 billion in the
same 2003 period. The debt reduction in the 2004 year-to-date period was
primarily due to the prepayment of senior notes and a portion of Sprint's equity
unit notes, as well as payment of scheduled maturities on senior notes. The debt
reduction in the 2003 year-to-date period was mainly due to the tender for the
2003 and 2004 senior notes and the prepayment of borrowings under the Long
distance accounts receivable securitization facility. Sprint paid cash dividends
of $485 million in the 2004 year-to-date period compared with $343 million in
the same 2003 period. The dividend increase was due primarily to additional
shares of FON common stock issued in the April 2004 tracking stock
recombination.
Capital Requirements
Sprint's 2004 investing activities, mainly consisting of capital expenditures,
are expected to total approximately $4.0 billion. These expenditures are
primarily for increased network capacity and coverage. They also include
investments for growth in demand for enterprise services, broadband initiatives
including DSL and Evolution Data Optimized or EV-DO, which is the next version
of CDMA technology enabling high-speed wireless data capabilities, and the
phased transition from circuit to packet switching. Sprint continues to review
capital expenditure requirements closely and will adjust spending and capital
investment in concert with customer demand. Dividend payments are expected to
approximate $670 million in 2004. Sprint expects overall cash from operations to
be approximately $6.5 billion in 2004.
Liquidity
Prior to 2003, Sprint used the long-term bond market, as well as other financial
markets, to fund its needs. As a result of its improved liquidity position,
Sprint has not recently accessed the capital markets and does not currently
expect to do so in 2004 to fund either capital expenditures or operating
requirements.
In June 2004, Sprint entered into a new revolving credit facility with a
syndicate of banks. The $1.0 billion facility is unsecured, with no springing
liens, and is structured as a 364-day credit line with a subsequent one-year,
$1.0 billion term-out option. Sprint does not intend to draw against this
facility. Sprint had letters of credit serving as a backup to various
obligations of approximately $121 million as of September 30, 2004.
Sprint has a Wireless accounts receivable asset securitization facility that
provides Sprint with up to $500 million of additional liquidity. The facility,
which expires in 2005, does not include any ratings triggers that would allow
the lenders involved to terminate the facility in the event of a credit rating
downgrade. The maximum amount of funding available is based on numerous factors
and will fluctuate each month. Sprint has not drawn against the facility and
more than $356 million was available as of September 30, 2004.
Sprint has a Long distance accounts receivable asset securitization facility
that provides Sprint with up to $700 million of additional liquidity. The
facility, which expires in 2005, does not include any ratings triggers that
would allow the lenders involved to terminate the facility in the event of a
credit rating downgrade. The maximum amount of funding available is based on
numerous factors and will fluctuate each month. In February 2003, Sprint prepaid
all outstanding borrowings under this facility. As of September 30, 2004, Sprint
had more than $406 million total funding available under the facility.
The undrawn loan facilities described above would charge interest rates equal to
LIBOR or Prime Rate plus a spread that varies depending on Sprint's credit
ratings.
Debt maturities, including capital lease obligations, total approximately $160
million for the remainder of 2004 and $1.3 billion for 2005. Sprint's $4.0
billion cash balance at September 30, 2004 and expected 2004 cash flow from
operations more than fund these requirements.
Any borrowings Sprint may incur are ultimately limited by certain debt
covenants. At September 30, 2004, Sprint's most restrictive debt covenant would
allow an additional $8.9 billion of debt. Sprint is currently in compliance with
all debt covenants associated with its borrowings.
Fitch Ratings currently rates Sprint's senior unsecured debt at BBB with a
stable outlook. Standard and Poor's Corporate Ratings currently rates Sprint's
long-term senior unsecured debt at BBB-. On October 8, 2004, Standard and Poor's
placed Sprint's rating on CreditWatch with positive implications. Moody's
Investor Service currently rates Sprint's long-term senior unsecured debt at
Baa3 and on August 20, 2004 improved the outlook to positive from stable.
Sprint's ability to fund its capital needs is ultimately impacted by the overall
capacity and terms of the bank, term-debt and equity markets. Given the
volatility in the markets, Sprint continues to monitor the markets closely and
to take steps to maintain financial flexibility and a reasonable capital
structure cost. Sprint currently plans to access the markets only for extension,
replacement or renewal of current credit arrangements.
Off-Balance Sheet Financing
Sprint does not participate in, nor secure, financings for any unconsolidated,
special purpose entities.
--------------------------------------------------------------------------------
Financial Strategies
--------------------------------------------------------------------------------
General Risk Management Policies
Sprint selectively enters into interest rate swap agreements to manage its
exposure to interest rate changes on its debt. Sprint also enters into forward
contracts and options in foreign currencies to reduce the impact of changes in
foreign exchange rates. Sprint seeks to minimize counterparty credit risk
through stringent credit approval and review processes, the selection of only
the most creditworthy counterparties, continual review and monitoring of all
counterparties, and thorough legal review of contracts. Sprint also controls
exposure to market risk by regularly monitoring changes in foreign exchange and
interest rate positions under normal and stress conditions to ensure they do not
exceed established limits.
Sprint's derivative transactions are used principally for hedging purposes and
comply with Board-approved policies. Senior management receives frequent status
updates of all outstanding derivative positions.
Interest Rate Risk Management
Fair Value Hedges
Sprint enters into interest rate swap agreements to manage exposure to interest
rate movements and achieve an optimal mixture of floating and fixed-rate debt
while minimizing liquidity risk. The interest rate swap agreements designated as
fair value hedges effectively convert Sprint's fixed-rate debt to a floating
rate by receiving fixed rate amounts in exchange for floating rate interest
payments over the life of the agreement without an exchange of the underlying
principal amount. During 2003, Sprint entered into interest rate swap
agreements, which were designated as fair value hedges.
Cash Flow Hedges
Sprint enters into interest rate swap agreements designated as cash flow hedges
to reduce the impact of interest rate movements on future interest expense by
effectively converting a portion of its floating-rate debt to a fixed-rate. As
of September 30, 2004, Sprint had no outstanding interest rate cash flow hedges.
Other Derivatives
In certain business transactions, Sprint is granted warrants to purchase the
securities of other companies at fixed rates. These warrants are supplemental to
the terms of the business transaction and are not designated as hedging
instruments.
During 2003, Sprint entered into variable prepaid forward contracts to monetize
equity securities held as available for sale. The derivatives have been
designated as cash flow hedges to reduce the variability in expected cash flows
related to the forecasted sale of the underlying equity securities.
Foreign Exchange Risk Management
Sprint's foreign exchange risk management program focuses on reducing
transaction exposure to optimize consolidated cash flow. Sprint's primary
transaction exposure results from payments made to and received from overseas
telecommunications companies for completing international calls made by Sprint's
domestic customers and from the operation of its international subsidiaries.
These international operations were immaterial to the consolidated financial
position at September 30, 2004 or results of operations or cash flows for the
quarter ended September 30, 2004. Sprint has not entered into any significant
foreign currency forward and option contracts or other derivative instruments to
reduce the effects of adverse fluctuations in foreign exchange rates. As a
result, Sprint was not subject to material foreign exchange risk.
PART I.
Item 3
Item 3. Quantitative and Qualitative Disclosures about Market Risk
The risk inherent in Sprint's market risk sensitive instruments and positions is
the potential loss arising from adverse changes in those factors. Sprint is
susceptible to certain risks related to changes in interest rates and foreign
currency exchange rate fluctuations. Sprint does not purchase or hold any
derivative financial instruments for trading purposes.
Interest Rate Risk
The communications industry is a capital intensive, technology driven business.
Sprint is subject to interest rate risk primarily associated with its
borrowings. Sprint selectively enters into interest rate swap agreements to
manage its exposure to interest rate changes on its debt.
Approximately 93% of Sprint's outstanding debt at September 30, 2004 is
fixed-rate debt, excluding interest rate swaps. While changes in interest rates
impact the fair value of this debt, there is no impact on earnings and cash
flows because Sprint intends to hold these obligations to maturity unless market
conditions are favorable.
As of September 30, 2004, Sprint held fair value interest rate swaps with a
notional value of $1 billion. These swaps were entered into as hedges of the
fair value of a portion of our senior notes. These interest rate swaps have
maturities ranging from 2008 to 2012. On a semiannual basis, Sprint pays a
floating rate of interest equal to the six-month LIBOR, plus a fixed spread,
which averaged 4.7% as of September 30, 2004, and received an average interest
rate equal to the coupon rates stated on the underlying senior notes of 7.2%.
Assuming a one percentage point increase in the prevailing forward yield curve,
the fair value of the interest rate swaps and the underlying senior notes would
change by $48 million. These interest rate swaps met all the requirements for
perfect effectiveness under derivative accounting rules; therefore, there is no
impact on earnings and cash flows for any fair value fluctuations.
Sprint performs interest rate sensitivity analyses on its variable-rate debt
including interest rate swaps. These analyses indicate that a one percentage
point change in interest rates would have an annual pre-tax impact of $17
million on the Statements of Operations and Consolidated Statements of Cash
Flows at September 30, 2004. While Sprint's variable-rate debt is subject to
earnings and cash flows impacts as interest rates change, it is not subject to
changes in fair values.
Sprint also performs a sensitivity analysis on the fair market value of its
outstanding debt. A 10% decrease in market interest rates would cause a $569
million increase in fair market value of its debt to $20 billion.
Foreign Currency Risk
Sprint also enters into forward and option contracts in foreign currencies to
reduce the impact of changes in foreign exchange rates. Sprint uses foreign
currency derivatives to hedge its foreign currency exposure related to
settlement of international telecommunications access charges and the operation
of international subsidiaries. The dollar equivalent of Sprint's net foreign
currency payables from international settlements was $42 million and net foreign
currency receivables from international operations was $23 million at September
30, 2004. The potential immediate pre-tax loss to Sprint that would result from
a hypothetical 10% change in foreign currency exchange rates based on these
positions would be approximately $3 million.
PART I.
Item 4
Item 4. Controls and Procedures
In connection with the preparation of this Form 10-Q and as of September 30,
2004, under the supervision and with the participation of Sprint's management,
including Sprint's Chief Executive Officer and Chief Financial Officer, Sprint
carried out an evaluation of the effectiveness of the design and operation of
Sprint's disclosure controls and procedures. Based on these discussions and the
report of Sprint's internal auditors, the Chief Executive Officer and Chief
Financial Officer each concluded that the design and operation of the disclosure
controls and procedures were effective as of September 30, 2004 in providing
reasonable assurance that information required to be disclosed in reports Sprint
files or submits under the Securities Exchange Act of 1934 is accumulated and
communicated to management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosure and in providing reasonable assurance that the information is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms. No changes were made in Sprint's internal controls
over financial reporting during the quarter ended September 30, 2004 that have
materially affected, or are reasonably likely to materially affect, Sprint's
internal controls over financial reporting.
During a review of internal controls relating to its capital assets, Sprint
identified, in the 2004 third quarter, a calculation error that had resulted,
since 1999, in the overstatement of interest capitalized during the construction
of its Wireless capital assets, with a corresponding understatement of interest
expense. The error subsequently resulted in an overstatement of depreciation
expense after the associated capital assets were placed in service. While Sprint
believes the impacts of this calculation error are not material to any
previously issued financial statement, Sprint determined that this calculation
error was most appropriately corrected through restatement of previously issued
financial statements.
This overstatement of capitalized interest resulted from the application of
interest capitalization rates to assets which were under construction, but had
not yet required the payment of cash or the incurrence of an interest-bearing
liability, and accordingly, were not incurring interest cost. SFAS No. 34,
Capitalization of Interest Costs, requires that assets under construction be
incurring interest cost through the payment of cash or incurrence of an
interest-bearing liability in order to qualify for interest capitalization.
Process changes have been instituted to appropriately exclude assets under
construction which are not incurring interest cost from the capitalized interest
calculation in the future.
See Note 3 of the Condensed Notes to Consolidated Financial Statements for the
impact of this restatement on previously issued financial statements.
PART II.
Other Information
PART II. - Other Information
Item 1. Legal Proceedings
In 2003, a series of putative class action lawsuits were filed by
shareholders against Sprint, certain current and former officers and
directors, and its former auditor, Ernst & Young (EY). The lawsuits
alleged that Sprint's financial statements were misleading as a result
of failure to disclose personal tax strategies utilized by senior
executives of Sprint and allegedly sponsored by EY, and that EY was not
independent. The cases were consolidated into a single proceeding in
the U.S. District Court for the District of Kansas, and in April 2004,
the court dismissed those allegations on defendants' motion and
dismissed EY with prejudice, but permitted plaintiffs to amend their
complaint against other defendants. Plaintiffs filed an amended
complaint alleging that Sprint's 2001 and 2002 proxy statements were
misleading because they described new employment agreements entered
into with senior executives without disclosing that the board allegedly
was considering terminating those same executives. The lawsuit seeks to
recover any decline in the value of FON common stock and PCS common
stock during the class period. In September, 2004, the court denied
defendants' motion to dismiss these new allegations, and the parties
have stipulated that the case can proceed as a class action. All
defendants have denied plaintiffs' allegations and intend to vigorously
defend this matter.
Various other suits, proceedings and claims, including purported class
actions, typical for a business enterprise, are pending against Sprint.
While it is not possible to determine the ultimate disposition of each
of these proceedings and whether they will be resolved consistent with
Sprint's beliefs, Sprint expects that the outcome of such proceedings,
individually or in the aggregate, will not have a material adverse
effect on the financial condition or results of operations of Sprint or
its business segments.
Item 2. Changes in Securities
Sale of Unregistered Equity Securities
In September 2004, Sprint issued to certain of its directors and
current and former executive officers an aggregate of 5,440
unregistered restricted stock units relating to shares of FON common
stock. These restricted stock units were the result of dividend
equivalent rights attached to restricted stock units granted to these
directors and officers in 2003. Each restricted stock unit represents
the right to one share of FON common stock once the unit vests. The
restricted stock units are scheduled to vest beginning in 2005 and
ending in 2007. Delivery of the shares may be delayed under certain
circumstances.
Neither these restricted stock units nor the common stock issuable once
the units vest were registered under the Securities Act of 1933. The
issuance of the restricted stock units was exempt from registration
under the Securities Act in reliance on the exemption provided by
Section 4(2) of the Securities Act because the restricted stock units
were issued in transactions not involving a public offering.
Issuer Purchases of Equity Securities
--- ---------------- --- ----------------- -- ------------- -----------------
Total Maximum Number
Number of (or Approximate
Shares Dollar Value)
Purchased of Shares that
as Part of May Yet Be
Total Number Average Price Publicly Purchased Under
of Shares Paid Announced the Plans or
Period Purchased(1) Per Share(2),(3) Plans or Programs
Programs
--- ---------------- --- ----------------- -- ------------- -----------------
July 1 through July 31
FON common stock 5,206 $ 17.512 - -
August 1 through August 31
FON common stock 2,471 $ 18.320 - -
September 1 through
September 30
FON common stock 1,198 $ 18.358 - -
(1) All acquisitions of equity securities during the 2004 third
quarter were the result of the operation of the terms of Sprint's
shareholder approved equity compensation plans (the Management
Incentive Stock Option Plan and the 1997 Long-Term Stock Incentive
Program) and the terms of the equity grants pursuant to those
plans, as follows: the forfeiture of restricted stock; the
surrender of restricted stock to pay required minimum income,
Medicare and FICA tax withholding on the vesting of restricted
stock; and the delivery of previously owned shares owned by the
grantee to pay additional income tax withholding on (i) the
vesting of restricted stock, (ii) the delivery of shares
underlying restricted stock units, and (iii) the exercise of
options. Excludes shares used for the exercise price of options
and required minimum tax withholding on the exercise of options
and the delivery of shares underlying restricted stock units when
only the net shares were issued.
(2) Excludes the amount paid in the 2004 third quarter for fractional
shares of FON common stock acquired in the 2004 second quarter
recombination of the PCS common stock and FON common stock.
Pursuant to Sprint's Articles of Incorporation, the cash value per
share is determined by averaging the high and low reported sales
price of the FON common stock on the fifth trading day before the
date on which the payment is made. The payment is made when the
certificates for PCS common stock are surrendered for exchange. In
the 2004 third quarter, payment was made for an aggregate of 128.5
shares of FON common stock at an average price per share of
$18.14.
(3) Excludes forfeited restricted stock since the purchase price was
zero. The purchase price of a share of stock used for tax
withholding is the amount of withholding paid per share used for
that purpose, which is the market price of the stock on the date
of vesting of the restricted stock, the delivery date of the stock
underlying restricted stock units, and the date of the exercise of
the option.
No options may be granted pursuant to the Management Incentive Stock
Option Plan after April 18, 2005. No awards may be granted pursuant to
the 1997 Long-Term Stock Incentive Program after April 15, 2007.
Options, restricted stock awards and restricted stock unit awards
outstanding on those dates may continue to be outstanding after those
dates. Sprint cannot estimate how many shares will be acquired in the
manner described in footnote (1) to the table above through operation
of these plans.
Item 3. Defaults Upon Senior Securities
There were no reportable events during the quarter ended September 30,
2004.
Item 4. Submission of Matters to a Vote of Security Holders
There were no reportable events during the quarter ended September 30,
2004.
Item 5. Other Information
Ratios of Earnings to Fixed Charges
Sprint's ratio of earnings to fixed charges were inadequate to cover
fixed charges by $3.1 billion in the 2004 third quarter and $2.3
billion in the year-to-date period and were inadequate to cover fixed
charges by $769 million and $609 million in the same 2003 periods. The
ratio of earnings to fixed charges was computed by dividing fixed
charges into the sum of earnings, after certain adjustments, and fixed
charges. Earnings include income from continuing operations before
income taxes plus net losses in equity method investees, less
capitalized interest. Fixed charges include interest on all debt of
continuing operations, including amortization of debt issuance costs,
and the interest component of operating rents.
Item 6. Exhibits
(a) The following exhibits are filed as part of this report:
(3) Articles of Incorporation and Bylaws:
(a) Restated Articles of Incorporation, dated as of
December 9, 2003 (filed as Exhibit 3(a) to Sprint
Corporation's Quarterly Report on Form 10-Q for the
quarter ended March 31, 2004 and incorporated herein by
reference).
(b) Certificate of Designation, Preferences and Rights of
Preferred Stock-Sixth Series, dated as of April 23,
2004 (filed as Exhibit 3(b) to Sprint Corporation's
Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004 and incorporated herein by reference).
(c) Certificate of Elimination of Designations of Preferred
Stock-Eighth Series, dated as of April 23, 2004
(filed as Exhibit 3(c) to Sprint Corporation's
Quarterly Report on Form 10-Q for the quarter ended
March 31, 2004 and incorporated herein by reference).
(d) Amended and Restated Bylaws (filed as Exhibit 3(d) to
Sprint Corporation's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2004 and incorporated
herein by reference).
(4) Instruments defining the Rights of Sprint's Security Holders:
(a) The rights of Sprint's equity security holders are
defined in the Fifth, Sixth, Seventh and Eighth
Articles of Sprint's Articles of Incorporation. See
Exhibits 3(a), 3(b) and 3(c).
(b) Provision regarding Kansas Control Share Acquisition
Act is in Article II, Section 5 of the Bylaws.
Provisions regarding Stockholders' Meetings are set
forth in Article III of the Bylaws. See Exhibit 3(d).
(c) Second Amended and Restated Rights Agreement between
Sprint Corporation and UMB Bank, n.a., as Rights Agent,
dated as of March 16, 2004 and effective as of April
23, 2004 (filed as Exhibit 1 to Amendment No. 5 to
Sprint Corporation's Registration Statement on Form 8-A
relating to Sprint's Rights, filed April 12, 2004, and
incorporated herein by reference).
(10) Executive Compensation Plans and Arrangements
(a) Form of 2004 Award Agreement (awarding stock options
and restricted stock units) with Messrs. Forsee, Fuller
and Lauer.
(b) Form of 2004 Award Agreement (awarding stock options
and restricted stock units) with other Executive
Officers.
(c) Form of 2004 Award Agreement (awarding restricted stock
units) with Directors.
(d) Management Incentive Plan, as amended (filed as Exhibit
10.1 to Sprint Corporation Current Report on Form 8-K
dated October 11, 2004 and incorporated herein by
reference).
(e) Executive Deferred Compensation Plan, as amended,
including summary of certain Amendments to the
Executive Deferred Compensation Plan (filed as Exhibit
10.2 to Sprint Corporation Current Report on Form 8-K
dated October 11, 2004 and incorporated herein by
reference).
(f) Directors' Deferred Fee Plan, as amended (filed as
Exhibit 10.3 to Sprint Corporation Current Report on
Form 8-K dated October 11, 2004 and incorporated herein
by reference).
(g) 1997 Long-Term Stock Incentive Program, as amended
(filed as Exhibit 10.4 to Sprint Corporation Current
Report on Form 8-K dated October 11, 2004 and
incorporated herein by reference).
(h) Employment Agreement between Sprint Corporation and one
of its Executive Officers (Mr. Kelly).
(12) Computation of Ratios of Earnings to Fixed Charges
(31) (a) Certification of Chief Executive Officer Pursuant to
Securities Exchange Act of 1934 Rule 13a-14(a).
(b) Certification of Chief Financial Officer Pursuant to
Securities Exchange Act of 1934 Rule 13a-14(a).
(32) (a) Certification of Chief Executive Officer pursuant to
18 U.S.C. Section 1350, As Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002.
(b) Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, As Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
Sprint will furnish to the Securities and Exchange Commission, upon request, a
copy of the instruments defining the rights of holders of long-term debt that
does not exceed 10% of the total assets of Sprint.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SPRINT CORPORATION
(Registrant)
By /s/ John P. Meyer
-----------------------------------
John P. Meyer
Senior Vice President -- Controller
Principal Accounting Officer
Dated: November 9, 2004