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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
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 No. 1-4721
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 11315, 64112
Kansas City, Missouri (Zip Code)
(Address of principal executive
offices)
Registrant's telephone number, (913) 624-3000
including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Preferred Stock, without par
value
First series, $7.50 stated
value New York Stock Exchange
Second series, $6.25 stated
value New York Stock Exchange
FON Common Stock, Series 1,
$2.00
par value, and FON Group
Rights New York Stock Exchange
PCS Common Stock, Series 1,
$1.00
par value, and PCS Group
Rights New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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 these 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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [_]
Aggregate market value of voting and non-voting stock held by non-affiliates at
February 26, 1999, was $42,048,340,359.
COMMON SHARES OUTSTANDING AT FEBRUARY 26, 1999:
FON COMMON STOCK 345,480,707
PCS COMMON STOCK 404,119,795
CLASS A COMMON STOCK 86,236,036
Documents incorporated by reference.
Registrant's definitive proxy statement filed under Regulation 14A promulgated
by the Securities and Exchange Commission under the Securities Exchange Act of
1934, which definitive proxy statement is to be filed within 120 days after the
end of Registrant's fiscal year ended December 31, 1998, is incorporated by
reference in Part III hereof.
SECURITIES AND EXCHANGE COMMISSION
ANNUAL REPORT ON FORM 10-K Sprint Corporation
Part I
- --------------------------------------------------------------------------------
Item 1. Business
- --------------------------------------------------------------------------------
The Corporation
Sprint Corporation, incorporated in 1938 under the laws of Kansas, is mainly a
holding company. In November 1998, Sprint's shareholders approved the formation
of the FON Group and the PCS Group and the creation of the FON stock and the
PCS stock. In addition, Sprint purchased the remaining ownership interests in
Sprint Spectrum Holding Company, L.P. and PhillieCo, L.P. (together, Sprint
PCS), other than a minority interest in Cox Communications PCS, L.P. (Cox PCS).
Sprint acquired these ownership interests from Tele-Communications, Inc. (TCI),
Comcast Corporation and Cox Communications, Inc. (the Cable Partners). In
exchange, Sprint issued the Cable Partners special low-vote PCS shares and
warrants to acquire additional PCS shares. Sprint also issued the Cable
Partners shares of a new class of preferred stock convertible into PCS shares.
The purchase of the Cable Partners' interests is referred to as the PCS
Restructuring.
Also in November 1998, Sprint reclassified each of its publicly traded common
shares into one share of FON stock and 1/2 share of PCS stock. This
recapitalization was tax-free to shareholders. Each Class A common share owned
by France Telecom S.A. (FT) and Deutsche Telekom AG (DT) was reclassified to
represent an equity interest in the FON Group and the PCS Group that entitles
FT and DT to one share of FON stock and 1/2 share of PCS stock. These
transactions are referred to as the Recapitalization.
In connection with the PCS Restructuring, FT and DT purchased 5.1 million
additional PCS shares to maintain their combined 20% voting power in Sprint
(Top-up).
The PCS stock is intended to reflect the performance of Sprint's domestic
wireless personal communication services (PCS) operations. These operations are
referred to as the PCS Group.
The FON stock is intended to reflect the performance of all of Sprint's other
operations. These operations are referred to as the FON Group and include the
following:
. Core businesses
. Long distance division
. Local division
. Product distribution and directory publishing businesses
. Activities to develop and deploy Sprint ION(SM), Integrated On-Demand
Network
. Other ventures, including Sprint's investment in Global One.
Characteristics of Tracking Stock
FON and PCS shareholders are subject to the risks related to all of Sprint's
businesses, assets and liabilities. Owning FON or PCS shares does not represent
a direct legal interest in the assets and liabilities of the Groups. Rather,
shareholders remain invested in Sprint and continue to vote as a single voting
class for Board member elections (other than Class A directors elected by FT
and DT) and most other company matters.
The vote per share of the PCS stock is different from the vote of the FON
stock. The FON stock has one vote per share. The vote of the PCS stock is based
on the market price of a share of PCS stock relative to the market price of a
share of FON stock for a period of time prior to the record date for a
shareholders meeting. The shares of PCS stock held by the Cable Partners have
1/10 of the vote per share of the publicly traded PCS stock. The shares held by
the Cable Partners will convert into full voting PCS stock upon sale to the
public. Sprint anticipates that the FON stock will have greater voting power
than the PCS stock for the foreseeable future and therefore will be in a
position to control the outcome of shareholder votes.
The price of the FON stock may not accurately reflect the performance of the
FON Group and the price of the PCS stock may not accurately reflect the
performance of the PCS Group. Events affecting the results of one Group could
adversely affect the results and stock price of the other Group. Net losses of
either Group, and dividends or distributions on, or repurchases of, one stock
will reduce Sprint funds legally available for dividends on both stocks. Debt
incurred by either Group could affect the credit rating of Sprint as a whole
and increase borrowing costs for both Groups.
Holders of one of the stocks may have different or conflicting interests from
the holders of the other stock. For example, conflicts could arise with respect
to decisions by the Sprint Board to (1) allocate consideration in a merger of
Sprint among holders of FON stock and PCS stock, (2) convert the outstanding
shares of PCS stock into shares of FON stock, (3) sell assets of a Group,
either to the other Group or to a third party, (4) transfer assets from one
Group to the other Group, (5) formulate public policy positions which could
have an unequal effect on the interests of the FON Group and the PCS Group, and
(6) make operational and financial decisions with respect to one Group that
could be considered to be detrimental to the other Group. Material conflicts
are addressed in accordance with the Tracking Stock Policies adopted by the
Sprint Board. In addition, the Board has appointed a committee of its members
(the Capital Stock Committee) to interpret and oversee the implementation of
these policies.
Transfers of assets from the FON Group to the PCS Group treated as an equity
contribution will result in an
1
increase in the intergroup interest of the FON Group in the PCS Group. This
interest is similar to the FON Group holding PCS stock. A transfer of funds
from the PCS Group to the FON Group would decrease the intergroup interest. An
intergroup interest of the PCS Group in the FON Group cannot be created.
If either the FON Group or the PCS Group were a stand-alone entity, a person
that does not wish to negotiate with management could seek to acquire such
Group by means of a tender offer or proxy contest involving only that entity's
shareholders. However, because the FON Group and the PCS Group are each part of
Sprint, acquiring either Group without negotiation with Sprint's management
would require a proxy contest or tender offer that yielded control of Sprint
generally and would likely require solicitations to shareholders of both
Groups.
The Clinton Administration's annual budget proposal included a recommendation
to tax the future issuance of tracking stocks. If enacted as proposed, the
recommendation could adversely affect Sprint's ability to use tracking stocks
to raise equity capital in the future.
Sprint FON Group
General Overview of the Sprint FON Group
The main activities of the FON Group include its core businesses, consisting of
domestic and international long distance communications, local exchange
communications, and product distribution and directory publishing activities.
The FON Group also includes results from Sprint ION(SM), and other ventures,
including Sprint's investment in Global One.
Core Businesses--Long Distance Division
General
The FON Group's long distance division (LDD) is the nation's third largest long
distance phone company. LDD operates a nationwide, all-digital long distance
telecommunications network using state-of-the-art fiber-optic and electronic
technology. LDD provides domestic and international voice, video and data
communications services as well as integration management and support services
for computer networks. It consists mainly of Sprint Communications Company L.P.
(the Limited Partnership).
LDD's financial performance for 1998, 1997 and 1996 is summarized as follows:
- --------------------------------------------------
1998 1997 1996
- --------------------------------------------------
(in millions)
Net operating revenues $9,910.9 $8,994.0 $8,302.1
--------------------------
Operating income(/1/) $1,366.8 $1,025.3 $ 911.5
--------------------------
(/1/)Includes nonrecurring litigation charges of $20 million in 1997 and $60
million in 1996.
Competition
The division competes with AT&T, MCI WorldCom and other telecommunications
providers in all segments of the long distance communications market. AT&T
continues to have the largest market share of the domestic long distance
communications market. MCI WorldCom is the nation's second largest long
distance phone company. Competition in long distance is based on price and
pricing plans, the types of services offered, customer service, and
communications quality, reliability and availability.
Strategy
In order to achieve profitable market share growth in an increasingly
competitive long distance communications environment, LDD intends to leverage
its principal strategic assets: its national brand, innovative marketing and
pricing plans, its reputation for superior customer service, its state-of-the-
art technology, and offerings available from other FON Group operating entities
and the PCS Group. LDD will focus on expanding its presence in the high-growth
data communications markets such as Asynchronous Transfer Mode (ATM) and Frame
Relay and intends to become the provider of choice for delivery of end-to-end
service to companies with complex distributed computing environments. The FON
Group continues to deploy network and systems infrastructure which provides
industry-leading reliability, cost effectiveness and technological
improvements. In order to create integrated product offerings for its
customers, the FON Group is solidifying the linkage of its long distance
division with Sprint's other operations such as the local division, the Global
One alliance and the PCS Group in the areas of sales support, marketing,
integration of systems and the development of common products and services. The
long distance division also supports Sprint ION(SM). See "Sprint ION--Strategy"
for more details.
Core Businesses--Local Division
General
The local division (LTD) consists of regulated local phone companies serving
more than 7.6 million access lines in 18 states. LTD provides local phone
services, access by phone customers and other carriers to LTD's local network,
sales of telecommunications equipment, and long distance services within
certain regional calling areas, or LATAs.
LTD's financial performance for 1998, 1997 and 1996 is summarized as follows:
- -------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------
(in millions)
Net operating revenues(/1/) $5,371.4 $5,293.9 $5,127.0
--------------------------
Operating income $1,407.0 $1,390.7 $1,334.7
--------------------------
(/1/Beginning)in July 1997, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. For further discussion, see the FON Group's "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
2
AT&T is LTD's largest customer for network access services. In 1998, 1997 and
1996, 13% of the division's net operating revenues were from services (mainly
network access services) provided to AT&T. Revenues from AT&T were 4% of the
FON Group's revenues in 1998 and 5% in 1997 and 1996. While AT&T is a
significant customer, LTD does not believe the division's revenues are
dependent on AT&T, since any long distance provider must pay access charges to
LTD related to interLATA long distance telephone service.
Competition
Because LTD operations are largely in rural markets, competition in its markets
is occurring more gradually. There is already some competition in urban areas
served by LTD and for business customers located in all areas. Certain proposed
combinations, such as the merger of AT&T and TCI, would likely accelerate
competition in the areas served by LTD. The merger with TCI would enable AT&T
to bypass the local phone company and reach local customers through the cable
of TCI. In addition, wireless services will continue to grow as an alternative
to wireline services as a means of reaching local customers.
Strategy
To continue to build on its successful track record, LTD has embarked on a
growth strategy whereby it will aggressively market Sprint's entire product
portfolio to its local customers as well as its core product line of advanced
network features and data products. LTD also supports the FON Group's
initiatives with Sprint ION(sm). See "Sprint ION--Strategy" for more details.
Core Businesses--Product Distribution and Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
The financial performance for the product distribution and directory publishing
businesses for 1998, 1997 and 1996 is summarized as follows:
- -------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------
(in millions)
Net operating revenues(/1/) $1,683.1 $1,454.3 $1,225.4
--------------------------
Operating income(/1/) $ 230.9 $ 179.9 $ 101.6
--------------------------
(/1/Beginning)in July 1997, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. For further discussion, see the FON Group's "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Sprint ION
Sprint ION extends Sprint's existing advanced network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for data, Internet, and video. It is also expected to be the
foundation for Sprint to provide new competitive local service.
The financial performance for Sprint ION for 1998 and 1997 is summarized as
follows:
- ---------------------------------
1998 1997
- ---------------------------------
(in millions)
Operating expenses $ 143.1 $ 5.2
-------------
Strategy
This integrated services capability is expected to generate increased demand
for Sprint's products and services, and at the same time reduce the costs to
provide those services. Cisco Systems, Inc. (Cisco) and Bell Communications
Research, Inc. are assisting in the Sprint ION development effort. Cisco will
be a major supplier of Sprint's equipment requirements for digital subscriber
line deployment.
Sprint ION intends to rely largely on the long distance division's transmission
infrastructure and, to a lesser extent, on the transmission infrastructure of
the local division. Sprint will evaluate whether facilities should be built,
leased or acquired where they currently do not exist. Because a great amount of
future investment will be related to specific customer contracts, Sprint
expects to manage its investment in Sprint ION consistent with customer demand.
Other Ventures
The "other ventures" segment includes the FON Group's investment in Global One,
a joint venture with FT and DT. Sprint is a 1/3 partner in Global One's
operating group serving Europe (excluding France and Germany) and a 50% partner
in Global One's operating group for the worldwide activities outside the United
States and Europe. This segment also includes the FON Group's investments in
EarthLink Network, Inc., an Internet service provider; Call-Net, a long
distance provider in Canada operating under the Sprint brand name; and certain
other telecommunications investments and ventures. All of these investments are
accounted for on the equity basis.
The financial performance of the operations of other ventures for 1998, 1997
and 1996 is summarized as follows:
- ---------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------
(in millions)
Operating expenses $ 39.9 $ 83.8 $ 48.6
------------------------
Equity in losses of affiliates $(236.7) $(172.0) $(87.0)
------------------------
Operating expenses mainly relate to the FON Group's offering of Internet
services. In June 1998, the FON Group completed the strategic alliance to
combine its
3
Internet business with EarthLink. As part of the alliance, EarthLink obtained
the FON Group's Sprint Internet Passport customers and took over the day-to-day
operations of those services. In exchange, the FON Group owns an equity
interest in EarthLink.
"Equity in losses of affiliates" mainly consists of losses from Global One.
Global One's strategic objective is to be the premier provider of global
telecommunications services. To achieve this objective, the Global One business
strategy is designed to achieve maximum global coverage and seamless global
connectivity. Under a single global brand and through a single interface to
customers in each country, Global One offers a comprehensive array of state-of-
the-art telecommunications services, delivered through its advanced global
network infrastructure.
Sprint PCS Group
General Overview of the Sprint PCS Group
The PCS Group includes Sprint's domestic wireless mobile phone services. It
operates the only 100% digital PCS wireless network in the United States, with
licenses to provide nationwide service using a single frequency and a single
technology. At year-end 1998, the PCS Group, together with certain affiliates,
operated PCS systems in 45 of the 50 largest U.S. metropolitan areas. The PCS
Group has licenses to serve 270 million people in all 50 states, Puerto Rico
and the U.S. Virgin Islands. With market launches in January 1999, the PCS
Group's service now reaches nearly 170 million people. The PCS Group provides
nationwide service through:
. operating its own digital network in major U.S. metropolitan areas,
. affiliating with other companies, mainly in and around smaller U.S.
metropolitan areas,
. roaming on other providers' analog cellular networks using Dual-
Band/Dual-Mode handsets, and
. roaming on other providers' digital PCS networks that use code division
multiple access (CDMA).
The financial performance for the PCS Group for 1998, 1997 and 1996 is
summarized as follows:
- ----------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------
(in millions)
Net operating revenues(/1/) $ 1,225.4 $ -- $ --
---------------------------
Operating loss(/1/),(/2/) $(2,569.4) $ (18.5) $ (0.5)
---------------------------
Other partners' loss in Sprint PCS $ 1,250.9 $ -- $ --
---------------------------
Equity in loss of Sprint PCS $ -- $(659.6) $(191.8)
---------------------------
(/1/The)PCS Group's 1998 results of operations included SprintCom's operating
results as well as Sprint PCS' operating results on a consolidated basis
for the entire year. Before 1998, Sprint's investment in Sprint PCS was
accounted for using the equity method.
(/2/Includes)a nonrecurring charge to write-off $179 million of acquired in-
process research and development costs related to the PCS Restructuring in
1998. For further discussion, see the PCS Group's "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
License Coverage
The number of Pops (one person residing in a license area equals one Pop)
covered by licenses held by the PCS Group is set forth in the chart below:
- --------------------------------------------------------
Sprint
Entity Pops(/1/) Ownership
- --------------------------------------------------------
(in millions)
Sprint Spectrum Holding Company
Sprint Spectrum 155.9 100.0%
Cox PCS(/2/) 21.0 59.2
American PCS 8.3 100.0
PhillieCo 9.2 100.0
SprintCom 74.9 100.0
- ----------------------------------------------
Total 269.3
-------------
(/1/Based)on 1997 population data supplied by Equifax Inc.
(/2/Pops)data for Cox PCS includes 100% of its Pops, not the PCS Group's
proportional interest. Sprint Spectrum Holding Company and Cox, the holder
of the remaining 40.8% partnership interest in Cox PCS, have entered into
an arrangement whereby Cox may require Sprint Spectrum Holding Company to
purchase Cox's remaining partnership interest in Cox PCS. Commencing in
2001, Sprint Spectrum Holding Company will have the right to require that
Cox sell all of its remaining partnership interest in Cox PCS to Sprint
Spectrum Holding Company.
Competition
Each of the markets in which the PCS Group competes is served by other two-way
wireless service providers, including cellular and PCS operators and resellers.
A majority of the markets will have five or more commercial mobile radio
service (CMRS) providers and each of the top 50 metropolitan markets have at
least one other PCS competitor in addition to two cellular incumbents. Many of
these competitors have been operating for a number of years and currently
service a significant subscriber base.
Strategy
The business objective of the PCS Group is to expand network coverage and
increase market penetration by aggressively marketing competitively priced PCS
products and services under the Sprint and Sprint PCS brand names, offering
enhanced services and seeking to provide superior customer service. The
principal elements of the PCS Group's strategy for achieving these goals are:
. Operating a nationwide digital wireless network
. Leveraging Sprint's national brand
. Utilizing state-of-the-art CDMA technology
. Delivering superior value to its customers
. Growing customer base using multiple distribution channels
. Continuing to expand coverage
4
Regulatory Developments
Sprint FON Group
The Telecommunications Act of 1996 (Telecom Act) was designed to promote
competition in all aspects of telecommunications. It eliminated legal and
regulatory barriers to entry into local phone markets. It also required
incumbent local phone companies, among other things, to allow local resale at
wholesale rates, negotiate interconnection agreements, provide
nondiscriminatory access to unbundled network elements and allow collocation of
interconnection equipment by competitors. The Telecom Act also allows Regional
Bell Operating Companies (RBOCs) to provide in-region long distance service
once they obtain state certification of compliance with a competitive
"checklist," have a facilities-based competitor, and obtain a Federal
Communications Commission (FCC) ruling that the provision of in-region long
distance service is in the public interest. The Telecom Act's impact on Sprint
remains unclear because the rules for competition are still being decided by
regulators and the courts.
In accordance with the Telecom Act, the FCC adopted detailed rules in 1996 to
govern interconnection to incumbent local networks by new market entrants. Some
local phone companies and state public utility commissions appealed these rules
to the U.S. Court of Appeals. In 1997, the court struck down the FCC's pricing
rules. It ruled that the Telecom Act left jurisdiction over pricing matters to
the states. The U.S. Supreme Court, on January 25, 1999, reversed the appeals
court decision and reinstated the FCC's authority to establish rules and
prices. Further FCC action and court appeals are expected.
In 1997, the FCC issued important decisions on the structure and level of
access charges and universal service. These decisions were designed to remove
implicit subsidies from access charges and bring access rates closer to costs.
The decisions also called for establishing explicit universal service subsidies
for serving high cost areas and to fund additional telecommunications for
schools, libraries and rural health care providers.
It is too early to ascertain the impact of these matters on Sprint because
appeals and further regulatory proceedings are pending. Sprint's long distance
division benefits from lower access charges because access is the single
largest cost in providing long distance service. In addition, in 1998 Sprint
established charges to flow through certain access and universal service
payments to its customers. Reductions in access charges adversely affect
revenues of the local division.
Some RBOCs have challenged the Telecom Act restrictions on their entry into
long distance markets as unconstitutional. A federal district court in Texas
ruled the restrictions were unlawful because they constituted a legislative act
that imposed punishment without a judicial proceeding. However, that decision
was overturned by the Fifth Circuit Court of Appeals. Similar arguments have
also been rejected by the D.C. Circuit Court of Appeals. To date, the U.S.
Supreme Court has declined to review these decisions.
Since the Telecom Act was passed in 1996, several RBOCs have filed applications
with the FCC to provide in-region long distance service in certain states. None
have been approved. It is expected that more applications will be filed with
the FCC in 1999 and some may be approved. The entry of RBOCs into the long
distance market will impact competition, but the extent of the impact will
depend on many factors. These factors include the RBOCs' competitive ability,
the appeal of the RBOC brand to different market segments, and the response of
competitors. Some of the impact on Sprint may be offset by wholesale revenues
from those RBOCs that choose to resell Sprint services.
As a result of competition, a number of carriers have combined. Sprint has
raised concerns about some pending mergers (especially SBC Communications, Inc.
and Ameritech Corporation, and GTE Corporation and Bell Atlantic Corporation)
that appear to threaten competition. Federal regulators are closely
scrutinizing these mergers.
Sprint PCS Group
The FCC sets rules, regulations and policies to, among other things:
. grant licenses for PCS frequencies and license renewals,
. rule on assignments and transfers of control of PCS licenses,
. govern the interconnection of PCS networks with other wireless and
wireline carriers,
. establish access and universal service funding provisions,
. impose fines and forfeitures for violations of any of the FCC's rules,
and
. regulate the technical standards of PCS networks.
The FCC prohibits a single entity from having a combined attributable interest
(20% or greater interest in any license) in broadband PCS, cellular and
specialized mobile radio licenses totaling more than 45 megahertz (MHz) in any
geographic area.
PCS License Transfers and Assignments
The FCC must approve any substantial changes in ownership or control of a PCS
license. Noncontrolling interests in an entity that holds a PCS license or
operates PCS networks generally may be bought or sold without prior FCC
approval. In addition, a recent FCC order requires only post-consummation
notification of certain pro forma assignments or transfers of control.
5
PCS License Conditions
All PCS licenses are granted for 10-year terms if the FCC's buildout
requirements are followed. Based on those requirements, all 30 MHz broadband
major trading area licensees must build networks offering coverage to 1/3 of
the population within five years and 2/3 within 10 years. All 10 MHz broadband
PCS licensees must build networks offering coverage to at least 1/4 of the
population within five years or make a showing of "substantial service" within
that five-year period. Licenses may be revoked if the rules are violated.
PCS licenses may be renewed for additional 10-year terms. Renewal applications
are not subject to auctions. However, third parties may oppose renewal
applications and/or file competing applications.
Other FCC Requirements
Broadband PCS providers cannot unreasonably restrict or prohibit other
companies from reselling their services. They also cannot unreasonably
discriminate against resellers. Resale obligations will automatically expire in
2002.
Local phone companies and most CMRS carriers (PCS and cellular providers) must
program their networks to allow customers to change service providers without
changing phone numbers. This is referred to as service provider number
portability. Most CMRS providers were required to deliver calls from their
networks to ported numbers anywhere in the country by year-end 1998. By
November 2002, CMRS providers must be able to offer their own customers number
portability in their switches in the 100 largest metropolitan areas. They also
must be able to support nationwide roaming.
Broadband PCS and other CMRS providers may provide wireless local loop and
other fixed services that would directly compete with the wireline services of
local phone companies. Broadband PCS and other CMRS providers must implement
enhanced emergency 911 capabilities to be completed in phases by October 2001.
The PCS Group and other wireless carriers complied with the first phase in
October 1998 and are currently analyzing various technical methods for
complying with the second phase.
Communications Assistance for Law Enforcement Act
The Communications Assistance for Law Enforcement Act (CALEA) was enacted in
1994 to preserve electronic surveillance capabilities authorized by federal and
state law. CALEA requires telecommunications carriers to meet certain
"assistance capability requirements" by the end of June 2000. In 1997,
telecommunications industry standard-setting organizations agreed to a joint
standard to implement CALEA's capability requirements. The PCS Group is able to
offer traditional electronic surveillance capabilities to law enforcement and
is currently evaluating its ability to satisfy the CALEA requirements.
The FCC is also considering petitions from numerous parties to establish and
implement technical compliance standards required by CALEA.
Other Federal Regulations
Wireless systems must comply with certain FCC and Federal Aviation
Administration regulations about the siting, lighting and construction of
transmitter towers and antennas. In addition, certain FCC environmental
regulations may cause certain cell site locations to come under National
Environmental Policy Act (NEPA) regulation. NEPA requires carriers to meet
certain land use and radio frequency standards.
Review of Universal Service Requirements
The FCC and the states established a "universal service" program to ensure
affordable, quality telecommunications services for all Americans. Although the
PCS Group is challenging in federal court the states' authority to collect
universal service contributions from CMRS providers, the PCS Group is required
to contribute to the federal program as well as existing state programs. The
PCS Group's "contribution" to the federal program is a percentage of end-user
revenues. Although many states are likely to adopt a similar assessment
methodology, the states may calculate the contributions in any manner as long
as the process is consistent with FCC rules. Currently, management cannot
predict the extent of the PCS Group's total federal and state universal service
assessments, or its ability to recover its contributions from the universal
service fund.
Environmental Compliance
Sprint's environmental compliance and remediation expenditures mainly result
from the operation of standby power generators for its telecommunications
equipment. The expenditures arise in connection with standards compliance,
permits or occasional remediation, which are usually related to generators,
batteries or fuel storage. Sprint has been identified as a potentially
responsible party at sites relating to either landfill contamination or
discontinued power generation operations. Sprint's environmental compliance and
remediation expenditures have not been material to its financial statements or
to its operations and are not expected to have any future material adverse
effects on the FON Group or the PCS Group.
Patents, Trademarks and Licenses
Sprint owns numerous patents, patent applications, service marks and trademarks
in the United States and other countries. Sprint expects to apply for and
develop trademarks, service marks and patents for the benefit of the Groups in
the ordinary course of business. Sprint is a registered trademark of Sprint and
Sprint PCS is a registered service mark of Sprint. Sprint is also licensed
under domestic and foreign patents and trademarks owned by others. In total,
these patents, patent
6
applications, trademarks, service marks and licenses are of material importance
to the business. Generally, Sprint's trademarks, trademark licenses and service
marks have no limitation on duration; Sprint's patents and licensed patents
have lives generally ranging from one to 17 years.
Pursuant to certain of the PCS Group's third party supplier contracts, the PCS
Group has certain rights to use third party supplier trademarks in connection
with the buildout, marketing and operation of its network.
Employee Relations
At year-end 1998, Sprint had approximately 64,900 employees. Approximately
10,800 FON Group employees were represented by unions. During 1998, Sprint had
no material work stoppages caused by labor controversies.
Management
For information concerning the executive officers of Sprint, see "Executive
Officers of the Registrant" in this document.
Information as to Business Segments
For information required by this section, refer to Sprint's "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the FON Group's "Management's Discussion and Analysis of Financial Condition
and Results of Operations." Also refer to Note 14 of Sprint's "Notes to
Consolidated Financial Statements" and Note 12 of the FON Group's "Notes to
Combined Financial Statements" sections of the Financial Statements and
Financial Statement Schedules filed as part of this document.
- --------------------------------------------------------------------------------
Item 2. Properties
- --------------------------------------------------------------------------------
Sprint's gross property, plant and equipment totaled $32.1 billion at year-end
1998, of which $14.9 billion relates to the FON Group's local communications
services, $9.2 billion relates to the FON Group's long distance communications
services, and $7.0 billion relates to the PCS Group's PCS wireless services.
The FON Group's gross property, plant and equipment totaled $25.2 billion at
year-end 1998. These properties mainly consist of land, buildings, digital
fiber-optic network, switching equipment, microwave radio and cable and wire
facilities. Sprint leases certain switching equipment and several general
office facilities. The LDD has been granted easements, rights-of-way and
rights-of-occupancy, mainly by railroads and other private landowners, for its
fiber-optic network.
The product distribution and directory publishing businesses' properties mainly
consist of office and warehouse facilities to support the business units in the
distribution of telecommunications products and publication of telephone
directories.
The PCS Group's properties consist of leased and owned office space for its
corporate operations, network monitoring personnel, customer care centers and
retail stores. The PCS Group leases space for base station towers and switch
sites for its nationwide network. At year-end 1998, the PCS Group had under
lease (or options to lease) approximately 10,300 cell sites.
Sprint owns its corporate headquarters building and is in the process of
building a $700 million corporate campus in the greater Kansas City
metropolitan area.
Property, plant and equipment totaling $13.9 billion for the FON Group is
either pledged as security for first mortgage bonds and certain notes or is
restricted for use as mortgaged property. PCS Group property, plant and
equipment totaling $4.1 billion is pledged as security for certain notes.
- --------------------------------------------------------------------------------
Item 3. Legal Proceedings
- --------------------------------------------------------------------------------
The FON Group is involved in various legal proceedings arising in the ordinary
course of business. While it is not possible to determine the ultimate
disposition of each of these proceedings, the FON Group believes that the
outcome of such proceedings, individually and in the aggregate, will not have a
material adverse effect on the FON Group's financial condition or results of
operations.
The PCS Group has been involved in legal proceedings in various states
concerning the suspension of the processing or approval of permits for wireless
telecommunications towers, the denial of applications for permits and other
issues arising in connection with tower siting. There can be no assurance that
such litigation and similar actions taken by others seeking to block the
construction of individual cell sites of the PCS Group's network will not, in
the aggregate, significantly delay expansion of the PCS Group's network
coverage.
The PCS Group is involved in various other legal proceedings incidental to the
conduct of its business. While it is not possible to determine the ultimate
disposition of each of these proceedings, the PCS Group believes that the
outcome of such proceedings, individually or in the aggregate, will not have a
material adverse effect on the PCS Group's financial condition or results of
operations.
- --------------------------------------------------------------------------------
Item 4. Submission of Matters to a Vote of Security Holders
- --------------------------------------------------------------------------------
On November 13, 1998, Sprint held a Special Meeting of Shareholders to vote on
its proposal (the "Tracking Stock Proposal") involving, among other things,
. the restructuring of Sprint's wireless operations,
. the creation of the PCS Group and the FON Group, and
. the tax-free recapitalization of Sprint's outstanding publicly traded
common stock into PCS stock and FON stock.
7
In addition, the shareholders voted on a proposal (the "Incentive Plans
Proposal") to, among other things,
. authorize stock-based awards with respect to 10 million shares of PCS
stock to replace the Sprint Spectrum L.P. Long-Term Incentive
Compensation Plan and
. permit non-employee members of the Board of Directors to participate
with Sprint employees under the 1997 Long-Term Stock Incentive Program.
The shareholders approved both the Tracking Stock Proposal and the Incentive
Plans Proposal.
The following votes were cast with respect to the Tracking Stock Proposal:
FOR 315,477,746
AGAINST 4,007,712
ABSTAIN 2,253,484
The following votes were cast by the common stock, voting as a separate class,
with respect to the Tracking Stock Proposal:
FOR 229,124,699
AGAINST 4,005,695
ABSTAIN 2,246,702
The following votes were cast by the Class A common stock, voting as a separate
class, with respect to the Tracking Stock Proposal:
FOR 86,236,036
AGAINST --
ABSTAIN --
The following votes were cast with respect to the Incentive Plans Proposal:
FOR 235,654,776
AGAINST 83,360,499
ABSTAIN 2,723,667
8
- --------------------------------------------------------------------------------
Item 10(b). Executive Officers of the Registrant
- --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Office Name Age
- -------------------------------------------------------------------------------
Chairman and Chief Executive Officer William T. Esrey(/1/) 59
President and Chief Operating Officer Ronald T. LeMay(/2/) 53
President--Local Telecommunications Division Michael B. Fuller(/3/) 54
President--Long Distance Division Patti S. Manuel(/4/) 42
President--Sprint PCS Andrew J. Sukawaty(/5/) 43
President--Sprint International John E. Berndt(/6/) 58
President--National Integrated Services Kevin E. Brauer(/7/) 48
Executive Vice President--General Counsel and
External Affairs J. Richard Devlin(/8/) 48
Executive Vice President--Chief Financial Officer Arthur B. Krause(/9/) 57
Senior Vice President--Treasurer Gene M. Betts(/10/) 46
Senior Vice President--One Sprint Strategic
Development Arthur A. Kurtze(/11/) 54
Senior Vice President--Controller John P. Meyer(/12/) 48
Senior Vice President--Strategic Planning and
Corporate Development Theodore H. Schell(/13/) 54
Senior Vice President--Human Resources I. Benjamin Watson(/14/) 50
Senior Vice President--Consumer Market Strategy
and Communications Thomas E. Weigman(/15/) 51
Vice President--Secretary Don A. Jensen(/16/) 63
(/1/Mr.)Esrey was elected Chairman in 1990. He was elected Chief Executive
Officer and a member of the Board of Directors in 1985.
(/2/Mr.)LeMay was first elected President and Chief Operating Officer in
February 1996. From July 1997 to October 1997, he served as Chairman and
Chief Executive Officer of Waste Management, Inc., a provider of
comprehensive waste management services. He was re-elected President and
Chief Operating Officer of Sprint effective October 1997. From 1995 to 1996
Mr. LeMay served as Vice Chairman of Sprint. He also served as Chief
Executive Officer of Sprint Spectrum Holding Company from 1995 to 1996.
From 1989 to 1995, he served as President and Chief Operating Officer--Long
Distance Division. Mr. LeMay served on Sprint's Board of Directors from
1993 until he went to work for Waste Management, Inc. He was re-elected to
Sprint's Board of Directors in December 1997.
(/3/Mr.)Fuller was elected President--Local Telecommunications Division in
October 1996. From 1990 to 1996, he served as President of United
Telephone--Midwest Group, an operating group of subsidiaries of Sprint.
(/4/Ms.)Manuel was elected President--Long Distance Division in February 1998.
She was also elected as President and Chief Operating Officer of the
Limited Partnership in February 1998. She had served as President of Sprint
Business, a division of the Limited Partnership, since May 1997. From 1994
to 1997, she was President of sales and marketing for Sprint Business. She
was named President of marketing for Sprint Business in 1993.
(/5/Mr.)Sukawaty was elected President--Sprint PCS in December 1998. He was
appointed Chief Executive Officer of Sprint Spectrum Holding Company in
September 1996. Prior to joining Sprint Spectrum Holding Company, Mr.
Sukawaty was Chief Executive Officer of NTL, the British diversified
broadcast transmission and communications company, since 1994. From 1989 to
1993, he was Chief Operating Officer of Mercury One-2-One, the British
company which started the world's first PCS service in the United Kingdom
in 1993.
(/6/Mr.)Berndt was elected President--Sprint International in April 1998.
Before that, Mr. Berndt was President of Fluor Daniel Telecommunications
since January 1997. He was President--Multimedia Ventures and Technologies
for AT&T and Lucent Technologies from 1995 to 1996. From 1993 to 1995, Mr.
Berndt was President of New Business Development for AT&T.
(/7/Mr.)Brauer was elected President--National Integrated Services in October
1997. He had served as Senior Vice President since June 1997. From 1994 to
1997, he was President of Sprint Business and from 1993 to 1994, he was
President of Sales of Sprint Business.
(/8/Mr.)Devlin was elected Executive Vice President--General Counsel and
External Affairs in 1989.
(/9/Mr.)Krause was elected Executive Vice President--Chief Financial Officer in
1988.
(/10/Mr.)Betts was elected Senior Vice President in 1990. He was elected
Treasurer in December 1998.
(/11/Mr.)Kurtze was appointed Senior Vice President--One Sprint Strategic
Development in February 1999. He had served as Chief Operating Officer of
Sprint Spectrum Holding Company since 1995. Prior to joining Sprint
Spectrum Holding Company, Mr. Kurtze was Senior Vice President--Operations
for Sprint's Local Division since 1993.
(/12/Mr.)Meyer was elected Senior Vice President--Controller in 1993.
(/13/Mr.)Schell was elected Senior Vice President--Strategic Planning and
Corporate Development in 1990.
(/14/Mr.)Watson was elected Senior Vice President--Human Resources in 1993.
(/15/Mr.)Weigman was appointed Senior Vice President--Consumer Market Strategy
and Communications in February 1999. He had served as President--Consumer
Services Group of Sprint's Long Distance Division since 1995. From 1993 to
1995, he served as President--Multimedia/Strategic Services of the Long
Distance Division. He joined the Long Distance Division as Chief Marketing
Officer in 1991.
(/16/Mr.)Jensen was elected Vice President--Secretary in 1975.
There are no known family relationships between any of the persons named above
or between any of these persons and any outside directors of Sprint. Officers
are elected annually.
9
Part II
- --------------------------------------------------------------------------------
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
- --------------------------------------------------------------------------------
Common Stock Data
- ------------------------------------------------
1998 Market Price
---------------------------
End
of
High Low Period
- ------------------------------------------------
Sprint Stock
First quarter $75 5/8 $55 1/4 $67 11/16
Second quarter 75 5/8 65 70 1/2
Third quarter 80 1/8 61 1/2 72
Fourth quarter(/1/) 82 7/8 69 1/16 81 5/16
FON Stock(/2/) 85 5/16 71 5/8 84 1/8
PCS Stock(/2/) 23 3/8 14 1/16 23 1/8
- ------------------------------------------------
1997 Market Price
---------------------------
End
of
High Low Period
- ------------------------------------------------
Sprint Stock
First quarter $48 $38 3/8 $45 3/8
Second quarter 52 3/4 42 1/4 52 1/4
Third quarter 52 5/8 44 50
Fourth quarter 60 5/8 48 3/4 58 5/8
(/1/Fourth)quarter per share market data is for the period October 1, 1998
through November 23, 1998.
(/2/FON)Stock and PCS Stock per share market data is for the period November
24, 1998 through December 31, 1998.
As of February 28, 1999, Sprint had approximately 78,000 FON stock record
holders, 75,000 PCS stock record holders and two Class A common stock record
holders. The principal trading market for Sprint's FON stock and PCS stock is
the New York Stock Exchange. The Class A common stock is not publicly traded.
Sprint paid a FON stock dividend of $0.25 per share in the fourth quarter of
1998. Sprint paid common stock dividends of $0.25 per share in the first three
quarters of 1998 and each quarter of 1997. Sprint paid Class A common stock
dividends of $0.25 per share in each quarter of 1998 and 1997. Sprint does not
intend to pay dividends on the PCS stock in the foreseeable future.
During 1998 and the first part of 1999, Sprint issued the following securities
which were not registered under the Securities Act of 1933, as amended.
In November 1998, Sprint issued an aggregate of 195,094,340 shares of Series 2
PCS low-vote stock, warrants to purchase an aggregate of 12,452,831 shares of
PCS Stock and 246,766 shares of Convertible Preferred Stock, Seventh Series
(PCS preferred stock) to the Cable Partners in connection with the PCS
Restructuring. The Series 2 PCS stock and the warrants were issued as
consideration for the Cable Partners' interests in Sprint PCS. The PCS
preferred stock was issued either to purchase certain debt loaned to Sprint PCS
by the Cable Partners or as consideration for their interests in Sprint PCS.
Each warrant is exercisable for a share of PCS stock at any time before
November 2003 at an exercise price with respect to each warrant equal to
approximately $24.02. Each share of PCS preferred stock is convertible into
approximately 32.5 shares of PCS stock.
In November 1998, in connection with the PCS Restructuring and the issuance of
PCS stock and PCS preferred stock to the Cable Partners, Sprint issued an
aggregate of 5,198,668 shares of Series 3 PCS stock to FT and DT for an
aggregate of $85 million. These shares were purchased by FT and DT in order to
maintain their aggregate voting power at 20% of Sprint's outstanding voting
power.
In February 1999, Sprint issued an aggregate of 6,100,750 shares of Series 3
PCS stock to FT and DT for an aggregate of $169 million in conjunction with the
registered public offering of 24,403,000 shares of Series 1 PCS stock. These
shares were also purchased by FT and DT in order to maintain their aggregate
voting power at 20% of Sprint's outstanding voting power.
All of the transactions described above were exempt from the registration
requirements of the Securities Act pursuant to Section 4(2) of the Securities
Act. No solicitation was made to sell such shares to the public, and the Cable
Partners, FT and DT were each provided with all material information that was
available regarding Sprint. All of the purchasers are accredited investors
having sufficient knowledge and experience in financial and business matters
necessary to evaluate the merits and risks of their investment. All of such
purchasers were informed that the transactions were being effected without
registration under the Securities Act and that the shares acquired could not be
resold without registration under the Securities Act unless the sale is
effected pursuant to an exemption from the registration requirements of the
Securities Act. The Cable Partners, FT and DT have been given certain
registration rights by Sprint.
- --------------------------------------------------------------------------------
Item 6. Selected Financial Data
- --------------------------------------------------------------------------------
For information required by Item 6, refer to the "Selected Financial Data"
sections of the Financial Statements and Financial Statement Schedules filed as
part of this document.
- --------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
- --------------------------------------------------------------------------------
For information required by Item 7, refer to the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" sections of the
Financial Statements and Financial Statement Schedules filed as part of this
document.
10
- --------------------------------------------------------------------------------
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
- --------------------------------------------------------------------------------
Sprint's exposure to market risk--through derivative financial instruments and
other financial instruments, such as investments in marketable securities and
long-term debt--is not material.
- --------------------------------------------------------------------------------
Item 8. Financial Statements and Supplementary Data
- --------------------------------------------------------------------------------
For information required by Item 8, refer to the "Consolidated Financial
Statements" and "Combined Financial Statements" sections of the Financial
Statements and Financial Statement Schedules filed as part of this document.
- --------------------------------------------------------------------------------
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
- --------------------------------------------------------------------------------
None.
11
Part III
- --------------------------------------------------------------------------------
Item 10. Directors and Executive Officers of the Registrant
- --------------------------------------------------------------------------------
Pursuant to Instruction G(3) to Form 10-K, the information relating to
Directors of Sprint required by Item 10 is incorporated by reference from
Sprint's definitive proxy statement which is to be filed pursuant to Regulation
14A within 120 days after the end of Sprint's fiscal year ended December 31,
1998.
For information pertaining to Executive Officers of Sprint, as required by
Instruction 3 of Paragraph (b) of Item 401 of Regulation S-K, refer to the
"Executive Officers of the Registrant" section of Part I of this document.
Pursuant to Instruction G(3) to Form 10-K, the information relating to
compliance with Section 16(a) required by Item 10 is incorporated by reference
from Sprint's definitive proxy statement which is to be filed pursuant to
Regulation 14A within 120 days after the end of Sprint's fiscal year ended
December 31, 1998.
- --------------------------------------------------------------------------------
Item 11. Executive Compensation
- --------------------------------------------------------------------------------
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 11
is incorporated by reference from Sprint's definitive proxy statement which is
to be filed pursuant to Regulation 14A within 120 days after the end of
Sprint's fiscal year ended December 31, 1998.
- --------------------------------------------------------------------------------
Item 12. Security Ownership of Certain Beneficial Owners and Management
- --------------------------------------------------------------------------------
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 12
is incorporated by reference from Sprint's definitive proxy statement which is
to be filed pursuant to Regulation 14A within 120 days after the end of
Sprint's fiscal year ended December 31, 1998.
- --------------------------------------------------------------------------------
Item 13. Certain Relationships and Related Transactions
- --------------------------------------------------------------------------------
Pursuant to Instruction G(3) to Form 10-K, the information required by Item 13
is incorporated by reference from Sprint's definitive proxy statement which is
to be filed pursuant to Regulation 14A within 120 days after the end of
Sprint's fiscal year ended December 31, 1998.
12
Part IV
- --------------------------------------------------------------------------------
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
- --------------------------------------------------------------------------------
(a) 1. The consolidated financial statements of Sprint and the combined
financial statements of the FON Group and the PCS Group, filed as part
of this report, are listed in the Index to Financial Statements and
Financial Statement Schedules.
2. The consolidated financial statement schedule of Sprint and the combined
financial statement schedules of the FON Group and the PCS Group, filed
as part of this report, are listed in the Index to Financial Statements
and Financial Statement Schedules.
3. The following exhibits are filed as part of this report:
EXHIBITS
(3) Articles of Incorporation and Bylaws:
(a) Articles of Incorporation, as amended (filed as Exhibit 4A to
Post-Effective Amendment No. 2 to Sprint Corporation's
Registration Statement on Form S-3 (No. 33-58488) and
incorporated herein by reference).
(b) Bylaws, as amended (filed as Exhibit 4C to Post-Effective
Amendment No. 2 to Sprint Corporation's Registration Statement on
Form S-3 (No. 33-58488) 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 Exhibit 3(a).
(b) Rights Agreement dated as of November 23, 1998, between Sprint
Corporation and UMB Bank, n.a. (filed as Exhibit 4.1 to Amendment
No. 1 to Sprint Corporation's Registration Statement on Form 8-A
relating to Sprint's PCS Group Rights, filed November 25, 1998,
and incorporated herein by reference).
(c) Tracking Stock Policies of Sprint Corporation (filed as Exhibit
4D to Post-Effective Amendment No. 2 to Sprint Corporation's
Registration Statement on Form S-3 (No. 33-58488) and
incorporated herein by reference).
(d) Amended and Restated Standstill Agreement dated November 23,
1998, by and among Sprint Corporation, France Telecom S.A. and
Deutsche Telekom AG (filed as Exhibit 4E to Post-Effective
Amendment No.2 to Sprint Corporation's Registration Statement on
Form S-3 (No. 33-58488) and incorporated herein by reference).
(e) Indenture, dated as of October 1, 1998, among Sprint Capital
Corporation, Sprint Corporation and Bank One, N.A., as Trustee
(filed as Exhibit 4(b) to Sprint Corporation's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1998, and
incorporated herein by reference).
(f) First Supplemental Indenture, dated as of January 15, 1999, among
Sprint Capital Corporation, Sprint Corporation and Bank One,
N.A., as Trustee (filed as Exhibit 4(b) to Sprint Corporation
Current Report on Form 8-K dated February 2, 1999 and
incorporated herein by reference).
(g) Indenture, dated as of October 1, 1998, between Sprint
Corporation and Bank One, N.A., as Trustee (filed as Exhibit 4(a)
to Sprint Corporation's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1998, and incorporated herein by
reference).
(h) First Supplemental Indenture, dated as of January 15, 1999,
between Sprint Corporation and Bank One, N.A., as Trustee (filed
as Exhibit 4(a) to Sprint Corporation Current Report on Form 8-K
dated February 2, 1999 and incorporated herein by reference).
13
(10) Material Agreements
(a) Joint Venture Agreement dated as of June 22, 1995 among Sprint
Corporation, Sprint Global Venture, Inc., France Telecom S.A. and
Deutsche Telekom AG (filed as Exhibit (10)(a) to Sprint
Corporation Quarterly Report on Form 10-Q for the quarter ended
June 30, 1995 and incorporated herein by reference).
(b) Amendment No. 1 to Joint Venture Agreement, dated as of January
31, 1996, among Sprint Corporation, Sprint Global Venture, Inc.,
France Telecom, Deutsche Telekom AG and Atlas Telecommunications,
S.A. (filed as Exhibit 99A to Sprint Corporation Current Report
on Form 8-K dated January 31, 1996 and incorporated herein by
reference).
(c) Amended and Restated Stockholders' Agreement among France Telecom
S.A., Deutsche Telekom AG and Sprint Corporation, dated as of
November 23, 1998.
(d) Restructuring and Merger Agreement By and Among Sprint
Corporation, Tele-Communications, Inc., Comcast Corporation, Cox
Communications, Inc. and certain of their subsidiaries, dated as
of May 26, 1998 (filed as Exhibit 2 to Sprint Corporation Current
Report on Form 8-K dated May 26, 1998 and incorporated herein by
reference).
(e) Amended and Restated Registration Rights Agreement, dated as of
November 23, 1998, among Sprint Corporation, France Telecom S.A.
and Deutsche Telekom A.G. (filed as Exhibit 10.1 to Amendment No.
1 to Sprint Corporation Registration Statement on Form S-3 (No.
333-64241) and incorporated herein by reference).
(f) Registration Rights Agreement, dated as of November 23, 1998,
among Sprint Corporation, Tele-Communications, Inc., Comcast
Corporation and Cox Communications, Inc. (filed as Exhibit 10.2
to Amendment No. 1 to Sprint Corporation Registration Statement
on Form S-3 (No. 333-64241) and incorporated herein by
reference).
(g) Standstill Agreements, dated May 26, 1996, between Sprint
Corporation and each of Tele-Communications, Inc., Comcast
Corporation and Cox Communications, Inc.
(h) 364-Day Credit Agreement, dated as of August 7, 1998, among
Sprint Corporation and Sprint Capital Corporation, as Borrowers,
and the initial Lenders named therein, as Initial Lenders, and
Citibank, N.A., as Administrative Agent, and Morgan Guaranty
Trust Company of New York, as Syndication Agent, and Bank of
America National Trust and Savings Association and The Chase
Manhattan Bank, as Documentation Agents (filed as Exhibit 10.23
to Sprint Corporation Registration Statement on Form S-3 (No.
333-64241) and incorporated herein by reference).
(i) Five-Year Credit Agreement, dated as of August 7, 1998, among
Sprint Corporation and Sprint Capital Corporation, as Borrowers,
and the initial Lenders named therein, as Initial Lenders, and
Citibank, N.A., as Administrative Agent, and Morgan Guaranty
Trust Company of New York, as Syndication Agent, and Bank of
America National Trust and Savings Association and The Chase
Manhattan Bank, as Documentation Agents (filed as Exhibit 10.24
to Sprint Corporation Registration Statement on Form S-3 (No.
333-64241) and incorporated herein by reference).
(10) Executive Compensation Plans and Arrangements:
(j) 1985 Stock Option Plan, as amended (filed as Exhibit (10)(a) to
Sprint Corporation Quarterly Report on Form 10-Q for the quarter
ended September 30, 1997 and incorporated herein by reference).
(k) 1990 Stock Option Plan, as amended.
(l) 1990 Restricted Stock Plan, as amended.
(m) Executive Deferred Compensation Plan, as amended (filed as
Exhibit (10)(k) to Sprint Corporation Annual Report on Form 10-K
for the year ended December 31, 1996 and incorporated herein by
reference). Summary of amendments (filed as Exhibit 10(c) to
Sprint Corporation Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 and incorporated herein by reference).
Summary of additional amendments.
(n) Management Incentive Stock Option Plan, as amended.
14
(o) 1997 Long-Term Stock Incentive Program (filed as part of Annex
VII to the proxy statement/prospectus that forms a part of Sprint
Corporation's Registration Statement on Form S-4 (No. 333-65173)
and incorporated herein by reference).
(p) Sprint Supplemental Executive Retirement Plan (filed as Exhibit
(10)(i) to Sprint Corporation Quarterly Report on Form 10-Q for
the quarter ended September 30, 1995 and incorporated herein by
reference).
(q) Amended and Restated Centel Directors Deferred Compensation Plan
(filed as Exhibit (10)(c) to Sprint Corporation Quarterly Report
on Form 10-Q for the quarter ended September 30, 1997 and
incorporated herein by reference).
(r) Restated Memorandum Agreements Respecting Supplemental Pension
Benefits between Sprint Corporation (formerly United
Telecommunications, Inc.) and two of its current and former
executive officers (filed as Exhibit 10(i) to Sprint Corporation
Annual Report on Form 10-K for the year ended December 31, 1992,
and incorporated herein by reference).
(s) Executive Long-Term Incentive Plan (filed as Exhibit 10(j) to
Sprint Corporation Annual Report on Form 10-K for the year ended
December 31, 1993 and incorporated herein by reference).
(t) Executive Management Incentive Plan (filed as Exhibit 10(k) to
Sprint Corporation Annual Report on Form 10-K for the year ended
December 31, 1993 and incorporated herein by reference).
(u) Long-Term Incentive Compensation Plan, as amended (filed as
Exhibit 10(i) to Sprint Corporation Quarterly Report on Form 10-Q
for the quarter ended September 30, 1996, and incorporated herein
by reference).
(v) Short-Term Incentive Compensation Plan (filed as Exhibit 10(k) to
United Telecommunications, Inc. Annual Report on Form 10-K for
the year ended December 31, 1989, and incorporated herein by
reference).
(w) Retirement Plan for Directors, as amended (filed as Exhibit
(10)(u) to Sprint Corporation Annual Report on Form 10-K for the
year ended December 31, 1996 and incorporated herein by
reference).
(x) Key Management Benefit Plan, as amended (filed as Exhibit 10(g)
to Sprint Corporation Quarterly Report on Form 10-Q for the
quarter ended September 30, 1996 and incorporated herein by
reference).
(y) Agreements Regarding Special Compensation and Post Employment
Restrictive Covenants between Sprint Corporation and certain of
its Executive Officers (filed as Exhibit 10(d) to Sprint
Corporation Quarterly Report on Form 10-Q for the quarter ended
September 30, 1994, Exhibit 10(h) to Sprint Corporation Quarterly
Report on Form 10-Q for the quarter ended March 31, 1996, Exhibit
(10)(w) to Sprint Corporation Annual Report on Form 10-K for the
year ended December 31, 1996, Exhibit 10(w) to Sprint Corporation
Annual Report on Form 10-K for the year ended December 31, 1997,
and Exhibit 10 (b) to Sprint Corporation Quarterly Report on Form
10-Q for the quarter ended June 30, 1998, and incorporated herein
by reference).
(z) Director's Deferred Fee Plan, as amended (filed as Exhibit
(10)(x) to Sprint Corporation Annual Report on Form 10-K for the
year ended December 31, 1996 and incorporated herein by
reference). Summary of amendments (filed as Exhibit 10(c) to
Sprint Corporation Quarterly Report on Form 10-Q for the quarter
ended June 30, 1998 and incorporated herein by reference).
Summary of additional amendments (see Exhibit (10)(m)).
(aa) Form of Contingency Employment Agreements between Sprint
Corporation and certain of its executive officers (filed as
Exhibit 10(b) to Sprint Corporation Quarterly Report on Form 10-
Q for the quarter ended March 31, 1995, and incorporated herein
by reference).
(bb) Form of Indemnification Agreements between Sprint Corporation
(formerly United Telecommunications, Inc.) and its Directors and
Officers (filed as Exhibit 10(s) to Sprint Corporation Annual
Report on Form 10-K for the year ended December 31, 1991, and
incorporated herein by reference).
15
(cc) Summary of Executive Officer and Board of Directors Benefits.
(dd) Amended and Restated Centel Director Stock Option Plan (filed as
Exhibit 10(aa) to Sprint Corporation Annual Report on Form 10-K
for the year ended December 31, 1993, and incorporated herein by
reference).
(ee) Employment Agreement, dated as of July 29, 1996, between Sprint
Spectrum Holding Company, L.P. and Andrew Sukawaty (filed as
Exhibit 10.20 to Sprint Spectrum L.P. Registration Statement on
Form S-1 (No. 333-06609) and incorporated herein by reference).
(12) Computation of Ratio of Earnings to Fixed Charges
(21) Subsidiaries of Registrant
(23) (a)Consent of Ernst & Young LLP
(b) Consent of Deloitte & Touche LLP
(27) Financial Data Schedules
(a) December 31, 1998
(b) September 30, 1998 Restated
(c) June 30, 1998 Restated
(d) March 31, 1998 Restated
(e) December 31, 1997 Restated
(f) December 31, 1996 Restated
Sprint will furnish to the Securities and Exchange Commission, upon request, a
copy of the instruments defining the rights of holders of its long-term debt.
The total amount of securities authorized under any of said instruments (other
than those listed above) does not exceed 10% of the total assets of Sprint.
16
(b)Reports on Form 8-K
Sprint filed a Current Report on Form 8-K dated October 28, 1998, in which it
reported that it had elected to delay a planned public offering of its PCS
stock and would, instead, proceed with the Recapitalization, subject to
shareholder approval.
Sprint filed a Current Report on Form 8-K dated November 2, 1998 in which it
reiterated that it had elected to proceed with the Recapitalization, subject to
shareholder approval, and that it would proceed with a debt offering. Sprint
included in this Current Report the audited consolidated financial results of
Sprint and the audited combined financial results of the FON Group, the PCS
Group and Sprint Spectrum Holding Company combined with MinorCo and PhillieCo
as well as certain other information contained in the proxy
statement/prospectus sent to Sprint shareholders in connection with the PCS
Restructuring and the Recapitalization, updated to reflect (1) financial
results and other information for the nine months ended September 30, 1998, (2)
the delay of the planned public offering of PCS Stock, and (3) the planned debt
offering. The financial statements included the following:
Annex I-Sprint Corporation Information
-Selected Financial Data
-Sprint Corporation Management's Discussion and Analysis of
Financial Condition and Results of Operations
-Report of Independent Auditors
-Independent Auditors' Report
-Sprint Corporation Consolidated Financial Statements and Notes
thereto
-Sprint Corporation Unaudited Pro Forma Condensed Combined
Financial Statements and Notes thereto
Annex II-PCS Group Information
-Business
-Historical PCS Group Selected Financial Data
-PCS Group Management's Discussion and Analysis of Financial
Condition and Results of Operations
-Report of Independent Auditors
-PCS Group Combined Financial Statements and Notes thereto
-Sprint Spectrum Holding Company Combined with MinorCo and
PhillieCo Selected Financial Data
-Sprint Spectrum Holding Company Combined with MinorCo and
PhillieCo Management's Discussion and Analysis of Financial
Condition and Results of Operations
-Independent Auditors' Report
-Sprint Spectrum Holding Company Combined with MinorCo and
PhillieCo Financial Statements and Notes thereto
-PCS Group Unaudited Pro Forma Condensed Combined Financial
Statements and Notes thereto
Annex III-FON Group Information
-Business
-FON Group Selected Financial Data
-FON Group Management's Discussion and Analysis of Financial
Condition and Results of Operations
-Report of Independent Auditors
-FON Group Combined Financial Statements and Notes thereto
Sprint filed a Current Report on Form 8-K dated November 12, 1998 in order to
file the Computation of Supplemental Pro Forma Ratios of Earnings to Fixed
Charges in connection with its $5.0 billion debt offering.
Sprint filed a Current Report on Form 8-K dated November 23, 1998 in which it
reported consummation of the PCS Restructuring.
(c)Exhibits are listed in Item 14(a).
17
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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/ W. T. Esrey
-------------------------------------
William T. Esrey
Chairman and Chief Executive Officer
Date: March 5, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 5th day of March, 1999.
/s/ W. T. Esrey
-------------------------------------
William T. Esrey
Chairman and Chief Executive Officer
/s/ Arthur B. Krause
-------------------------------------
Arthur B. Krause
Executive Vice President and Chief
Financial Officer
/s/ John P. Meyer
-------------------------------------
John P. Meyer
Senior Vice President and Controller
Principal Accounting Officer
18
SIGNATURES
SPRINT CORPORATION
(Registrant)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 5th day of March, 1999.
/s/ DuBose Ausley /s/ Ronald T. LeMay
- ------------------------------------- -------------------------------------
DuBose Ausley, Director
Ronald T. LeMay, Director
/s/ Warren L. Batts /s/ Linda K. Lorimer
- ------------------------------------- -------------------------------------
Warren L. Batts, Director
Linda K. Lorimer, Director
/s/ Michel Bon /s/ Charles E. Rice
- ------------------------------------- -------------------------------------
Michel Bon, Director
Charles E. Rice, Director
/s/ W. T. Esrey /s/ Ron Sommer
- ------------------------------------- -------------------------------------
William T. Esrey, Director
Ron Sommer, Director
/s/ Irvine O. Hockaday Jr. /s/ Stewart Turley
- ------------------------------------- -------------------------------------
Irvine O. Hockaday Jr., Director
Stewart Turley, Director
/s/ Harold S. Hook
- -------------------------------------
Harold S. Hook, Director
19
INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES
Page
Reference
ANNEX I ---------
SPRINT CORPORATION
- ------------------
Selected Financial Data I-1
Management's Discussion and Analysis of Financial Condition and
Results of Operations I-2
Consolidated Financial Statements
Management Report I-11
Report of Independent Auditors I-12
Consolidated Statements of Income for each of the three years ended
December 31, 1998 I-13
Consolidated Statements of Comprehensive Income for each of the
three years ended December 31, 1998 I-15
Consolidated Balance Sheets as of December 31, 1998 and 1997 I-16
Consolidated Statements of Cash Flows for each of the three years
ended December 31, 1998 I-17
Consolidated Statements of Shareholders' Equity for each of the
three years ended December 31, 1998 I-18
Notes to Consolidated Financial Statements I-19
Financial Statement Schedule
Schedule II--Consolidated Valuation and Qualifying Accounts for each
of the three years ended December 31, 1998 I-36
ANNEX II
SPRINT FON GROUP
- ----------------
Selected Financial Data II-1
Management's Discussion and Analysis of Financial Condition and
Results of Operations II-2
Combined Financial Statements
Management Report II-9
Report of Independent Auditors II-9
Combined Statements of Income for each of the three years ended
December 31, 1998 II-10
Combined Statements of Comprehensive Income for each of the three
years ended December 31, 1998 II-11
Combined Balance Sheets as of December 31, 1998 and 1997 II-12
Combined Statements of Cash Flows for each of the three years ended
December 31, 1998 II-13
Notes to Combined Financial Statements II-14
Financial Statement Schedule
Schedule II--Combined Valuation and Qualifying Accounts for each of
the three years ended December 31, 1998 II-27
ANNEX III
SPRINT PCS GROUP
- ----------------
Selected Financial Data III-1
Management's Discussion and Analysis of Financial Condition and
Results of Operations III-2
Combined Financial Statements
Management Report III-7
Report of Independent Auditors III-8
Combined Statements of Operations for each of the three years ended
December 31, 1998 III-10
Combined Balance Sheets as of December 31, 1998 and 1997 III-11
Combined Statements of Cash Flows for each of the three years ended
December 31, 1998 III-12
Notes to Combined Financial Statements III-13
Financial Statement Schedule
Schedule II--Combined Valuation and Qualifying Accounts for the year
ended December 31, 1998 III-24
Annex I
SPRINT CORPORATION
Consolidated Financial Information
SELECTED FINANCIAL DATA Sprint Corporation
- ---------------------------------------------------------------------------------
1998 1997 1996 1995 1994
- ---------------------------------------------------------------------------------
(in millions, except per share data)
Results of Operations
- ---------------------------------------------------------------------------------
Net operating revenues $17,134.3 $14,873.9 $13,887.5 $12,735.3 $11,964.8
Operating income(/1/),(/2/) 190.4 2,451.4 2,267.2 1,834.3 1,690.7
Income from continuing
operations(/1/),(/2/),(/3/) 450.5 952.5 1,190.9 946.1 899.2
Earnings per Share and Divi-
dends
- ---------------------------------------------------------------------------------
Earnings per common share
from continuing
operations:(/2/),(/3/)
Diluted $ NM $ 2.18 $ 2.79 $ 2.69 $ 2.56
Basic NM 2.21 2.82 2.71 2.59
Dividends per common share 1.00 1.00 1.00 1.00 1.00
Pro Forma Earnings (Loss)
per Share(/4/)
- ---------------------------------------------------------------------------------
Earnings (Loss) per common
share from continuing
operations:(/2/),(/3/)
Sprint FON Group (diluted) $ 3.55 $ 3.14 $ 3.07 $ 2.74 $ 2.56
Sprint FON Group (basic) 3.61 3.19 3.11 2.76 2.59
Sprint PCS Group (diluted
and basic) (4.42) (3.52) NA NA NA
Financial Position
- ---------------------------------------------------------------------------------
Total assets $33,231.1 $18,273.6 $16,915.2 $15,074.3 $14,425.2
Property, plant and
equipment, net 18,983.0 11,494.1 10,464.1 9,715.8 10,258.8
Total debt (including short-
term borrowings) 12,189.3 3,879.6 3,273.9 5,668.9 4,927.7
Shareholders' equity 12,448.3 9,025.2 8,519.9 4,642.6 4,524.8
Cash Flow Data
- ---------------------------------------------------------------------------------
Net cash provided by
operating activities--
continuing operations(/5/) $ 4,255.4 $ 3,379.0 $ 2,403.5 $ 2,609.6 $ 2,339.6
Capital expenditures 4,231.1 2,862.6 2,433.6 1,857.3 1,751.6
Certain prior-year amounts have been reclassified to conform to the current-
year presentation. These reclassifications had no effect on the results of
operations or shareholders' equity as previously reported.
Sprint's 1998 results of operations include Sprint PCS' operating results on a
consolidated basis for the entire year. The Cable Partners' share of losses
through the PCS Restructuring date has been reflected as "Other partners' loss
in Sprint PCS" in the Consolidated Statements of Income. Before 1998, Sprint's
investment in Sprint PCS was accounted for using the equity method. Sprint PCS'
financial position at year-end 1998 has also been reflected on a consolidated
basis. Cash flow data reflects Sprint PCS' cash flows only after the PCS
Restructuring date. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--General" for a more detailed description
of the PCS Restructuring, the Recapitalization and the Top-up.
(/1/In)1998, the PCS Group recorded a nonrecurring charge to write off $179
million of acquired in-process research and development costs related to
the PCS Restructuring. This charge reduced operating income and income from
continuing operations by $179 million.
(/2/The)FON Group recorded nonrecurring charges of $20 million in 1997 and $60
million in 1996 related to litigation within the long distance division.
These charges reduced income from continuing operations by $13 million in
1997 and $36 million in 1996. In 1995, The FON Group recorded a
nonrecurring charge of $88 million related to a restructuring within the
local division. This reduced income from continuing operations by $55
million.
(/3/In)1998, the FON Group recorded net nonrecurring gains of $104 million
mainly from the sale of local exchanges. This increased income from
continuing operations by $62 million. In 1997, The FON Group recorded
nonrecurring gains of $71 million mainly from sales of local exchanges and
certain investments. These gains increased income from continuing
operations by $44 million. In 1994, the FON Group recognized a $35 million
gain on the sale of equity securities, which increased income from
continuing operations by $22 million.
(/4/Pro)forma earnings per share for the FON Group assumes the FON shares
created in the Recapitalization existed for all periods presented.
Pro forma loss per share for the PCS Group assumes the PCS Restructuring,
the Recapitalization and the Top-up occurred at the beginning of 1997 and
excludes the PCS Group's write-off of $179 million of acquired in-process
research and development costs. These pro forma amounts are for comparative
purposes only and do not necessarily represent what actual results of
operations would have been had the transactions occurred at the beginning of
1997, nor do they indicate the results of future operations.
(/5/The)1996 amount was reduced by $600 million for cash required to terminate
an accounts receivable sales agreement.
NM = Not meaningful
NA = Not applicable
I-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Sprint Corporation
- --------------------------------------------------------------------------------
General
- --------------------------------------------------------------------------------
In November 1998, Sprint's shareholders approved the formation of the FON Group
and the PCS Group and the creation of the FON stock and the PCS stock. In
addition, Sprint purchased the remaining ownership interests in Sprint Spectrum
Holding Company, L.P. and PhillieCo, L.P. (together, Sprint PCS), other than a
minority interest in Cox Communications PCS, L.P. (Cox PCS). Sprint acquired
these ownership interests from Tele-Communications, Inc., Comcast Corporation
and Cox Communications, Inc. (the Cable Partners). In exchange, Sprint issued
the Cable Partners special low-vote PCS shares and warrants to acquire
additional PCS shares. Sprint also issued the Cable Partners shares of a new
class of preferred stock convertible into PCS shares. The purchase of the Cable
Partners' interests is referred to as the PCS Restructuring.
Also in November 1998, Sprint reclassified each of its publicly traded common
shares into one share of FON stock and 1/2 share of PCS stock. This
recapitalization was tax-free to shareholders. Each Class A common share owned
by France Telecom S.A. (FT) and Deutsche Telekom AG (DT) was reclassified to
represent an equity interest in the FON Group and the PCS Group that entitles
FT and DT to one share of FON stock and 1/2 share of PCS stock. These
transactions are referred to as the Recapitalization.
In connection with the PCS Restructuring, FT and DT purchased 5.1 million
additional PCS shares to maintain their combined 20% voting power in Sprint
(Top-up).
The PCS stock is intended to reflect the performance of Sprint's domestic
wireless personal communication services (PCS) operations. These operations are
referred to as the PCS Group.
The FON stock is intended to reflect the performance of all of Sprint's other
operations. These operations are referred to as the FON Group and include the
following:
. Core businesses
. Long distance division
. Local division
. Product distribution and directory publishing businesses
. Activities to develop and deploy Sprint ION(SM), Integrated On-Demand
Network
. Other ventures, including Sprint's investment in Global One.
FON and PCS shareholders are subject to the risks related to all of Sprint's
businesses, assets and liabilities. Owning FON or PCS shares does not represent
a direct legal interest in the assets and liabilities of the Groups. Rather,
shareholders remain invested in Sprint and continue to vote as a single voting
class for Board member elections (other than Class A directors elected by FT
and DT) and most other company matters.
FON Group or PCS Group events affecting Sprint's consolidated income statements
and balance sheets could, in turn, affect the other Group's financial
statements or stock price.
Net losses of either Group, and dividends or distributions on, or repurchases
of, PCS stock or FON stock will reduce Sprint funds legally available for
dividends on both Groups' stock. Sprint does not expect to pay dividends on the
PCS shares in the foreseeable future.
Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations" (MD&A) should be read along with the FON Group's MD&A
and the PCS Group's MD&A.
- --------------------------------------------------------------------------------
Forward-looking Information
- --------------------------------------------------------------------------------
Sprint includes certain estimates, projections and other forward-looking
statements in its reports, in presentations to analysts and others, and in
other publicly available material. 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:
. the effects of vigorous competition in the markets in which Sprint
operates;
. the costs and business risks related to entering and expanding new
markets necessary to provide seamless services and new services;
. the ability of the PCS Group to establish and grow a significant market
presence;
. the risks related to Sprint's investments in Global One and other joint
ventures;
. the impact of any unusual items resulting from ongoing evaluations of
Sprint's business strategies;
. requirements imposed on Sprint or latitude allowed its competitors by
the Federal Communications Commission (FCC) or state regulatory
commissions under the Telecommunications Act of 1996 (Telecom Act);
. unexpected results of litigation filed against Sprint;
. the impact of the Year 2000 issue and any related noncompliance; and
. the possibility of one or more of the markets in which Sprint competes
being impacted by changes in political, economic or other factors such
as monetary policy, legal and regulatory changes or other external
factors over which Sprint has no control.
I-2
The words "estimate," "project," "intend," "expect," "believe" and similar
expressions are intended to identify forward-looking statements. Forward-
looking statements are found throughout MD&A. 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.
- --------------------------------------------------------------------------------
General Overview of the Sprint FON Group
- --------------------------------------------------------------------------------
Core Businesses
Long Distance Division
The long distance division is the nation's third-largest long distance phone
company. It operates a nationwide, all-digital long distance communications
network using state-of-the-art fiber-optic and electronic technology. The
division provides domestic and international voice, video and data
communications services as well as integration management and support services
for computer networks.
Local Division
The local division consists of regulated local phone companies serving more
than 7.6 million access lines in 18 states. It provides local phone services,
access by phone customers and other carriers to its local network, sales of
telecommunications equipment, and long distance services within certain
regional calling areas.
Product Distribution and Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
Sprint ION(SM)
Sprint ION extends Sprint's existing advanced network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for data, Internet, and video. It is also expected to be the
foundation for Sprint to provide new competitive local service.
Other Ventures
The "other ventures" segment includes the FON Group's investment in Global One,
a joint venture with FT and DT. Sprint is a 1/3 partner in Global One's
operating group serving Europe (excluding France and Germany) and is a 50%
partner in Global One's operating group for the worldwide activities outside
the United States and Europe. The segment also includes the FON Group's
investments in EarthLink Network, Inc., an Internet service provider; Call-Net,
a long distance provider in Canada operating under the Sprint brand name; and
certain other telecommunications investments and ventures. All of these
investments are accounted for on the equity basis.
- --------------------------------------------------------------------------------
General Overview of the Sprint PCS Group
- --------------------------------------------------------------------------------
The PCS Group includes Sprint's domestic wireless mobile phone services. It
operates the only 100% digital PCS wireless network in the United States, with
licenses to provide nationwide service using a single frequency and a single
technology. At year-end 1998, the PCS Group, together with certain affiliates,
operated PCS systems in 45 of the 50 largest U.S. metropolitan areas. The PCS
Group has licenses to serve nearly 270 million people in all 50 states, Puerto
Rico and the U.S. Virgin Islands. With market launches in January 1999, the PCS
Group's service now reaches nearly 170 million people across the nation. The
PCS Group provides nationwide service through:
. operating its own digital network in major U.S. metropolitan areas,
. affiliating with other companies, mainly in and around smaller U.S.
metropolitan areas,
. roaming on other providers' analog cellular networks using Dual-
Band/Dual-Mode handsets, and
. roaming on other providers' digital PCS networks that use code division
multiple access (CDMA).
The PCS Group began commercial CDMA operations in certain markets late in the
1996 fourth quarter.
- --------------------------------------------------------------------------------
Results of Operations
- --------------------------------------------------------------------------------
Consolidated
Total net operating revenues were as follows:
- -------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------
(in millions)
FON Group $16,016.9 $14,873.9 $13,887.5
PCS Group 1,225.4 -- --
Intergroup eliminations (108.0) -- --
- -------------------------------------------------------
Net operating revenues $17,134.3 $14,873.9 $13,887.5
---------------------------------------
Income from continuing operations was as follows:
- ----------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------
(in millions)
FON Group $1,540.1 $1,371.6 $1,310.6
PCS Group (1,089.6) (419.1) (119.7)
- ----------------------------------------------------------------
Income from continuing operations $ 450.5 $ 952.5 $1,190.9
----------------------------------------------
I-3
Sprint FON Group
- --------------------------------------------------------
1998 1997 1996
- --------------------------------------------------------
(in millions)
Net operating revenues $16,016.9 $14,873.9 $13,887.5
Operating expenses 13,257.1 12,404.0 11,619.8
- --------------------------------------------------------
Operating income $ 2,759.8 $ 2,469.9 $ 2,267.7
----------------------------------------
Operating margin 17.2% 16.6% 16.3%
----------------------------------------
Capital expenditures $ 3,159.2 $ 2,708.9 $ 2,433.6
----------------------------------------
Net Operating Revenues
Net operating revenues increased 8% in 1998 and 7% in 1997. These increases
mainly reflect growth of the FON Group's long distance and local divisions.
Long Distance Division
All major market segments--business, residential and wholesale--contributed to
the increase in the long distance division's revenues in 1998 and 1997. The
increases mainly reflect strong data services revenue growth and strong minute
growth of 15% in 1998 and 14% in 1997, partly offset by a more competitive
pricing environment and a change in the mix of products sold.
Business and data market revenues increased 15% in 1998 and 10% in 1997. This
reflects growth in data services as well as toll-free inbound and outbound
calls.
Residential market revenues increased 5% in 1998 and 6% in 1997. These
increases reflect strong revenue and volume growth from long distance calls.
Growth was also enhanced by Sprint Sense Anytime(R) as well as increased
international revenues, prepaid card revenues and calling card calls made by
customers of local phone companies.
Wholesale market revenues increased 8% in 1998 and 22% in 1997. This reflects
strong minute growth mainly from increased outbound toll-free calls, partly
offset by a change in international mix to lower yielding, but higher margin,
countries.
Local Division
Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. Sprint sold approximately 139,000 residential and business access
lines in Illinois in 1997 and the remaining 81,000 access lines were sold in
November 1998. For comparative purposes, the following discussion of local
division results assumes these transfer pricing changes and sales of exchanges
occurred at the beginning of 1996.
Local division revenues increased 5% in both 1998 and 1997, mainly reflecting
customer access line growth and increased sales of equipment and network-based
services, such as Caller ID and Call Waiting.
Local service revenues, which grew 9% in 1998 and 10% in 1997, increased due to
customer access line growth and continued demand for network-based services.
Revenues in 1998 also reflect increased sales of private line services and
revenues from maintaining customer wiring and equipment. The 1997 growth also
reflects expanded local calling areas.
Network access revenues increased 4% in 1998 and 3% in 1997 reflecting an 8%
increase in minutes of use in 1998 and a 7% increase in 1997, partly offset by
FCC-mandated access rate reductions. Access rate reductions took effect in July
1997 and January and July 1998.
Toll service revenues decreased 26% in 1998 and 20% in 1997, mainly due to
increased competition in the intraLATA long distance market, which is expected
to continue. In addition, toll service areas have been decreasing in size
because certain local calling areas are expanding. The reduced revenues were,
in part, offset by increases in local service revenues and by increases in
network access revenues paid by other carriers providing long distance services
to the local division's customers.
Other revenues increased 9% in 1998 and 11% in 1997 because of increased
equipment sales of business systems and data networks, growth in payphone and
commission revenues, and revenues from providing billing and collection
services.
Product Distribution & Directory Publishing Businesses
Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. The following discussion assumes these transfer pricing changes
occurred at the beginning of 1996.
The product distribution and directory publishing businesses' revenues
increased 16% in 1998 and 19% in 1997. Nonaffiliated revenues, which account
for roughly 60% of revenues in 1998 and 1997, increased 10% in 1998 and
remained flat in 1997 due to increased competition.
Operating Expenses
The FON Group's operating expenses increased 7% in both 1998 and 1997 mainly to
support revenue growth.
Long Distance Division
Long distance division operating expenses increased 7% in 1998 and 8% in 1997.
Interconnection costs decreased 2% in 1998 and increased 6% in 1997. Reductions
in per minute costs for both domestic and international access more than offset
the impact of increased calling volumes in 1998 versus 1997, and partly offset
the impact of increased calling volumes in 1997 versus 1996. The rate
reductions were generally due to domestic FCC-mandated access rate reductions
I-4
that took effect in July 1997 and in January and July 1998. Operations expense
increased due to growth in data services as well as increases in network
equipment operating leases in both years. Operations expense in 1998 also
includes costs related to Sprint's efforts to achieve Year 2000 compliance for
its telecommunications network and operating systems. Operations expense in
1997 also reflects increased costs related to FCC-mandated payments to public
payphone providers. Selling, general and administrative (SG&A) expense
increased reflecting the overall growth of the business as well as increased
marketing and promotions to support products and services. SG&A for 1998 also
included costs related to Sprint's efforts to achieve Year 2000 compliance for
information systems and applications supporting such processes as billing,
customer service and other administrative support services.
Local Division
The following local division discussion assumes the transfer pricing changes
and sales of exchanges occurred at the beginning of 1996. See "Net Operating
Revenues--Local Division" for more details.
Local division operating expenses increased 3% in 1998 and 4% in 1997
reflecting increases in SG&A expenses and depreciation and amortization. SG&A
increased mainly because of increased customer service costs related to
customer access line growth and marketing costs to promote new products and
services. SG&A for 1998 also included costs related to Sprint's efforts to
achieve Year 2000 compliance. Depreciation and amortization expense increased
reflecting increased capital expenditures.
Product Distribution & Directory Publishing Businesses
The following PDDP discussion assumes the transfer pricing changes occurred at
the beginning of 1996. See "Net Operating Revenues--Product Distribution and
Directory Publishing Businesses" for more details.
The product distribution and directory publishing businesses' operating
expenses increased reflecting increased equipment sales. SG&A expense increased
because of costs related to the division's acquisition of a sales force from
another directory sales company.
Sprint ION(SM)
Operating expenses for Sprint ION in 1998 reflect its initial development and
deployment activities and include costs for network research and testing,
systems and operations development, product development, and advertising to
increase public awareness.
Other Ventures
The "other ventures" segment's operating expenses mainly reflect activities
related to offering Internet services. In June 1998, the FON Group completed
the strategic alliance to combine its Internet business with EarthLink. As part
of the alliance, EarthLink obtained the FON Group's Sprint Internet Passport
customers and took over the day-to-day operations of those services. In
exchange, Sprint acquired an equity interest in EarthLink.
Sprint PCS Group
- -------------------------------------------------
1998 1997 1996
- -------------------------------------------------
(in millions)
Net operating revenues $ 1,225.4 $ -- $ --
Operating expenses 3,794.8 18.5 0.5
- -------------------------------------------------
Operating loss $(2,569.4) $(18.5) $(0.5)
-----------------------------
Capital expenditures $ 1,071.9 $153.7 $ --
-----------------------------
The PCS Group's 1998 results of operations included SprintCom's operating
results as well as Sprint PCS' operating results on a consolidated basis for
the entire year. Before 1998, Sprint's investment in Sprint PCS was accounted
for using the equity method.
In 1998, the PCS Group recorded a one-time, non-cash charge of $179 million to
write off acquired in-process research and development costs related to the PCS
Restructuring.
The PCS Group markets its products through multiple distribution channels,
including its own retail stores as well as other retail outlets. Equipment
sales to one retail outlet, and service revenues generated by sales to its
customers, accounted for 25% of net operating revenues in 1998.
Pro Forma Sprint PCS Group
To provide a more meaningful analysis of the PCS Group's underlying operating
results, the following supplemental discussion assumes the PCS Restructuring
occurred at the beginning of 1997 and excludes the write-off of acquired in-
process research and development costs.
- --------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------
(in millions)
Net operating revenues $ 1,225.4 $ 258.0
Operating expenses 3,865.4 2,360.7
- --------------------------------------------------------------------
Operating loss $(2,640.0) $(2,102.7)
--------------------------------------------
Capital expenditures (including capital lease
obligations) $ 2,903.6 $ 2,278.3
--------------------------------------------
The PCS Group's net operating revenues include subscriber revenues (including
monthly recurring charges and usage charges), roaming revenues and sales of
handsets and accessory equipment. The PCS Group's net operating revenues were
$1.2 billion in 1998 versus $258 million in 1997, reflecting the launch of 91
new markets and the addition of 1.7 million customers in 1998. The PCS Group
ended 1998 with nearly 2.6 million customers in 225 markets nationwide.
Approximately 20% of 1998 net operating revenues, and
I-5
nearly half of 1997 revenues, were from sales of handsets and accessories. As
part of the PCS Group's marketing plans, handsets are normally sold at prices
well below the PCS Group's cost.
The PCS Group's costs of services and products mainly includes handset and
accessory costs, interconnection costs, and switch and cell site expenses.
These costs increased $720 million in 1998 driven by the significant growth in
customers and the expanded market coverage.
The PCS Group's SG&A expense mainly includes marketing costs to promote
products and services, as well as salary and benefit costs. SG&A expense
increased $766 million in 1998 reflecting increased marketing and advertising
costs to promote products and services, as well as increased labor costs to
support increased subscriber activity.
Depreciation and amortization expense for the PCS Group consists of
depreciation of network assets and amortization of intangible assets acquired
in the PCS Restructuring. The intangible assets include goodwill, PCS licenses,
customer base, microwave relocation costs and assembled workforce, which are
being amortized over three to 40 years. Depreciation and amortization expense
increased $19 million in 1998.
- --------------------------------------------------------------------------------
Nonoperating Items
- --------------------------------------------------------------------------------
Interest Expense
Interest costs in the following table only reflect interest costs on
borrowings. Interest costs related to deferred compensation plans and customer
deposits have been excluded so as not to distort the effective interest rate on
borrowings.
- -------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------
(in millions)
Interest expense on outstanding debt(/1/) $ 672.2 $ 159.9 $ 182.7
Capitalized interest costs 167.1 93.0 104.0
- -------------------------------------------------------------------------
Total interest costs on outstanding debt $ 839.3 $ 252.9 $ 286.7
--------------------------------------------------------
Average debt outstanding(/2/) $10,019.0 $3,251.3 $3,604.9
--------------------------------------------------------
Effective interest rate 8.4% 7.8% 8.0%
--------------------------------------------------------
(/1/Interest)expense for 1996 includes $21.5 million of interest expense
included in "Discontinued operation, net" on the Consolidated Statements of
Income.
(/2/Average)debt outstanding for 1998 is on a pro forma basis as if Sprint PCS
debt had been included in Sprint's outstanding debt balance all year.
The PCS Group capitalizes interest costs related to network buildout and PCS
licenses in markets that are not yet operational. Capitalization of interest
stops and amortization begins when the related markets are launched. The FON
Group capitalizes interest costs related to constructing capital assets.
Sprint capitalized interest costs related to its investment in Sprint PCS until
July 1997 when Sprint PCS emerged from the development stage. Amortization of
the capitalized balance began at that time.
Sprint's 1998 interest costs include an entire year of Sprint PCS' interest due
to the PCS Restructuring. The increase in the 1998 effective interest rate was
mainly due to Sprint PCS' borrowings made before the PCS Restructuring. These
borrowings had higher interest rates than Sprint's borrowings. The increase in
the effective interest rate was partly offset by an increase in Sprint's short-
term borrowings, which have lower interest rates compared to long-term
borrowings.
Global One
Sprint recorded losses related to Global One totaling $186 million in 1998,
$162 million in 1997 and $82 million in 1996. In an effort to improve
profitability, Global One is refocusing its efforts to place more emphasis on
multinational customers. The 1998 loss includes $37 million of nonrecurring
charges for business improvement and network rationalization initiatives.
Global One is continuing to implement these initiatives, which are expected to
result in additional charges.
Sprint PCS
Prior to the PCS Restructuring, Sprint's ownership interest in Sprint PCS was
accounted for using the equity method. Sprint's share of losses from Sprint PCS
was $660 million in 1997 and $192 million in 1996. The increased losses in 1997
reflect marketing and promotional costs, including losses on handset sales, to
support a growing customer base and service launches in additional markets. In
1998, the Cable Partners' share of losses through the PCS Restructuring date
has been reflected as "Other partners' loss in Sprint PCS" in the Consolidated
Statements of Income.
Other Income, Net
Other income consisted of the following:
- --------------------------------------------------
1998 1997 1996
- --------------------------------------------------
(in millions)
Dividend and interest income $ 92.8 $ 75.4 $ 99.7
Other, net 77.7 65.1 15.6
- --------------------------------------------------
Total $170.5 $140.5 $115.3
-----------------------------
Dividend and interest income for all years reflects interest earned on
temporary investments. For 1998, it also reflects interest earned on loans to
unconsolidated affiliates and interest earned on short-term investments
following Sprint's $5.0 billion debt offering (see "Liquidity and Capital
Resources--Liquidity" for more details). "Other, net" for 1998 and 1997 mainly
reflects net gains on sales of local exchanges and certain other investments,
partly offset by losses from certain equity method investments.
I-6
Income Taxes
Sprint's effective tax rates were 46.5% in 1998, 39.8% in 1997 and 37.7% in
1996. See Note 6 of Notes to Consolidated Financial Statements for information
about the differences that caused the effective income tax rates to vary from
the statutory federal rate.
Extraordinary Items, Net
In 1998, Sprint redeemed, prior to scheduled maturities, $138 million of FON
Group debt with interest rates ranging from 7.9% to 9.3%. This resulted in a $5
million after-tax extraordinary loss for the FON Group. Also in 1998, Sprint
redeemed, prior to scheduled maturities, $3.3 billion of PCS Group debt with a
weighted average interest rate of 8.3%. This resulted in a $31 million after-
tax extraordinary loss for the PCS Group. This debt was repaid with a portion
of the proceeds from Sprint's $5.0 billion debt offering in November 1998. In
1996, Sprint also redeemed, prior to scheduled maturities, $190 million of FON
Group debt with interest rates ranging from 6.0% to 9.5%. This resulted in a $5
million after-tax extraordinary loss for the FON Group.
- --------------------------------------------------------------------------------
Financial Condition
- --------------------------------------------------------------------------------
- ----------------------------------------
1998 1997
- ----------------------------------------
(in millions)
Consolidated assets $33,231.1 $18,273.6
-----------------
Consolidated assets increased mainly due to the PCS Restructuring. Net
property, plant and equipment increased $7.5 billion in 1998 reflecting the PCS
Restructuring and capital expenditures to support the PCS network buildout. The
increase also reflects capital expenditures to support the core long distance
and local networks and expanded product and service offerings. Net intangibles
increased $6.8 billion reflecting goodwill, PCS licenses, microwave relocation
costs and customer base resulting from the PCS Restructuring. Sprint's debt-to-
capital ratio was 49.5% at year-end 1998 versus 30.0% at year-end 1997. See
"Liquidity and Capital Resources" for more information about changes in
Sprint's Consolidated Balance Sheets.
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
Consolidated cash flows include Sprint PCS' cash flows only after the PCS
Restructuring date.
Operating Activities
- -----------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------
(in millions)
Cash flows provided by operating activities $4,255.4 $3,379.0 $2,403.5
-----------------------------------------------------
Operating cash flows increased 26% in 1998 and 41% in 1997 mainly reflecting
improved operating results in the FON Group's core businesses and changes in
working capital in both the FON Group and the PCS Group. During 1996, the FON
Group terminated an accounts receivable sales agreement, which reduced cash
flows by $600 million.
Investing Activities
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
(in millions)
Cash flows used by investing activities from
continuing operations $(4,485.4) $(4,499.5) $(3,115.5)
-------------------------------------------------------------
The FON Group's capital expenditures totaled $3.2 billion in 1998, $2.7 billion
in 1997 and $2.4 billion in 1996. Long distance capital expenditures were
incurred mainly to enhance network reliability, meet increased demand for voice
and data-related services and upgrade capabilities for providing new products
and services. The local division incurred capital expenditures to accommodate
access line growth and expand capabilities for providing enhanced services. PCS
Group capital expenditures, totaling $1.1 billion in 1998 and $154 million in
1997, were incurred to support the PCS network buildout.
Investing activities also include proceeds from sales of assets (mainly sales
of local exchanges) totaling $230 million in 1998 and $292 million in 1997. In
addition, in 1997, Sprint paid $460 million toward the purchase of its PCS
licenses and purchased the net assets of Paranet, Inc. for $375 million.
"Investments in and loans to affiliates, net" consisted of the following:
- -------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------
(in millions)
Sprint PCS
Capital contributions $ 33.5 $ 405.9 $297.6
Loans and advances, net 153.6 254.1 67.1
Capitalized interest -- 46.3 96.3
Investments in debt securities -- -- 100.0
- -------------------------------------------------------
187.1 706.3 561.0
- -------------------------------------------------------
Global One
Capital contributions 283.5 -- 39.5
Advances, net (15.7) 199.7 --
- -------------------------------------------------------
267.8 199.7 39.5
- -------------------------------------------------------
Other, net 235.8 185.8 41.9
- -------------------------------------------------------
Total $690.7 $1,091.8 $642.4
-----------------------------------
Amounts for Sprint PCS in 1998 reflect contributions and advances prior to the
PCS Restructuring. These amounts, as well as capital contributions and net
advances to Sprint PCS prior to 1998, were used to fund capital and operating
requirements. Capital contributions and net advances to Global One in all years
were also mainly
I-7
used to fund capital and operating requirements. "Other, net" includes the FON
Group's investment in EarthLink and an additional $148 million investment in
Call-Net in 1998 to retain the FON Group's approximate 25% interest after Call-
Net purchased Fonorola Inc.
Financing Activities
- ----------------------------------------------------------------
1998 1997 1996
- ----------------------------------------------------------------
(in millions)
Cash flows provided by financing activities $733.5 $71.6 $479.1
------------------------------------------
Financing activities in 1998 reflect proceeds from long-term debt of $5.2
billion, partly offset by payments on long-term debt. Net proceeds from
borrowings in 1998 were mainly used to repay existing debt. In 1997, Sprint had
net borrowings of $532 million, mainly to fund investments in and loans to
affiliates. In 1996, FT and DT acquired Class A common shares for a combined
total of $3.7 billion. Sprint mainly used these proceeds, and the cash from
Cellular's repayment of intercompany advances, to reduce outstanding debt.
Sprint paid dividends of $430 million in 1998 and 1997, and $420 million in
1996.
Capital Requirements
Sprint's 1999 investing activities, mainly consisting of capital expenditures
and investments in affiliates, are expected to require cash of $6.4 to $7.0
billion. FON Group capital expenditures are expected to range between $3.7 and
$4.0 billion, and PCS Group capital expenditures are expected to be between
$2.3 and $2.6 billion. Additional funds will be required to fund the PCS
Group's expected operating losses, working capital and debt service
requirements. Investments in affiliates are expected to require cash of
approximately $400 million. Dividend payments are expected to approximate $445
million in 1999.
In connection with the PCS Restructuring, Sprint adopted a tax sharing
agreement that provides for the allocation of income taxes between the FON
Group and the PCS Group. Sprint expects the FON Group to make significant
payments to the PCS Group under this agreement because of expected PCS Group
operating losses in the near future. These payments will reflect the PCS
Group's incremental cumulative effect on Sprint's consolidated federal and
state tax liability and tax credit position. During 1998, the PCS Group accrued
benefits under the agreement totaling $191 million and received related
payments from the FON Group totaling $20 million. The remaining $171 million
will be paid by the FON Group during the first half of 1999. See Note 2 of
Notes to Consolidated Financial Statements, "Allocation of Federal and State
Income Taxes," for more details.
Liquidity
Sprint mainly uses commercial paper to fund its short-term working capital
needs. Sprint also uses the long-term bond market as well as other debt markets
to fund its needs. Sprint intends to continue borrowing funds through the U.S.
and international money and capital markets and bank credit markets to fund
capital expenditures, and operating and working capital requirements.
In August 1998, Sprint entered into $5.0 billion of new revolving credit
facilities with syndicates of domestic and international banks. These
facilities support Sprint's commercial paper operations and replaced its
previous $1.5 billion revolving credit facility. Sprint also has a separate
five-year revolving credit facility with a bank. At year-end 1998, Sprint had
total unused lines of credit of $4.8 billion under these facilities.
At year-end 1998, the PCS Group had borrowed $1.8 billion under revolving
credit facilities with banks totaling $2.1 billion.
In October 1998, Sprint filed a shelf registration statement with the
Securities and Exchange Commission for $8.0 billion of debt securities. This
replaced Sprint's existing shelf registration of $1.0 billion. In November
1998, Sprint issued $5.0 billion under the new shelf. Sprint may offer for sale
up to $3.0 billion under the new shelf. Sprint allocated $3.9 billion of the
debt proceeds to the PCS Group with a weighted average interest rate of
approximately 8.5%. The PCS Group used these funds to repay existing debt.
Any borrowings Sprint may incur are ultimately limited by certain debt
covenants. Sprint could borrow up to $14.1 billion at year-end 1998 under the
most restrictive of its debt covenants. For some borrowings, Sprint must
maintain certain levels of consolidated net worth.
In 1998, FT and DT purchased 5.1 million PCS shares as part of the PCS
Restructuring to maintain their combined 20% voting power. Proceeds from
exercising these equity purchase rights totaled $85 million and were used to
fund working capital needs and the continued buildout of the PCS Group's
network.
In February 1999, Sprint completed an offering of Series 1 PCS stock. In this
offering, Sprint sold 24.4 million shares at a price to the public of $28.75
per share. The net proceeds to Sprint totaled $672 million. In connection with
this offering, FT and DT purchased 6.1 million shares of Series 3 PCS stock.
The net proceeds to Sprint from the sale of this stock totaled $169 million.
The proceeds from the offering and purchase by FT and DT were attributed to the
PCS Group and will be used for the continued buildout of the PCS network and
working capital needs.
- --------------------------------------------------------------------------------
Regulatory Developments
- --------------------------------------------------------------------------------
See "Regulatory Developments" in the FON Group's MD&A and the PCS Group's MD&A.
I-8
- --------------------------------------------------------------------------------
Financial Strategies
- --------------------------------------------------------------------------------
General Hedging Policies
Sprint selectively enters into interest rate swap and cap 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 for hedging purposes only and comply
with Board-approved policies. Senior management receives frequent status
updates of all outstanding derivative positions.
Interest Rate Risk Management
Sprint's interest rate risk management program focuses on minimizing exposure
to interest rate movements, setting an optimal mixture of floating- and fixed-
rate debt, and minimizing liquidity risk. Sprint uses simulation analysis to
assess its interest rate exposure and establish the desired ratio of floating-
and fixed-rate debt. To the extent possible, Sprint manages interest rate
exposure and the floating-to-fixed ratio through its borrowings, but sometimes
uses interest rate swaps and caps to adjust its risk profile.
Foreign Exchange Risk Management
Sprint's foreign exchange risk management program focuses on hedging
transaction exposure to optimize consolidated cash flow. Sprint's main
transaction exposure results from net payments made to overseas
telecommunications companies for completing international calls made by
Sprint's domestic customers. These international operations were not material
to the consolidated financial position, results of operations or cash flows at
year-end 1998. In addition, foreign currency transaction gains and losses were
not material to Sprint's 1998 results of operations. Sprint has not entered
into any significant foreign currency forward contracts or other derivative
instruments to hedge the effects of adverse fluctuations in foreign exchange
rates. As a result, Sprint was not subject to material foreign exchange risk.
- --------------------------------------------------------------------------------
Year 2000 Issue
- --------------------------------------------------------------------------------
The "Year 2000" issue affects Sprint's installed computer systems, network
elements, software applications and other business systems that have time-
sensitive programs that may not properly reflect or recognize the year 2000.
Because many computers and computer applications define dates by the last two
digits of the year, "00" may not be properly identified as the year 2000. This
error could result in miscalculations or systems errors. The Year 2000 issue
may also affect the systems and applications of Sprint's customers, vendors,
resellers or affiliates.
The FON Group started a program in 1996 to identify and address the Year 2000
issue. It has completed an inventory and Year 2000 assessment of its principal
computer systems, network elements, software applications and other business
systems. The FON Group has also completed the renovation of these computer
systems, network elements, other business systems and more than 90% of its
software applications. Year 2000 testing began in the 1998 third quarter and
will be completed in 1999. The FON Group is using both internal and external
resources to identify, correct or reprogram, and test its systems for Year 2000
compliance. It is also contacting others with whom it conducts business to
receive the proper warranties and assurances that those third parties,
including affiliates, are or will be Year 2000 compliant.
The PCS Group has completed an inventory of its computer systems, network
elements, software applications, products and other business systems. The Year
2000 assessment of these items has begun and the PCS Group expects to complete
the assessment in the 1999 first quarter along with plans to address any
required renovation. The PCS Group is using both internal and external
resources to identify, correct or reprogram, and test its systems for Year 2000
compliance. It expects Year 2000 compliance for these critical systems to be
achieved in 1999.
The PCS Group is also contacting others with whom it conducts business to
receive the proper warranties and assurances that those third parties,
including affiliates, are or will be Year 2000 compliant. The PCS Group relies
on third-party vendors for a significant portion of its important operating and
computer system functions and, therefore, is highly dependent on those third-
party vendors to remediate network elements, computer systems, software
applications and other business systems. In addition, the PCS Group uses
publicly available services that are acquired without contract, such as global
positioning system timing signal, that may be affected by the Year 2000 issue.
While the PCS Group believes these systems will be Year 2000 compliant, the PCS
Group has no contractual or other right to force compliance.
The FON Group incurred approximately $140 million in 1998 for its Year 2000
compliance program and expects to incur approximately $110 million in 1999. The
PCS Group expects to incur approximately $50 million in 1999 for its Year 2000
compliance program. If compliance is not achieved in a timely manner by Sprint,
its affiliates (including Global One), or any significant
I-9
related third party, the Year 2000 issue could have a material adverse effect
on Sprint's operations. Sprint is focusing on identifying and addressing all
aspects of its operations that may be affected by the Year 2000 issue. Sprint
is developing and will implement, if necessary, appropriate contingency plans
to mitigate to the extent possible the effects of any Year 2000 noncompliance.
- --------------------------------------------------------------------------------
Recently Issued Accounting Pronouncement
- --------------------------------------------------------------------------------
See Note 15 of Notes to Consolidated Financial Statements for a discussion of a
recently issued accounting pronouncement.
I-10
MANAGEMENT REPORT
Sprint Corporation's management is responsible for the integrity and
objectivity of the information contained in this document. Management is
responsible for the consistency of reporting this information and for ensuring
that generally accepted accounting principles are used.
In discharging this responsibility, management maintains a comprehensive system
of internal controls and supports an extensive program of internal audits, has
made organizational arrangements providing appropriate divisions of
responsibility and has established communication programs aimed at assuring
that its policies, procedures and codes of conduct are understood and practiced
by its employees.
The financial statements included in this document have been audited by Ernst &
Young LLP, independent auditors. Their audits were conducted using generally
accepted auditing standards and their reports are included herein.
The Board of Director's responsibility for these financial statements is
pursued mainly through its Audit Committee. The Audit Committee, composed
entirely of directors who are not officers or employees of Sprint, meets
periodically with the internal auditors and independent auditors, both with and
without management present, to assure that their respective responsibilities
are being fulfilled. The internal and independent auditors have full access to
the Audit Committee to discuss auditing and financial reporting matters.
/s/ W. T. Esrey
- --------------------------------------------------------------------------------
William T. Esrey
Chairman and Chief Executive Officer
/s/ Arthur B. Krause
- --------------------------------------------------------------------------------
Arthur B. Krause
Executive Vice President and Chief Financial Officer
I-11
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Sprint Corporation
We have audited the accompanying consolidated balance sheets of Sprint
Corporation (Sprint) as of December 31, 1998 and 1997, and the related
consolidated statements of income, comprehensive income, cash flows and
shareholders' equity for each of the three years in the period ended December
31, 1998. Our audits also included the financial statement schedule listed in
the Index to Financial Statements and Financial Statement Schedules. These
financial statements and the schedule are the responsibility of the management
of Sprint. Our responsibility is to express an opinion on these financial
statements and the schedule based on our audits. We did not audit the 1998 or
1997 consolidated financial statements of Sprint Spectrum Holding Company,
L.P., a wholly owned subsidiary of Sprint as of December 31, 1998 and an
investment in which Sprint had a 40% interest through November 23, 1998 (as
discussed in Note 1). Such financial statements reflect assets of $2.7 billion
as of December 31, 1998, and revenues of $1.2 billion for the year then ended
which we did not audit. Sprint's equity in Sprint Spectrum Holding Company,
L.P. is stated at $749 million at December 31, 1997, and Sprint's equity in the
net loss of Sprint Spectrum Holding Company, L.P. is stated at $625 million for
the year then ended. The consolidated financial statements and financial
statement schedule of Sprint Spectrum Holding Company, L.P. have been audited
by other auditors whose report has been furnished to us, and our opinion,
insofar as it relates to the 1998 assets and revenues and the 1997 equity
investment accounts which we did not audit, is based solely on the report of
the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Sprint at December
31, 1998 and 1997, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
Ernst & Young LLP
Kansas City, Missouri
February 2, 1999
REPORT OF INDEPENDENT AUDITORS
The Board of Directors of Sprint Corporation and Partners of Sprint Spectrum
Holding Company, L.P.
We have audited the consolidated balance sheets of Sprint Spectrum Holding
Company, L.P. and subsidiaries (Holdings) as of December 31, 1998 and 1997, and
the related consolidated statements of operations and cash flows for the three
years in the period ended December 31, 1998. Our audits also included the
financial statement schedule (Schedule II). These financial statements and
Schedule II are the responsibility of Partnership management. Our
responsibility is to express an opinion on these consolidated financial
statements and Schedule II based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Sprint Spectrum Holding Company,
L.P. and subsidiaries at December 31, 1998 and 1997, and the results of their
operations and their cash flows for the three years ended December 31,1998, in
conformity with generally accepted accounting principles. Also, in our opinion,
Schedule II, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.
Deloitte & Touche LLP
Kansas City, Missouri
February 2, 1999
I-12
CONSOLIDATED STATEMENTS OF INCOME Sprint Corporation
(in millions)
- -------------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------------
Net Operating Revenues $17,134.3 $14,873.9 $13,887.5
- -------------------------------------------------------------------------------
Operating Expenses
Costs of services and products 8,787.2 7,451.0 6,912.9
Selling, general and administrative 5,272.8 3,245.2 3,116.4
Depreciation and amortization 2,704.8 1,726.3 1,591.0
Acquired in-process research and development
costs 179.1 -- --
- -------------------------------------------------------------------------------
Total operating expenses 16,943.9 12,422.5 11,620.3
- -------------------------------------------------------------------------------
Operating Income 190.4 2,451.4 2,267.2
Interest expense (728.2) (187.2) (196.7)
Equity in loss of Global One (186.0) (162.1) (82.1)
Other partners' loss in Sprint PCS 1,250.9 -- --
Equity in loss of Sprint PCS -- (659.6) (191.8)
Minority interest 144.8 -- --
Other income, net 170.5 140.5 115.3
- -------------------------------------------------------------------------------
Income from continuing operations before
income taxes 842.4 1,583.0 1,911.9
Income taxes (391.9) (630.5) (721.0)
- -------------------------------------------------------------------------------
Income from Continuing Operations 450.5 952.5 1,190.9
Discontinued operation, net -- -- (2.6)
Extraordinary items, net (36.0) -- (4.5)
- -------------------------------------------------------------------------------
Net Income 414.5 952.5 1,183.8
Preferred stock dividends (1.7) (1.0) (1.3)
- -------------------------------------------------------------------------------
Earnings applicable to common stock $ 412.8 $ 951.5 $ 1,182.5
---------------------
See accompanying Notes to Consolidated Financial Statements.
I-13
CONSOLIDATED STATEMENTS OF INCOME (continued) Sprint Corporation
(in millions, except per share data)
- ----------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- ----------------------------------------------------------------------------
SPRINT COMMON STOCK(/1/)
Earnings applicable to common stock $ 852.9 $951.5 $1,182.5
--------------
Diluted Earnings per Common Share
Continuing operations $ 1.96 $ 2.18 $ 2.79
Discontinued operation -- -- (0.01)
Extraordinary items (0.01) -- (0.01)
- ----------------------------------------------------------------------------
Total $ 1.95 $ 2.18 $ 2.77
--------------
Diluted weighted average common shares 438.6 436.5 427.0
--------------
Basic Earnings per Common Share
Continuing operations $ 1.99 $ 2.21 $ 2.82
Discontinued operation -- -- (0.01)
Extraordinary items (0.01) -- (0.01)
- ----------------------------------------------------------------------------
Total $ 1.98 $ 2.21 $ 2.80
--------------
Basic weighted average common shares 430.8 430.2 421.7
--------------
FON COMMON STOCK(/1/)
Earnings applicable to common stock $ 118.3
-------
Diluted earnings per common share $ 0.27
-------
Diluted weighted average common shares 434.5
-------
Basic earnings per common share $ 0.28
-------
Basic weighted average common shares 427.6
-------
PCS COMMON STOCK(/1/)
Loss applicable to common stock $(558.4)
-------
Basic and Diluted Loss per Common Share
Continuing operations $ (1.26)
Extraordinary item (0.08)
- ----------------------------------------------------------------------------
Total $ (1.34)
-------
Basic and diluted weighted average common shares 415.8
-------
DIVIDENDS PER COMMON SHARE
Sprint common stock $ 0.75 $ 1.00 $ 1.00
--------------
FON common stock $ 0.25
-------
(/1/As)discussed in Note 1 of Notes to Consolidated Financial Statements, the
Recapitalization occurred in November 1998. As a result, earnings per share
for Sprint common stock reflects earnings through the Recapitalization
date, while earnings (loss) per share for FON common stock and PCS common
stock reflects results from that date to year-end 1998.
See accompanying Notes to Consolidated Financial Statements.
I-14
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME Sprint Corporation
(in millions)
- ---------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------
Net Income $414.5 $952.5 $1,183.8
- ---------------------------------------------------------------------
Other Comprehensive Income
Unrealized holding gains on securities 21.0 11.7 4.6
Income tax expense (7.6) (4.4) (1.7)
- ---------------------------------------------------------------------
Net unrealized holding gains on securities 13.4 7.3 2.9
Foreign currency translation adjustments (2.1) 9.4 (0.8)
- ---------------------------------------------------------------------
Total other comprehensive income 11.3 16.7 2.1
- ---------------------------------------------------------------------
Comprehensive Income $425.8 $969.2 $1,185.9
-------
See accompanying Notes to Consolidated Financial Statements.
I-15
CONSOLIDATED BALANCE SHEETS Sprint Corporation
(in millions, except per share data)
- ----------------------------------------------------------------------------
December 31, 1998 1997
- ----------------------------------------------------------------------------
Assets
Current assets
Cash and equivalents $ 605.2 $ 101.7
Accounts receivable, net of allowance for doubtful
accounts of $185.5 and $146.7 2,690.7 2,495.6
Inventories 477.1 352.0
Prepaid expenses 259.8 159.1
Notes and other receivables 118.2 464.6
Other 236.9 199.6
- ----------------------------------------------------------------------------
Total current assets 4,387.9 3,772.6
Investments in equity securities 489.2 303.0
Property, plant and equipment
FON Group 25,156.0 23,023.6
PCS Group 6,988.3 187.3
- ----------------------------------------------------------------------------
Total property, plant and equipment 32,144.3 23,210.9
Accumulated depreciation (13,161.3) (11,716.8)
- ----------------------------------------------------------------------------
Net property, plant and equipment 18,983.0 11,494.1
Investments in and advances to affiliates 645.0 1,243.0
Intangible assets
Goodwill 3,701.4 384.0
PCS licenses 3,036.6 544.5
Other 1,137.4 56.2
- ----------------------------------------------------------------------------
Total intangible assets 7,875.4 984.7
Accumulated amortization (182.4) (46.0)
- ----------------------------------------------------------------------------
Net intangible assets 7,693.0 938.7
Other 1,033.0 522.2
- ----------------------------------------------------------------------------
Total $33,231.1 $18,273.6
----------
Liabilities and Shareholders' Equity
Current liabilities
Current maturities of long-term debt $ 246.9 $ 131.0
Accounts payable 1,654.9 1,100.1
Construction obligations 978.9 --
Accrued interconnection costs 592.4 672.7
Accrued taxes 439.9 270.7
Advance billings 229.3 202.9
Other 1,298.8 699.4
- ----------------------------------------------------------------------------
Total current liabilities 5,441.1 3,076.8
- ----------------------------------------------------------------------------
Long-term debt 11,942.4 3,748.6
Deferred credits and other liabilities
Deferred income taxes and investment tax credits 1,830.3 1,016.5
Postretirement and other benefit obligations 1,064.1 1,036.2
Other 504.9 370.3
- ----------------------------------------------------------------------------
Total deferred credits and other liabilities 3,399.3 2,423.0
Shareholders' equity
Common stock
Sprint, par value $2.50 per share, 1,000.0 shares
authorized, 350.3 shares issued and 343.8 shares
outstanding -- 875.7
Class A common stock, par value $2.50 per share,
200.0 shares authorized, 86.2 shares issued and
outstanding 215.6 215.6
FON, par value $2.00 per share, 4,200.0 shares
authorized, 350.3 shares issued and 344.5 shares
outstanding 700.5 --
PCS, par value $1.00 per share, 2,350.0 shares
authorized, 375.4 shares issued and 372.7 shares
outstanding 375.4 --
PCS preferred stock, no par, 0.3 shares authorized,
0.2 shares issued and outstanding 246.8 --
Capital in excess of par or stated value 7,586.2 4,457.7
Retained earnings 3,650.9 3,693.1
Treasury stock, at cost, 8.5 and 6.5 shares (426.0) (292.9)
Accumulated other comprehensive income 103.6 107.9
Other (4.7) (31.9)
- ----------------------------------------------------------------------------
Total shareholders' equity 12,448.3 9,025.2
- ----------------------------------------------------------------------------
Total $33,231.1 $18,273.6
----------
See accompanying Notes to Consolidated Financial Statements.
I-16
CONSOLIDATED STATEMENTS OF CASH FLOWS Sprint Corporation
(in millions)
- ----------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- ----------------------------------------------------------------------------
Operating Activities
Net income $ 414.5 $ 952.5 $ 1,183.8
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in net losses of affiliates 1,077.7 843.7 273.7
Extraordinary items, net 31.9 -- 4.9
Depreciation and amortization 2,036.0 1,726.3 1,591.0
Deferred income taxes and investment tax
credits 132.4 165.7 (10.3)
Acquired in-process research and
development costs 179.1 -- --
Net (gains) losses on sales of assets (103.8) (93.2) 7.5
Changes in assets and liabilities,
excluding the PCS Restructuring:
Accounts receivable, net 101.3 (127.0) (982.1)
Inventories and other current assets (188.9) (94.4) 15.7
Accounts payable and other current
liabilities 732.5 18.0 362.0
Noncurrent assets and liabilities, net (125.7) (18.4) (25.5)
Other, net (31.6) 5.8 (17.2)
- ----------------------------------------------------------------------------
Net cash provided by operating activities 4,255.4 3,379.0 2,403.5
- ----------------------------------------------------------------------------
Investing Activities
Capital expenditures (4,231.1) (2,862.6) (2,433.6)
PCS licenses purchased -- (460.1) (84.0)
Investments in and loans to affiliates,
net (690.7) (1,091.8) (642.4)
Cash acquired in the PCS Restructuring 244.3 -- --
Proceeds from sales of assets 230.0 292.3 2.1
Paranet acquisition -- (375.0) --
Other, net (37.9) (2.3) 42.4
- ----------------------------------------------------------------------------
Net cash used by continuing operations (4,485.4) (4,499.5) (3,115.5)
Repayment by cellular division of
intercompany advances -- -- 1,400.0
Net cash used by cellular division -- -- (140.7)
- ----------------------------------------------------------------------------
Net cash used by investing activities (4,485.4) (4,499.5) (1,856.2)
- ----------------------------------------------------------------------------
Financing Activities
Proceeds from long-term debt 5,213.3 866.5 9.4
Payments on long-term debt (3,822.1) (135.0) (433.1)
Net change in short-term borrowings -- (200.0) (1,986.8)
Proceeds from sales of shares to FT and DT 84.6 -- 3,661.3
Dividends paid (430.3) (430.0) (419.6)
Treasury stock purchased (315.2) (144.5) (407.2)
Other, net 3.2 114.6 55.1
- ----------------------------------------------------------------------------
Net cash provided by financing activities 733.5 71.6 479.1
- ----------------------------------------------------------------------------
Increase (Decrease) in Cash and
Equivalents 503.5 (1,048.9) 1,026.4
Cash and Equivalents at Beginning of Year 101.7 1,150.6 124.2
- ----------------------------------------------------------------------------
Cash and Equivalents at End of Year $ 605.2 $ 101.7 $ 1,150.6
-----------------
See accompanying Notes to Consolidated Financial Statements.
I-17
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(in millions) Sprint Corporation
- --------------------------------------------------------------------------------------------------------
PCS
Common Capital in
Sprint FON and Excess of Par
Common Common Preferred or Retained Treasury
Stock Stock Stock Stated Value Earnings Stock Other Total
- --------------------------------------------------------------------------------------------------------
Beginning 1996 balance $ 872.9 $ -- $ -- $ 960.0 $2,772.9 $ -- $36.8 $ 4,642.6
Net income -- -- -- -- 1,183.8 -- -- 1,183.8
Common stock dividends -- -- -- -- (346.1) -- (346.1)
Class A common stock and
preference stock
dividends -- -- -- -- (74.9) -- -- (74.9)
Common stock issued 2.5 -- -- 17.5 -- -- -- 20.0
Class A common stock
issued 215.6 -- -- 3,436.3 -- -- -- 3,651.9
Treasury stock purchased -- -- -- -- -- (407.2) -- (407.2)
Treasury stock issued -- -- -- -- (52.9) 145.0 -- 92.1
Spinoff of cellular
division -- -- -- -- (260.2) -- -- (260.2)
Other, net 0.3 -- -- 12.1 (0.2) -- 5.7 17.9
- --------------------------------------------------------------------------------------------------------
Ending 1996 balance 1,091.3 -- -- 4,425.9 3,222.4 (262.2) 42.5 8,519.9
Net income -- -- -- -- 952.5 -- -- 952.5
Common stock dividends -- -- -- -- (343.3) -- -- (343.3)
Class A common stock
dividends -- -- -- -- (86.2) -- -- (86.2)
Treasury stock purchased -- -- -- -- -- (144.5) -- (144.5)
Treasury stock issued -- -- -- -- (48.8) 113.8 -- 65.0
Tax benefit from stock
options exercised -- -- -- 26.2 -- -- -- 26.2
Other, net -- -- -- 5.6 (3.5) -- 33.5 35.6
- --------------------------------------------------------------------------------------------------------
Ending 1997 balance 1,091.3 -- -- 4,457.7 3,693.1 (292.9) 76.0 9,025.2
Net income -- -- -- -- 414.5 -- -- 414.5
Common stock dividends -- -- -- -- (344.9) -- -- (344.9)
Class A common stock
dividends -- -- -- -- (86.2) -- -- (86.2)
Sprint common stock
recapitalized (875.7) 700.5 175.2 -- -- -- -- --
PCS Series 2 common
stock issued -- -- 195.1 3,005.2 -- -- -- 3,200.3
PCS Series 3 common
stock issued -- -- 5.1 79.5 -- -- -- 84.6
PCS preferred stock
issued -- -- 246.8 -- -- -- -- 246.8
Treasury stock purchased -- -- -- -- -- (321.5) -- (321.5)
Treasury stock issued -- -- -- -- (23.9) 188.4 -- 164.5
Tax benefit from stock
options exercised -- -- -- 49.0 -- -- -- 49.0
Other, net -- -- -- (5.2) (1.7) -- 22.9 16.0
- --------------------------------------------------------------------------------------------------------
Ending 1998 balance $ 215.6 $700.5 $622.2 $7,586.2 $3,650.9 $(426.0) $98.9 $12,448.3
--------------------------------------------------------------------------------
Shares Outstanding
- -----------------------------------------------------------------------
Beginning 1996 balance 349.2 -- --
Common stock issued 1.1 -- --
Class A common stock
issued 86.2 -- --
Treasury stock purchased (10.1) -- --
Treasury stock issued 3.7 -- --
- -----------------------------------------------------------------------
Ending 1996 balance 430.1 -- --
Treasury stock purchased (3.0) -- --
Treasury stock issued 2.9 -- --
- -----------------------------------------------------------------------
Ending 1997 balance 430.0 -- --
Sprint common stock
recapitalized (350.3) 350.3 175.2
Treasury shares
recapitalized 5.4 (5.4) (2.7)
PCS Series 2 common
stock issued -- -- 195.1
PCS Series 3 common
stock issued -- -- 5.1
PCS preferred stock
issued -- -- 0.2
Treasury stock purchased (4.2) (0.5) --
Treasury stock issued 5.3 0.1 --
- -----------------------------------------------------------------------
Ending 1998 balance 86.2 344.5 372.9
--------------------------------
See accompanying Notes to Consolidated Financial Statements.
I-18
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sprint Corporation
- --------------------------------------------------------------------------------
1. PCS Restructuring and Recapitalization
- --------------------------------------------------------------------------------
In November 1998, Sprint's shareholders approved the formation of the FON Group
and the PCS Group and the creation of the FON stock and the PCS stock. In
addition, Sprint purchased the remaining ownership interests in Sprint Spectrum
Holding Company, L.P. and PhillieCo, L.P. (together, Sprint PCS), other than a
minority interest in Cox Communications PCS, L.P. (Cox PCS). Sprint acquired
these ownership interests from Tele-Communications, Inc., Comcast Corporation
and Cox Communications, Inc. (the Cable Partners). In exchange, Sprint issued
the Cable Partners special low-vote PCS shares and warrants to acquire
additional PCS shares. Sprint also issued the Cable Partners shares of a new
class of preferred stock convertible into PCS shares. The purchase of the Cable
Partners' interests is referred to as the PCS Restructuring.
Also in November 1998, Sprint reclassified each of its publicly traded common
shares into one share of FON stock and 1/2 share of PCS stock. This
recapitalization was tax-free to shareholders. Each Class A common share owned
by France Telecom S.A. (FT) and Deutsche Telekom AG (DT) was reclassified to
represent an equity interest in the FON Group and the PCS Group that entitles
FT and DT to one share of FON stock and 1/2 share of PCS stock. These
transactions are referred to as the Recapitalization.
In connection with the PCS Restructuring, FT and DT purchased 5.1 million
additional PCS shares to maintain their combined 20% voting power in Sprint
(Top-up).
The PCS stock is intended to reflect the performance of Sprint's domestic
wireless personal communication services (PCS) operations. The FON stock is
intended to reflect the performance of all of Sprint's other operations.
- --------------------------------------------------------------------------------
2. Summary of Significant Accounting Policies
- --------------------------------------------------------------------------------
Basis of Consolidation and Presentation
The consolidated financial statements include the accounts of Sprint and its
wholly owned and majority-owned subsidiaries. Sprint PCS' results of operations
for 1998 have been consolidated for the entire year. The Cable Partners' share
of losses through the PCS Restructuring date has been reflected as "Other
partners' loss in Sprint PCS" in the Consolidated Statements of Income. Sprint
PCS' financial position has been reflected on a consolidated basis at year-end
1998. Before 1998, Sprint's investment in Sprint PCS was accounted for using
the equity method. Sprint's cash flows include Sprint PCS' cash flows only
after the PCS Restructuring date.
Investments in entities in which Sprint exercises significant influence, but
does not control, are accounted for using the equity method (see Note 4).
The consolidated financial statements are prepared using generally accepted
accounting principles. 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 results of
operations or shareholders' equity as previously reported.
Classification of Operations
Sprint FON Group
Core Businesses
Long Distance Division
The long distance division is the nation's third-largest long distance phone
company. It operates a nationwide, all-digital long distance communications
network using state-of-the-art fiber-optic and electronic technology. The
division provides domestic and international voice, video and data
communications services. It also provides integration management and support
services for computer networks.
Local Division
The local division consists of regulated local phone companies serving more
than 7.6 million access lines in 18 states. It provides local services, access
by phone customers and other carriers to the local network, sales of
telecommunications equipment, and long distance services within certain
regional calling areas, or local access transport areas. In early November
1998, Sprint sold its remaining 81,000 residential and business access lines in
Illinois.
Product Distribution & Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
I-19
Sprint ION(SM)
Sprint ION extends Sprint's existing advanced network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for data, Internet, and video. It is also expected to be the
foundation for Sprint to provide new competitive local service.
Other Ventures
The "other ventures" segment includes the FON Group's investment in Global One.
Sprint is a 1/3 partner in Global One's operating group serving Europe
(excluding France and Germany) and is a 50% partner in Global One's operating
group for the worldwide activities outside the United States and Europe. The
segment also includes the FON Group's investments in EarthLink Network, Inc.,
an Internet service provider; Call-Net, a long distance provider in Canada
operating under the Sprint brand name; and certain other telecommunications
investments and ventures. All of these investments are accounted for on the
equity basis.
Sprint PCS Group
The PCS Group includes Sprint's domestic wireless mobile phone services. It
operates the only 100% digital PCS wireless network in the United States, with
licenses to provide nationwide service using a single frequency and a single
technology. At year-end 1998, the PCS Group, together with certain affiliates,
operated PCS systems in 45 of the 50 largest U.S. metropolitan areas.
Allocation of Shared Services
Sprint directly assigns, where possible, certain general and administrative
costs to the FON Group and the PCS Group based on their actual use of those
services. Where direct assignment of costs is not possible, or practical,
Sprint uses other methods to estimate the assignment of costs to each Group.
Allocation of Federal and State Income Taxes
Sprint files a consolidated federal income tax return and certain state income
tax returns which include FON Group and PCS Group results. In connection with
the PCS Restructuring, Sprint adopted a tax sharing agreement which provides
for the allocation of income taxes between the two Groups. The FON Group's
income taxes are calculated as if it files returns which exclude the PCS Group.
The PCS Group's income taxes reflect the PCS Group's incremental cumulative
impact on Sprint's consolidated income taxes. Intergroup tax payments are
satisfied on the date Sprint's related tax payment is due to or the refund is
received from the applicable tax authority. During 1998, the PCS Group accrued
income tax benefits in accordance with the tax sharing agreement totaling $191
million.
Allocation of Group Financing
Financing activities for the Groups are managed by Sprint on a centralized
basis. Debt incurred by Sprint on behalf of the Groups is specifically
allocated to and reflected in the financial statements of the applicable Group.
Interest expense is allocated to the PCS Group based on an interest rate that
is largely equal to the rate it would be able to obtain from third parties as a
direct or indirect wholly owned Sprint subsidiary, but without the benefit of
any guaranty by Sprint or any member of the FON Group. That interest rate is
higher than the rate Sprint obtains on borrowings. The difference between
Sprint's actual interest rate and the rate charged to the PCS Group is
reflected as a reduction in the FON Group's interest expense.
Under Sprint's centralized cash management program, one Group may advance funds
to the other Group. These advances are accounted for as short-term borrowings
between the Groups and bear interest at a market rate that is substantially
equal to the rate that Group would be able to obtain from third parties on a
short-term basis.
Income Taxes
Sprint records deferred income taxes based on temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
their tax bases.
Revenue Recognition
Sprint recognizes operating revenues as services are rendered or as products
are delivered to customers. Sprint records operating revenues net of an
estimate for uncollectible accounts.
Cash and Equivalents
Cash equivalents generally include highly liquid investments with original
maturities of three months or less. They are stated at cost, which approximates
market value. Sprint uses controlled disbursement banking arrangements as part
of its cash management program. Outstanding checks in excess of cash balances,
which were included in accounts payable, totaled $336 million at year-end 1998
and $225 million at year-end 1997. Sprint had sufficient funds available to
fund the outstanding checks when they were presented for payment.
Investments in Equity Securities
Investments in equity securities are classified as available for sale and
reported at fair value (estimated based on quoted market prices). Gross
unrealized holding gains and losses are reflected in the Consolidated Balance
Sheets as adjustments to "Shareholders' equity--Accumulated other comprehensive
income," net of related income taxes.
Inventories
Inventories for the FON Group are stated at the lower of cost (principally
first-in, first-out method) or market value.
I-20
Inventories for the PCS Group are stated at the lower of cost (principally
first-in, first-out) or replacement value.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Generally, ordinary asset
retirements and disposals are charged against accumulated depreciation with no
gain or loss recognized. The cost of property, plant and equipment is generally
depreciated on a straight-line basis over estimated economic useful lives.
Repairs and maintenance costs are expensed as incurred.
Capitalized Interest
Capitalized interest totaled $167 million in 1998, $93 million in 1997 and $104
million in 1996. In 1998, capitalized interest reflects capitalized costs
related to the PCS Group's network buildout and PCS licenses as well as the FON
Group's construction of capital assets. In 1997 and 1996, capitalized interest
mainly reflected interest related to Sprint's investment in Sprint PCS. Sprint
capitalized these costs until July 1997 when Sprint PCS emerged from the
development stage.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the
net assets acquired in business combinations accounted for as purchases.
Goodwill is being amortized over eight to 40 years using the straight-line
method. Accumulated amortization totaled $63 million at year-end 1998 and $10
million at year-end 1997.
PCS Licenses
The PCS Group acquired licenses from the Federal Communications Commission to
operate as a PCS service provider. These licenses are granted for up to 10-year
terms with renewals for additional 10-year terms if license obligations are
met. These licenses are recorded at cost and are amortized on a straight-line
basis over 40 years when service begins in a specific geographic area.
Accumulated amortization totaled $51 million at year-end 1998.
Earnings per Share
Earnings per share (EPS) was calculated on a consolidated basis until the PCS
stock and FON stock were created as part of the November 1998 PCS Restructuring
and Recapitalization. From that time forward, EPS was computed individually for
the FON Group and PCS Group.
Sprint's convertible preferred dividends totaled $0.5 million through the
Recapitalization date and in 1997 and 1996. Dilutive securities, such as
options (see Note 9), included in the calculation of diluted weighted average
common shares totaled 7.8 million in 1998 through the Recapitalization, 6.3
million in 1997 and 5.3 million in 1996.
From the Recapitalization date to year-end 1998, the FON Group's convertible
preferred dividends totaled $0.1 million and dilutive securities (mainly
options) totaled 6.9 million shares. Dilutive securities for the PCS Group
mainly include options, warrants and convertible preferred stock. These
securities did not have a dilutive effect on loss per share because the PCS
Group incurred net losses for the year. As a result, diluted loss per share
equaled basic loss per share.
Stock-based Compensation
Sprint adopted the pro forma disclosure requirements under Statement of
Financial Accounting Standards (SFAS) No. 123, "Stock-based Compensation," and
continues to apply Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," to its stock option and employee stock purchase
plans.
- --------------------------------------------------------------------------------
3. Business Combination
- --------------------------------------------------------------------------------
In November 1998, Sprint acquired the remaining interest in Sprint PCS (except
for a minority interest in Cox PCS) from the Cable Partners. In exchange,
Sprint issued the Cable Partners 195.1 million low-vote shares of PCS stock and
12.5 million warrants to purchase additional shares of PCS stock. The purchase
price was $3.2 billion. In addition, Sprint issued the Cable Partners shares of
a new class of preferred stock convertible into PCS shares.
Sprint accounted for the transaction as a purchase. The excess of the purchase
price over the fair value of the net liabilities acquired was allocated as
follows:
- ----------------------------------------------------------------------
(in millions)
Purchase price including transaction costs $3,226.0
Net liabilities acquired 280.8
Fair value assigned to customer base acquired (681.4)
Fair value assigned to assembled workforce acquired (45.3)
Increase in property, plant and equipment to fair value (203.1)
Mark-to-market of long-term debt 84.6
Deferred taxes on acquired assets and liabilities 678.3
In-process research and development costs (179.1)
- ----------------------------------------------------------------------
Goodwill $3,160.8
--------------------------------------
With respect to the purchase price attributed to in-process research and
development (IPR&D), the acquired IPR&D was limited to significant new products
under development that were intended to address new and emerging market needs
and requirements, such as the rapid adoption of the Internet and the rapid
convergence of voice, data, and video. No routine research and development
projects, minor refinements, normal enhancements, or production activities were
included in the acquired IPR&D.
The income approach was the primary technique utilized in valuing the acquired
IPR&D. This approach included, but was not limited to, an analysis of (i) the
I-21
markets for each product; (ii) the completion costs for projects; (iii) the
expected cash flows attributable to the IPR&D projects; (iv) the risks
associated with achieving these cash flows and; (v) the stage of development of
each project. The issue of alternative future use was extensively evaluated and
these technologies, once completed, could only be economically used for their
intended purposes.
Pro Forma Results
The following unaudited pro forma combined results of operations assume the PCS
Restructuring, Recapitalization and Top-up occurred at the beginning of 1997
and exclude the write-off of acquired IPR&D costs. These pro forma amounts are
for comparative purposes only and do not necessarily represent what actual
results of operations would have been had the transactions occurred at the
beginning of 1997, nor do they indicate the results of future operations. Pro
forma results were as follows:
- -------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------
(in millions, except per
share data)
Net operating revenues $ 17,134.3 $ 15,131.9
--------------------------------------------------
Loss before extraordinary item $ (306.6) $ (94.6)
--------------------------------------------------
Net loss $ (342.6) $ (94.6)
--------------------------------------------------
Diluted and basic loss per PCS common share:
Loss before extraordinary item $ (4.42) $ (3.52)
Extraordinary item (0.08) --
- -------------------------------------------------------------------------
Total $ (4.50) $ (3.52)
--------------------------------------------------
- --------------------------------------------------------------------------------
4. Investments
- --------------------------------------------------------------------------------
Investments in Equity Securities
The cost of investments in equity securities was $105 million at year-end 1998
and 1997. Gross unrealized holding gains were $384 million at year-end 1998 and
$198 million at year-end 1997.
Investments in and Loans to Affiliates
At year-end 1998, investments accounted for using the equity method consisted
of the FON Group's investments in Global One, Call-Net, EarthLink and other
strategic investments.
In November 1998, Sprint assumed 100% ownership of Sprint PCS; as a result,
Sprint consolidated Sprint PCS' results in 1998. Prior to 1998, Sprint
accounted for its investment in Sprint PCS on the equity basis. Sprint PCS'
1997 results of operations are reflected in the unaudited pro forma disclosures
in Note 3. Its assets at year-end 1997 totaled $7.1 billion. At year-end 1997,
Sprint's investment in Sprint PCS, including advances and a vendor financing
loan, totaled $1.1 billion.
Combined, summarized financial information (100% basis) of other entities
accounted for using the equity method was as follows:
- ------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------
(in millions)
Results of operations
Net operating revenues $2,386.1 $1,939.6 $1,725.4
------------------------------------
Operating loss $ (396.4) $ (780.7) $ (421.3)
------------------------------------
Net loss $ (695.9) $ (826.1) $ (362.0)
------------------------------------
Financial position
Current assets $1,748.0 $2,999.2
Noncurrent assets 3,089.1 4,221.0
--------------------
Total $4,837.1 $7,220.2
--------------------
Current liabilities $1,838.3 $2,073.2
Noncurrent liabilities 1,007.6 2,070.3
Owners' equity 1,991.2 3,076.7
--------------------
Total $4,837.1 $7,220.2
--------------------
Sprint's investment in Global One, including advances, totaled $182 million at
year-end 1998 and $93 million at year-end 1997. At year-end 1998, Sprint's
share of underlying equity in Global One's net assets exceeded the carrying
value of its related investment by $100 million. This difference is being
amortized on a straight-line basis through January 2001.
- --------------------------------------------------------------------------------
5. Employee Benefit Plans
- --------------------------------------------------------------------------------
Defined Benefit Pension Plan
Most FON Group employees are covered by a noncontributory defined benefit
pension plan. Benefits for plan participants belonging to unions are based on
negotiated schedules. For non-union participants, pension benefits are based on
years of service and the participants' compensation. Effective January 1999,
most PCS Group employees will also be covered by this plan.
Sprint's policy is to make annual plan contributions equal to an actuarially
determined amount consistent with federal tax regulations. The funding
objective is to accumulate funds at a relatively stable rate over the
participants' working lives so benefits are fully funded at retirement.
The following table shows the changes in the projected benefit obligation:
- --------------------------------------
1998 1997
- --------------------------------------
(in millions)
Beginning balance $2,240.9 $1,967.0
Service cost 71.7 61.7
Interest cost 165.0 148.9
Amendments 9.7 14.7
Actuarial gain 202.2 151.9
Benefits paid (110.1) (103.3)
- --------------------------------------
Ending balance $2,579.4 $2,240.9
-------------
I-22
The following table shows the changes in plan assets:
- -------------------------------------------------
1998 1997
- -------------------------------------------------
(in millions)
Beginning balance $2,929.4 $2,584.2
Actual return on plan assets 350.0 448.5
Benefits paid (110.1) (103.3)
- -------------------------------------------------
Ending balance $3,169.3 $2,929.4
------------------------
At year-end, the funded status and amounts recognized in the Consolidated
Balance Sheets for the plan were as follows:
- --------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------
(in millions)
Plan assets in excess of the projected benefit obligation $589.9 $688.5
Unrecognized net gains (375.3) (496.4)
Unrecognized prior service cost 104.3 105.4
Unamortized transition asset (97.1) (122.1)
- --------------------------------------------------------------------------
Prepaid pension cost $221.8 $175.4
-----------------------------------------------
Discount rate 7.00% 7.25%
-----------------------------------------------
Expected blended rate of future pay raises 4.00% 4.25%
-----------------------------------------------
The net pension cost (credit) consisted of the following:
- -------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------
(in millions)
Service cost--benefits earned during the year $ 71.7 $ 61.7 $ 65.4
Interest on projected benefit obligation 165.0 148.9 138.5
Expected return on plan assets (265.2) (194.2) (181.2)
Amortization of unrecognized transition asset (25.0) (25.0) (25.0)
Recognition of prior service cost 10.9 9.6 9.0
Recognition of actuarial (gains) and losses (3.8) 1.1 3.6
- -------------------------------------------------------------------------
Net pension cost (credit) $(46.4) $ 2.1 $ 10.3
---------------------------------------------------
Discount rate 7.25% 7.75% 7.25%
---------------------------------------------------
Expected long-term rate of return on plan assets 10.00% 9.50% 9.50%
---------------------------------------------------
Expected blended rate of future pay raises 4.25% 4.75% 4.25%
---------------------------------------------------
Defined Contribution Plans
Sprint sponsors defined contribution employee savings plans covering most FON
Group employees. Participants may contribute portions of their pay to the
plans. For union employees, Sprint matches contributions based on negotiated
amounts. Sprint also matches contributions of non-union employees in FON stock
and PCS stock. The matching is equal to 50% of participants' contributions up
to 6% of their pay. In addition, Sprint may, at the discretion of the Board of
Directors, provide additional matching contributions based on the performance
of FON stock and PCS stock compared to other telecommunications companies'
stock. Sprint's matching contributions were $54 million in 1998 and 1997, and
$56 million in 1996. At year-end 1998, the plans held 16.7 million FON shares
and 10.4 million PCS shares.
Sprint PCS sponsored a savings and retirement program for certain employees.
Sprint PCS matched contributions equal to 50% of the contribution of each
participant, up to the first 6% that the employee elected to contribute.
Expense under the savings plan was $7 million in 1998. Effective January 1999,
the PCS Group employees began making contributions to Sprint's defined
contribution plan. The existing assets of the Sprint PCS savings plan will be
rolled over to that defined contribution plan in early 1999.
Postretirement Benefits
Sprint provides postretirement benefits (mainly medical and life insurance) to
most FON Group employees. Employees retiring before certain dates are eligible
for benefits at no cost, or at a reduced cost. Employees retiring after certain
dates are eligible for benefits on a shared-cost basis. Sprint funds the
accrued costs as benefits are paid. In January 1999, PCS Group employees will
also be covered by this plan.
The following table shows the changes in the accumulated postretirement benefit
obligation:
- ----------------------------------
1998 1997
- ----------------------------------
(in millions)
Beginning balance $832.2 $815.0
Service cost 20.2 20.8
Interest cost 57.8 52.3
Actuarial gains (6.3) (31.6)
Benefits paid (40.2) (24.3)
- ----------------------------------
Ending balance $863.7 $832.2
-------
Amounts included in the Consolidated Balance Sheets at year-end were as
follows:
- ------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------
(in millions)
Accumulated postretirement benefit obligation $ 863.7 $ 832.2
Unrecognized prior service cost 60.8 5.4
Unrecognized net gains 124.7 190.0
- ------------------------------------------------------------------
Accrued postretirement benefits cost $1,049.2 $1,027.6
-----------------------------------------
Discount rate 7.00% 7.25%
-----------------------------------------
The assumed 1999 annual health care cost trend rates are 7.6% before Medicare
eligibility and 8.1% after Medicare eligibility. Both rates gradually decrease
to an ultimate level of 5% by 2005. A 1% increase in the rates would have
increased the 1998 accumulated postretirement benefit obligation by an
estimated $111 million. A 1% decrease would have reduced the obligation by an
estimated $91 million.
I-23
The net postretirement benefits cost consisted of the following:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
(in millions)
Service cost--benefits earned during the year $20.2 $20.8 $21.7
Interest on accumulated postretirement benefit obligation 57.8 52.3 49.9
Recognition of prior service cost (6.2) (0.4) (0.4)
Recognition of actuarial gains (20.6) (19.0) (13.3)
- -------------------------------------------------------------------------------
Net postretirement benefits cost $51.2 $53.7 $57.9
--------------------------------------------------------
Discount rate 7.25% 7.75% 7.25%
--------------------------------------------------------
For measurement purposes, the assumed 1998 weighted average annual health care
cost trend rates were 8.4% before Medicare eligibility and 8.5% after Medicare
eligibility. Both rates gradually decrease to an ultimate level of 5% by 2005.
A 1% increase in the rates would have increased the 1998 postretirement
benefits service and interest costs by an estimated $13 million. A 1% decrease
would have reduced the 1998 postretirement benefits service and interest costs
by an estimated $10 million.
- --------------------------------------------------------------------------------
6. Income Taxes
- --------------------------------------------------------------------------------
Income tax expense allocated to continuing operations consists of the
following:
- -------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------
(in millions)
Current income tax expense
Federal $215.4 $385.9 $655.4
State 44.1 78.9 75.9
- -------------------------------------------------------------
Total current 259.5 464.8 731.3
- -------------------------------------------------------------
Deferred income tax expense (benefit)
Federal 126.1 170.5 (33.8)
State 6.3 (4.8) 23.5
- -------------------------------------------------------------
Total deferred 132.4 165.7 (10.3)
- -------------------------------------------------------------
Total $391.9 $630.5 $721.0
----------------------------------------
The differences that caused Sprint's effective income tax rates to vary from
the 35% federal statutory rate were as follows:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
(in millions)
Income tax expense at the federal statutory rate $294.8 $554.1 $669.2
Effect of:
State income taxes, net of federal income tax effect 32.7 48.2 64.6
Equity in losses of foreign joint ventures 13.1 36.4 8.6
Write-off of in-process research and development costs 62.7 -- --
Other, net (11.4) (8.2) (21.4)
- -------------------------------------------------------------------------------
Income tax expense $391.9 $630.5 $721.0
----------------------------------------------------------
Effective income tax rate 46.5% 39.8% 37.7%
----------------------------------------------------------
Income tax expense (benefit) allocated to other items was as follows:
- -------------------------------------------------
1998 1997 1996
- -------------------------------------------------
(in millions)
Discontinued operation $ -- $ -- $ 7.0
Extraordinary items (22.9) -- (2.9)
Unrealized holding gains
on investments(/1/) 7.6 4.4 1.7
Stock ownership,
purchase and options
arrangements(/2/) (49.0) (26.2) (14.1)
- -------------------------------------------------
(/1/These)amounts have been recorded directly to "Shareholders' equity--
Accumulated other comprehensive income" in the Consolidated Balance Sheets.
(/2/These)amounts have been recorded directly to "Shareholders' equity--Capital
in excess of par or stated value" in the Consolidated Balance Sheets.
Sprint recognizes deferred income taxes for the temporary differences between
the carrying amounts of its assets and liabilities for financial statement
purposes and their tax bases. The sources of the differences that give rise to
the deferred income tax assets and liabilities at year-end 1998 and 1997, along
with the income tax effect of each, were as follows:
- -------------------------------------------------------------------
1998 Deferred Income Tax
----------------------------------------------
Assets Liabilities
- -------------------------------------------------------------------
(in millions)
Property, plant and equipment $ -- $ 2,047.5
Intangibles -- 453.7
Postretirement and other benefits 418.8 --
Reserves and allowances 171.5 --
Unrealized holding gains on investments -- 60.4
Operating loss carryforwards 265.2 --
Other, net 141.6 --
- -------------------------------------------------------------------
997.1 2,561.6
Less valuation allowance 211.8 --
- -------------------------------------------------------------------
Total $ 785.3 $ 2,561.6
----------------------------------------------
- -------------------------------------------------------------------
1997 Deferred Income Tax
----------------------------------------------
Assets Liabilities
- -------------------------------------------------------------------
(in millions)
Property, plant and equipment $ -- $ 1,436.5
Intangibles -- 52.3
Postretirement and other benefits 376.1 --
Reserves and allowances 111.3 --
Unrealized holding gains on investments -- 61.7
Other, net 108.5 --
- -------------------------------------------------------------------
595.9 1,550.5
Less valuation allowance 11.8 --
- -------------------------------------------------------------------
Total $ 584.1 $ 1,550.5
----------------------------------------------
Management believes it is more likely than not that these deferred income tax
assets, net of the valuation allowance, will be realized based on current
income tax laws and expectations of future taxable income stemming from the
reversal of existing deferred tax
I-24
liabilities or ordinary operations. Uncertainties surrounding income tax law
changes, shifts in operations between state taxing jurisdictions and future
operating income levels may, however, affect the ultimate realization of all or
some of these deferred income tax assets.
The valuation allowance related to deferred income tax assets increased $200
million in 1998 and decreased $2 million in 1997 and $4 million in 1996.
Sprint acquired approximately $192 million of potential tax benefits related to
net operating loss carryforwards in the PCS Restructuring which are subject to
certain realization restrictions under various tax laws. A valuation allowance
was provided for the total of these benefits. If these benefits are
subsequently recognized, they will reduce the goodwill or other noncurrent
intangible assets resulting from the PCS Restructuring.
In connection with the PCS Restructuring, the PCS Group is required to
reimburse the FON Group and the Cable Partners for net operating loss and tax
credit carryforward benefits generated prior to the PCS Restructuring if
realization by the PCS Group produces a cash benefit that would not otherwise
have been realized. The reimbursement will equal 60% of the net cash benefit
received by the PCS Group and will be made to the FON Group in cash and to the
Cable Partners in shares of Series 2 PCS stock. The carryforward benefits
subject to this requirement total $246 million, which includes the $192 million
acquired in the PCS Restructuring.
At year-end 1998, Sprint had federal operating loss carryforwards of
approximately $265 million and state operating loss carryforwards of
approximately $4.4 billion. In addition, Sprint had available for income tax
purposes, federal alternative minimum tax credit carryforwards of $27 million,
state alternative minimum tax credit carryforwards of $4 million, and federal
alternative minimum tax net operating loss carryforwards of $14 million. The
loss carryforwards expire in varying amounts through 2018.
- --------------------------------------------------------------------------------
7. Long-term Debt and Capital Lease Obligations
- --------------------------------------------------------------------------------
Sprint's consolidated long-term debt at year-end was as follows:
- ----------------------------------------------------------------------------
1998
--------------------------------
Sprint Sprint
Maturing FON Group PCS Group Consolidated 1997
- ----------------------------------------------------------------------------
(in millions)
Senior notes
5.7% to 6.9%(/1/) 2003 to 2028 $1,059.4 $3,940.6 $ 5,000.0 $ --
8.1% to 9.8% 1998 to 2003 632.3 -- 632.3 675.3
11.0% to 12.5%(/2/) 2006 -- 698.6 565.5 --
Debentures and notes
5.8% to 9.6% 2000 to 2022 564.5 -- 564.5 587.0
Notes payable and
commercial paper -- 745.8 -- 745.8 866.5
First mortgage bonds
2.0% to 9.9% 1998 to 2025 1,312.0 -- 1,312.0 1,468.4
Capital lease
obligations
5.3% to 7.5% 1998 to 2006 31.7 452.0 483.7 35.3
Revolving credit
facilities
Variable rates 2005 to 2006 -- 1,800.0 1,800.0 --
Other(/2/)(/3/)
2.0% to 10.0% 1998 to 2007 370.4 1,029.8 1,085.5 247.1
- ----------------------------------------------------------------------------
4,716.1 7,921.0 12,189.3 3,879.6
Less: current
maturities(/2/) 33.3 348.3 246.9 131.0
- ----------------------------------------------------------------------------
Long-term debt and
capital lease
obligations $4,682.8 $7,572.7 $11,942.4 $3,748.6
------------------------------
(/1/These)borrowings were incurred by Sprint and allocated to the applicable
Group. At year-end 1998, Sprint's weighted average interest rate related to
these borrowings was 6.4%. The weighted average interest rate related to
the borrowings allocated to the PCS Group was approximately 8.5%. See Note
2 for a more detailed description of how Sprint allocates financing to each
of the Groups.
(/2/Consolidated)debt does not equal the total of PCS Group and FON Group debt
due to intergroup debt eliminated in consolidation. At year-end 1998, the
FON Group had an investment in the PCS Group's Senior Discount notes
totaling $133 million. In addition, the PCS Group had other long-term debt
payable to the FON Group totaling $315 million, including $135 million
classified as current at year-end 1998.
(/3/Includes)$358 million of notes recorded by the FON Group that may be
exchanged at maturity for SBC Communications, Inc. (SBC) common shares
owned by the FON Group or for cash. Based on SBC's closing price, had the
notes matured at year-end 1998, they could have been exchanged for 6.6
million SBC shares. At year-end 1998, Sprint held 7.6 million SBC shares,
which have been included in "Investments in equity securities" in the FON
Group's Combined Balance Sheets.
I-25
Long-term debt maturities, excluding reclassified short-term borrowings, during
each of the next five years are as follows:
- ------------------------------
Sprint Sprint
FON PCS
Group Group Sprint
- ------------------------------
(in millions)
1999 $ 33.3 $ 348.3 $ 246.9
2000 864.0 175.3 1,039.3
2001 41.1 407.1 217.0
2002 353.0 357.3 710.3
2003 774.8 1,115.0 1,889.8
- ------------------------------
Sprint
Short-term Borrowings
Sprint had bank notes payable totaling $454 million at year-end 1998 and $618
million at year-end 1997. In addition, Sprint had commercial paper borrowings
totaling $292 million at year-end 1998 and $249 million at year-end 1997.
Though these borrowings are renewable at various dates throughout the year,
they were classified as long-term debt because of Sprint's intent and ability,
through unused credit facilities, to refinance these borrowings on a long-term
basis.
In 1998, Sprint replaced its previous $1.5 billion credit facility with new
facilities with syndicates of domestic and international banks. The new
facilities totaled $5.0 billion and expire in 1999 and 2003. Commercial paper
and certain bank notes payable are supported by Sprint's revolving credit
facilities. Certain other notes payable relate to a separate revolving credit
facility. At year-end 1998, Sprint had total unused lines of credit of $4.8
billion.
Bank notes outstanding had weighted average interest rates of 5.7% at year-end
1998 and 6.1% at year-end 1997. The weighted average interest rate of
commercial paper was 5.8% at year-end 1998 and 6.8% at year-end 1997.
Long-term Debt
In October 1998, Sprint filed a shelf registration statement with the
Securities and Exchange Commission for $8.0 billion of debt securities. This
replaced Sprint's previous shelf registration of $1.0 billion. In November
1998, Sprint issued $5.0 billion under the new shelf. Sprint allocated these
borrowings to the Groups, and the related proceeds were mainly used to repay
existing debt. See Note 2 for a more detailed description of how Sprint
allocates debt to the Groups.
Sprint FON Group
In 1998, Sprint redeemed, prior to scheduled maturities, $138 million of FON
Group debt with interest rates ranging from 7.9% to 9.3%. This resulted in a $5
million after-tax extraordinary loss for the FON Group. In 1996, Sprint also
redeemed, prior to scheduled maturities, $190 million of FON Group debt with
interest rates ranging from 6.0% to 9.5%. This resulted in a $5 million after-
tax extraordinary loss for the FON Group.
FON Group property, plant and equipment totaling $13.9 billion is either
pledged as security for first mortgage bonds and certain notes or is restricted
for use as mortgaged property.
Sprint PCS Group
At year-end 1998, the PCS Group had borrowed $1.8 billion under revolving
credit facilities with banks totaling $2.1 billion. These facilities had a
weighted average interest rate of 5.8% at year-end 1998.
At year-end 1998, the PCS Group had $265 million of outstanding debt payable to
the FCC related to the purchase of certain PCS licenses in 1996. These
borrowings have an interest rate of 7.8% and mature in 2001.
In 1998, Sprint redeemed, prior to scheduled maturities, $3.3 billion of PCS
Group debt with a weighted average interest rate of 8.3%. This resulted in a
$31 million after-tax extraordinary loss for the PCS Group. The debt was repaid
with a portion of the proceeds from Sprint's $5.0 billion debt offering in
November 1998.
PCS Group property, plant and equipment totaling $4.1 billion is pledged as
security for certain notes.
Other
Sprint, including the FON Group and the PCS Group, had complied with all
restrictive or financial covenants relating to its debt arrangements at year-
end 1998.
- --------------------------------------------------------------------------------
8. Common Stock
- --------------------------------------------------------------------------------
Sprint FON Stock and Sprint PCS Stock
In November 1998, Sprint recapitalized its common stock into FON stock and PCS
stock and restructured its interests in Sprint PCS. As a result, Sprint created
the following series of common stock:
. Series 1 FON stock and Series 1 PCS stock Existing Sprint common
shareholders received one share of FON stock and 1/2 share of PCS stock
for each Sprint share owned. Authorized shares totaled 2.5 billion for
the Series 1 FON stock and 1.25 billion for the Series 1 PCS stock.
I-26
. Series 2 FON stock and Series 2 PCS stock The Cable Partners received
PCS shares for their ownership interests in Sprint PCS. These shares
have 1/10 the voting power of the Series 1 and Series 3 PCS shares.
Authorized shares totaled 500 million for both the Series 2 FON stock
and Series 2 PCS stock.
. Series 3 FON stock and Series 3 PCS stock To maintain their voting power
at 10% each, FT and DT purchased a combined total of 5.1 million Series
3 PCS shares for $85 million. Series 3 FON and PCS stock would also be
used if FT and DT were to elect to convert their Class A common shares
into FON and PCS stock. Authorized shares totaled 1.2 billion for the
Series 3 FON stock and 600 million for the Series 3 PCS stock.
At year-end 1998, Sprint had 8.5 million treasury shares, which were recorded
at cost. These shares consisted of 5.8 million FON shares and 2.7 million PCS
shares. The PCS shares are held by the FON Group and represent an intergroup
interest in the PCS Group.
Beginning in November 2001, Sprint has the option to convert PCS shares into
FON shares.
Class A Common Stock
FT and DT each own Class A common shares with 10% of Sprint's voting power.
During 1998 and 1997, Sprint declared and paid Class A common dividends of
$1.00 per share. During 1996, Sprint declared and paid Class A common dividends
of $0.75 per share.
In November 1998, the 86.2 million Class A common shares were reclassified to
represent an equity interest in the FON Group (86.2 million shares) and the PCS
Group (43.1 million shares). FT and DT maintained their combined 20% voting
power in Sprint by purchasing an additional 5.1 million Series 3 PCS shares for
$85 million.
FT and DT, as Class A common and Series 3 PCS shareholders, have the right in
most cases to pro rata representation on Sprint's Board of Directors. They may
also purchase additional shares of FON stock and PCS stock from Sprint to keep
their ownership level at 10% each. FT and DT have entered into a standstill
agreement with Sprint restricting their ability to acquire Sprint voting shares
(other than as intended by their agreements with Sprint). The standstill
agreement also contains customary provisions restricting FT and DT from
initiating or participating in any proposal with respect to the control of
Sprint.
PCS Preferred Stock
As part of the PCS Restructuring, Sprint issued to the Cable Partners a new
class of convertible preferred stock convertible into PCS shares. This stock
was issued either to purchase certain debt loaned to Sprint PCS by the Cable
Partners or as consideration for their interests in Sprint PCS.
Common Stock Reserved for Future Grants
At year-end 1998, common stock reserved for future grants under stock option
plans or for future issuances under various other arrangements was as follows:
Sprint FON Group
- ----------------------------------------------------------------------
Shares
- ----------------------------------------------------------------------
(in millions)
Employees Stock Purchase Plan 7.0
Employee savings plans 3.4
Automatic Dividend Reinvestment Plan 1.2
Officer and key employees' and directors' stock options 9.4
Conversion of preferred stock and other 1.6
- ----------------------------------------------------------------------
22.6
----
Sprint PCS Group
- ----------------------------------------------------------------------
Shares
- ----------------------------------------------------------------------
(in millions)
Employees Stock Purchase Plan 3.5
Employee savings plans 1.7
Officer and key employees' and directors' stock options 10.1
Warrants issued to Cable Partners 12.5
Conversion of preferred stock and other 10.7
- ----------------------------------------------------------------------
38.5
----
Shareholder Rights Plan
Under a Shareholder Rights Plan, one preferred stock purchase right was
attached to each common and Class A common share. During 1998, Sprint amended
the plan to attach one preferred stock purchase right to each share of FON
stock, PCS stock and Class A common stock. The rights may be redeemed by Sprint
at $0.01 per right and will expire in June 2007, unless extended. The rights
are exercisable only if certain takeover events occur and are entitled to the
following:
. Each FON stock right will initially entitle the holder to purchase
1/1,000 of a share (Unit) of a no par Preferred Stock-Sixth Series at
$275 per Unit.
. Each PCS stock right will initially entitle the holder to purchase a
Unit of a no par Preferred Stock-Eighth Series at $150 per Unit.
. Each Class A right will initially entitle the holder to purchase a Unit
of Preferred Stock-Sixth Series at $275 per Unit and 1/2 Unit of
Preferred Stock-Eighth Series at $75 per 1/2 Unit.
Preferred Stock-Sixth Series is voting, cumulative and accrues dividends on a
quarterly basis generally equal to the greater of $100 per share or 1,000 times
the total per share amount of all FON stock common dividends. Preferred Stock-
Eighth Series has the same features as
I-27
the Sixth Series, but applies to PCS shares. No Preferred Stock-Sixth Series or
Preferred Stock-Eighth Series were issued or outstanding at year-end 1998.
Other
The indentures and financing agreements of certain of Sprint's subsidiaries
contain provisions limiting cash dividend payments on subsidiary common stock
held by Sprint. As a result, $576 million of those subsidiaries' $1.5 billion
total retained earnings was restricted at year-end 1998. The flow of cash in
the form of advances from the subsidiaries to Sprint is generally not
restricted.
- --------------------------------------------------------------------------------
9. Stock-based Compensation
- --------------------------------------------------------------------------------
Management Incentive Stock Option Plan
Under the Management Incentive Stock Option Plan (MISOP), Sprint has granted
stock options to employees who are eligible to receive annual incentive
compensation. Eligible employees are entitled to receive stock options in lieu
of a portion of the target incentive under Sprint's management incentive plans.
The options generally become exercisable on December 31 of the year granted and
have a maximum term of 10 years. MISOP options are granted with exercise prices
equal to the market price of the underlying common stock on the grant date. At
year-end 1998, authorized FON shares under this plan approximated 11.4 million
and authorized PCS shares approximated 5.7 million. These amounts increased by
approximately 3.1 million FON shares and 3.3 million PCS shares on January 1,
1999. PCS Group employees also became eligible to participate in this plan in
1999.
Stock Option Plan
Under the Sprint Stock Option Plan (SOP), Sprint has granted stock options to
officers and key employees. The options generally become exercisable at the
rate of 25% per year, beginning one year from the grant date, and have a
maximum term of 10 years. SOP options are granted with exercise prices equal to
the market price of the underlying common stock on the grant date. Authorized
FON shares under this plan approximated 21.0 million and authorized PCS shares
approximated 18.6 million. The PCS shares include 2.7 million shares granted
under this plan to certain PCS Group employees in December 1998.
In 1997, Sprint granted performance-based stock options to certain key
executives. In 1998, the FON Group expensed $14 million and the PCS Group
expensed $1 million related to these performance-based stock options.
Employees Stock Purchase Plan
Under Sprint's Employees Stock Purchase Plan (ESPP), employees may elect to
purchase FON common stock or PCS common stock at a price equal to 85% of the
market value on the grant or exercise date, whichever is less. At year-end
1998, authorized FON shares under this plan approximated 8.2 million and
authorized PCS shares approximated 4.1 million. PCS Group employees also became
eligible to participate in this plan in 1999.
Sprint PCS Long-term Incentive Plan
PCS Group employees meeting certain eligibility requirements were included in
Sprint PCS' long-term incentive plan (LTIP). Under this plan, participants
received appreciation units based on independent appraisals. Appreciation on
the units was based on annual independent appraisals. The 1997 plan year
appreciation units vest 25% per year beginning one year from the grant date and
also expire after 10 years. Under the 1996 plan, appreciation units vest 25%
per year, beginning two years from the grant date, and expire after 10 years.
In connection with the PCS Restructuring, Sprint discontinued the Sprint PCS
LTIP plan. The appreciation units were converted to PCS shares and options to
buy PCS shares based on a formula designed to replace the appreciated value of
the units at the beginning of July 1998. For vested units at year-end 1998,
participants could elect to receive the appreciation in cash, or in shares and
options. Most elected to receive shares and options.
Sprint will issue the shares, and the options will become exercisable, based on
the vesting requirements of the converted units. Assuming all participants stay
employed by Sprint until all replacement options and shares are vested, Sprint
would issue approximately 1.6 million PCS shares and 1.9 million PCS shares
under option.
Recapitalization
Due to the Recapitalization, the number of shares and the related exercise
prices have been adjusted to maintain both the total fair value of common stock
underlying the options and ESPP share elections, and the relationship between
the market value of the common stock and the exercise prices of the options and
ESPP share elections.
Pro Forma Disclosures
Pro forma net income (loss) and earnings (loss) per share have been determined
as if Sprint had used the fair value method of accounting for its stock option
grants and ESPP share elections after 1994. Under this method, compensation
expense is recognized over the applicable vesting periods and is based on the
shares under option and their related fair values on the grant date.
The following pro forma information will not likely represent the information
reported in future years because options granted in 1995 (the year SFAS 123 was
effective) will continue to vest over the next year. In addition, compensation
expense resulting from the Recapitalization will decline over the next several
years.
I-28
Sprint's pro forma net income and earnings per share were as follows:
- ------------------------------------------------------------
1998(/1/) 1997 1996
- ------------------------------------------------------------
(in millions, except
per share data)
Pro forma net income $ 785 $ 908 $1,158
--------------------------------------
Pro forma diluted earnings per share $1.79 $2.11 $ 2.74
--------------------------------------
(/1/Reflects)consolidated pro forma net income and earnings per share until the
Recapitalization date.
From the Recapitalization date through year-end 1998, the FON Group's pro forma
net income was $103 million and pro forma diluted EPS was $0.24. The FON
Group's pro forma net income for 1998 was reduced by $19 million ($0.04 per FON
share) due to additional compensation resulting from modifications to terms of
options and ESPP share elections related to the Recapitalization.
The application of SFAS No. 123 did not have a material impact on the PCS
Group's pro forma net loss from the Recapitalization date through year-end
1998.
Fair Value Disclosures
MISOP and SOP
The following tables reflect the weighted average fair value per option
granted, as well as the significant weighted average assumptions used in
determining those fair values using the Black-Scholes pricing model:
Sprint Common Stock
- -----------------------------------------
1998 MISOP SOP
- -----------------------------------------
Fair value on grant date $14.58 $16.00
Risk-free interest rate 5.5% 5.5%
Expected volatility 21.7% 21.7%
Expected dividend yield 1.7% 1.7%
Expected life (years) 5 6
- -----------------------------------------
1997 MISOP SOP
- -----------------------------------------
Fair value on grant date $ 9.66 $11.74
Risk-free interest rate 6.2% 6.2%
Expected volatility 22.8% 22.8%
Expected dividend yield 2.3% 2.3%
Expected life (years) 4 6
- -----------------------------------------
1996 MISOP SOP
- -----------------------------------------
Fair value on grant date $ 9.17 $10.96
Risk-free interest rate 5.2% 5.2%
Expected volatility 23.3% 23.3%
Expected dividend yield 2.5% 2.5%
Expected life (years) 4 6
PCS Common Stock
- ---------------------------------
1998 SOP
- ---------------------------------
Fair value on grant date $10.88
Risk-free interest rate 4.4%
Expected volatility 75.0%
Expected dividend yield --
Expected life (years) 6
Employees Stock Purchase Plan
During 1998, FON Group employees elected to purchase 2.1 million ESPP shares
with each election having a weighted average fair value (using the Black-
Scholes pricing model) of $13.90 per share. No ESPP shares were offered in
1997. During 1996, Sprint employees elected to purchase 2.8 million ESPP shares
with each election having a weighted average fair value of $10.06 per share.
Stock Options
Stock option plan activity was as follows:
Sprint Common Stock
- -------------------------------------------------------
Weighted
Average
per Share
Sprint Exercise
Shares Price
- -------------------------------------------------------
(in millions)
Outstanding, beginning of 1996 12.3 $24.88
Granted 4.9 36.94
Exercised (2.6) 22.28
Forfeited/Expired (1.0) 29.22
----
Outstanding, year-end 1996 13.6 29.42
Granted 9.4 46.14
Exercised (3.4) 27.17
Forfeited/Expired (0.9) 38.10
----
Outstanding, year-end 1997 18.7 37.85
Granted 9.1 59.73
Exercised (3.4) 33.54
Forfeited/Expired (0.6) 47.28
----
Converted in November 1998 23.8 $46.60
------------------------------
FON Common Stock
- -------------------------------------------------------
Weighted
Average
Sprint per Share
FON Exercise
Shares Price
- -------------------------------------------------------
(in millions)
Converted in November 1998 23.8 $42.02
Exercised (0.1) 31.90
----
Outstanding, year-end 1998 23.7 $42.06
------------------------------
PCS Common Stock
- -------------------------------------------------------
Weighted
Average
Sprint per Share
PCS Exercise
Shares Price
- -------------------------------------------------------
(in millions)
Converted in November 1998 11.9 $ 9.16
Granted 2.7 15.84
----
Outstanding, year-end 1998 14.6 $10.40
------------------------------
I-29
Options exercisable were 8.3 million at year-end 1997 and 8.4 million at year-
end 1996. At year-end 1997, the weighted average exercise price for exercisable
options was $32.65.
The following tables summarize outstanding and exercisable options at year-end
1998:
FON Common Stock
- -------------------------------------------------
Options Outstanding
----------------------------------
Weighted
Weighted Average
Average per
Range of Remaining Share
Exercise Number Contractual Exercise
Prices Outstanding Life Price
- -------------------------------------------------
(in millions) (in years)
$10.00-$24.99 2.5 4.9 $21.27
25.00- 34.99 4.6 6.3 30.99
35.00- 44.99 6.3 8.1 40.64
45.00- 59.99 9.6 8.9 51.92
60.00- 84.99 0.7 5.0 65.67
- -------------------------------------------------
- -------------------------------------
Options Exercisable
----------------------
Weighted
Average
per
Range of Share
Exercise Number Exercise
Prices Exercisable Price
- -------------------------------------
(in millions)
$10.00-$24.99 2.0 $21.12
25.00- 34.99 3.2 30.68
35.00- 44.99 1.9 39.28
45.00- 59.99 3.5 52.66
- -------------------------------------
PCS Common Stock
- ---------------------------------------------------
Options Outstanding
----------------------------------
Weighted
Weighted Average
Average per
Remaining Share
Range of Number Contractual Exercise
Exercise Prices Outstanding Life Price
- ---------------------------------------------------
(in millions) (in years)
$ 2.50-$ 4.99 1.2 4.9 $ 4.64
5.00- 7.49 2.2 6.3 6.73
7.50- 9.99 3.2 8.1 8.85
10.00- 14.99 5.2 8.6 11.52
15.00- 19.99 2.8 8.6 15.84
- ---------------------------------------------------
- ---------------------------------------
Options Exercisable
----------------------
Weighted
Average
per
Share
Range of Number Exercise
Exercise Prices Exercisable Price
- ---------------------------------------
(in millions)
$ 2.50-$ 4.99 1.0 $4.60
5.00- 7.49 1.6 6.66
7.50- 9.99 0.9 8.55
10.00- 14.99 1.8 11.49
15.00- 19.99 0.5 15.84
- ---------------------------------------
- --------------------------------------------------------------------------------
10. Commitments and Contingencies
- --------------------------------------------------------------------------------
Litigation, Claims and Assessments
In December 1996, an arbitration panel entered a $61 million award in favor of
Network 2000 Communications Corporation on its breach of contract claim against
Sprint. The arbitrators directed Sprint to pay 50% of this award to Network
2000. The remainder was directed to be paid to the Missouri state court in
which a proposed class action by Network 2000's independent marketing
representatives against Network 2000 and Sprint is pending.
In June 1997, Sprint recorded additional expense of $20 million. This charge
related to the settlement of both the class action lawsuit against Sprint and
Network 2000 and the related claims of Network 2000 against Sprint. In June
1998, the court approved the class action settlement; however, a small number
of potential class members chose not to be a part of that settlement and have
filed a separate lawsuit asserting their individual claims. Some potential
class members have appealed the approval of the settlement, which has delayed
final approval.
Other suits arising in the ordinary course of business are pending against
Sprint. Management cannot predict the final outcome of these actions but
believes they will not be material to Sprint's consolidated financial
statements.
Commitments
The PCS Group has procurement and service contracts with certain vendors. These
contracts are for the engineering and construction of the PCS network. The
contracts provide for initial terms of three to five years through 2002 with
renewals for additional one-year terms. At year-end 1998, $696 million of the
total commitment was satisfied, leaving a remaining commitment of $204 million.
The PCS Group has a purchase and supply contract with a vendor to purchase
handsets and other equipment totaling more than $600 million through April
2000. At year-end 1998, the remaining commitments totaled $163 million.
In June 1998, the PCS Group became the managing partner of Cox PCS. At year-end
1998, the PCS Group owned 59.2% of Cox PCS. Cox holds the minority interest in
the partnership. Under the partnership agreement, Cox has the right to require
the PCS Group to purchase, under certain circumstances, all or part of Cox's
interest in Cox PCS, which could involve significant cash requirements. Cox may
require the PCS Group to acquire an additional 10.2% interest in Cox PCS per
year through 2000. Beginning in 2001 through 2005, Cox may require the PCS
Group to acquire up to all of its interest in Cox PCS. Cox has given the PCS
Group notice to start the appraisal process related to a potential put of all
or a portion of Cox's remaining partnership interest to the PCS Group.
I-30
Operating Leases
Sprint's minimum rental commitments at year-end 1998 for all noncancelable
operating leases, consisting mainly of leases for data processing equipment,
real estate, cell and switch sites, and office space are as follows:
- -------------------------
(in millions)
1999 $568.3
2000 463.0
2001 330.1
2002 214.1
2003 126.0
Thereafter 291.4
- -------------------------
Sprint's gross rental expense totaled $730 million in 1998, $410 million in
1997 and $401 million in 1996. Rental commitments for subleases, contingent
rentals and executory costs were not significant. The table excludes renewal
options related to certain cell and switch site leases. These renewal options
generally have five-year terms and may be exercised from time to time.
- --------------------------------------------------------------------------------
11. Financial Instruments
- --------------------------------------------------------------------------------
Fair Value of Financial Instruments
Sprint estimates the fair value of its financial instruments using available
market information and appropriate valuation methodologies. As a result, the
following estimates do not necessarily represent the values Sprint could
realize in a current market exchange. Although management is not aware of any
factors that would affect the year-end 1998 estimated fair values, those
amounts have not been comprehensively revalued for purposes of these financial
statements since that date. Therefore, estimates of fair value after year-end
1998 may differ significantly from the amounts presented below.
The carrying amounts and estimated fair values of Sprint's financial
instruments at year-end were as follows:
- ------------------------------------------------------------------
1998
--------------------
Carrying Estimated
Amount Fair Value
- ------------------------------------------------------------------
(in millions)
Cash and equivalents $ 605.2 $ 605.2
Investments in equity securities 489.2 489.2
Long-term debt and capital lease obligations 12,189.3 12,771.0
- ------------------------------------------------------------------
- ------------------------------------------------------------------
1997
--------------------
Carrying Estimated
Amount Fair Value
- ------------------------------------------------------------------
(in millions)
Cash and equivalents $ 101.7 $ 101.7
Investments in equity securities 303.0 303.0
Investment in affiliate debt securities(/1/) 142.4 142.4
Long-term debt and capital lease obligations 3,879.6 4,155.8
- ------------------------------------------------------------------
(/1/At)year-end 1998, Sprint's investment in affiliate debt securities was
eliminated in consolidation.
The carrying values of Sprint's cash and equivalents approximate fair value at
year-end 1998 and 1997. The estimated fair value of investments in equity
securities is based on quoted market prices. The estimated fair value of long-
term debt is based on quoted market prices for publicly traded issues. The
estimated fair value of all other issues is based on the present value of
estimated future cash flows using a discount rate based on the risks involved.
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.
Interest Rate Swap Agreements
Sprint uses interest rate swap agreements as part of its interest rate risk
management program. Net interest paid or received related to these agreements
is recorded using the accrual method and is recorded as an adjustment to
interest expense. Sprint had interest rate swap agreements with notional
amounts of $134 million outstanding at year-end 1998 and $150 million
outstanding at year-end 1997. Net interest expense (income) related to interest
rate swap agreements was $0.1 million in 1998, $(0.2) million in 1997 and $2
million in 1996.
In 1998, Sprint deferred losses from interest rate swap agreements used to
hedge a portion of a $5.0 billion debt offering. These losses, totaling $75
million, will be amortized to interest expense using the effective interest
method over the term of the debt. There were no deferred gains or losses
related to any terminated interest rate swap agreements at year-end 1997 or
1996.
Foreign Currency Contracts
As part of its foreign currency exchange risk management program, Sprint
purchases and sells over-the-counter forward contracts and options in various
foreign currencies. Sprint had outstanding open forward contracts to buy
various foreign currencies of $18 million at year-end 1998 and $29 million at
year-end 1997. Sprint had outstanding open purchase option contracts to call
various foreign currencies of $10 million at year-end 1998 and $14 million at
year-end 1997. The premium paid for an option is deferred and amortized over
the life of the option. The forward contracts and options open at year-end 1998
and 1997 all had original maturities of six months or less. The net gain or
loss recorded to reflect the fair value of these contracts is
I-31
recorded in the period incurred. Total net losses, including hedge costs, of
$0.6 million in 1998, $0.1 million in 1997 and $0.4 million in 1996 were
recorded related to foreign currency transactions and contracts.
- --------------------------------------------------------------------------------
12. Paranet Acquisition
- --------------------------------------------------------------------------------
In September 1997, Sprint paid $375 million to purchase the net assets of
Houston-based Paranet, Inc., a provider of integration, management and support
services for computer networks.
The transaction was accounted for using the purchase method of accounting. As a
result, Sprint's financial statements reflect Sprint Paranet's results of
operations beginning in October 1997.
The excess of the purchase price over the tangible net assets acquired was $357
million. This excess was allocated to noncompete agreements and goodwill, and
is being amortized on a straight-line basis over four to 10 years.
- --------------------------------------------------------------------------------
13. Spinoff of Cellular Division
- --------------------------------------------------------------------------------
Sprint completed the tax-free spinoff of its Cellular division (Cellular) to
Sprint common shareholders in 1996. To complete the spinoff, Sprint distributed
all Cellular common shares at a rate of one share for every three Sprint common
shares held. In addition, Cellular repaid $1.4 billion of its intercompany debt
owed to Sprint. Sprint also contributed to Cellular's equity capital $185
million of debt owed by Cellular in excess of the amount repaid.
Cellular's 1996 net operating results through the spinoff date, as summarized
in the following table, were separately classified as a discontinued operation
in the Consolidated Statements of Income. Interest expense was allocated to
Cellular based on the assumed repayment of intercompany debt to Sprint by
Cellular. The operating expenses as presented below do not include Cellular's
share of Sprint's general corporate overhead expenses. These expenses, totaling
$2 million in 1996, were reallocated to Sprint's other operating entities.
- ------------------------------------------
(in millions)
Net operating revenues $190.2
Operating expenses 156.0
- ------------------------------------------
Operating income 34.2
Interest expense (21.5)
Other expense, net (8.3)
- ------------------------------------------
Income before income taxes 4.4
Income taxes (7.0)
- ------------------------------------------
Loss from cellular division $ (2.6)
----------
- --------------------------------------------------------------------------------
14. Additional Financial Information
- --------------------------------------------------------------------------------
Segment Information
In 1998, Sprint adopted SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information."
The FON Group operates in five business segments, based on services and
products: the long distance division, the local division, the product
distribution and directory publishing businesses, activities to develop and
deploy Sprint ION(SM) and other ventures. See Note 12 of Sprint FON Group Notes
to the Combined Financial Statements for more information about the FON Group's
business segments.
The PCS Group businesses operate in a single segment.
I-32
Industry segment financial information was as follows:
- -------------------------------------------------------------------------------
Sprint Sprint Intergroup
FON Group PCS Group Eliminations Consolidated
- -------------------------------------------------------------------------------
(in millions)
1998
Net operating revenues $16,016.9 $ 1,225.4 $ (108.0) $17,134.3
Intergroup revenues 107.7 0.3 (108.0) --
Depreciation and amortization 1,915.1 789.7 -- 2,704.8
Operating expenses 13,257.1 3,794.8 (108.0) 16,943.9
Operating income (loss) 2,759.8 (2,569.4) -- 190.4
Operating margin 17.2% NM -- NM
Other partners' loss in Sprint
PCS -- 1,250.9 -- 1,250.9
Equity in losses of affiliates (227.2) -- -- (227.2)
Capital expenditures 3,159.2 1,071.9 -- 4,231.1
Total assets 19,274.8 15,138.4 (1,182.1) 33,231.1
1997
Net operating revenues $14,873.9 $ -- $ -- $14,873.9
Depreciation and amortization 1,726.3 -- -- 1,726.3
Operating expenses 12,404.0 18.5 -- 12,422.5
Operating income (loss) 2,469.9 (18.5) -- 2,451.4
Operating margin 16.6% NM -- 16.5%
Equity in losses of affiliates (172.2) (659.6) -- (831.8)
Capital expenditures 2,708.9 153.7 -- 2,862.6
Total assets 16,580.5 1,703.1 (10.0) 18,273.6
1996
Net operating revenues $13,887.5 $ -- $ -- $13,887.5
Depreciation and amortization 1,591.0 -- -- 1,591.0
Operating expenses 11,619.8 0.5 -- 11,620.3
Operating income (loss) 2,267.7 (0.5) -- 2,267.2
Operating margin 16.3% NM -- 16.3%
Equity in losses of affiliates (74.2) (191.8) -- (266.0)
Capital expenditures 2,433.6 -- -- 2,433.6
Total assets 15,655.4 1,259.8 -- 16,915.2
NM = Not meaningful
I-33
Supplemental Cash Flows Information
Sprint's cash paid for interest and income taxes was as follows:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
(in millions)
Interest (net of capitalized interest)
Continuing operations $ 216.7 $197.9 $212.1
-----------------------------------------------------------
Cellular division $ -- $ -- $ 21.5
-----------------------------------------------------------
Income taxes $ 307.3 $365.8 $695.3
-----------------------------------------------------------
Sprint's noncash activities include the following:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
(in millions)
Common stock issued to the Cable Partners to purchase
Sprint PCS $3,200.3 $ -- $ --
-----------------------------------------------------------
Capital lease obligations $ 460.0 $ 30.1 $ --
-----------------------------------------------------------
Preferred stock issued to the Cable Partners in
exchange for interim financing $ 246.8 $ -- $ --
-----------------------------------------------------------
Common stock issued under Sprint's ESPP $ 95.1 $ 5.2 $ 65.2
-----------------------------------------------------------
Tax benefit from stock options exercised $ 49.0 $ 26.2 $ 14.1
-----------------------------------------------------------
Net book value of assets and liabilities contributed to
Global One $ -- $ -- $ 73.3
-----------------------------------------------------------
See Note 3 for more details about the assets and liabilities acquired in the
PCS Restructuring.
Related Party Transactions
Sprint provided various voice, data and administrative services to Global One
totaling $277 million in 1998, $415 million in 1997 and $361 million in 1996.
In addition, Global One provided data and administrative services to Sprint
totaling $140 million in 1998, $114 million in 1997 and $130 million in 1996.
Sprint's receivable from Global One was $187 million at year-end 1998 and $154
million at year-end 1997. Sprint's payable to Global One was $42 million at
year-end 1998 and $104 million at year-end 1997.
The Cable Partners advanced PhillieCo $26 million in 1998 and $24 million in
1997. These advances, which accrue interest at prime, mature in the 1999 first
quarter.
- --------------------------------------------------------------------------------
15. Recently Issued Accounting Pronouncement
- --------------------------------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This standard
requires all derivatives to be recorded on the balance sheet as either assets
or liabilities and be measured at fair value. Gains or losses from changes in
the derivative values are to be accounted for based on how the derivative was
used and whether it qualifies for hedge accounting. When adopted in January
2000, this statement is not expected to have a material impact on Sprint's
consolidated financial statements.
I-34
- --------------------------------------------------------------------------------
16. Quarterly Financial Data (Unaudited)
- --------------------------------------------------------------------------------
Quarter
---------------------------------------
1998 1st(/1/) 2nd(/1/) 3rd(/1/) 4th(/1/)
- ----------------------------------------------------------------------------
(in millions, except per share data)
Net operating revenues $ 4,075.5 $ 4,189.5 $ 4,334.5 $ 4,534.8
Operating income (loss)(/6/) 214.2 184.4 148.4 (356.6)
Income (Loss) before extraordinary
items(/2/),(/6/) 210.7 210.9 239.2 (210.3)
Net income (loss)(/2/) 206.3 210.9 239.2 (241.9)
Earnings (Loss) per common share
before extraordinary items(/5/)
Sprint common stock
Diluted 0.48 0.48 0.54 0.45
Basic 0.49 0.49 0.55 0.46
FON common stock
Diluted NA NA NA 0.27
Basic NA NA NA 0.28
PCS common stock
Diluted and basic NA NA NA (1.26)
- ----------------------------------------------------------------------------
Quarter
---------------------------------------
1997 1st 2nd 3rd 4th
- -----------------------------------------------------------------------------
(in millions, except per share data)
Net operating revenues $ 3,578.5 $ 3,667.5 $ 3,778.9 $ 3,849.0
Operating income(/3/) 604.7 595.5 640.7 610.5
Income before extraordinary
items(/3/),(/4/) 290.0 255.9 211.7 194.9
Net income(/3/),(/4/) 290.0 255.9 211.7 194.9
Earnings per common share before ex-
traordinary items
Diluted 0.67 0.59 0.49 0.45
Basic 0.67 0.59 0.49 0.45
- -----------------------------------------------------------------------------
(/1/Amounts)for 1998 reflect certain reclassifications to conform to the
current-year presentation.
(/2/In)the 1998 fourth quarter, the FON Group recorded net nonrecurring gains
of $104 million, mainly from the sale of local exchanges. This increased
income before extraordinary items by $62 million.
(/3/In)the 1997 second quarter, the FON Group recorded nonrecurring charges of
$20 million related to litigation in the long distance division. These
charges reduced income before extraordinary items by $13 million (See Note
10).
(/4/In)the 1997 fourth quarter, the FON Group recognized gains of $71 million
from sales of local exchanges and certain investments. These gains
increased income before extraordinary items by $44 million.
(/5/Fourth)quarter 1998 reflects EPS for Sprint only through the date of the
November 1998 Recapitalization. EPS for the FON Group and the PCS Group
reflects EPS from the date of the Recapitalization through year-end 1998.
(/6/In)the 1998 fourth quarter, the PCS Group recorded a nonrecurring charge to
write off $179 million of acquired IPR&D related to the PCS Restructuring.
This charge increased operating loss and loss before extraordinary items by
$179 million.
NA = Not applicable
- --------------------------------------------------------------------------------
17. Subsequent Event (Unaudited)
- --------------------------------------------------------------------------------
In February 1999, Sprint completed an offering of Series 1 PCS stock. In this
offering, Sprint sold 24.4 million shares at a price to the public of $28.75
per share. The net proceeds to Sprint totaled $672 million. In connection with
this offering, FT and DT purchased 6.1 million shares of Series 3 PCS stock.
The net proceeds to Sprint from the sale of this stock totaled $169 million.
The proceeds from the offering and purchase by FT and DT were attributed to the
PCS Group and will be used for the continued buildout of the PCS network and
working capital needs.
I-35
SPRINT CORPORATION
SCHEDULE II--CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1998, 1997 and 1996
Additions
-------------------------------------
Balance Charged to Balance
Beginning PCS Charged to Other Other End of
of Year Restructuring Income Accounts Deductions Year
- ------------------------------------------------------------------------------------------------
(in millions)
1998
Allowance for doubtful
accounts $146.7 $ 7.79(/2/) $378.6 $ 2.6 $(350.1)(/1/) $185.5
----------------------------------------------------------------
Valuation allowance--
deferred income tax
assets $ 11.8 $192.0(/3/) $ -- $16.2 $ (8.2) $211.8
----------------------------------------------------------------
1997
Allowance for doubtful
accounts $117.4 $ -- $388.9 $ 4.0 $(363.6)(/1/) $146.7
----------------------------------------------------------------
Valuation allowance--
deferred income tax
assets $ 13.7 $ -- $ 2.6 $ -- $ (4.5) $ 11.8
----------------------------------------------------------------
1996
Allowance for doubtful
accounts $125.8 $ -- $248.5 $(1.5) $(255.4)(/1/) $117.4
----------------------------------------------------------------
Valuation allowance--
deferred income tax
assets $ 17.4 $ -- $ 1.9 $ -- $ (5.6) $ 13.7
----------------------------------------------------------------
(/1/Accounts)written off, net of recoveries.
(/2/As)discussed in Note 3, the PCS Group's assets and liabilities were
recorded at their fair values on the PCS Restructuring date. Therefore, the
data presented in this Schedule reflects activity since the PCS
Restructuring.
(/3/Represents)a valuation allowance for deferred income tax assets recorded in
the purchase price allocation related to the PCS Restructuring.
I-36
Annex II
Sprint FON Group
Combined Financial Information
SELECTED FINANCIAL DATA
Sprint FON Group
- -------------------------------------------------------------------------------
1998 1997 1996 1995 1994
- -------------------------------------------------------------------------------
(in millions, except per share data)
Results of Operations
- -------------------------------------------------------------------------------
Net operating revenues $16,016.9 $14,873.9 $13,887.5 $12,735.3 $11,964.8
Operating income(/1/) 2,759.8 2,469.9 2,267.7 1,834.3 1,690.7
Income from continuing
operations(/1/),(/2/) 1,540.1 1,371.6 1,310.6 966.0 899.2
Pro Forma Earnings per Share
and Dividends(/3/)
- -------------------------------------------------------------------------------
Pro forma earnings per
common share from
continuing
operations(/1/),(/2/)
Diluted $ 3.55 $ 3.14 $ 3.07 $ 2.74 $ 2.56
Basic 3.61 3.19 3.11 2.76 2.59
Pro forma dividends per
common share 1.00 1.00 1.00 1.00 1.00
Financial Position
- -------------------------------------------------------------------------------
Total assets $19,274.8 $16,580.5 $15,655.4 $14,100.6 $14,374.1
Property, plant and
equipment, net 12,464.0 11,306.8 10,464.1 9,715.8 10,258.8
Total debt (including short-
term borrowings) 4,716.1 3,879.6 3,273.9 5,668.9 4,927.7
Group equity 9,024.5 7,639.3 7,332.3 3,676.9 4,473.7
Cash Flow Data
- -------------------------------------------------------------------------------
Net cash provided by
operating activities(/4/) $ 3,971.3 $ 2,906.8 $ 2,267.2 $ 2,590.1 $ 2,339.6
Capital expenditures 3,159.2 2,708.9 2,433.6 1,857.3 1,751.6
Certain prior-year amounts have been reclassified to conform to the current-
year presentation. These reclassifications had no effect on the results of
operations or group equity as previously reported.
The FON Group was created as a result of the PCS Restructuring and
Recapitalization. See Sprint's "Management's Discussion and Analysis of
Financial Condition and Results of Operations--General" for a more detailed
description of the PCS Restructuring and Recapitalization.
(/1/The)FON Group recorded nonrecurring charges of $20 million in 1997 and $60
million in 1996 related to litigation within the long distance division.
These charges reduced income from continuing operations by $13 million in
1997 and $36 million in 1996. In 1995, the FON Group recorded a
nonrecurring charge of $88 million related to a restructuring within the
local division. This reduced income from continuing operations by $55
million.
(/2/In)1998, the FON Group recorded net nonrecurring gains of $104 million
mainly from the sale of local exchanges. This increased income from
continuing operations by $62 million. In 1997, the FON Group recorded
nonrecurring gains of $71 million mainly from sales of local exchanges and
certain investments. These gains increased income from continuing
operations by $44 million. In 1994, the FON Group recognized a $35 million
gain on the sale of equity securities, which increased income from
continuing operations by $22 million.
(/3/Pro)forma earnings per share and dividends for the FON Group assume the FON
shares created in the Recapitalization existed for all periods presented.
(/4/The)1996 amount was reduced by $600 million for cash required to terminate
an accounts receivable sales agreement.
II-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF Sprint FON Group
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
- --------------------------------------------------------------------------------
General
- --------------------------------------------------------------------------------
See Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--General" for a discussion of the PCS Restructuring, the
Recapitalization and the Top-up.
- --------------------------------------------------------------------------------
Forward-looking Information
- --------------------------------------------------------------------------------
See Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Forward-looking Information" for a discussion of
forward-looking information.
- --------------------------------------------------------------------------------
Sprint FON Group
- --------------------------------------------------------------------------------
Core Businesses
Long Distance Division
The long distance division is the nation's third-largest long distance phone
company. It operates a nationwide, all-digital long distance communications
network using state-of-the-art fiber-optic and electronic technology. The
division provides domestic and international voice, video and data
communications services as well as integration management and support services
for computer networks.
Local Division
The local division consists of regulated local phone companies serving more
than 7.6 million access lines in 18 states. It provides local phone services,
access by phone customers and other carriers to its local network, sales of
telecommunications equipment, and long distance services within certain
regional calling areas.
Product Distribution and Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
Sprint ION(SM)
Sprint ION extends Sprint's existing advanced network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for data, Internet, and video. It is also expected to be the
foundation for Sprint to provide new competitive local service.
Other Ventures
The "other ventures" segment includes the FON Group's investment in Global One,
a joint venture with FT and DT. Sprint is a 1/3 partner in Global One's
operating group serving Europe (excluding France and Germany) and is a 50%
partner in Global One's operating group for the worldwide activities outside
the United States and Europe. This segment also includes the FON Group's
investments in EarthLink Network Inc., an Internet service provider; Call-Net,
a long distance provider in Canada operating under the Sprint brand name; and
certain other telecommunications investments and ventures. All of these
investments are accounted for on the equity basis.
- --------------------------------------------------------------------------------
Results of Operations
- --------------------------------------------------------------------------------
Total net operating revenues for 1998 were $16.0 billion, an 8% increase from
$14.9 billion in 1997. Total net operating revenues for 1996 were $13.9
billion.
Income from continuing operations was $1.5 billion in 1998 compared with $1.4
billion in 1997 and $1.3 billion in 1996.
Core Businesses
In 1998, the FON Group's core businesses generated improved net operating
revenues and operating income from 1997. Long distance calling volumes
increased 15% in 1998 and 14% in 1997. Access lines served by the local
division increased 5.1% in 1998 and 5.6% in 1997, excluding sales of local
exchanges.
Core net income included net nonrecurring pretax gains of $104 million in 1998
and $51 million in 1997. These gains mainly consisted of sales of local
exchanges and certain investments, partly offset by litigation charges in 1997.
In 1996, core net income included pretax litigation charges within the long
distance division of $60 million.
Excluding these nonrecurring items, operating income from core operations was
$2.9 billion in 1998 versus $2.6 billion in 1997 and $2.4 billion in 1996.
II-2
- --------------------------------------------------------------------------------
Segmental Results of Operations
- --------------------------------------------------------------------------------
Long Distance Division
- ------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------
(in millions)
Net operating revenues $9,910.9 $8,994.0 $8,302.1
- ------------------------------------------------------------------------
Operating expenses
Interconnection 3,860.1 3,949.3 3,722.7
Operations 1,453.2 1,257.1 1,051.8
Selling, general and administrative(/1/) 2,348.6 2,035.3 1,982.8
Depreciation and amortization 882.2 727.0 633.3
- ------------------------------------------------------------------------
Total operating expenses 8,544.1 7,968.7 7,390.6
- ------------------------------------------------------------------------
Operating income $1,366.8 $1,025.3 $ 911.5
----------------------------------------------------
Operating margin 13.8% 11.4% 11.0%
----------------------------------------------------
Capital expenditures $1,363.8 $1,223.2 $1,139.8
----------------------------------------------------
(/1/The)FON Group recorded nonrecurring litigation charges of $20 million in
1997 and $60 million in 1996.
Net Operating Revenues
All major market segments--business, residential and wholesale--contributed to
the increase in net operating revenues in 1998 and 1997. The increases mainly
reflect strong data services revenue growth and strong minute growth of 15% in
1998 and 14% in 1997, partly offset by a more competitive pricing environment
and a change in the mix of products sold.
Business and Data Market
Business and data market revenues increased 15% in 1998 and 10% in 1997. Data
services, which includes sales of capacity on Sprint's network to Internet
service providers, showed strong growth because of accelerated use of the
Internet and expanded service offerings. The increases also reflect strong
calling volumes for inbound and outbound toll-free calls made within the United
States.
Residential Market
Residential market revenues increased 5% in 1998 and 6% in 1997. These
increases reflect strong revenue and volume growth from residential long
distance calls. Growth was also enhanced by the Sprint Sense Anytime(R) "10 by
24" product--dime-a-minute calls, 24 hours a day--which generated increased
sales in 1998. Other growth factors included increased international and
prepaid card revenues as well as calling card calls made by customers of local
phone companies. Through various agreements Sprint has with local phone
companies, their customers use the Sprint network when making long distance
calls.
Wholesale Market
Wholesale market revenues increased 8% in 1998 and 22% in 1997. This reflects
strong minute growth mainly from increased inbound and outbound toll-free
calls, partly offset by a change in international mix to lower yielding but
higher margin countries.
Interconnection Costs
Interconnection costs consist of amounts paid to local phone companies, other
domestic service providers and foreign phone companies to complete calls made
by the division's domestic customers. These costs decreased 2% in 1998 and
increased 6% in 1997. Reductions in per-minute costs for both domestic and
international access more than offset the impact of increased calling volumes
in 1998 versus 1997, and partially offset the impact of increased calling
volumes in 1997 versus 1996. The rate reductions were generally due to domestic
FCC-mandated access rate reductions that took effect in July 1997 and in
January and July 1998. Interconnection costs were 38.9% of net operating
revenues in 1998, 43.9% in 1997 and 44.8% in 1996.
Operations Expense
Operations expense includes costs to operate and maintain the long distance
network and costs of equipment sales. It also includes costs to provide
operator, public payphone and video teleconferencing services as well as
telecommunications services for the hearing-impaired. Operations expense
increased 16% in 1998 and 20% in 1997. These increases were driven by growth in
data services as well as increases in network equipment operating leases in
both years. Operations expense for 1998 also includes costs related to Sprint's
efforts to achieve Year 2000 compliance for its telecommunications network and
operating systems. The 1997 increase also reflects increased costs related to
FCC-mandated payments to public payphone providers. Operations expense was
14.7% of net operating revenues in 1998, 14.0% in 1997 and 12.7% in 1996.
Selling, General and Administrative Expense
Selling, general and administrative (SG&A) expense increased 15% in 1998 and 3%
in 1997. These increases mainly reflect the overall growth of the business as
well as increased marketing and promotions to support products and services.
SG&A for 1998 also includes costs related to Sprint's efforts to achieve Year
2000 compliance for information systems and applications supporting such
processes as billing, customer service and other administrative support
services. SG&A expense was 23.7% of net operating revenues in 1998, 22.6% in
1997 and 23.9% in 1996.
Depreciation and Amortization Expense
Depreciation and amortization expense increased 21% in 1998 and 15% in 1997.
These increases were generally due to an increased asset base with shorter
average depreciable lives. Capital expenditures were incurred mainly to enhance
network reliability, meet increased demand for voice and data-related services
and upgrade
II-3
capabilities for providing new products and services. Depreciation and
amortization expense was 8.9% of net operating revenues in 1998, 8.1% in 1997
and 7.6% in 1996.
Local Division
- -------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------
(in millions)
Net operating revenues $5,371.4 $5,293.9 $5,127.0
- -------------------------------------------------------------------
Operating expenses
Costs of services and products 1,855.1 1,892.1 1,843.2
Selling, general and administrative 1,150.6 1,075.6 1,039.5
Depreciation and amortization 958.7 935.5 909.6
- -------------------------------------------------------------------
Total operating expenses 3,964.4 3,903.2 3,792.3
- -------------------------------------------------------------------
Operating income $1,407.0 $1,390.7 $1,334.7
------------------------------------------------
Operating margin 26.2% 26.3% 26.0%
------------------------------------------------
Capital expenditures $1,374.4 $1,270.0 $1,149.7
------------------------------------------------
Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. The main effect of this change was a reduction in the local division's
"Net Operating Revenues--Other Revenues." Sprint sold approximately 139,000
residential and business access lines in Illinois in 1997 and the remaining
81,000 access lines in November 1998. For comparative purposes, the following
discussion of local division results assumes these transfer pricing changes and
sales of exchanges occurred at the beginning of 1996. Adjusting for these
transfer pricing changes and sales of exchanges, operating margins would have
been 26.0% in 1998, 25.0% in 1997 and 24.3% in 1996.
Net Operating Revenues
Net operating revenues increased 5% in both 1998 and 1997. These increases
mainly reflect customer access line growth and increased sales of equipment and
network-based services such as Caller ID and Call Waiting. Customer access
lines increased 5.1% in 1998 and 5.6% in 1997. Net operating revenues were $5.3
billion in 1998, $5.1 billion in 1997, and $4.9 billion in 1996.
Local Service Revenues
Local service revenues, derived from local exchange services, grew 9% in 1998
and 10% in 1997 because of customer access line growth and continued demand for
network-based services. Revenue growth in 1998 also reflects increased sales of
private line services and revenues from maintaining customer wiring and
equipment. The 1997 growth also reflects extended area calling plans.
Network Access Revenues
Network access revenues, derived from long distance phone companies using the
local network to complete calls, increased 4% in 1998 and 3% in 1997. These
revenues reflect an 8% increase in minutes of use in 1998 and a 7% increase in
1997, partly offset by access rate reductions mandated by the FCC. Access rate
reductions took effect in July 1997 and January and July 1998.
Toll Service Revenues
Toll service revenues are mainly derived from providing long distance services
within specified regional calling areas, or LATAs, that are beyond the local
calling area. These revenues decreased 26% in 1998 and 20% in 1997, mainly
reflecting increased competition in the intraLATA long distance market, which
is expected to continue. In addition, toll service areas are decreasing in size
because certain local calling areas have been expanding. However, the reduced
revenues were, in part, offset by increases in local service revenues and by
increases in network access revenues paid by other carriers providing long
distance services to the local division's customers.
Other Revenues
Other revenues increased 9% in 1998 and 11% in 1997 reflecting increased
equipment sales of business systems and data networks, as well as growth in
payphone and commission revenues. It also reflects increased revenues from
providing billing and collection services.
Costs of Services and Products
Costs of services and products includes costs to operate and maintain the local
network and costs of equipment sales. These expenses remained flat in 1998 and
increased 4% in 1997. Efficiencies realized from streamlining and standardizing
business processes have allowed the division to control operating costs in both
1998 and 1997, while still supporting customer access line growth and increased
equipment sales. Also impacting costs of services and products for 1998 was a
reduction in pension costs due to increased returns on plan assets. Costs of
services and products for 1998 also includes costs related to Sprint's efforts
to achieve Year 2000 compliance for its telecommunications network and
operating systems. Costs of services and products was 34.5% of net operating
revenues in 1998, 36.1% in 1997 and 36.5% in 1996.
Selling, General and Administrative Expense
SG&A expenses increased 9% in 1998 and 4% in 1997. These increases were mainly
due to marketing costs to promote new products and services, and increased
customer service costs related to customer access line growth. Also impacting
SG&A for 1998 was a reduction in pension costs due to increased returns on plan
assets. SG&A for 1998 also includes costs related to Sprint's efforts to
achieve Year 2000 compliance for information systems and applications
supporting such processes as billing, customer service, and other
administrative support services. SG&A expense was 21.6% of net operating
revenues in 1998, 20.8% in 1997 and 21.0% in 1996.
II-4
Depreciation and Amortization Expense
Depreciation and amortization expense increased 4% in both 1998 and 1997,
mainly because of increased capital expenditures, partly offset by lower
depreciation rates resulting from longer asset lives. Depreciation and
amortization expense was 17.9% of net operating revenues in 1998, 18.1% in 1997
and 18.2% in 1996.
Product Distribution and Directory Publishing Businesses
- -------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------
(in millions)
Net operating revenues $1,683.1 $1,454.3 $1,225.4
- -------------------------------------------------------------------
Operating expenses
Costs of services and products 1,329.7 1,172.9 1,025.7
Selling, general and administrative 109.6 93.3 90.9
Depreciation and amortization 12.9 8.2 7.2
- -------------------------------------------------------------------
Total operating expenses 1,452.2 1,274.4 1,123.8
- -------------------------------------------------------------------
Operating income $ 230.9 $ 179.9 $ 101.6
------------------------------------------------
Operating margin 13.7% 12.4% 8.3%
------------------------------------------------
Capital expenditures $ 8.7 $ 10.5 $ 9.4
------------------------------------------------
Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. The following discussion assumes these transfer pricing changes
occurred at the beginning of 1996. Adjusting for these changes, the product
distribution and directory publishing businesses' operating margins would have
been 15.8% in 1997 and 16.3% in 1996.
Net operating revenues increased 16% in 1998 and 19% in 1997. Nonaffiliated
revenues accounted for roughly 60% of revenues in 1998 and 1997. These revenues
increased 10% in 1998 and remained flat in 1997 because of increased
competition. Sales to affiliates increased 27% in 1998 and 64% in 1997. Growth
in both years reflects the centralization of certain local division purchasing
and warehousing functions at North Supply in 1997. As a result, the affiliates
now purchase more through North Supply than third-party vendors.
Costs of services and products increased 19% in 1998 and 22% in 1997 reflecting
increased sales. SG&A expense increased 17% in 1998 and 3% in 1997 because of
costs related to the division's acquisition of a sales force from another
directory sales company.
Sprint ION(SM)
- ------------------------------------
1998 1997
- ------------------------------------
(in millions)
Operating expenses $ 143.1 $ 5.2
--------
Capital expenditures $ 154.3 $ 45.8
--------
Operating expenses for Sprint ION in 1998 reflect its initial development and
deployment activities and include costs for network research and testing,
systems and operations development, product development and advertising to
increase public awareness. Depreciation and amortization totaled $5 million in
1998 and $2 million in 1997.
Other Ventures
- ---------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------
(in millions)
Operating expenses $ 39.9 $ 83.8 $ 48.6
------------------------------------
Equity in losses of affiliates $(236.7) $(172.0) $(87.0)
------------------------------------
Capital expenditures $ -- $ 17.1 $ 36.7
------------------------------------
Operating expenses and capital expenditures mainly relate to the FON Group's
offering of Internet services. In June 1998, the FON Group completed the
strategic alliance to combine its Internet business with EarthLink. As part of
the alliance, EarthLink obtained the FON Group's Sprint Internet Passport
customers and took over the day-to-day operations of those services. In
exchange, the FON Group acquired an equity interest in EarthLink. As a result,
beginning in 1998, the FON Group's share of EarthLink's losses has been
reflected in "Equity in losses of affiliates" above.
"Equity in losses of affiliates" mainly consists of losses from Global One
totaling $186 million in 1998, $162 million in 1997 and $82 million in 1996. In
an effort to improve profitability, Global One is refocusing its efforts to
place more emphasis on multinational customers. The 1998 loss includes $37
million of nonrecurring charges for business improvement and network
rationalization initiatives. Global One is continuing to implement these
initiatives, which are expected to result in additional charges.
- --------------------------------------------------------------------------------
Nonoperating Items
- --------------------------------------------------------------------------------
Interest Expense
Interest costs in the following table only reflect interest costs on
borrowings. Interest costs related to deferred compensation plans and customer
deposits have been excluded so as not to distort the effective interest rate on
borrowings.
- ------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------
(in millions)
Interest expense on outstanding debt(/1/) $ 269.5 $ 183.5 $ 182.7
Capitalized interest costs 41.5 69.4 104.0
- ------------------------------------------------------------------------
Total interest costs on outstanding debt $ 311.0 $ 252.9 $ 286.7
------------------------------------------------------
Average debt outstanding $4,340.1 $3,251.3 $3,604.9
------------------------------------------------------
Effective interest rate 7.2% 7.8% 8.0%
------------------------------------------------------
(/1/Interest)expense for 1996 includes $21.5 million of interest expense
included in "Discontinued operation, net" on the Combined Statements of
Income.
II-5
The FON Group capitalizes interest costs related to constructing capital
assets. Sprint capitalized interest costs related to its investment in Sprint
PCS until July 1997 when Sprint PCS emerged from the development stage. Sprint
also capitalized interest costs related to the PCS Group's network buildout and
PCS licenses that were not yet operational. As a result of the PCS
Restructuring, this capitalized interest was contributed to, and is being
amortized by, the PCS Group.
The decrease in the FON Group's effective interest rate for 1998 reflects an
increase in short-term borrowings, which have lower interest rates. Average
debt outstanding in 1998 increased to support Sprint ION(SM) and various other
FON Group initiatives.
Effective with the PCS Restructuring, interest expense on borrowings incurred
by Sprint and allocated to the PCS Group is based on rates the PCS Group would
be able to obtain from third parties. Those interest rates are higher than the
rates Sprint obtains on the borrowings. The difference between Sprint's actual
interest rates and the rates charged to the PCS Group is reflected as a
reduction in the FON Group's interest expense. See Note 2 of Notes to Combined
Financial Statements for a more detailed description of Sprint's policies about
the allocation of Group financing.
Other Income, Net
Other income consisted of the following:
- --------------------------------------------------
1998 1997 1996
- --------------------------------------------------
(in millions)
Dividend and interest income $139.5 $ 99.0 $ 99.7
Other, net 78.6 65.1 15.6
- --------------------------------------------------
Total $218.1 $164.1 $115.3
-----------------------------
Dividend and interest income for all years reflects interest earned on
temporary investments. For 1998, it also reflects interest earned on loans to
unconsolidated affiliates and interest earned on short-term investments
following Sprint's $5.0 billion debt offering (see Sprint's "Management's
Discussion and Analysis of Financial Condition and Results of Operations--
Liquidity and Capital Resources--Liquidity" for more details). "Other, net" for
1998 and 1997 mainly reflects net gains on sales of local exchanges and certain
investments, partly offset by losses from certain equity method investments.
Income Taxes
The FON Group's effective tax rates were 37.8% in 1998, 39.3% in 1997 and 37.7%
in 1996. See Note 5 of Notes to Combined Financial Statements for information
about the differences that caused the effective income tax rates to vary from
the statutory federal rate.
Extraordinary Items, Net
In 1998, Sprint redeemed, prior to scheduled maturities, $138 million of FON
Group debt with interest rates ranging from 7.9% to 9.3%. This resulted in a $5
million after-tax extraordinary loss. In 1996, Sprint also redeemed, prior to
scheduled maturities, $190 million of FON Group debt with interest rates
ranging from 6.0% to 9.5%. This resulted in a $5 million after-tax
extraordinary loss.
- --------------------------------------------------------------------------------
Financial Condition
- --------------------------------------------------------------------------------
- ------------------------------------
1998 1997
- ------------------------------------
(in millions)
Combined assets $19,274.8 $16,580.5
-------------
The increase in assets was due to increased capital expenditures to support the
core long distance and local networks as well as increased advances and loans
to the PCS Group. See "Liquidity and Capital Resources" for more information
about changes in the Combined Balance Sheets.
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
Operating Activities
- -----------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------
(in millions)
Cash flows provided by operating activities $3,971.3 $2,906.8 $2,267.2
-----------------------------------------------------
The increase in 1998 operating cash flows mainly reflects improved operating
results in the FON Group's core businesses and changes in working capital.
During 1996, Sprint terminated an accounts receivable sales agreement, which
reduced cash flows by $600 million.
Investing Activities
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
(in millions)
Cash flows used by investing activities from
continuing operations $(3,639.7) $(4,027.3) $(2,979.2)
-------------------------------------------------------------
Capital expenditures, which are the FON Group's largest investing activity,
totaled $3.2 billion in 1998, $2.7 billion in 1997 and $2.4 billion in 1996.
Long distance capital expenditures were incurred mainly to enhance network
reliability, meet increased demand for voice and data-related services and
upgrade capabilities to accommodate growth and provide new products and
services. The local division incurred capital expenditures to accommodate
access line growth and expand capabilities for providing enhanced services.
The FON Group had advances to the PCS Group and loans to Sprint PCS to fund
capital and operating requirements. Loans to Sprint PCS in 1998 were partly
offset by the repayment of a vendor financing loan. Equity transfers to the PCS
Group were also used to fund its capital and operating requirements and were
offset by current tax benefits used by the FON Group.
II-6
Investing activities also include proceeds from sales of assets (mainly sales
of local exchanges) totaling $230 million in 1998 and $292 million in 1997. In
addition, in 1997, the FON Group purchased the net assets of Paranet, Inc. for
$375 million (see Note 10 of Notes to Combined Financial Statements).
"Investments in and loans to other affiliates, net" consisted of the following:
- -------------------------------------------
1998 1997 1996
- -------------------------------------------
(in millions)
Global One
Capital contributions $283.5 $ -- $39.5
Advances, net (15.7) 199.7 --
- -------------------------------------------
267.8 199.7 39.5
Other, net 235.8 185.8 41.9
- -------------------------------------------
Total $503.6 $385.5 $81.4
---------------------
Capital contributions and net advances to Global One were mainly used to fund
capital and operating requirements. "Other, net" includes the FON Group's
investment in EarthLink and an additional $148 million investment in Call-Net
to retain the FON Group's approximate 25% interest after Call-Net purchased
Fonorola Inc.
Financing Activities
- -----------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------
(in millions)
Cash flows provided (used) by financing activities $(0.8) $71.6 $479.1
------------------------------------------------
Financing activities during 1998 mainly reflect long-term borrowings of $1.1
billion, partly offset by payments on long-term debt of $388 million. In 1997,
the FON Group had net borrowings of $532 million, mainly to fund investments in
and loans to affiliates. In 1996, FT and DT acquired Class A common shares for
a combined total of $3.7 billion. The FON Group mainly used these proceeds, and
cash from the repayment of intercompany advances by its cellular division, to
reduce outstanding debt.
The FON Group paid dividends of $430 million in 1998 and 1997, and $420 million
in 1996. The indicated annual dividend rate on FON stock is $1.00 per share.
Capital Requirements
The FON Group's 1999 investing activities, mainly consisting of capital
expenditures and investments in affiliates, are expected to require cash of
$4.1 to $4.4 billion. FON Group capital expenditures are expected to range
between $3.7 and $4.0 billion in 1999. The long distance and local divisions
will require the majority of this total. Sprint ION is expected to require $600
to $800 million for capital expenditures in 1999. Dividend payments are
expected to approximate $435 million.
In connection with the PCS Restructuring, Sprint adopted a tax sharing
agreement that provides for the allocation of income taxes between the FON
Group and the PCS Group. Sprint expects the FON Group to make significant
payments to the PCS Group under this agreement because of expected PCS Group
operating losses in the near future. These payments will reflect the PCS
Group's incremental cumulative effect on Sprint's consolidated federal and
state tax liability and tax credit position. During 1998, the PCS Group accrued
benefits under the agreement totaling $191 million and received a related
payment from the FON Group totaling $20 million. The remaining $171 million
will be paid by the FON Group during the first half of 1999. See Note 2 of
Notes to Combined Financial Statements, "Allocation of Federal and State Income
Taxes" for more details.
Liquidity
See Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity" for a discussion of liquidity.
- --------------------------------------------------------------------------------
Regulatory Developments
- --------------------------------------------------------------------------------
The Telecom Act was designed to promote competition in all aspects of
telecommunications. It eliminated legal and regulatory barriers to entry into
local phone markets. It also required incumbent local phone companies, among
other things, to allow local resale at wholesale rates, negotiate
interconnection agreements, provide nondiscriminatory access to unbundled
network elements and allow collocation of interconnection equipment by
competitors. The Telecom Act also allows Regional Bell Operating Companies
(RBOCs) to provide in-region long distance service once they obtain state
certification of compliance with a competitive "checklist," have a facilities-
based competitor and obtain an FCC ruling that the provision of in-region long
distance service is in the public interest. The Telecom Act's impact on Sprint
remains unclear because the rules for competition are still being decided by
regulators and the courts.
In accordance with the Telecom Act, the FCC adopted detailed rules in 1996 to
govern interconnection to incumbent local networks by new market entrants. Some
local phone companies and state public utility commissions appealed these rules
to the U.S. Court of Appeals. In 1997, the court struck down the FCC's pricing
rules. It ruled that the Telecom Act left jurisdiction over pricing matters to
the states. The U.S. Supreme Court, in January 1999, reversed the appeals court
decision and reinstated the FCC's authority to establish rules and prices.
Further FCC action and court appeals are expected.
In 1997, the FCC issued important decisions on the structure and level of
access charges and universal service. These decisions were designed to remove
implicit subsidies from access charges and bring access rates closer to costs.
The decisions also called for establishing explicit universal service subsidies
for serving high cost areas and to fund additional telecommunications for
schools, libraries and rural health care providers.
II-7
It is too early to ascertain the impact of these matters on Sprint because
appeals and further regulatory proceedings are pending. Sprint benefits from
lower access charges as a provider of long distance services because access is
the single largest cost in providing long distance service. In addition, in
1998 Sprint's long distance division established charges to flow through
certain access and universal service payments to its customers. Reductions in
access charges adversely affect revenues of the local division.
Some RBOCs have challenged the Telecom Act restrictions on their entry into
long distance markets as unconstitutional. A federal district court in Texas
ruled the restrictions were unlawful because they constituted a legislative act
that imposed punishment without a judicial proceeding. However, that decision
was overturned by the Fifth Circuit Court of Appeals. Similar arguments have
also been rejected by the D.C. Circuit Court of Appeals. To date, the U.S.
Supreme Court has declined to review these decisions.
Since the Telecom Act was passed in 1996, several RBOCs have filed applications
with the FCC to provide in-region long distance service in certain states. None
have been approved. It is expected that more applications will be filed with
the FCC in 1999 and some may be approved. The entry of RBOCs into the long
distance market will impact competition, but the extent of the impact will
depend on many factors. These factors include the RBOCs' competitive ability,
the appeal of the RBOC brand to different market segments and the response of
competitors. Some of the impact on Sprint may be offset by wholesale revenues
from those RBOCs that choose to resell Sprint services.
As a result of competition, a number of carriers have combined. Sprint has
raised concerns about some pending mergers (especially SBC Communications, Inc.
and Ameritech Corporation, and GTE Corporation and Bell Atlantic Corporation)
that appear to threaten competition. Federal regulators are closely
scrutinizing these mergers.
- --------------------------------------------------------------------------------
Financial Strategies
- --------------------------------------------------------------------------------
Financial strategies are determined by Sprint on a centralized basis. See
Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Strategies."
- --------------------------------------------------------------------------------
Year 2000 Issue
- --------------------------------------------------------------------------------
The "Year 2000" issue affects the FON Group's installed computer systems,
network elements, software applications and other business systems that have
time-sensitive programs that may not properly reflect or recognize the year
2000. Because many computers and computer applications define dates by the last
two digits of the year, "00" may not be properly identified as the year 2000.
This error could result in miscalculations or system failures. The Year 2000
issue may also affect the systems and applications of the FON Group's
customers, vendors, resellers or affiliates.
The FON Group started a program in 1996 to identify and address the Year 2000
issue. It has completed an inventory and Year 2000 assessment of its principal
computer systems, network elements, software applications and other business
systems. The FON Group has also completed the renovation of these computer
systems, network elements, other business systems and more than 90% of its
software applications. Year 2000 testing began in the 1998 third quarter and
will be completed during 1999. The FON Group is using both internal and
external sources to identify, correct or reprogram, and test its systems for
Year 2000 compliance. The FON Group is also contacting others with whom it
conducts business to receive the proper warranties and assurances that those
third parties are, or will be, Year 2000 compliant.
The FON Group incurred approximately $140 million in 1998 for its Year 2000
compliance program and expects to incur approximately $110 million in 1999. If
compliance is not achieved in a timely manner by the FON Group, its affiliates
(including Global One) or any significant related third party, the Year 2000
issue could have a material adverse effect on the FON Group's operations.
However, the FON Group is focusing on identifying and addressing all aspects of
its operations that may be affected by the Year 2000 issue. The FON Group is
developing and will implement, if necessary, appropriate contingency plans to
mitigate to the extent possible the effects of any Year 2000 noncompliance.
- --------------------------------------------------------------------------------
Recently Issued Accounting Pronouncement
- --------------------------------------------------------------------------------
See Note 13 of Notes to Combined Financial Statements for a discussion of a
recently issued accounting pronouncement.
II-8
MANAGEMENT REPORT
Sprint Corporation's management is responsible for the integrity and
objectivity of the information contained in this annex. Management is
responsible for the consistency of reporting this information and for ensuring
that generally accepted accounting principles are used.
In discharging this responsibility, management maintains a comprehensive system
of internal controls and supports an extensive program of internal audits, has
made organizational arrangements providing appropriate divisions of
responsibility and has established communication programs aimed at assuring
that its policies, procedures and codes of conduct are understood and practiced
by its employees.
The combined financial statements included in this annex have been audited by
Ernst & Young LLP, independent auditors. Their audits were conducted using
generally accepted auditing standards and their report is included herein.
The Board of Director's responsibility for these combined financial statements
is pursued mainly through its Audit Committee. The Audit Committee, composed
entirely of directors who are not officers or employees of Sprint, meets
periodically with the internal auditors and independent auditors, both with and
without management present, to assure that their respective responsibilities
are being fulfilled. The internal and independent auditors have full access to
the Audit Committee to discuss auditing and financial reporting matters.
/s/ W. T. Esrey
- --------------------------------------------------------------------------------
William T. Esrey
Chairman and Chief Executive Officer
/s/ Arthur B. Krause
- --------------------------------------------------------------------------------
Arthur B. Krause
Executive Vice President and Chief Financial Officer
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders
Sprint Corporation
We have audited the accompanying combined balance sheets of the Sprint FON
Group (as described in Note 2) as of December 31, 1998 and 1997, and the
related combined statements of income, comprehensive income and cash flows for
each of the three years in the period ended December 31, 1998. Our audits also
included the financial statement schedule listed in the Index to Financial
Statements and Financial Statement Schedules. These financial statements and
the schedule are the responsibility of the management of Sprint Corporation
(Sprint). Our responsibility is to express an opinion on these financial
statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the combined financial position of the Sprint
FON Group at December 31, 1998 and 1997, and the combined results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
As more fully discussed in Note 2, the combined financial statements of the
Sprint FON Group should be read together with the audited consolidated
financial statements of Sprint.
Ernst & Young LLP
Kansas City, Missouri
February 2, 1999
II-9
COMBINED STATEMENTS OF INCOME Sprint FON Group
(in millions)
- --------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- --------------------------------------------------------------------------
Net Operating Revenues $16,016.9 $14,873.9 $13,887.5
- --------------------------------------------------------------------------
Operating Expenses
Costs of services and products 7,601.0 7,451.0 6,912.9
Selling, general and administrative 3,741.0 3,226.7 3,115.9
Depreciation and amortization 1,915.1 1,726.3 1,591.0
- --------------------------------------------------------------------------
Total operating expenses 13,257.1 12,404.0 11,619.8
- --------------------------------------------------------------------------
Operating Income 2,759.8 2,469.9 2,267.7
Interest expense (317.8) (210.8) (196.7)
Equity in loss of Global One (186.0) (162.1) (82.1)
Other income, net 218.1 164.1 115.3
- --------------------------------------------------------------------------
Income from continuing operations before
income taxes 2,474.1 2,261.1 2,104.2
Income taxes (934.0) (889.5) (793.6)
- --------------------------------------------------------------------------
Income from Continuing Operations 1,540.1 1,371.6 1,310.6
Discontinued operation, net -- -- (2.6)
Extraordinary items, net (4.8) -- (4.5)
- --------------------------------------------------------------------------
Net Income $ 1,535.3 $ 1,371.6 $ 1,303.5
----------------
See accompanying Notes to Combined Financial Statements.
II-10
COMBINED STATEMENTS OF COMPREHENSIVE INCOME Sprint FON Group
(in millions)
- -------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- -------------------------------------------------------------------------
Net Income $1,535.3 $1,371.6 $1,303.5
- -------------------------------------------------------------------------
Other Comprehensive Income
Unrealized holding gains on securities 28.0 11.7 4.6
Income tax expense (10.1) (4.4) (1.7)
- -------------------------------------------------------------------------
Net unrealized holding gains on securities 17.9 7.3 2.9
Foreign currency translation adjustments (2.1) 9.4 (0.8)
- -------------------------------------------------------------------------
Total other comprehensive income 15.8 16.7 2.1
- -------------------------------------------------------------------------
Comprehensive Income $1,551.1 $1,388.3 $1,305.6
-------------
See accompanying Notes to Combined Financial Statements.
II-11
COMBINED BALANCE SHEETS Sprint FON Group
(in millions)
- ----------------------------------------------------------------------------
December 31, 1998 1997
- ----------------------------------------------------------------------------
Assets
Current assets
Cash and equivalents $ 432.5 $ 101.7
Accounts receivable, net of allowance for doubtful
accounts of $174.8 and $146.7 2,384.3 2,495.6
Inventories 349.7 352.0
Prepaid expenses 199.4 156.2
Notes and other receivables 118.2 443.4
Advances and loans to the PCS Group 483.9 31.5
Other 74.1 56.9
- ----------------------------------------------------------------------------
Total current assets 4,042.1 3,637.3
Investments in equity securities 489.2 303.0
Property, plant and equipment
Long distance division 9,241.3 8,249.1
Local division 14,858.5 14,034.5
Other 1,056.2 740.0
- ----------------------------------------------------------------------------
Total property, plant and equipment 25,156.0 23,023.6
Accumulated depreciation (12,692.0) (11,716.8)
- ----------------------------------------------------------------------------
Net property, plant and equipment 12,464.0 11,306.8
- ----------------------------------------------------------------------------
Investments in and loans to the PCS Group 656.1 142.4
Investments in and advances to other affiliates 645.0 459.1
Other assets 978.4 731.9
- ----------------------------------------------------------------------------
Total $19,274.8 $16,580.5
-----------
Liabilities and Group Equity
Current liabilities
Current maturities of long-term debt $ 33.3 $ 131.0
Accounts payable 1,283.7 1,082.3
Accrued interconnection costs 592.4 672.7
Accrued taxes 346.5 270.7
Advance billings 229.3 202.9
Other 808.2 659.6
- ----------------------------------------------------------------------------
Total current liabilities 3,293.4 3,019.2
Long-term debt 4,682.8 3,748.6
Deferred credits and other liabilities
Deferred income taxes and investment tax credits 828.3 767.2
Postretirement and other benefit obligations 1,064.1 1,036.2
Other 381.7 370.0
- ----------------------------------------------------------------------------
Total deferred credits and other liabilities 2,274.1 2,173.4
Group equity 9,024.5 7,639.3
- ----------------------------------------------------------------------------
Total $19,274.8 $16,580.5
-----------
See accompanying Notes to Combined Financial Statements.
II-12
COMBINED STATEMENTS OF CASH FLOWS Sprint FON Group
(in millions)
- ---------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------
Operating Activities
Net income $ 1,535.3 $1,371.6 $1,303.5
Adjustments to reconcile net income to net
cash provided by operating activities:
Equity in net losses of affiliates 237.5 184.1 81.9
Extraordinary items, net 0.7 -- 4.9
Depreciation and amortization 1,915.1 1,726.3 1,591.0
Deferred income taxes and investment tax
credits 64.9 (10.0) (74.5)
Net (gains) losses on sales of assets (103.8) (93.2) 7.5
Changes in assets and liabilities:
Accounts receivable, net 102.2 (127.0) (982.1)
Inventories and other current assets (18.8) (91.5) 15.7
Accounts payable and other current
liabilities 346.7 (39.6) 362.0
Affiliate receivables and payables (83.5) -- --
Noncurrent assets and liabilities, net (24.2) (19.7) (25.5)
Other, net (0.8) 5.8 (17.2)
- ---------------------------------------------------------------------------
Net cash provided by operating activities 3,971.3 2,906.8 2,267.2
- ---------------------------------------------------------------------------
Investing Activities
Capital expenditures (3,159.2) (2,708.9) (2,433.6)
Investments in and loans to Sprint PCS (153.6) (300.4) (263.5)
Advances to the PCS Group (338.1) -- --
Equity transfers from (to) the PCS Group 340.0 (547.5) (245.2)
Investments in and loans to other
affiliates, net (503.6) (385.5) (81.4)
Paranet acquisition -- (375.0) --
Proceeds from sales of assets 230.0 292.3 2.1
Other, net (55.2) (2.3) 42.4
- ---------------------------------------------------------------------------
Net cash used by continuing operations (3,639.7) (4,027.3) (2,979.2)
Repayment by cellular division of
intercompany advances -- -- 1,400.0
Net cash used by cellular division -- -- (140.7)
- ---------------------------------------------------------------------------
Net cash used by investing activities (3,639.7) (4,027.3) (1,719.9)
- ---------------------------------------------------------------------------
Financing Activities
Proceeds from long-term debt 1,059.3 866.5 9.4
Payments on long-term debt (387.9) (135.0) (433.1)
Net change in short-term borrowings -- (200.0) (1,986.8)
Dividends paid (430.3) (430.0) (419.6)
Other net change in group equity (315.2) (144.5) 3,254.1
Other, net 73.3 114.6 55.1
- ---------------------------------------------------------------------------
Net cash provided (used) by financing
activities (0.8) 71.6 479.1
- ---------------------------------------------------------------------------
Increase (Decrease) in Cash and Equivalents 330.8 (1,048.9) 1,026.4
Cash and Equivalents at Beginning of Year 101.7 1,150.6 124.2
- ---------------------------------------------------------------------------
Cash and Equivalents at End of Year $ 432.5 $ 101.7 $1,150.6
----------------
See accompanying Notes to Combined Financial Statements.
II-13
NOTES TO COMBINED FINANCIAL STATEMENTS Sprint FON Group
- --------------------------------------------------------------------------------
1. PCS Restructuring and Recapitalization
- --------------------------------------------------------------------------------
In November 1998, Sprint's shareholders approved the formation of the FON Group
and the PCS Group and the creation of the FON stock and the PCS stock. In
addition, Sprint purchased the remaining ownership interests in Sprint Spectrum
Holding Company, L.P. and PhillieCo, L.P. (together, Sprint PCS), other than a
minority interest in Cox Communications PCS, L.P. (Cox PCS). Sprint acquired
these ownership interests from Tele-Communications, Inc., Comcast Corporation
and Cox Communications, Inc. (the Cable Partners). In exchange, Sprint issued
the Cable Partners special low-vote PCS shares and warrants to acquire
additional PCS shares. Sprint also issued the Cable Partners shares of a new
class of preferred stock convertible into PCS shares. The purchase of the Cable
Partners' interests is referred to as the PCS Restructuring.
Also in November 1998, Sprint reclassified each of its publicly traded common
shares into one share of FON stock and 1/2 share of PCS stock. This
recapitalization was tax-free to shareholders. Each Class A common share owned
by France Telecom S.A. (FT) and Deutsche Telekom AG (DT) was reclassified to
represent an equity interest in the FON Group and the PCS Group that entitles
FT and DT to one share of FON stock and 1/2 share of PCS stock. These
transactions are referred to as the Recapitalization.
In connection with the PCS Restructuring, FT and DT purchased 5.1 million
additional PCS shares to maintain their combined 20% voting power in Sprint
(Top-up).
The PCS stock is intended to reflect the performance of Sprint's domestic
wireless personal communication services (PCS) operations. The FON stock is
intended to reflect the performance of all of Sprint's other operations.
- --------------------------------------------------------------------------------
2. Summary of Significant Accounting Policies
- --------------------------------------------------------------------------------
Basis of Combination and Presentation
The combined FON Group financial statements, together with the combined PCS
Group financial statements, include all the accounts in Sprint's consolidated
financial statements. The combined financial statements for each Group were
prepared on a basis that management believes is reasonable and proper and
include:
. the combined historical balance sheets, results of operations and cash
flows for each of the Groups, with all significant intragroup amounts
and transactions eliminated,
. an allocation of Sprint's debt, including the related effects on results
of operations and cash flows, and
. an allocation of corporate overhead after the PCS Restructuring date.
The FON Group entities are commonly controlled companies. Transactions between
the PCS Group and the FON Group have not been eliminated in the combined
financial statements of either Group.
The FON Group combined financial statements provide FON shareholders with
financial information about the FON Group operations. Investors in FON stock
and PCS stock are Sprint shareholders and are subject to risks related to all
of Sprint's businesses, assets and liabilities. Sprint retains ownership and
control of the assets and operations of each Group (subject to a minority
interest in Cox PCS). Financial effects of either Group that affect Sprint's
results of operations or financial condition could affect the results of
operations, financial position or market price of the other Group's stock. Net
losses of either Group, and dividends or distributions on, or repurchases of,
PCS stock or FON stock will reduce Sprint funds legally available for dividends
on both Groups' stock. As a result, the FON Group combined financial statements
should be read along with Sprint's consolidated financial statements and the
PCS Group's combined financial statements.
The FON Group combined financial statements are prepared using generally
accepted accounting principles. 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 results of
operations or group equity as previously reported.
Investments in entities in which the FON Group exercises significant influence,
but does not control, are accounted for using the equity method (see Note 3).
Classification of Operations
Core Businesses
Long Distance Division
The long distance division is the nation's third-largest long distance phone
company. It operates a nationwide, all-digital long distance communications
network using
II-14
state-of-the-art fiber-optic and electronic technology. The division provides
domestic and international voice, video and data communications services. It
also provides integration management and support services for computer
networks.
Local Division
The local division consists of regulated local phone companies serving more
than 7.6 million access lines in 18 states. It provides local services, access
by phone customers and other carriers to its local network, sales of
telecommunications equipment, and long distance services within certain
regional calling areas, or local access transport areas. In early November
1998, Sprint sold its remaining 81,000 residential and business access lines in
Illinois.
Product Distribution and Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
Sprint ION(SM)
Sprint ION extends Sprint's existing advanced network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for data, Internet, and video. It is also expected to be the
foundation for Sprint to provide new competitive local service.
Other Ventures
The "other ventures" segment includes the FON Group's investment in Global One.
Sprint is a 1/3 partner in Global One's operating group serving Europe
(excluding France and Germany) and is a 50% partner in Global One's operating
group for the worldwide activities outside the United States and Europe. The
segment also includes the FON Group's investments in EarthLink Network, Inc.,
an Internet service provider; Call-Net, a long distance provider in Canada
operating under the Sprint brand name; and certain other telecommunications
investments and ventures. All of these investments are accounted for on the
equity basis.
Allocation of Shared Services
Sprint directly assigns, where possible, certain general and administrative
costs to the FON Group and the PCS Group based on their actual use of those
services. Where direct assignment of costs is not possible, or practical,
Sprint uses other methods to estimate the assignment of costs to each Group.
Allocation of Federal and State Income Taxes
Sprint files a consolidated federal income tax return and certain state income
tax returns which include FON Group and PCS Group results. In connection with
the PCS Restructuring, Sprint adopted a tax sharing agreement which provides
for the allocation of income taxes between the two Groups. The FON Group's
income taxes are calculated as if it files returns which exclude the PCS Group.
Intergroup tax payments are satisfied on the date Sprint's related tax payment
is due to or the refund is received from the applicable tax authority. During
1998, the FON Group accrued income taxes payable to the PCS Group in accordance
with the tax sharing agreement totaling $191 million.
Allocation of Group Financing
Financing activities for the Groups are managed by Sprint on a centralized
basis. Debt incurred by Sprint on behalf of the Groups is specifically
allocated to and reflected in the financial statements of the applicable Group.
Interest expense is allocated to the PCS Group based on an interest rate that
is largely equal to the rate it would be able to obtain from third parties as a
direct or indirect wholly owned Sprint subsidiary, but without the benefit of
any guaranty by Sprint or any member of the FON Group. That interest rate is
higher than the rate Sprint obtains on borrowings. The difference between
Sprint's actual interest rate and the rate charged to the PCS Group is
reflected as a reduction in the FON Group's interest expense.
Under Sprint's centralized cash management program, one Group may advance funds
to the other Group. These advances are accounted for as short-term borrowings
between the Groups and bear interest at a market rate that is substantially
equal to the rate that Group would be able to obtain from third parties on a
short-term basis.
Income Taxes
The FON Group records deferred income taxes based on temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and their tax bases.
Revenue Recognition
The FON Group recognizes operating revenues as services are rendered or as
products are delivered to customers. The FON Group records operating revenues
net of an estimate for uncollectible accounts.
Cash and Equivalents
Cash and equivalents generally include highly liquid investments with original
maturities of three months or less. They are stated at cost, which approximates
market value. Sprint uses controlled disbursement banking arrangements as part
of its cash management program. Outstanding checks in excess of cash balances
for the FON Group were included in accounts payable. These amounts totaled $263
million at year-end 1998 and $214 million at year-end 1997. The FON Group had
sufficient funds available to fund these outstanding checks when they were
presented for payment.
II-15
Investments in Debt and Equity Securities
Investments in debt and equity securities are classified as available for sale
and reported at fair value (estimated based on quoted market prices). Gross
unrealized holding gains and losses are reflected as adjustments to "Group
equity," net of related income taxes.
Inventories
Inventories are stated at the lower of cost (principally first-in, first-out
method) or market value.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Generally, ordinary asset
retirements and disposals are charged against accumulated depreciation with no
gain or loss recognized. The cost of property, plant and equipment is generally
depreciated on a straight-line basis over estimated economic useful lives.
Repair and maintenance costs are expensed as incurred.
Capitalized Interest
The FON Group capitalized interest costs related to constructing capital assets
of $42 million in 1998, $23 million in 1997 and $8 million in 1996. In
addition, Sprint capitalized interest costs related to the PCS Group's network
buildout. This capitalized interest totaled $61 million for 1998 and $24
million for 1997 and was contributed to, and will be amortized by, the PCS
Group. Sprint also capitalized interest costs related to its investment in
Sprint PCS until July 1997 when Sprint PCS emerged from the development stage.
This capitalized interest, totaling $46 million in 1997 and $96 million in
1996, was contributed to, and is being amortized by, the PCS Group.
Earnings per Share
As a result of the Recapitalization, earnings per share for the FON Group has
been calculated based on the Group's income from November 1998 through year-end
1998. It was not calculated on a Group basis in prior years because the FON
stock was not part of Sprint's capital structure at that time. During this 1998
period, the FON Group's convertible preferred dividends totaled $0.1 million,
and dilutive securities (mainly options) totaled 6.9 million shares.
The FON Group's earnings per common share after the Recapitalization date was
as follows:
- -----------------------------------------------------
1998
- -----------------------------------------------------
(in millions,
except per
share data)
Earnings applicable to common stock $ 118.3
----------------------
Diluted earnings per common share $ 0.27
----------------------
Diluted weighted average common shares 434.5
----------------------
Basic earnings per common share $ 0.28
----------------------
Basic weighted average common shares 427.6
----------------------
Stock-based Compensation
The FON Group participates in the incentive-based stock option plans and
employee stock purchase plans administered by Sprint for executives and other
employees. Sprint adopted the pro forma disclosure requirements under Statement
of Financial Accounting Standards (SFAS) No. 123, "Stock-based Compensation,"
and continues to apply Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," to its stock option and employee stock purchase
plans. Had the FON Group applied SFAS 123, pro forma net income would have been
$103 million from the Recapitalization date through year-end 1998. See Note 9
of Sprint's Notes to Consolidated Financial Statements for more information
about Sprint's stock-based compensation and the FON Group's pro forma net
income.
In 1997, Sprint granted performance-based stock options to certain key
executives. In 1998, the FON Group expensed $14 million related to these
performance-based stock options.
- --------------------------------------------------------------------------------
3. Investments
- --------------------------------------------------------------------------------
Investments in Equity Securities
The cost of investments in equity securities was $105 million at year-end 1998
and 1997. Gross unrealized holding gains were $384 million at year-end 1998 and
$198 million at year-end 1997.
Investments in and Advances to Other Affiliates
At year-end 1998, investments accounted for using the equity method consisted
of the FON Group's investments in Global One, Call-Net, EarthLink and other
strategic investments. Combined, summarized financial information (100% basis)
of these entities and others accounted for using the equity method was as
follows:
- ------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------
(in millions)
Results of operations
Net operating revenues $2,386.1 $1,939.6 $1,725.4
------------------------------------
Operating loss $ (396.4) $ (780.7) $ (421.3)
------------------------------------
Net loss $ (695.9) $ (826.1) $ (362.0)
------------------------------------
Financial position
Current assets $1,748.0 $2,999.2
Noncurrent assets 3,089.1 4,221.0
----------------------------------------------
Total $4,837.1 $7,220.2
--------------------
Current liabilities $1,838.3 $2,073.2
Noncurrent liabilities 1,007.6 2,070.3
Owners' equity 1,991.2 3,076.7
----------------------------------------------
Total $4,837.1 $7,220.2
--------------------
The FON Group's investment in Global One, including advances, totaled $182
million at year-end 1998 and $93 million at year-end 1997. At year-end 1998,
Sprint's share of underlying equity in Global One's net assets exceeded the
carrying value of its related investment by $100 million. This difference is
being amortized on a straight-line basis through January 2001.
II-16
- --------------------------------------------------------------------------------
4. Employee Benefit Plans
- --------------------------------------------------------------------------------
Defined Benefit Pension Plan
Most FON Group employees are covered by a noncontributory defined benefit
pension plan. Benefits for plan participants belonging to unions are based on
negotiated schedules. For non-union participants, pension benefits are based on
years of service and the participants' compensation.
Sprint's policy is to make annual plan contributions equal to an actuarially
determined amount consistent with federal tax regulations. The funding
objective is to accumulate funds at a relatively stable rate over the
participants' working lives so benefits are fully funded at retirement.
The following table shows the changes in the projected benefit obligation:
- --------------------------------------
1998 1997
- --------------------------------------
(in millions)
Beginning balance $2,240.9 $1,967.0
Service cost 71.7 61.7
Interest cost 165.0 148.9
Amendments 9.7 14.7
Actuarial gain 202.2 151.9
Benefits paid (110.1) (103.3)
- --------------------------------------
Ending balance $2,579.4 $2,240.9
-------------
The following table shows changes in plan assets:
- -------------------------------------------------
1998 1997
- -------------------------------------------------
(in millions)
Beginning balance $2,929.4 $2,584.2
Actual return on plan assets 350.0 448.5
Benefits paid (110.1) (103.3)
- -------------------------------------------------
Ending balance $3,169.3 $2,929.4
------------------------
At year-end, the funded status and amounts recognized in the Combined Balance
Sheets for the plan were as follows:
- --------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------
(in millions)
Plan assets in excess of the projected benefit obligation $589.9 $688.5
Unrecognized net gains (375.3) (496.4)
Unrecognized prior service cost 104.3 105.4
Unamortized transition asset (97.1) (122.1)
- --------------------------------------------------------------------------
Prepaid pension cost $221.8 $175.4
-----------------------------------------------
Discount rate 7.00% 7.25%
-----------------------------------------------
Expected blended rate of future pay raises 4.00% 4.25%
-----------------------------------------------
The net pension cost (credit) consisted of the following:
- -------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------
(in millions)
Service cost--benefits earned during the year $ 71.7 $ 61.7 $ 65.4
Interest on projected benefit obligation 165.0 148.9 138.5
Expected return on plan assets (265.2) (194.2) (181.2)
Amortization of unrecognized transition asset (25.0) (25.0) (25.0)
Recognition of prior service cost 10.9 9.6 9.0
Recognition of actuarial (gains) and losses (3.8) 1.1 3.6
- -------------------------------------------------------------------------
Net pension cost (credit) $(46.4) $ 2.1 $ 10.3
---------------------------------------------------
Discount rate 7.25% 7.75% 7.25%
---------------------------------------------------
Expected long-term rate of return on plan assets 10.00% 9.50% 9.50%
---------------------------------------------------
Expected blended rate of future pay raises 4.25% 4.75% 4.25%
---------------------------------------------------
Defined Contribution Plans
Sprint sponsors defined contribution employee savings plans covering most FON
Group employees. Participants may contribute portions of their pay to the
plans. For union employees, Sprint matches contributions based on negotiated
amounts. Sprint also matches contributions of non-union employees in FON and
PCS stock. The matching is equal to 50% of participants' contributions up to 6%
of their pay. In addition, Sprint may, at the discretion of the Board of
Directors, provide additional matching contributions based on the performance
of FON and PCS stock compared to other telecommunications companies' stock.
Sprint's matching contributions were $54 million in 1998 and 1997 and $56
million in 1996. At year-end 1998, the plans held 16.7 million FON shares and
10.4 million PCS shares.
Postretirement Benefits
Sprint provides postretirement benefits (principally medical and life insurance
benefits) to most FON Group employees. Employees retiring before certain dates
are eligible for benefits at no cost, or at a reduced cost. Employees retiring
after certain dates are eligible for benefits on a shared-cost basis. Sprint
funds the accrued costs as benefits are paid.
The following table shows the changes in the accumulated postretirement benefit
obligation:
- ----------------------------------
1998 1997
- ----------------------------------
(in millions)
Beginning balance $832.2 $815.0
Service cost 20.2 20.8
Interest cost 57.8 52.3
Actuarial gains (6.3) (31.6)
Benefits paid (40.2) (24.3)
- ----------------------------------
Ending balance $863.7 $832.2
-------
II-17
Amounts included in the Combined Balance Sheets at year-end were as follows:
- ------------------------------------------------------------------
1998 1997
- ------------------------------------------------------------------
(in millions)
Accumulated postretirement benefit obligation $ 863.7 $ 832.2
Unrecognized prior service cost 60.8 5.4
Unrecognized net gains 124.7 190.0
- ------------------------------------------------------------------
Accrued postretirement benefits cost $1,049.2 $1,027.6
-----------------------------------------
Discount rate 7.00% 7.25%
-----------------------------------------
The assumed 1999 annual health care cost trend rates are 7.6% before Medicare
eligibility and 8.1% after Medicare eligibility. Both rates gradually decrease
to an ultimate level of 5% by 2005. A 1% increase in the rates would have
increased the 1998 accumulated postretirement benefit obligation by an
estimated $111 million. A 1% decrease would have reduced the obligation by an
estimated $91 million.
The net postretirement benefits cost consisted of the following:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
(in millions)
Service cost--benefits earned during the year $20.2 $20.8 $21.7
Interest on accumulated postretirement benefit obligation 57.8 52.3 49.9
Recognition of prior service cost (6.2) (0.4) (0.4)
Recognition of actuarial gains (20.6) (19.0) (13.3)
- -------------------------------------------------------------------------------
Net postretirement benefits cost $51.2 $53.7 $57.9
--------------------------------------------------------
Discount rate 7.25% 7.75% 7.25%
--------------------------------------------------------
For measurement purposes, the assumed 1998 weighted average annual health care
cost trend rates were 8.4% before Medicare eligibility and 8.5% after Medicare
eligibility. Both rates gradually decrease to an ultimate level of 5% by 2005.
A 1% increase in the rates would have increased the 1998 postretirement
benefits service and interest costs by an estimated $13 million. A 1% decrease
would have reduced the 1998 postretirement benefits service and interest costs
by an estimated $10 million.
- --------------------------------------------------------------------------------
5. Income Taxes
- --------------------------------------------------------------------------------
Income tax expense allocated to continuing operations consisted of the
following:
- -------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------
(in millions)
Current income tax expense
Federal $794.6 $800.0 $778.2
State 74.5 99.5 89.9
- -------------------------------------------------------------
Total current 869.1 899.5 868.1
- -------------------------------------------------------------
Deferred income tax expense (benefit)
Federal 43.3 (16.5) (93.2)
State 21.6 6.5 18.7
- -------------------------------------------------------------
Total deferred 64.9 (10.0) (74.5)
- -------------------------------------------------------------
Total $934.0 $889.5 $793.6
----------------------------------------
The differences that caused the FON Group's effective income tax rates to vary
from the 35% federal statutory rate were as follows:
- -----------------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------------
(in millions)
Income tax expense at the federal statutory rate $865.9 $791.4 $736.5
Effect of:
State income taxes, net of federal income tax effect 62.4 68.9 70.6
Equity in losses of foreign joint ventures 13.1 36.4 8.6
Other, net (7.4) (7.2) (22.1)
- -----------------------------------------------------------------------------
Income tax expense $934.0 $889.5 $793.6
--------------------------------------------------------
Effective income tax rate 37.8% 39.3% 37.7%
--------------------------------------------------------
Income tax expense (benefit) allocated to other items was as follows:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
(in millions)
Discontinued operation $ -- $ -- $ 7.0
Extraordinary items (3.0) -- (2.9)
Unrealized holding gains on investments(/1/) 10.1 4.4 1.7
Stock ownership, purchase and options arrangements(/1/) (49.0) (26.2) (14.1)
- ------------------------------------------------------------------------------
(/1/)These amounts have been recorded directly to "Group equity."
II-18
The FON Group recognizes deferred income taxes for the temporary differences
between the carrying amounts of its assets and liabilities for financial
statement purposes and their tax bases. The sources of the differences that
give rise to the deferred income tax assets and liabilities at year-end 1998
and 1997, along with the income tax effect of each, were as follows:
- -------------------------------------------------------------------
1998 Deferred Income Tax
--------------------------
Assets Liabilities
- -------------------------------------------------------------------
(in millions)
Property, plant and equipment $ -- $ 1,402.1
Postretirement and other benefits 418.8 --
Reserves and allowances 149.2 --
Unrealized holding gains on investments -- 71.8
Other, net 116.8 --
- -------------------------------------------------------------------
684.8 1,473.9
Less valuation allowance 3.6 --
- -------------------------------------------------------------------
Total $ 681.2 $ 1,473.9
---------------------------------------------
- -------------------------------------------------------------------
1997 Deferred Income Tax
--------------------------
Assets Liabilities
- -------------------------------------------------------------------
(in millions)
Property, plant and equipment $ -- $ 1,278.0
Postretirement and other benefits 376.1 --
Reserves and allowances 103.1 --
Unrealized holding gains on investments -- 61.7
Other, net 155.2 --
- -------------------------------------------------------------------
634.4 1,339.7
Less valuation allowance 11.8 --
- -------------------------------------------------------------------
Total $ 622.6 $ 1,339.7
---------------------------------------------
Management believes it is more likely than not that these deferred income tax
assets, net of the valuation allowance, will be realized based on current
income tax laws and expectations of future taxable income stemming from the
reversal of existing deferred tax liabilities or ordinary operations.
Uncertainties surrounding income tax law changes, shifts in operations between
state taxing jurisdictions, and future operating income levels may, however,
affect the ultimate realization of all or some of these deferred income tax
assets.
The valuation allowance related to deferred income tax assets decreased $8
million in 1998 and $2 million in 1997 and $4 million in 1996.
At year-end 1998, the FON Group had available for income tax purposes $4
million of state alternative minimum tax credit carryforwards to offset state
income tax payable in future years. In addition, the FON Group had state
operating loss carryforwards of $426 million. The tax benefits related to these
loss carryforwards are $11 million, which expire in varying amounts through
2018.
II-19
- --------------------------------------------------------------------------------
6. Long-term Debt and Capital Lease Obligations
- --------------------------------------------------------------------------------
Sprint's consolidated long-term debt at year-end was as follows:
- ----------------------------------------------------------------------------
1998
-----------------------------------------
Sprint Sprint
Maturing FON Group PCS Group Consolidated 1997
- ----------------------------------------------------------------------------
(in millions)
Senior notes
5.7% to 6.9%(/1/) 2003 to 2028 $1,059.4 $3,940.6 $5,000.0 $ --
8.1% to 9.8% 1998 to 2003 632.3 -- 632.3 675.3
11.0% to 12.5%(/2/) 2006 -- 698.6 565.5 --
Debentures and notes
5.8% to 9.6% 2000 to 2022 564.5 -- 564.5 587.0
Notes payable and
commercial paper -- 745.8 -- 745.8 866.5
First mortgage bonds
2.0% to 9.9% 1998 to 2025 1,312.0 -- 1,312.0 1,468.4
Capital lease
obligations
5.3% to 7.5% 1998 to 2006 31.7 452.0 483.7 35.3
Revolving credit
facilities
Variable rates 2005 to 2006 -- 1,800.0 1,800.0 --
Other(/2/),(/3/)
2.0% to 10.0% 1998 to 2007 370.4 1,029.8 1,085.5 247.1
- ----------------------------------------------------------------------------
4,716.1 7,921.0 12,189.3 3,879.6
Less: current
maturities(/2/) 33.3 348.3 246.9 131.0
- ----------------------------------------------------------------------------
Long-term debt and
capital lease
obligations $4,682.8 $7,572.7 $11,942.4 $3,748.6
----------------------------
(/1/These)borrowings were incurred by Sprint and allocated to the applicable
Group. At year-end 1998, Sprint's weighted average interest rate related to
these borrowings was 6.4%. The weighted average interest rate related to
the borrowings allocated to the PCS Group was approximately 8.5%. See Note
2 for a more detailed description of how Sprint allocates financing to each
of the Groups.
(/2/Consolidated)debt does not equal the total of PCS Group and FON Group debt
due to intergroup debt eliminated in consolidation. At year-end 1998, the
FON Group had an investment in the PCS Group's Senior Discount notes
totaling $133 million. In addition, the PCS Group had other long-term debt
payable to the FON Group totaling $315 million, including $135 million
classified as current at year-end 1998.
(/3/Includes)$358 million of notes recorded by the FON Group that may be
exchanged at maturity for SBC Communications, Inc. (SBC) common shares
owned by the FON Group or for cash. Based on SBC's closing price, had the
notes matured at year-end 1998, they could have been exchanged for
6.6 million SBC shares. At year-end 1998, Sprint held 7.6 million SBC
shares, which have been included in "Investments in equity securities" in
the FON Group's Combined Balance Sheets.
II-20
Long-term debt maturities, excluding reclassified short-term borrowings, during
each of the next five years are as follows:
- ------------------------------
Sprint Sprint
FON PCS
Group Group Sprint
- ------------------------------
(in millions)
1999 $ 33.3 $ 348.3 $ 246.9
2000 864.0 175.3 1,039.3
2001 41.1 407.1 217.0
2002 353.0 357.3 710.3
2003 774.8 1,115.0 1,889.8
- ------------------------------
Sprint
Short-term Borrowings
Sprint had bank notes payable totaling $454 million at year-end 1998 and $618
million at year-end 1997. In addition, Sprint had commercial paper borrowings
totaling $292 million at year-end 1998 and $249 million at year-end 1997.
Though these borrowings are renewable at various dates throughout the year,
they were classified as long-term debt because of Sprint's intent and ability,
through unused credit facilities, to refinance these borrowings on a long-term
basis.
In 1998, Sprint replaced its previous $1.5 billion credit facility with new
facilities with syndicates of domestic and international banks. The new
facilities totaled $5.0 billion and expire in 1999 and 2003. Commercial paper
and certain bank notes payable are supported by Sprint's revolving credit
facilities. Certain other notes payable relate to a separate revolving credit
facility. At year-end 1998, Sprint had total unused lines of credit of $4.8
billion.
Bank notes outstanding had weighted average interest rates of 5.7% at year-end
1998 and 6.1% at year-end 1997. The weighted average interest rate of
commercial paper was 5.8% at year-end 1998 and 6.8% at year-end 1997.
Long-term Debt
In October 1998, Sprint filed a shelf registration statement with the
Securities and Exchange Commission for $8.0 billion of debt securities. This
replaced Sprint's previous shelf registration of $1.0 billion. In November
1998, Sprint issued $5.0 billion under the new shelf. Sprint allocated these
borrowings to the Groups, and the related proceeds were mainly used to repay
existing debt. See Note 2 for a more detailed description of how Sprint
allocates debt to the Groups.
Sprint FON Group
In 1998, Sprint redeemed, prior to scheduled maturities, $138 million of FON
Group debt with interest rates ranging from 7.9% to 9.3%. This resulted in a $5
million after-tax extraordinary loss. In 1996, Sprint also redeemed, prior to
scheduled maturities, $190 million of FON Group debt with interest rates
ranging from 6.0% to 9.5%. This resulted in a $5 million after-tax
extraordinary loss.
FON Group property, plant and equipment totaling $13.9 billion is either
pledged as security for first mortgage bonds and certain notes or is restricted
for use as mortgaged property.
Other
Sprint, including the FON Group, had complied with all restrictive or financial
covenants relating to its debt arrangements at year-end 1998.
- --------------------------------------------------------------------------------
7. Group Equity
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------
(in millions)
Beginning balance $7,639.3 $7,332.3 $3,676.9
Net income 1,535.3 1,371.6 1,303.5
Dividends (431.1) (429.5) (421.0)
Equity issued 164.5 65.0 3,764.0
Equity repurchased (283.1) (144.5) (407.2)
Spinoff of cellular division -- -- (260.2)
Contributions to the PCS Group (146.4) (1,052.1) (478.3)
Equity transfer from the PCS Group 460.4 434.7 136.8
Other comprehensive income 15.8 16.7 2.1
Other, net 69.8 45.1 15.7
- -----------------------------------------------------------------
Ending balance $9,024.5 $7,639.3 $7,332.3
-----------------------------------------------
II-21
- --------------------------------------------------------------------------------
8. Commitments and Contingencies
- --------------------------------------------------------------------------------
Litigation, Claims and Assessments
FON shareholders are subject to all of the risks related to an investment in
Sprint and the FON Group, including the effects of any legal proceedings and
claims against the PCS Group.
In December 1996, an arbitration panel entered a $61 million award in favor of
Network 2000 Communications Corporation on its breach of contract claim against
Sprint. The arbitrators directed Sprint to pay 50% of this award to Network
2000. The remainder was directed to be paid to the Missouri state court in
which a proposed class action by Network 2000's independent marketing
representatives against Network 2000 and Sprint is pending.
In June 1997, the FON Group recorded additional expense of $20 million. This
charge related to the settlement of both the class action lawsuit against
Sprint and Network 2000 and the related claims of Network 2000 against Sprint.
In June 1998, the court approved the class action settlement; however, a small
number of potential class members chose not to be a part of that settlement and
have filed a separate lawsuit asserting their individual claims. Some potential
class members have appealed the approval of the settlement, which has delayed
final approval.
Other suits arising in the ordinary course of business are pending against
Sprint. Management cannot predict the final outcome of these actions but
believes they will not be material to the FON Group's combined financial
statements.
Operating Leases
The FON Group's minimum rental commitments at year-end 1998 for all
noncancelable operating leases, consisting mainly of leases for data processing
equipment and real estate, are as follows:
- -------------------------
(in millions)
1999 $373.7
2000 276.8
2001 184.9
2002 126.7
2003 95.5
Thereafter 226.6
- -------------------------
The FON Group's gross rental expense totaled $474 million in 1998, $406 million
in 1997 and $401 million in 1996. Rental commitments for subleases, contingent
rentals and executory costs were not significant.
- --------------------------------------------------------------------------------
9. Financial Instruments
- --------------------------------------------------------------------------------
Fair Value of Financial Instruments
Sprint estimates the fair value of the FON Group's financial instruments using
available market information and appropriate valuation methodologies. As a
result, the following estimates do not necessarily represent the values the FON
Group could realize in a current market exchange. Although management is not
aware of any factors that would affect the year-end 1998 estimated fair values,
those amounts have not been comprehensively revalued for purposes of these
financial statements since that date. Therefore, estimates of fair value after
year-end 1998 may differ significantly from the amounts presented below.
The carrying amounts and estimated fair values of the FON Group's financial
instruments at year-end were as follows:
- -----------------------------------------------------------------
1998
-------------------
Carrying Estimated
Amount Fair Value
- -----------------------------------------------------------------
(in millions)
Cash and equivalents $ 432.5 $ 432.5
Investment in affiliate debt securities 164.6 164.6
Investments in equity securities 489.2 489.2
Long-term debt and capital lease obligations 4,716.1 5,107.7
- -----------------------------------------------------------------
- -----------------------------------------------------------------
1997
-------------------
Carrying Estimated
Amount Fair Value
- -----------------------------------------------------------------
(in millions)
Cash and equivalents 101.7 101.7
Investment in affiliate debt securities 142.4 142.4
Investments in equity securities 303.0 303.0
Long-term debt and capital lease obligations 3,879.6 4,155.8
- -----------------------------------------------------------------
The carrying values of the FON Group's cash and equivalents approximate fair
value at year-end 1998 and 1997. The estimated fair value of investments in
debt and equity securities was based on quoted market prices. The estimated
fair value of long-term debt was based on quoted market prices for publicly
traded issues. The estimated fair value of all other issues was based on the
present value of estimated future cash flows using a discount rate based on the
risks involved.
Concentrations of Credit Risk
The FON Group's accounts receivable are not subject to any concentration of
credit risk.
Interest Rate Swap Agreements
In 1998, Sprint deferred losses from interest rate swap agreements used to
hedge a portion of a $5.0 billion debt offering. These losses were allocated to
the FON Group and the PCS Group. The FON Group's share of
II-22
these deferred losses totaled $16 million and will be amortized to interest
expense using the effective interest method over the term of the debt. There
were no deferred gains or losses related to any terminated interest rate swap
agreements at year-end 1997 or 1996.
- --------------------------------------------------------------------------------
10. Paranet Acquisition
- --------------------------------------------------------------------------------
In September 1997, Sprint paid $375 million to purchase the net assets of
Houston-based Paranet, Inc., a provider of integration, management and support
services for computer networks.
The transaction was accounted for using the purchase method of accounting. As a
result, the FON Group's combined financial statements reflect Sprint Paranet's
results of operations beginning in October 1997.
The excess of the purchase price over the tangible net assets acquired was $357
million. This excess was allocated to noncompete agreements and goodwill, and
is being amortized on a straight-line basis over four to 10 years.
- --------------------------------------------------------------------------------
11. Spinoff of Cellular Division
- --------------------------------------------------------------------------------
Sprint completed the tax-free spinoff of Cellular to Sprint common shareholders
in 1996. To complete the spinoff, Sprint distributed all Cellular common shares
at a rate of one share for every three Sprint common shares held. In addition,
Cellular repaid $1.4 billion of its intercompany debt owed to Sprint. Sprint
also contributed to Cellular's equity capital $185 million of debt owed by
Cellular in excess of the amount repaid.
Cellular's 1996 net operating results through the spinoff date, as summarized
below, were separately classified as a discontinued operation in the Combined
Statements of Income. Interest expense was allocated to Cellular based on the
assumed repayment of intercompany debt to Sprint by Cellular. The operating
expenses as presented below do not include Cellular's share of Sprint's general
corporate overhead expenses. These expenses, totaling $2 million in 1996, were
reallocated to the FON Group's other operating entities.
- ------------------------------------------
(in millions)
Net operating revenues $190.2
Operating expenses 156.0
- ------------------------------------------
Operating income 34.2
Interest expense (21.5)
Other expense, net (8.3)
- ------------------------------------------
Income before income taxes 4.4
Income taxes (7.0)
- ------------------------------------------
Loss from cellular division $ (2.6)
----------
- --------------------------------------------------------------------------------
12. Additional Financial Information
- --------------------------------------------------------------------------------
Segment Information
In 1998, Sprint adopted SFAS 131, "Disclosures about Segments of an Enterprise
and Related Information."
The FON Group operates in five business segments, based on services and
products: the long distance division, the local division, the product
distribution and directory publishing businesses, activities to develop and
deploy Sprint IONSM and other ventures.
II-23
Industry segment financial information was as follows:
- ------------------------------------------------------------------------------------------------------
Product Corporate
Long Distribution and Sprint
Distance Local & Directory Sprint Other Elim- FON
Division Division Publishing ION(SM) Ventures(/1/) inations Group
- ------------------------------------------------------------------------------------------------------
(in millions)
1998
Net operating revenues $9,910.9 $5,371.4 $1,683.1 $ -- $ -- $ (948.5) $16,016.9
Intercompany revenues 137.3 207.4 711.5 -- -- (948.5) 107.7
Depreciation and
amortization 882.2 958.7 12.9 4.7 7.2 49.4 1,915.1
Operating expenses 8,544.1 3,964.4 1,452.2 143.1 39.9 (886.6) 13,257.1
Operating income (loss) 1,366.8 1,407.0 230.9 (143.1) (39.9) (61.9) 2,759.8
Operating margin 13.8% 26.2% 13.7% NM NM -- 17.2%
Capital expenditures 1,363.8 1,374.4 8.7 154.3 -- 258.0 3,159.2
Total assets 6,445.1 7,044.4 726.7 199.4 446.0 4,413.2 19,274.8
1997
Net operating revenues $8,994.0 $5,293.9 $1,454.3 $ -- $ -- $ (868.3) $14,873.9
Intercompany revenues 3.3 294.5 570.5 -- -- (868.3) --
Depreciation and
amortization 727.0 935.5 8.2 2.2 9.4 44.0 1,726.3
Operating expenses 7,968.7 3,903.2 1,274.4 5.2 83.8 (831.3) 12,404.0
Operating income (loss) 1,025.3 1,390.7 179.9 (5.2) (83.8) (37.0) 2,469.9
Operating margin 11.4% 26.3% 12.4% NM NM -- 16.6%
Capital expenditures 1,223.2 1,270.0 10.5 45.8 17.1 142.3 2,708.9
Total assets 6,828.2 7,933.0 601.4 49.8 228.0 940.1 16,580.5
1996
Net operating revenues $8,302.1 $5,127.0 $1,225.4 $ -- $ -- $ (767.0) $13,887.5
Intercompany revenues 30.9 410.2 325.9 -- -- (767.0) --
Depreciation and
amortization 633.3 909.6 7.2 -- -- 40.9 1,591.0
Operating expenses 7,390.6 3,792.3 1,123.8 -- 48.6 (735.5) 11,619.8
Operating income (loss) 911.5 1,334.7 101.6 -- (48.6) (31.5) 2,267.7
Operating margin 11.0% 26.0% 8.3% -- NM -- 16.3%
Capital expenditures 1,139.8 1,149.7 9.4 -- 36.7 98.0 2,433.6
Total assets 6,199.3 7,690.8 487.0 -- 148.9 1,129.4 15,655.4
NM = Not meaningful
(/1/The)"other ventures" segment's equity in losses of affiliates totaled $237
million in 1998, $172 million in 1997 and $87 million in 1996.
II-24
Supplemental Cash Flows Information
The FON Group's cash paid for interest and income taxes was as follows:
- ------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------
(in millions)
Interest (net of capitalized interest)
Continuing operations $216.7 $197.9 $212.1
--------------------------------------
Cellular division $ -- $ -- $ 21.5
--------------------------------------
Income taxes $327.5 $365.8 $695.3
--------------------------------------
Noncash activities for the FON Group consisted of the following:
- ---------------------------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------
(in millions)
Noncash activity in Group equity $144.1 $31.4 $79.3
----------------------------------------------------
Capital lease obligations $ -- $30.1 $ --
----------------------------------------------------
Net book value of assets and liabilities contributed to
Global One $ -- $ -- $73.3
----------------------------------------------------
Intergroup Investments and Transactions
Sprint FON Group Investments in the Sprint PCS Group
The following table reflects the FON Group's noncurrent investments in the PCS
Group, which have been eliminated in Sprint's consolidated financial
statements:
- --------------------------------------------
1998 1997
- --------------------------------------------
(in millions)
Preferred intergroup interest $279.2 $ --
Long-term loans 180.0 --
Investment in debt securities 164.6 142.4
Common intergroup interest 32.3 --
- --------------------------------------------
Total $656.1 $142.4
-----------------
Preferred Intergroup Interest
The FON Group provided Sprint PCS and the PCS Group with interim financing from
the date the PCS Restructuring agreement was signed in May 1998 until it was
completed in November 1998. As part of the PCS Restructuring, Sprint converted
this financing, totaling $279 million, into an intergroup interest representing
0.3 million shares of 10-year PCS preferred stock convertible into a PCS common
intergroup interest.
Long-term Loans
Sprint provided Sprint PCS with additional interim financing of $180 million
from May 1998 through November 1998.
Investment in Debt Securities
In 1996, Sprint purchased $183 million (face value) of Sprint PCS Senior
Discount notes for $100 million.
Common Intergroup Interest
The FON Group holds a 1% intergroup interest in the PCS Group. This interest
represents 4.5 million notional PCS shares, and includes 2.7 million shares
held in treasury by the FON Group. These shares do not carry any vote.
The FON Group's 1% share of the PCS Group's net loss since the date of the PCS
Restructuring totaled $6.1 million and was included in "Other income, net" in
the Combined Statements of Income.
Intergroup Interest Income
The FON Group earned intergroup interest income of $92 million in 1998 and $24
million in 1997 related to loans and advances to the PCS Group. See Note 2 for
a more detailed description of how Sprint allocates interest expense to each of
the Groups.
Related Party Transactions
Global One
The FON Group provided various voice, data and administrative services to
Global One totaling $277 million in 1998, $415 million in 1997 and $361 million
in 1996. In addition, Global One provided data and administrative services to
the FON Group totaling $140 million in 1998, $114 million in 1997 and $130
million in 1996. The FON Group's receivable from Global One was $187 million at
year-end 1998 and $154 million at year-end 1997. The FON Group's payable to
Global One was $42 million at year-end 1998 and $104 million at year-end 1997.
Sprint PCS
The following discussion reflects related party transactions between Sprint and
Sprint PCS prior to the PCS Restructuring:
Sprint provided Sprint PCS with invoicing and operator services, and switching
equipment. Sprint PCS is also using the long distance division as its
interexchange carrier. Charges to Sprint PCS for these services totaled $125
million in 1998, $61 million in 1997 and $1 million in 1996.
Sprint provided management, printing, mailing and warehousing services to
Sprint PCS. Charges to Sprint PCS for these services totaled $30 million in
1998, $11 million in 1997, and $12 million in 1996.
Sprint had a vendor financing loan to Sprint PCS for $300 million at year-end
1997 which was repaid in 1998. Sprint also had advances to Sprint PCS of $114
million in 1998 and $21 million in 1997 which will be repaid in the 1999 first
quarter.
II-25
- --------------------------------------------------------------------------------
13. Recently Issued Accounting Pronouncement
- --------------------------------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This standard
requires all derivatives to be recorded on the balance sheet as either assets
or liabilities and be measured at fair value. Gains or losses from changes in
the derivative values are to be accounted for based on how the derivative was
used and whether it qualifies for hedge accounting. When adopted in January
2000, this statement is not expected to have a material impact on the FON
Group's combined financial statements.
- --------------------------------------------------------------------------------
14. Quarterly Financial Data (Unaudited)
- --------------------------------------------------------------------------------
Quarter
---------------------------------------
1998 1st 2nd 3rd 4th
- -------------------------------------------------------------------------------
(in millions, except per share data)
Net operating revenues $ 3,891.7 $ 3,944.7 $ 4,039.4 $ 4,141.1
Operating income 683.0 691.7 713.3 671.8
Income before extraordinary items(/1/) 355.9 363.8 415.4 405.0
Net income(/1/) 351.5 363.8 415.4 404.6
Pro forma earnings per common share
before extraordinary items(/4/)
Diluted 0.81 0.83 0.94 0.93
Basic 0.83 0.84 0.96 0.95
- -------------------------------------------------------------------------------
Quarter
---------------------------------------
1997 1st 2nd 3rd 4th
- -------------------------------------------------------------------------------
(in millions, except per share data)
Net operating revenues $ 3,578.5 $ 3,667.5 $ 3,778.9 $ 3,849.0
Operating income(/2/) 605.4 598.0 643.3 623.2
Income before extraordinary
items(/2/),(/3/) 343.0 342.6 329.3 356.7
Net income(/2/),(/3/) 343.0 342.6 329.3 356.7
Pro forma earnings per common share
before extraordinary items(/4/)
Diluted 0.79 0.78 0.76 0.82
Basic 0.80 0.80 0.77 0.83
- -------------------------------------------------------------------------------
(/1/In)the 1998 fourth quarter, the FON Group recorded net nonrecurring gains
of $104 million, mainly from the sale of local exchanges. This increased
income before extraordinary items by $62 million.
(/2/In)the 1997 second quarter, the FON Group recorded nonrecurring charges of
$20 million related to litigation in the long distance division. These
charges reduced income before extraordinary items by $13 million (See Note
8).
(/3/In)the 1997 fourth quarter, the FON Group recognized gains of $71 million
from sales of local exchanges and certain investments. These gains
increased income before extraordinary items by $44 million.
(/4/Pro)forma earnings per share assumes the FON shares created in the
Recapitalization existed for all periods presented.
II-26
SPRINT FON GROUP
SCHEDULE II--COMBINED VALUATION AND QUALIFYING ACCOUNTS
Years Ended December 31, 1998, 1997 and 1996
- --------------------------------------------------------------------------------
Additions
---------------------
Balance Charged to Balance
Beginning Charged to Other Other End of
of Year Income Accounts Deductions Year
- --------------------------------------------------------------------------------
(in millions)
1998
Allowance for doubtful
accounts $146.7 $364.9 $ 2.6 $(339.4)(/1/) $174.8
-----------------------------------------------
Valuation allowance--
deferred income tax
assets $ 11.8 $ -- $ -- $ (8.2) $ 3.6
-----------------------------------------------
1997
Allowance for doubtful
accounts $117.4 $388.9 $ 4.0 $(363.6)(/1/) $146.7
-----------------------------------------------
Valuation allowance--
deferred income tax
assets $ 13.7 $ 2.6 $ -- $ (4.5) $ 11.8
-----------------------------------------------
1996
Allowance for doubtful
accounts $125.8 $248.5 $(1.5) $(255.4)(/1/) $117.4
-----------------------------------------------
Valuation allowance--
deferred income tax
assets $ 17.4 $ 1.9 $ -- $ (5.6) $ 13.7
-----------------------------------------------
(/1/Accounts)written off, net of recoveries.
II-27
Annex III
Sprint PCS Group
Combined Financial Information
SELECTED FINANCIAL DATA
Sprint PCS Group
- -----------------------------------------------------------------------------
1998 1997 1996 1995 1994
- -----------------------------------------------------------------------------
(in millions, except per share data)
Results of Operations
- -----------------------------------------------------------------------------
Net operating revenues $ 1,225.4 $ -- $ -- $ -- $ --
Operating loss(/1/) (2,569.4) (18.5) (0.5) -- --
Other partners' loss in Sprint
PCS 1,250.9 -- -- -- --
Equity in loss of Sprint PCS -- (659.6) (191.8) (31.4) (1.3)
Loss before extraordinary
item(/1/) (1,089.6) (419.1) (119.7) (19.9) --
Net loss (1,120.8) (419.1) (119.7) (19.9) --
Pro Forma Loss per Share(/2/)
- -----------------------------------------------------------------------------
Diluted and basic loss per
common share before
extraordinary item $ (4.42) $ (3.52) NA NA NA
Financial Position
- -----------------------------------------------------------------------------
Total assets $15,138.4 $1,703.1 $1,259.8 $973.7 $51.1
Property, plant and equipment,
net 6,534.9 187.3 -- -- --
Investment in Sprint PCS -- 783.9 1,175.8 973.7 51.1
Total debt 7,921.0 -- -- -- --
Group equity 3,755.5 1,385.9 1,187.6 965.7 51.1
Cash Flow Data
- -----------------------------------------------------------------------------
Net cash provided (used) by
operating activities $ (158.9) $ 37.5 $ (0.5) $ -- $ --
Capital expenditures 1,071.9 153.7 -- -- --
PCS license purchases -- 460.1 84.0 -- --
Investments in Sprint PCS 33.5 405.9 297.5 910.9 51.1
Results of operations for 1998 include Sprint PCS' operating results on a
consolidated basis for the entire year. The Cable Partners' share of losses
through the PCS Restructuring date has been reflected as "Other partners' loss
in Sprint PCS" in the Combined Statements of Operations. Before 1998, the PCS
Group's investment in Sprint PCS was accounted for using the equity method.
Sprint PCS' financial position at year-end 1998 has also been reflected on a
consolidated basis. Cash flow data reflects Sprint PCS' cash flows only after
the PCS Restructuring date. See Sprint's "Management's Discussion and Analysis
of Financial Condition and Results of Operations--General" for a more detailed
description of the PCS Restructuring, the Recapitalization and the Top-up.
(/1/In)1998, the PCS Group recorded a nonrecurring charge to write off $179
million of acquired in-process research and development costs related to
the PCS Restructuring. This charge increased operating loss and loss before
extraordinary item by $179 million.
(/2/Pro)forma loss per share for the PCS Group assumes the PCS Restructuring,
the Recapitalization and the Top-up occurred at the beginning of 1997 and
excludes the PCS Group's write-off of $179 million of acquired in-process
research and development costs. These pro forma amounts are for comparative
purposes only and do not necessarily represent what actual results of
operations would have been had the transactions occurred at the beginning
of 1997, nor do they indicate the results of future operations.
NA = not applicable
III-1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS Sprint PCS Group
- --------------------------------------------------------------------------------
General
- --------------------------------------------------------------------------------
See Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--General" for a discussion of the PCS Restructuring, the
Recapitalization and the Top-up.
- --------------------------------------------------------------------------------
Forward-looking Information
- --------------------------------------------------------------------------------
See Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Forward-looking Information" for a discussion of
forward-looking information.
- --------------------------------------------------------------------------------
Sprint PCS Group
- --------------------------------------------------------------------------------
The PCS Group includes Sprint's domestic wireless mobile phone services. It
operates the only 100% digital PCS wireless network in the United States, with
licenses to provide nationwide service using a single frequency and a single
technology. At year-end 1998, the PCS Group, together with certain affiliates,
operated PCS systems in 45 of the 50 largest U.S. metropolitan areas. The PCS
Group has licenses to serve nearly 270 million people in all 50 states, Puerto
Rico and the U.S. Virgin Islands. With market launches in January 1999, the PCS
Group's service now reaches nearly 170 million people. The PCS Group provides
nationwide service through:
. operating its own digital network in major U.S. metropolitan areas,
. affiliating with other companies, mainly in and around smaller U.S.
metropolitan areas,
. roaming on other providers' analog cellular networks using Dual-
Band/Dual-Mode handsets, and
. roaming on other providers' digital PCS networks that use code division
multiple access (CDMA).
The PCS Group began commercial CDMA operations in certain markets late in the
1996 fourth quarter. The wireless industry typically generates a significantly
higher number of subscriber additions and handset sales in the fourth quarter
of each year versus the remaining quarters. This is due to the use of retail
distribution, which is dependent on the holiday shopping season; the timing of
new products and service introductions; and aggressive marketing and sales
promotions.
- --------------------------------------------------------------------------------
Results of Operations
- --------------------------------------------------------------------------------
- -------------------------------------------------
1998 1997 1996
- -------------------------------------------------
(in millions)
Net operating revenues $ 1,225.4 $ -- $ --
Operating expenses 3,794.8 18.5 0.5
- -------------------------------------------------
Operating loss $(2,569.4) $(18.5) $(0.5)
----------------------------
The PCS Group's 1998 results of operations included SprintCom's operating
results as well as Sprint PCS' operating results on a consolidated basis for
the entire year. Before 1998, Sprint's investment in Sprint PCS was accounted
for using the equity method.
In 1998, the PCS Group recorded a one-time, non-cash charge of $179 million to
write off acquired in-process research and development costs related to the PCS
Restructuring.
The PCS Group markets its products through multiple distribution channels,
including its own retail stores as well as other retail outlets. Equipment
sales to one retail outlet, and service revenues generated by sales to its
customers, accounted for 25% of net operating revenues in 1998.
Pro Forma Sprint PCS Group
To provide a more meaningful analysis of the PCS Group's underlying operating
results, the following supplemental discussion assumes the PCS Restructuring
occurred at the beginning of 1997 and excludes the write-off of acquired in-
process research and development costs.
- --------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------
(in millions)
Net operating revenues $ 1,225.4 $ 258.0
- --------------------------------------------------------------------
Operating expenses
Costs of services and products 1,294.2 574.3
Selling, general and administrative 1,531.8 765.6
Depreciation and amortization 1,039.4 1,020.8
- --------------------------------------------------------------------
Total operating expenses 3,865.4 2,360.7
- --------------------------------------------------------------------
Operating loss $(2,640.0) $(2,102.7)
--------------------------------------------
Capital expenditures (including capital lease
obligations) $ 2,903.6 $ 2,278.3
--------------------------------------------
Net operating revenues include subscriber revenues (including monthly recurring
charges and usage charges), roaming revenues and sales of handsets and
accessory equipment. The PCS Group's net operating revenues were $1.2 billion
in 1998 versus $258 million in 1997, reflecting the launch of 91 new markets
and the addition of 1.7 million customers in 1998. The PCS Group ended 1998
with nearly 2.6 million customers in
III-2
225 markets nationwide. Approximately 20% of 1998 net operating revenues, and
nearly half of 1997 revenues, were from sales of handsets and accessories. As
part of the PCS Group's marketing plans, handsets are normally sold at prices
well below the PCS Group's cost.
Costs of services and products mainly includes handset and accessory costs,
interconnection costs, and switch and cell site expenses. These costs increased
$720 million in 1998 driven by the significant growth in customers and the
expanded market coverage.
Selling, general and administrative (SG&A) expense mainly includes marketing
costs to promote products and services, as well as salary and benefit costs.
SG&A expense increased $766 million in 1998 reflecting increased marketing and
advertising costs to promote products and services, as well as increased labor
costs to support increased subscriber activity.
Depreciation and amortization expense, which increased $19 million in 1998,
consists of depreciation of network assets and amortization of intangible
assets. The intangible assets include goodwill, PCS licenses, customer base,
microwave relocation costs and assembled workforce, which are being amortized
over three to 40 years.
- --------------------------------------------------------------------------------
Nonoperating Items
- --------------------------------------------------------------------------------
Interest Expense
- -------------------------------------------------------
1998
- -------------------------------------------------------
(in millions)
Interest expense on outstanding debt $ 484.1
Capitalized interest costs 125.4
- -------------------------------------------------------
Total interest costs on outstanding debt $ 609.5
------------------------
Average debt outstanding(/1/) $6,152.7
------------------------
Effective interest rate 9.9%
------------------------
(/1/Average)debt outstanding for 1998 is on a pro forma basis as if Sprint PCS
debt had been included in the PCS Group's outstanding debt balance all
year.
The PCS Group capitalizes interest costs related to network buildout and PCS
licenses in markets that are not yet operational. Capitalization of interest
stops and amortization begins when the related markets are launched.
Sprint PCS
Prior to the PCS Restructuring, the PCS Group's ownership interest in Sprint
PCS was accounted for using the equity method. The PCS Group's share of losses
from Sprint PCS was $660 million in 1997 and $192 million in 1996. The
increased losses in 1997 reflected marketing and promotional costs, including
losses on handset sales, to support a growing customer base and service
launches in additional markets. In 1998, the Cable Partners' share of losses
through the PCS Restructuring date has been reflected as "Other partners' loss
in Sprint PCS" in the Combined Statements of Operations.
Other Income, Net
Other income for 1998 consisted mainly of interest income totaling $34 million,
reflecting interest earned on partner contributions from the Sprint PCS
partners prior to the PCS Restructuring.
Income Taxes
The PCS Group's effective tax rates were 33.2% in 1998, 38.2% in 1997 and 37.8%
in 1996. See Note 5 of Notes to Combined Financial Statements for information
about the differences that caused the effective tax rates to vary from the
statutory federal rate.
Extraordinary Item, Net
In 1998, Sprint redeemed, prior to scheduled maturities, $3.3 billion of PCS
Group debt with a weighted average interest rate of 8.3%. This resulted in a
$31 million after-tax extraordinary loss. This debt was repaid with a portion
of the proceeds from Sprint's $5.0 billion debt offering in November 1998.
- --------------------------------------------------------------------------------
Financial Condition
- --------------------------------------------------------------------------------
- -----------------------------------
1998 1997
- -----------------------------------
(in millions)
Combined assets $15,138.4 $1,703.1
-----------
Because of the PCS Restructuring, Sprint PCS' 1998 financial position was
reflected on a consolidated basis. Before 1998, the PCS Group's investment in
Sprint PCS was accounted for using the equity method.
Net property, plant and equipment increased $6.3 billion in 1998 reflecting the
PCS Restructuring and capital expenditures to support the PCS network buildout.
Net intangibles increased $6.8 billion reflecting goodwill, PCS licenses,
microwave relocation costs and customer base resulting from the PCS
Restructuring.
III-3
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
The PCS Group's cash flows include Sprint PCS' cash flows only after the date
of the PCS Restructuring.
Operating Activities
- -------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------
(in millions)
Cash flows provided (used) by operating activities $(158.9) $37.5 $(0.5)
--------------------------------------------------
Operating cash flows decreased $196 million from 1997 mainly reflecting
increased losses for the PCS Group. The losses were due to increased marketing
and promotional costs and operating costs to support a growing customer base.
Investing Activities
- ---------------------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------
(in millions)
Cash flows used by investing activities $(861.1) $(1,019.7) $(381.5)
--------------------------------------------------
The PCS Group's main use of cash has been to fund initial operating losses of
Sprint PCS, capital expenditures and PCS license acquisitions. Capital
expenditures for the PCS Group totaled $1.1 billion in 1998 and $154 million in
1997.
Financing Activities
- -------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------
(in millions)
Cash flows provided by financing activities $1,192.7 $982.2 $382.0
-----------------------------------------------
In 1998, the PCS Group used their allocated portion of the proceeds from
Sprint's $5.0 billion debt offering mainly to repay existing debt.
In connection with the PCS Restructuring, Sprint adopted a tax sharing
agreement that provides for the allocation of income taxes between the FON
Group and PCS Group. Sprint expects the FON Group to make significant payments
to the PCS Group under this agreement because of expected PCS Group operating
losses in the near future. These payments will reflect the PCS Group's
incremental cumulative effect on Sprint's consolidated federal and state tax
liability and tax credit position. During 1998, the PCS Group accrued benefits
under the agreement totaling $191 million and received related payments from
the FON Group totaling $20 million. The remaining $171 million will be paid by
the FON Group during the first half of 1999. See Note 2 of Notes to Combined
Financial Statements, "Allocation of Federal and State Income Taxes," for more
details.
Capital Requirements
The PCS Group's 1999 investing activities, mainly consisting of capital
expenditures, are expected to be between $2.3 and $2.6 billion. Additional
funds will be required to fund expected operating losses, working capital and
debt service requirements of the PCS Group.
In June 1998, the PCS Group became the managing partner of Cox PCS. At year-end
1998, the PCS Group owned 59.2% of Cox PCS. Cox holds the minority interest in
the partnership. Under the partnership agreement, Cox has the right to require
the PCS Group to purchase, under certain circumstances, all or part of Cox's
interest in Cox PCS, which could involve significant cash requirements. Cox may
require the PCS Group to acquire an additional 10.2% interest in Cox PCS per
year through 2000. Beginning in 2001 through 2005, Cox may require the PCS
Group to acquire up to all of its interest in Cox PCS. Cox has given the PCS
Group notice to start the appraisal process related to a potential put of all
or a portion of Cox's remaining partnership interest to the PCS Group.
PCS preferred stock dividend payments are expected to total $15 million,
including payments to the FON Group for its preferred intergroup interest. See
Note 10 of Notes to Combined Financial Statements for a more detailed
discussion of the FON Group's preferred intergroup interest in the PCS Group.
Liquidity
See Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity" for a discussion of liquidity.
- --------------------------------------------------------------------------------
Regulatory Developments
- --------------------------------------------------------------------------------
The FCC sets rules, regulations and policies to, among other things:
. grant licenses for PCS frequencies and PCS license renewals,
. rule on assignments and transfers of control of PCS licenses,
. govern the interconnection of PCS networks with other wireless and
wireline carriers,
. establish access and universal service funding provisions,
. impose fines and forfeitures for violations of any of the FCC's rules,
and
. regulate the technical standards of PCS networks.
The FCC prohibits a single entity from having a combined attributable interest
(20% or greater interest in any license) in broadband PCS, cellular and
specialized mobile radio licenses totaling more than 45 megahertz (MHz) in any
geographic area.
PCS License Transfers and Assignments
The FCC must approve any substantial changes in ownership or control of a PCS
license. Noncontrolling
III-4
interests in an entity that holds a PCS license or operates PCS networks
generally may be bought or sold without prior FCC approval. In addition, a
recent FCC order requires only post-consummation notification of certain pro
forma assignments or transfers of control.
PCS License Conditions
All PCS licenses are granted for 10-year terms if the FCC's buildout
requirements are followed. Based on those requirements, all 30 MHz broadband
major trading area licensees must build networks offering coverage to 1/3 of
the population within five years and 2/3 within 10 years. All 10 MHz broadband
PCS licensees must build networks offering coverage to at least 1/4 of the
population within five years or make a showing of "substantial service" within
that five-year period. Licenses may be revoked if the rules are violated.
PCS licenses may be renewed for additional 10-year terms. Renewal applications
are not subject to auctions. However, third parties may oppose renewal
applications and/or file competing applications.
Other FCC Requirements
Broadband PCS providers cannot unreasonably restrict or prohibit other
companies from reselling their services. They also cannot unreasonably
discriminate against resellers. Resale obligations will automatically expire in
2002.
Local phone companies and most commercial mobile radio service (CMRS) carriers
(PCS and cellular providers) must program their networks to allow customers to
change service providers without changing phone numbers. This is referred to as
service provider number portability. Most CMRS providers were required to
deliver calls from their networks to ported numbers anywhere in the country by
year-end 1998. By the end of November 2002, CMRS providers must be able to
offer their own customers number portability in their switches in the 100
largest metropolitan areas. They also must be able to support nationwide
roaming.
Broadband PCS and other CMRS providers may provide wireless local loop and
other fixed services that would directly compete with the wireline services of
local phone companies. Broadband PCS and other CMRS providers must implement
enhanced emergency 911 capabilities to be completed in phases by October 2001.
The PCS Group and other wireless carriers complied with the first phase in
October 1998 and are currently analyzing various technical methods for
complying with the second phase.
Communications Assistance for Law Enforcement Act
The Communications Assistance for Law Enforcement Act (CALEA) was enacted in
1994 to preserve electronic surveillance capabilities authorized by federal and
state law. CALEA requires telecommunications carriers to meet certain
"assistance capability requirements" by the end of June 2000. In 1997,
telecommunications industry standard-setting organizations agreed to a joint
standard to implement CALEA's capability requirements. The PCS Group is able to
offer traditional electronic surveillance capabilities to law enforcement and
is currently evaluating its ability to satisfy the CALEA requirements.
The FCC is also considering petitions from numerous parties to establish and
implement technical compliance standards required by CALEA.
Other Federal Regulations
Wireless systems must comply with certain FCC and Federal Aviation
Administration regulations about the siting, lighting and construction of
transmitter towers and antennas. In addition, certain FCC environmental
regulations may cause certain cell site locations to come under National
Environmental Policy Act (NEPA) regulation. NEPA requires carriers to meet
certain land use and radio frequency standards.
Review of Universal Service Requirements
The FCC and the states established a "universal service" program to ensure
affordable, quality telecommunications services for all Americans. Although the
PCS Group is challenging in federal court the states' authority to collect
universal service contributions from CMRS providers, the PCS Group is required
to contribute to the federal program as well as existing state programs. The
PCS Group's "contribution" to the federal program is a percentage of end-user
revenues. Although many states are likely to adopt a similar assessment
methodology, the states may calculate the contributions in any manner as long
as the process is consistent with FCC rules. Currently, management cannot
predict the extent of the PCS Group's total federal and state universal service
assessments, or its ability to recover its contributions from the universal
service fund.
- --------------------------------------------------------------------------------
Financial Strategies
- --------------------------------------------------------------------------------
Financial strategies are determined by Sprint on a centralized basis. See
Sprint's "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Financial Strategies."
III-5
- --------------------------------------------------------------------------------
Year 2000 Issue
- --------------------------------------------------------------------------------
The "Year 2000" issue affects the PCS Group's installed computer systems,
network elements, software applications, and other business systems that have
time-sensitive programs that may not properly reflect or recognize the year
2000. Because many computers and computer applications define dates by the last
two digits of the year, "00" may not be properly identified as the year 2000.
This error could result in miscalculations or system errors. The Year 2000
issue may also affect the systems and applications of the PCS Group's
customers, vendors, resellers or affiliates.
The PCS Group has completed an inventory of its computer systems, network
elements, software applications, products and other business systems. The Year
2000 assessment of these items has begun and the PCS Group expects to complete
this assessment in the 1999 first quarter, along with plans to address any
required renovation. The PCS Group is using both internal and external
resources to identify, correct or reprogram, and test its systems for Year 2000
compliance. It expects Year 2000 compliance for these critical systems to be
achieved in 1999.
The PCS Group is also contacting others with whom it conducts business to
receive the appropriate warranties and assurances that those third parties are
or will be Year 2000 compliant. The PCS Group relies on third-party vendors for
a significant portion of its important operating and computer system functions
and, therefore, is highly dependent on those vendors to remediate network
elements, computer systems, software applications and other business systems.
In addition, the PCS Group uses publicly available services that are acquired
without contract, such as global positioning system timing signal, that may be
affected by the Year 2000 issue. While the PCS Group believes these systems
will be Year 2000 compliant, it has no contractual or other right to force
compliance.
The PCS Group expects to incur approximately $50 million in 1999 for its Year
2000 compliance program. If compliance is not achieved in a timely manner by
the PCS Group, its affiliates or any significant third party, the Year 2000
issue could have a material adverse effect on the PCS Group's operations. The
PCS Group is focusing on identifying and addressing all aspects of its
operations that may be affected by the Year 2000 issue. The PCS Group is
developing and will implement, if necessary, appropriate contingency plans to
mitigate, to the extent possible, the effects of any Year 2000 noncompliance.
- --------------------------------------------------------------------------------
Recently Issued Accounting Pronouncement
- --------------------------------------------------------------------------------
See Note 11 of Notes to Combined Financial Statements for a discussion of a
recently issued accounting pronouncement.
III-6
MANAGEMENT REPORT
Sprint Corporation's management is responsible for the integrity and
objectivity of the information contained in this annex. Management is
responsible for the consistency of reporting this information and for ensuring
that generally accepted accounting principles are used.
In discharging this responsibility, management maintains a comprehensive system
of internal controls and supports an extensive program of internal audits, has
made organizational arrangements providing appropriate divisions of
responsibility and has established communication programs aimed at assuring
that its policies, procedures and codes of conduct are understood and practiced
by its employees.
The combined financial statements included in this annex have been audited by
Ernst & Young LLP, independent auditors. Their audits were conducted using
generally accepted auditing standards and their report is included herein.
The Board of Director's responsibility for these combined financial statements
is pursued mainly through its Audit Committee. The Audit Committee, composed
entirely of directors who are not officers or employees of Sprint, meets
periodically with the internal auditors and independent auditors, both with and
without management present, to assure that their respective responsibilities
are being fulfilled. The internal and independent auditors have full access to
the Audit Committee to discuss auditing and financial reporting matters.
/s/ W. T. Esrey
- --------------------------------------------------------------------------------
William T. Esrey
Chairman and Chief Executive Officer
/s/ Arthur B. Krause
- --------------------------------------------------------------------------------
Arthur B. Krause
Executive Vice President and Chief Financial Officer
III-7
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders Sprint Corporation
We have audited the accompanying combined balance sheets of the Sprint PCS
Group (as described in Note 2) as of December 31, 1998 and 1997, and the
related combined statements of operations and cash flows for each of the three
years in the period ended December 31, 1998. Our audits also included the
financial statement schedule listed in the Index to Financial Statements and
Financial Statement Schedules. These financial statements and the schedule are
the responsibility of the management of Sprint Corporation (Sprint). Our
responsibility is to express an opinion on these financial statements and the
schedule based on our audits. We did not audit the consolidated financial
statements of Sprint Spectrum Holding Company, L.P., a wholly owned subsidiary
of Sprint as of December 31, 1998 and an investment in which Sprint had a 40%
interest through November 23, 1998 (as discussed in Note 1). Such financial
statements reflect assets of $2.7 billion as of December 31, 1998 and revenues
of $1.2 billion for the year then ended which we did not audit. The PCS Group's
equity in Sprint Spectrum Holding Company, L.P. is stated at $749 million at
December 31, 1997, and the PCS Group's equity in the net loss of Sprint
Spectrum Holding Company, L.P. is stated at $625 million and $191 million for
the years ended December 31, 1997 and 1996, respectively. The consolidated
financial statements and financial statement schedule of Sprint Spectrum
Holding Company, L.P. have been audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the 1998 assets and
revenues and the 1997 and 1996 equity investment accounts which we did not
audit, is based solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits and the report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
combined financial statements referred to above present fairly, in all material
respects, the combined financial position of the Sprint PCS Group at December
31, 1998 and 1997, and the combined results of its operations and its cash
flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
As more fully discussed in Note 2, the combined financial statements of the
Sprint PCS Group should be read together with the audited consolidated
financial statements of Sprint.
Ernst & Young LLP
Kansas City, Missouri
February 2, 1999
III-8
REPORT OF INDEPENDENT AUDITORS
The Board of Directors of Sprint Corporation and Partners of Sprint Spectrum
Holding Company, L.P.
We have audited the consolidated balance sheets of Sprint Spectrum Holding
Company, L.P. and subsidiaries (Holdings) as of December 31, 1998 and 1997, and
the related consolidated statements of operations and cash flows for the three
years in the period ended December 31, 1998. Our audits also included the
financial statement schedule (Schedule II). These financial statements and
Schedule II are the responsibility of Partnership management. Our
responsibility is to express an opinion on these consolidated financial
statements and Schedule II based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the consolidated financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the consolidated
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all
material respects, the financial position of Sprint Spectrum Holding Company,
L.P. and subsidiaries at December 31, 1998 and 1997, and the results of their
operations and their cash flows for the three years ended December 31, 1998 in
conformity with generally accepted accounting principles. Also, in our opinion,
Schedule II, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects the
information set forth therein.
Deloitte & Touche LLP
Kansas City, Missouri
February 2, 1999
III-9
COMBINED STATEMENTS OF OPERATIONS Sprint PCS Group
(in millions)
- ---------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- ---------------------------------------------------------------------------
Net Operating Revenues $ 1,225.4 $ -- $ --
- ---------------------------------------------------------------------------
Operating Expenses
Costs of services and products 1,294.2 -- --
Selling, general and administrative 1,531.8 18.5 0.5
Depreciation and amortization 789.7 -- --
Acquired in-process research and development
costs 179.1 -- --
- ---------------------------------------------------------------------------
Total operating expenses 3,794.8 18.5 0.5
- ---------------------------------------------------------------------------
Operating Loss (2,569.4) (18.5) (0.5)
Interest expense (491.6) -- --
Other partners' loss in Sprint PCS 1,250.9 -- --
Equity in loss of Sprint PCS -- (659.6) (191.8)
Minority interest 144.8 -- --
Other income, net 33.6 -- --
- ---------------------------------------------------------------------------
Loss before income tax benefit (1,631.7) (678.1) (192.3)
Income tax benefit 542.1 259.0 72.6
- ---------------------------------------------------------------------------
Loss before Extraordinary Item (1,089.6) (419.1) (119.7)
Extraordinary item, net (31.2) -- --
- ---------------------------------------------------------------------------
Net Loss $(1,120.8) $(419.1) $(119.7)
--------------
See accompanying Notes to Combined Financial Statements.
III-10
COMBINED BALANCE SHEETS
(in millions) Sprint PCS Group
- -------------------------------------------------------------------------
December 31, 1998 1997
- -------------------------------------------------------------------------
Assets
Current assets
Cash and equivalents $ 172.7 $ --
Accounts receivable, net of allowance for doubtful
accounts of $10.7 in 1998 306.4 --
Inventories 127.4 --
Prepaid expenses 60.4 2.9
Current tax benefit receivable from the FON Group 170.5 --
Deferred income taxes 18.4 --
- -------------------------------------------------------------------------
Total current assets 855.8 2.9
Property, plant and equipment
Network equipment 3,998.8 --
Construction work in progress 1,607.2 187.3
Buildings and leasehold improvements 1,026.3 --
Other 356.0 --
- -------------------------------------------------------------------------
Total property, plant and equipment 6,988.3 187.3
Accumulated depreciation (453.4) --
- -------------------------------------------------------------------------
Net property, plant and equipment 6,534.9 187.3
Investment in Sprint PCS -- 783.9
Intangible assets
Goodwill 3,313.4 --
PCS licenses 3,036.6 544.5
Customer base 681.4 --
Microwave relocation costs 354.5 --
Other 45.4 --
- -------------------------------------------------------------------------
Total intangible assets 7,431.3 544.5
Accumulated amortization (93.5) --
- -------------------------------------------------------------------------
Net intangible assets 7,337.8 544.5
Other assets 409.9 184.5
- -------------------------------------------------------------------------
Total $15,138.4 $1,703.1
-------
Liabilities and Group Equity
Current liabilities
Current maturities of long-term debt $ 348.3 $ --
Accounts payable 371.2 17.8
Construction obligations 978.9 --
Advances from the FON Group 349.2 10.0
Accrued expenses and other current liabilities 626.1 39.8
- -------------------------------------------------------------------------
Total current liabilities 2,673.7 67.6
Long-term debt and capital lease obligations 7,572.7 --
Deferred credits and other liabilities
Deferred income taxes 1,013.3 249.3
Other 123.2 0.3
- -------------------------------------------------------------------------
Total deferred credits and other liabilities 1,136.5 249.6
Group equity 3,755.5 1,385.9
- -------------------------------------------------------------------------
Total $15,138.4 $1,703.1
-------
See accompanying Notes to Combined Financial Statements.
III-11
COMBINED STATEMENTS OF CASH FLOWS
(in millions) Sprint PCS Group
- -----------------------------------------------------------------------------
Years Ended December 31, 1998 1997 1996
- -----------------------------------------------------------------------------
Operating Activities
Net loss $(1,120.8) $ (419.1) $(119.7)
Adjustments to reconcile net loss to net cash
provided (used) by operating activities:
Equity in net losses of affiliates 840.2 659.6 191.8
Acquired in-process research and development
costs 179.1 -- --
Deferred income taxes 67.5 175.7 64.2
Depreciation and amortization 120.9 -- --
Extraordinary item, net 31.2 -- --
Current tax benefit used by the FON Group (460.4) (434.7) (136.8)
Changes in assets and liabilities, excluding
the PCS Restructuring:
Accounts receivable, net (0.9) -- --
Inventories and other current assets (170.1) (2.9) --
Accounts payable and other current
liabilities 385.8 57.6 --
Affiliate receivables and payables 100.9 -- --
Noncurrent assets and liabilities, net (101.5) 1.3 --
Other, net (30.8) -- --
- -----------------------------------------------------------------------------
Net cash provided (used) by operating
activities (158.9) 37.5 (0.5)
- -----------------------------------------------------------------------------
Investing Activities
Capital expenditures (1,071.9) (153.7) --
PCS licenses purchased -- (460.1) (84.0)
Cash acquired in the PCS Restructuring 244.3 -- --
Investments in Sprint PCS (33.5) (405.9) (297.5)
- -----------------------------------------------------------------------------
Net cash used by investing activities (861.1) (1,019.7) (381.5)
- -----------------------------------------------------------------------------
Financing Activities
Proceeds from long-term debt 4,154.0 -- --
Payments on long-term debt (3,434.2) -- --
Advances from the FON Group 338.1 -- --
Equity transfer (to) from the FON Group (340.0) 547.5 245.2
Current tax benefit used by the FON Group 460.4 434.7 136.8
Proceeds from PCS stock issued 84.6 -- --
Other, net (70.2) -- --
- -----------------------------------------------------------------------------
Net cash provided by financing activities 1,192.7 982.2 382.0
- -----------------------------------------------------------------------------
Increase in Cash and Equivalents 172.7 -- --
Cash and Equivalents at Beginning of Year -- -- --
- -----------------------------------------------------------------------------
Cash and Equivalents at End of Year $ 172.7 $ -- $ --
-----------------
See accompanying Notes to Combined Financial Statements.
III-12
NOTES TO COMBINED FINANCIAL STATEMENTS Sprint PCS Group
- --------------------------------------------------------------------------------
1. PCS Restructuring and Recapitalization
- --------------------------------------------------------------------------------
In November 1998, Sprint's shareholders approved the formation of the FON Group
and the PCS Group and the creation of the FON stock and the PCS stock. In
addition, Sprint purchased the remaining ownership interests in Sprint Spectrum
Holding Company, L.P. and PhillieCo, L.P. (together, Sprint PCS), other than a
minority interest in Cox Communications PCS, L.P. (Cox PCS). Sprint acquired
these ownership interests from Tele-Communications, Inc., Comcast Corporation
and Cox Communications, Inc. (the Cable Partners). In exchange, Sprint issued
the Cable Partners special low-vote PCS shares and warrants to acquire
additional PCS shares. Sprint also issued the Cable Partners shares of a new
class of preferred stock convertible into PCS shares. The purchase of the Cable
Partners' interests is referred to as the PCS Restructuring.
Also in November 1998, Sprint reclassified each of its publicly traded common
shares into one share of FON stock and 1/2 share of PCS stock. This
recapitalization was tax-free to shareholders. Each Class A common share owned
by France Telecom S.A. (FT) and Deutsche Telekom AG (DT) was reclassified to
represent an equity interest in the FON Group and the PCS Group that entitles
FT and DT to one share of FON stock and 1/2 share of PCS stock. These
transactions are referred to as the Recapitalization.
In connection with the PCS Restructuring, FT and DT purchased 5.1 million
additional PCS shares to maintain their combined 20% voting power in Sprint
(Top-up).
The PCS stock is intended to reflect the performance of Sprint's domestic
wireless personal communication services (PCS) operations. The FON stock is
intended to reflect the performance of all of Sprint's other operations.
- --------------------------------------------------------------------------------
2. Summary of Significant Accounting Policies
- --------------------------------------------------------------------------------
Basis of Combination and Presentation
The combined PCS Group financial statements, together with the combined FON
Group financial statements, include all the accounts included in Sprint's
consolidated financial statements. The combined financial statements for each
Group were prepared on a basis that management believes is reasonable and
proper and include:
. the combined historical balance sheets, results of operations and cash
flows for each of the Groups, with all significant intragroup amounts
and transactions eliminated,
. an allocation of Sprint's debt, including the related effects on results
of operations and cash flows, and
. an allocation of corporate overhead after the PCS Restructuring date.
The PCS Group entities are commonly controlled companies and, with the
exception of Cox PCS, are wholly owned by Sprint. Transactions between the PCS
Group and the FON Group have not been eliminated in the combined financial
statements of either Group.
The PCS Group combined financial statements provide PCS shareholders with
financial information about the PCS Group operations. Investors in FON stock
and PCS stock are Sprint shareholders and are subject to risks related to all
of Sprint's businesses, assets and liabilities. Sprint retains ownership and
control of the assets and operations of each Group (subject to a minority
interest in Cox PCS). Financial effects of either Group that affect Sprint's
results of operations or financial condition could affect the results of
operations, financial position or market price of the other Group's stock. Net
losses of either Group, and dividends or distributions on, or repurchases of,
PCS stock or FON stock will reduce Sprint funds legally available for dividends
on both Groups' stock. As a result, the PCS Group combined financial statements
should be read along with Sprint's consolidated financial statements and the
FON Group's combined financial statements.
Sprint PCS' results of operations for 1998 have been consolidated for the
entire year. The Cable Partners' share of losses through the PCS Restructuring
date has been reflected as "Other partners' loss in Sprint PCS" in the Combined
Statements of Operations. Sprint PCS financial position has been reflected on a
consolidated basis at year-end 1998. Before 1998, Sprint's investment in Sprint
PCS was accounted for using the equity method. The PCS Group's cash flows
include Sprint PCS' cash flows only after the PCS Restructuring date.
III-13
The PCS Group combined financial statements are prepared using generally
accepted accounting principles. 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 results of
operations or group equity as previously reported.
Classification of Operations
The PCS Group includes Sprint's domestic wireless mobile phone services. It
operates the only 100% digital PCS wireless network in the United States, with
licenses to provide nationwide service using a single frequency and a single
technology. At year-end 1998, the PCS Group, together with certain affiliates,
operated PCS systems in 45 of the 50 largest U.S. metropolitan areas.
Allocation of Shared Services
Sprint directly assigns, where possible, certain general and administrative
costs to the FON Group and the PCS Group based on their actual use of those
services. Where direct assignment of costs is not possible, or practical,
Sprint uses other methods to estimate the assignment of costs to each Group.
Allocation of Federal and State Income Taxes
Sprint files a consolidated federal income tax return and certain state income
tax returns which include FON Group and PCS Group results. In connection with
the PCS Restructuring, Sprint adopted a tax sharing agreement which provides
for the allocation of income taxes between the two Groups. The PCS Group's
income taxes reflect the PCS Group's incremental cumulative impact on Sprint's
consolidated income taxes. Intergroup tax payments are satisfied on the date
Sprint's related tax payment is due to or the refund is received from the
applicable tax authority. During 1998, the PCS Group accrued income tax
benefits in accordance with the tax sharing agreement totaling $191 million.
Allocation of Group Financing
Financing activities for the Groups are managed by Sprint on a centralized
basis. Debt incurred by Sprint on behalf of the Groups is specifically
allocated to and reflected in the financial statements of the applicable Group.
Interest expense is allocated to the PCS Group based on an interest rate that
is largely equal to the rate it would be able to obtain from third parties as a
direct or indirect wholly owned Sprint subsidiary, but without the benefit of
any guaranty by Sprint or any member of the FON Group. That interest rate is
higher than the rate Sprint obtains on borrowings. The difference between
Sprint's actual interest rate and the rate charged to the PCS Group is
reflected as a reduction in the FON Group's interest expense.
Under Sprint's centralized cash management program, one Group may advance funds
to the other Group. These advances are accounted for as short-term borrowings
between the Groups and bear interest at a market rate that is substantially
equal to the rate that Group would be able to obtain from third parties on a
short-term basis.
Income Taxes
The PCS Group records deferred income taxes based on temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and their tax bases.
Revenue Recognition
The PCS Group recognizes operating revenues as services are rendered or as
products are delivered to customers. The PCS Group records operating revenues
net of an estimate for uncollectible accounts.
Cash and Equivalents
Cash equivalents generally include highly liquid investments with original
maturities of three months or less. They are stated at cost, which approximates
market value. Sprint uses controlled disbursement banking arrangements as part
of its cash management program. Outstanding checks in excess of cash balances
for the PCS Group were included in accounts payable. These amounts totaled $73
million at year-end 1998 and $11 million at year-end 1997. The PCS Group had
sufficient funds available to fund these outstanding checks when they were
presented for payment.
Inventories
Inventories are stated at the lower of cost (principally first-in, first-out
method) or replacement value.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Generally, ordinary asset
retirements and disposals are charged against accumulated depreciation with no
gain or loss recognized. Property, plant and equipment is depreciated on a
straight-line basis over estimated economic useful lives. Repair and
maintenance costs are expensed as incurred.
Capitalized Interest
The PCS Group capitalizes interest costs related to network buildout and PCS
licenses, which totaled $64 million in 1998. In addition, Sprint capitalized
interest costs related to the PCS Group's network buildout. This capitalized
interest totaled $61 million for 1998 and $24 million for 1997 and was
contributed to, and will be amortized by, the PCS Group. Sprint also
capitalized interest costs related to its investment in Sprint PCS until July
1997 when Sprint PCS emerged from the development stage. This capitalized
interest, totaling $46 million in 1997 and $96 million in 1996, was contributed
to, and is being amortized by, the PCS Group.
III-14
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the
net assets acquired in business combinations accounted for as purchases.
Goodwill is being amortized over 40 years using the straight-line method.
Accumulated amortization totaled $11 million at year-end 1998.
PCS Licenses
The PCS Group acquired licenses from the Federal Communications Commission
(FCC) to operate as a PCS service provider. These licenses are granted for up
to 10-year terms with renewals for additional 10-year terms if license
obligations are met. These licenses are recorded at cost and are amortized on a
straight-line basis over 40 years when service begins in a specific geographic
area. Accumulated amortization totaled $51 million at year-end 1998.
Customer Base
The PCS Group capitalized the fair value of Sprint PCS' customer base acquired
in the PCS Restructuring. The customer base is being amortized over three years
using the straight-line method. Accumulated amortization totaled $23 million at
year-end 1998.
Microwave Relocation Costs
The PCS Group has incurred costs related to microwave relocation in
constructing the PCS network. Microwave relocation costs are being amortized
over the remaining lives of the PCS licenses. Accumulated amortization totaled
$6 million at year-end 1998.
Loss per Share
As a result of the PCS Restructuring and the Recapitalization, loss per share
for the PCS Group has been calculated based on the Group's net loss from
November 1998 through year-end 1998. It was not calculated on a Group basis in
prior years because the PCS stock was not part of Sprint's capital structure at
that time.
Dilutive securities for the PCS Group mainly include options, warrants and
convertible preferred stock. These securities did not have a dilutive effect on
loss per share because the PCS Group incurred net losses for 1998. As a result,
diluted loss per share equaled basic loss per share.
The PCS Group's basic and diluted loss per common share after the PCS
Restructuring and Recapitalization date was as follows:
- --------------------------------------------------------
1998
- --------------------------------------------------------
(in millions,
except per
share data)
Loss applicable to common stock $(558.4)
--------------------------
Basic and diluted loss per common share:
Loss before extraordinary item $ (1.26)
Extraordinary item (0.08)
- --------------------------------------------------------
Total $ (1.34)
--------------------------
Basic and diluted weighted average shares 415.8
--------------------------
Stock-based Compensation
The PCS Group participates in the incentive-based stock option plans and
employee stock purchase plans administered by Sprint for executives and other
employees. Sprint adopted the pro forma disclosure requirements under Statement
of Financial Accounting Standards (SFAS) No. 123, "Stock-based Compensation,"
and continues to apply Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," to its stock option and employee stock purchase
plans. Had the PCS Group applied SFAS 123, pro forma net loss would not have
changed materially. See Note 9 of Sprint's Notes to Consolidated Financial
Statements for more information about Sprint's stock-based compensation and the
PCS Group's pro forma net loss.
In 1997, Sprint granted performance-based stock options to certain key
executives. In 1998, the PCS Group expensed $1 million related to these
performance-based stock options.
- --------------------------------------------------------------------------------
3. Business Combination
- --------------------------------------------------------------------------------
In November 1998, Sprint acquired the remaining interest in Sprint PCS (except
for a minority interest in Cox PCS) from the Cable Partners. In exchange,
Sprint issued the Cable Partners 195.1 million low-vote shares of PCS stock and
12.5 million warrants to purchase additional shares of PCS stock. The purchase
price was $3.2 billion. In addition, Sprint issued the Cable Partners shares of
a new class of preferred stock convertible into PCS shares.
Sprint accounted for the transaction as a purchase. The excess of the purchase
price over the fair value of the net liabilities acquired was allocated as
follows:
- ----------------------------------------------------------------------
(in millions)
Purchase price including transaction costs $3,226.0
Net liabilities acquired 280.8
Fair value assigned to customer base acquired (681.4)
Fair value assigned to assembled workforce acquired (45.3)
Increase in property, plant and equipment to fair value (203.1)
Mark-to-market of long-term debt 84.6
Deferred taxes on acquired assets and liabilities 678.3
In-process research and development costs (179.1)
- ----------------------------------------------------------------------
Goodwill $3,160.8
---------------------------------------
III-15
With respect to the purchase price attributed to in- process research and
development (IPR&D), the acquired IPR&D was limited to significant new products
under development that were intended to address new and emerging market needs
and requirements, such as the rapid adoption of the Internet and the rapid
convergence of voice, data, and video. No routine research and development
projects, minor requirements, normal enhancements, or production activities
were included in the acquired IPR&D.
The income approach was the primary technique utilized in valuing the acquired
IPR&D. This approach included, but was not limited to, an analysis of (i) the
markets for each product; (ii) the completion costs for projects; (iii) the
expected cash flows attributable to the IPR&D projects; (iv) the risks
associated with achieving these cash flows; and (v) the stage of development of
each project. The issue of alternative future use was extensively evaluated and
these technologies, once completed, could only be economically used for their
intended purposes.
Sprint PCS Pro Forma Results
The following unaudited pro forma combined results of operations for the PCS
Group assume the PCS Restructuring, Recapitalization and Top-up occurred at the
beginning of 1997 and exclude the write-off of acquired in-process research and
development costs. These pro forma amounts are for comparative purposes only
and do not necessarily represent what actual results of operations would have
been had the transactions occurred at the beginning of 1997, nor do they
indicate the results of future operations. Pro forma results were as follows:
- -----------------------------------------------------------------
1998 1997
- -----------------------------------------------------------------
(in millions, except
per share data)
Net operating revenues $ 1,225.4 $ 258.0
-----------------------------------------
Loss before extraordinary item $ (1,846.7) $ (1,466.2)
-----------------------------------------
Net loss $ (1,877.9) $ (1,466.2)
-----------------------------------------
Basic and diluted loss per common share:
Loss before extraordinary item $ (4.42) $ (3.52)
Extraordinary item (0.08) --
- -----------------------------------------------------------------
Total $ (4.50) $ (3.52)
-----------------------------------------
- --------------------------------------------------------------------------------
4. Employee Benefit Plans
- --------------------------------------------------------------------------------
Defined Contribution Plan
Sprint PCS sponsored a savings and retirement program for certain employees.
Sprint PCS matched contributions equal to 50% of the contribution of each
participant, up to the first 6% that the employee elected to contribute.
Expense under the savings plan was $7 million in 1998. Effective January 1999,
the PCS Group employees began making contributions to Sprint's defined
contribution plan. The existing assets of the Sprint PCS savings plan will be
rolled over to Sprint's defined contribution plan in early 1999.
Defined Benefit Pension Plan
Effective January 1999, PCS Group employees also became eligible to participate
in Sprint's pension and postretirement plans.
- --------------------------------------------------------------------------------
5. Income Taxes
- --------------------------------------------------------------------------------
Income tax benefit allocated to continuing operations consisted of the
following:
- -----------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------
(in millions)
Current income tax benefit
Federal $(579.2) $(414.1) $(122.8)
State (30.4) (20.6) (14.0)
- -----------------------------------------------------------------
Total current (609.6) (434.7) (136.8)
- -----------------------------------------------------------------
Deferred income tax expense (benefit)
Federal 82.8 187.0 59.4
State (15.3) (11.3) 4.8
---------------------------------------------
Total deferred 67.5 175.7 64.2
---------------------------------------------
Total $(542.1) $(259.0) $ (72.6)
---------------------------------------------
The differences that caused the PCS Group's effective income tax rates to vary
from the 35% statutory federal rate were as follows:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
(in millions)
Income tax benefit at the statutory rate $(571.1) $(237.3) $(67.3)
Effect of:
State income taxes, net of federal income tax effect (29.7) (20.7) (6.0)
Write-off of in-process research and development
costs 62.7 -- --
Other, net (4.0) (1.0) 0.7
- -------------------------------------------------------------------------------
Income tax benefit $(542.1) $(259.0) $(72.6)
- -------------------------------------------------------------------------------
Effective income tax rate 33.2% 38.2% 37.8%
----------------------------------------------------------
In 1998, the income tax benefit allocated to the PCS Group's extraordinary loss
totaled $20 million.
The PCS Group recognizes deferred income taxes for the temporary differences
between the carrying amounts of its assets and liabilities for financial
statement purposes and their tax bases. The sources of the differences that
give rise to the deferred income tax assets and liabilities at year-end 1998
and 1997, along with the income tax effect of each, were as follows:
- ---------------------------------------------------------
1998 Deferred Income Tax
--------------------------
Assets Liabilities
- ---------------------------------------------------------
(in millions)
Property, plant and equipment $ -- $ 542.8
Intangibles -- 453.7
Capitalized interest -- 102.6
Reserves and allowances 22.3 --
Operating loss carryforwards 257.9 --
Other, net 32.2 --
- ---------------------------------------------------------
312.4 1,099.1
Less valuation allowance 208.2 --
- ---------------------------------------------------------
Total $ 104.2 $ 1,099.1
-----------------------------------
III-16
- ----------------------------------------------------------
1997 Deferred Income Tax
---------------------------
Assets Liabilities
- ----------------------------------------------------------
(in millions)
Property, plant and equipment $ -- $ 130.7
Intangibles -- 52.3
Capitalized interest -- 83.6
Reserves and allowances 8.2 --
Operating loss carryforwards 24.1 --
Other, net -- 15.0
- ----------------------------------------------------------
Total $ 32.3 $ 281.6
------------------------------------
Management believes it is more likely than not that these deferred income tax
assets, net of the valuation allowance, will be realized based on current
income tax laws and expectations of future taxable income stemming from the
reversal of existing deferred tax liabilities or ordinary operations.
Uncertainties surrounding income tax law changes, shifts in operations between
state taxing jurisdictions, and future operating income levels may, however,
affect the ultimate realization of all or some of these deferred income tax
assets.
The PCS Group acquired approximately $192 million of potential tax benefits
related to net operating loss carryforwards in the PCS Restructuring which are
subject to certain realization restrictions under various tax laws. A valuation
allowance was provided for the total of these benefits. If these benefits are
subsequently recognized, they will reduce the goodwill or other noncurrent
intangible assets resulting from the PCS Restructuring.
In connection with the PCS Restructuring, the PCS Group is required to
reimburse the FON Group and the Cable Partners for net operating loss and tax
credit carryforward benefits generated prior to the PCS Restructuring if
realization by the PCS Group produces a cash benefit that would not otherwise
have been realized. The reimbursement will equal 60% of the net cash benefit
received by the PCS Group and will be made to the FON Group in cash and to the
Cable Partners in shares of Series 2 PCS stock. The carryforward benefits
subject to this requirement totaled $246 million, which includes the $192
million acquired in the PCS Restructuring.
At year-end 1998, the PCS Group had federal operating loss carryforwards of
approximately $265 million and state operating loss carryforwards of
approximately $4.0 billion. In addition, the PCS Group had available for income
tax purposes federal alternative minimum tax credit carryforwards of $27
million and federal alternative minimum tax net operating loss carryforwards of
$14 million. The loss carryforwards expire in varying amounts through 2018.
III-17
- --------------------------------------------------------------------------------
6. Long-term Debt and Capital Lease Obligations
- --------------------------------------------------------------------------------
Sprint's consolidated long-term debt at year-end was as follows:
- ----------------------------------------------------------------------------
1998
--------------------------------
Sprint Sprint
Maturing FON Group PCS Group Consolidated 1997
- ----------------------------------------------------------------------------
(in millions)
Senior notes
5.7% to 6.9%(/1/) 2003 to 2028 $1,059.4 $3,940.6 $ 5,000.0 $ --
8.1% to 9.8% 1998 to 2003 632.3 -- 632.3 675.3
11.0% to 12.5%(/2/) 2006 -- 698.6 565.5 --
Debentures and notes
5.8% to 9.6% 2000 to 2022 564.5 -- 564.5 587.0
Notes payable and
commercial paper -- 745.8 -- 745.8 866.5
First mortgage bonds
2.0% to 9.9% 1998 to 2025 1,312.0 -- 1,312.0 1,468.4
Capital lease
obligations
5.3% to 7.5% 1998 to 2006 31.7 452.0 483.7 35.3
Revolving credit
facilities
Variable rates 2005 to 2006 -- 1,800.0 1,800.0 --
Other(/2/),(/3/)
2.0% to 10.0% 1998 to 2007 370.4 1,029.8 1,085.5 247.1
- ----------------------------------------------------------------------------
4,716.1 7,921.0 12,189.3 3,879.6
Less: current
maturities(/2/) 33.3 348.3 246.9 131.0
- ----------------------------------------------------------------------------
Long-term debt and
capital lease
obligations $4,682.8 $7,572.7 $11,942.4 $3,748.6
---------------------------
(/1/These)borrowings were incurred by Sprint and allocated to the applicable
Group. At year-end 1998, Sprint's weighted average interest rate related to
these borrowings was 6.4%. The weighted average interest rate related to
the borrowings allocated to the PCS Group was approximately 8.5%. See Note
2 for a more detailed description of how Sprint allocates financing to each
of the Groups.
(/2/Consolidated)debt does not equal the total of PCS Group and FON Group debt
due to intergroup debt eliminated in consolidation. At year-end 1998, the
FON Group had an investment in the PCS Group's Senior Discount notes
totaling $133 million. In addition, the PCS Group had other long-term debt
payable to the FON Group totaling $315 million, including $135 million
classified as current at year-end 1998.
(/3/Includes)$358 million of notes recorded by the FON Group that may be
exchanged at maturity for SBC Communications, Inc. (SBC) common shares
owned by the FON Group or for cash. Based on SBC's closing price, had the
notes matured at year-end 1998, they could have been exchanged for
6.6 million SBC shares. At year-end 1998, Sprint held 7.6 million SBC
shares, which have been included in "Investments in equity securities" in
the FON Group's Combined Balance Sheets.
III-18
Long-term debt maturities, excluding reclassified short-term borrowings, during
each of the next five years are as follows:
- ------------------------------
Sprint Sprint
FON PCS
Group Group Sprint
- ------------------------------
(in millions)
1999 $ 33.3 $ 348.3 $ 246.9
2000 864.0 175.3 1,039.3
2001 41.1 407.1 217.0
2002 353.0 357.3 710.3
2003 774.8 1,115.0 1,889.8
- ------------------------------
Sprint
Short-term Borrowings
Sprint had bank notes payable totaling $454 million at year-end 1998 and $618
million at year-end 1997. In addition, Sprint had commercial paper borrowings
totaling $292 million at year-end 1998 and $249 million at year-end 1997.
Though these borrowings are renewable at various dates throughout the year,
they were classified as long-term debt because of Sprint's intent and ability,
through unused credit facilities, to refinance these borrowings on a long-term
basis.
In 1998, Sprint replaced its previous $1.5 billion credit facility with new
facilities with syndicates of domestic and international banks. The new
facilities totaled $5.0 billion and expire in 1999 and 2003. Commercial paper
and certain bank notes payable are supported by Sprint's revolving credit
facilities. Certain other notes payable relate to a separate revolving credit
facility. At year-end 1998, Sprint had total unused lines of credit of $4.8
billion.
Bank notes outstanding had weighted average interest rates of 5.7% at year-end
1998 and 6.1% at year-end 1997. The weighted average interest rate of
commercial paper was 5.8% at year-end 1998 and 6.8% at year-end 1997.
Long-term Debt
In October 1998, Sprint filed a shelf registration statement with the
Securities and Exchange Commission for $8.0 billion of debt securities. This
replaced Sprint's previous shelf registration of $1.0 billion. In November
1998, Sprint issued $5.0 billion under the new shelf. Sprint allocated these
borrowings to the Groups, and the related proceeds were mainly used to repay
existing debt. See Note 2 for a more detailed description of how Sprint
allocates debt to the Groups.
Sprint PCS Group
At year-end 1998, the PCS Group had borrowed $1.8 billion under revolving
credit facilities with banks totaling $2.1 billion. These facilities had a
weighted average interest rate of 5.8% at year-end 1998.
At year-end 1998, the PCS Group had $265 million of outstanding debt payable to
the FCC related to the purchase of certain PCS licenses in 1996. These
borrowings have an interest rate of 7.8% and mature in 2001.
In 1998, Sprint redeemed, prior to scheduled maturities, $3.3 billion of PCS
Group debt with a weighted average interest rate of 8.3%. This resulted in a
$31 million after-tax extraordinary loss. The debt was repaid with a portion of
the proceeds from Sprint's $5.0 billion debt offering in November 1998.
PCS Group property, plant and equipment totaling $4.1 billion is pledged as
security for certain notes.
Other
Sprint, including the PCS Group, had complied with all restrictive or financial
covenants relating to its debt arrangements at year-end 1998.
- --------------------------------------------------------------------------------
7. Group Equity
- --------------------------------------------------------------------------------
- -----------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------
(in millions)
Beginning balance $ 1,385.9 $1,187.6 $ 965.8
Net loss (1,120.8) (419.1) (119.7)
Common stock issued 3,284.9 -- --
Preferred stock issued 246.8 -- --
Preferred intergroup interest 279.2 -- --
Contributions from the FON Group 146.4 1,052.1 478.3
Equity transfers to the FON Group (460.4) (434.7) (136.8)
Other, net (6.5) -- --
- -----------------------------------------------------------------
Ending balance $ 3,755.5 $1,385.9 $1,187.6
-----------------------------------------------
- --------------------------------------------------------------------------------
8. Commitments and Contingencies
- --------------------------------------------------------------------------------
Litigation, Claims and Assessments
PCS shareholders are subject to all of the risks related to an investment in
Sprint and the PCS Group, including the effects of any legal proceedings and
claims against the FON Group.
Various suits arising in the ordinary course of business are pending against
Sprint. Management cannot predict the final outcome of these actions but
believes they will not be material to the PCS Group combined financial
statements.
Commitments
The PCS Group has procurement and service contracts with certain vendors. These
contracts are for the engineering and construction of the PCS network. The
III-19
contracts provide for initial terms of three to five years through 2002 with
renewals for additional one-year terms. At year-end 1998, $696 million of the
total commitment was satisfied, leaving a remaining commitment of $204 million.
The PCS Group has a purchase and supply contract with a vendor to purchase
handsets and other equipment totaling more than $600 million through April
2000. At year-end 1998, the remaining commitments totaled $163 million.
In June 1998, the PCS Group became the managing partner of Cox PCS. At year-end
1998, the PCS Group owned 59.2% of Cox PCS. Cox holds the minority interest in
the partnership. Under the partnership agreement, Cox has the right to require
the PCS Group to purchase, under certain circumstances, all or part of Cox's
interest in Cox PCS, which could involve significant cash requirements. Cox may
require the PCS Group to acquire an additional 10.2% interest in Cox PCS per
year through 2000. Beginning in 2001 through 2005, Cox may require the PCS
Group to acquire up to all of its interest in Cox PCS. Cox has given the PCS
Group notice to start the appraisal process related to a potential put of all
or a portion of Cox's remaining partnership interest to the PCS Group.
Operating Leases
The PCS Group's minimum rental commitments at year-end 1998 for all
noncancelable operating leases, consisting mainly of leases for cell and switch
sites and office space, are as follows:
- -------------------------
(in millions)
1999 $194.6
2000 186.2
2001 145.2
2002 87.4
2003 30.5
Thereafter 64.8
- -------------------------
The PCS Group's gross rental expense totaled $256 million in 1998 and $4
million in 1997. The table excludes renewal options related to certain cell and
switch site leases. These renewal options generally have five-year terms and
may be exercised from time to time.
- --------------------------------------------------------------------------------
9. Financial Instruments
- --------------------------------------------------------------------------------
Fair Value of Financial Instruments
Sprint estimates the fair value of the PCS Group's financial instruments using
available market information and appropriate valuation methodologies. As a
result, the following estimates do not necessarily represent the values the PCS
Group could realize in a current market exchange. Although management is not
aware of any factors that would affect the estimated fair values presented at
year-end 1998, those amounts have not been comprehensively revalued for
purposes of these financial statements since that date. Therefore, estimates of
fair value after year-end 1998 may differ significantly from the amounts
presented below.
The carrying amounts and estimated fair values of the PCS Group's financial
instruments at year-end 1998 were as follows:
- -----------------------------------------------------------------
1998
-------------------
Carrying Estimated
Amount Fair Value
- -----------------------------------------------------------------
(in millions)
Cash and equivalents $ 172.7 $ 172.7
Long-term debt and capital lease obligations 7,921.0 8,111.1
- -----------------------------------------------------------------
The PCS Group did not have any financial instruments at year-end 1997.
The carrying values of the PCS Group's cash and equivalents approximate fair
value. The estimated fair value of the PCS Group's long-term debt is based on
quoted market prices for publicly traded issues. The estimated fair value of
all other issues is based on the present value of estimated future cash flows
using a discount rate based on the risks involved.
Concentrations of Credit Risk
The PCS Group's accounts receivable are not subject to any concentration of
credit risk.
Interest Rate Swap Agreements
In 1998, Sprint deferred losses from interest rate swap agreements used to
hedge a portion of a $5.0 billion debt offering. These losses were allocated to
the FON Group and the PCS Group. The PCS Group's share of these deferred losses
totaled $59 million and will be amortized to interest expense using the
effective interest method over the term of the debt. There were no deferred
gains or losses related to any terminated interest rate swap agreements at
year-end 1997 or 1996.
III-20
- --------------------------------------------------------------------------------
10. Additional Financial Information
- --------------------------------------------------------------------------------
Supplemental Cash Flows Information
The PCS Group received cash from the FON Group of $20 million related to income
taxes in 1998.
Noncash activities for the PCS Group included the following:
- -------------------------------------------------------------------------------
1998
- -------------------------------------------------------------------------------
(in millions)
Common stock issued to the Cable Partners to purchase Sprint PCS $3,200.3
------------------------------------------------
Capital lease obligations $ 460.0
------------------------------------------------
Conversion of interim financing to preferred intergroup interest $ 279.2
------------------------------------------------
Preferred stock issued to the Cable Partners in exchange for
interim financing $ 246.8
------------------------------------------------
See Note 3 for more details about the assets and liabilities acquired in the
PCS Restructuring.
Intergroup Investments and Transactions
Sprint FON Group Investments in the Sprint PCS Group
The following table reflects the FON Group's noncurrent investments in the PCS
Group, which have been eliminated in Sprint's consolidated financial
statements:
- --------------------------------------------
1998 1997
- --------------------------------------------
(in millions)
Preferred intergroup interest $279.2 $ --
Long-term loans 180.0 --
Investment in debt securities 164.6 142.4
Common intergroup interest 32.3 --
- --------------------------------------------
Total $656.1 $142.4
-----------------
Preferred Intergroup Interest
The FON Group provided Sprint PCS and the PCS Group with interim financing from
the date the PCS Restructuring agreement was signed in May 1998 until it was
completed in November 1998. As part of the PCS Restructuring, Sprint converted
this financing, totaling $279 million, into an intergroup interest representing
0.3 million shares of 10-year PCS preferred stock convertible into a PCS common
intergroup interest.
Long-term Loans
Sprint provided Sprint PCS with additional interim financing of $180 million
from May 1998 through November 1998.
Investment in Debt Securities
In 1996, Sprint purchased $183 million (face value) of Sprint PCS Senior
Discount notes for $100 million. The bonds mature in 2006. The accreted cost of
the notes was $133 million at year-end 1998 and $118 million at year-end 1997.
Gross unrealized holding gains totaled $32 million at year-end 1998 and $24
million at year-end 1997.
Common Intergroup Interest
The FON Group holds a 1% intergroup interest in the PCS Group. This interest
represents 4.5 million notional PCS shares, and includes 2.7 million shares
held in treasury by the FON Group. These shares do not carry any vote.
The FON Group's 1% share of the PCS Group's net loss since the date of the PCS
Restructuring totaled $6.1 million and was included in "Other income, net" in
the Sprint FON Group Combined Statements of Income.
Intergroup Interest Expense
The PCS Group incurred intergroup interest expense of $92 million in 1998 and
$24 million in 1997 related to advances and loans from the FON Group. See Note
2 for a more detailed description of how Sprint allocates interest expense to
each of the Groups.
Related Party Transactions
Sprint PCS Group
The Cable Partners advanced PhillieCo $26 million in 1998 and $24 million in
1997. These advances, which accrue interest at prime, mature in the 1999 first
quarter.
Sprint PCS
The following discussion reflects related party transactions between Sprint and
Sprint PCS prior to the PCS Restructuring:
Sprint provided Sprint PCS with invoicing and operator services, and switching
equipment. Sprint PCS is also using the long distance division as its
interexchange carrier. Charges to Sprint PCS for these services totaled $125
million in 1998, $61 million in 1997 and $1 million in 1996.
Sprint provided management, printing, mailing and warehousing services to
Sprint PCS. Charges to Sprint PCS for these services totaled $30 million in
1998, $11 million in 1997, and $12 million in 1996.
Sprint had a vendor financing loan to Sprint PCS for $300 million at year-end
1997 which was repaid in 1998. Sprint also loaned Sprint PCS $114 million in
1998 and $21 million in 1997, which will be repaid in the 1999 first quarter.
III-21
Major Customer
The PCS Group markets its products through multiple distribution channels,
including its own retail stores as well as other retail outlets. Equipment
sales to one retail outlet, and service revenues generated by sales to its
customers, accounted for 25% of net operating revenues in 1998.
- --------------------------------------------------------------------------------
11. Recently Issued Accounting Pronouncement
- --------------------------------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No.133,
"Accounting for Derivative Instruments and Hedging Activities." This standard
requires all derivatives to be recorded on the balance sheet as either assets
or liabilities and be measured at fair value. Gains or losses from changes in
the derivative values are to be accounted for based on how the derivative was
used and whether it qualified for hedge accounting. When adopted in January
2000, this statement is not expected to have a material impact on the PCS
Group's combined financial statements.
III-22
- --------------------------------------------------------------------------------
12. Quarterly Financial Data (Unaudited)
- --------------------------------------------------------------------------------
Quarter
----------------------------------------
1998 1st 2nd 3rd 4th
- -------------------------------------------------------------------------------
(in millions, except per share data)
Net operating revenues $ 203.3 $ 264.8 $ 319.9 $ 437.4
Operating loss(/1/) (468.8) (507.3) (564.9) (1,028.4)
Loss before extraordinary item(/1/) (145.2) (152.9) (176.2) (615.3)
Net loss(/1/) (145.2) (152.9) (176.2) (646.5)
Pro forma diluted and basic loss per
common share before extraordinary
item(/2/) (0.97) (0.98) (1.04) (1.43)
Quarter
----------------------------------------
1997 1st 2nd 3rd 4th
- -------------------------------------------------------------------------------
(in millions, except per share data)
Operating loss $ (0.7) $ (2.5) $ (2.6) $ (12.7)
Loss before extraordinary items (53.0) (86.7) (117.6) (161.8)
Net loss (53.0) (86.7) (117.6) (161.8)
Pro forma diluted and basic loss per
common share before extraordinary
item(/2/) (0.66) (0.79) (0.95) (1.12)
(/1/In)the 1998 fourth quarter, the PCS Group recorded a nonrecurring charge to
write off $179 million of acquired IPR&D costs related to the PCS
Restructuring. This charge increased operating loss and loss before
extraordinary item by $179 million.
(/2/Pro)forma loss per share assumes the PCS Restructuring, Recapitalization
and Top-up occurred at the beginning of 1997 and excludes the PCS Group's
write-off of $179 million of acquired IPR&D. These pro forma amounts are
for comparative purposes only and do not necessarily represent what actual
results of operations would have been had the transactions occurred at the
beginning of 1997, nor do they indicate the results of future operations.
- --------------------------------------------------------------------------------
13. Subsequent Event (Unaudited)
- --------------------------------------------------------------------------------
In February 1999, Sprint completed an offering of Series 1 PCS Stock. In this
offering, Sprint sold 24.4 million shares at a price to the public of $28.75
per share. The net proceeds to Sprint totaled $672 million. In connection with
this offering, FT and DT purchased 6.1 million shares of Series 3 PCS stock.
The net proceeds to Sprint from the sale of this stock totaled $169 million.
The proceeds from the offering and purchase by FT and DT were attributed to the
PCS Group and will be used for the continued buildout of the PCS network and
working capital needs.
III-23
SPRINT PCS GROUP
SCHEDULE II--COMBINED VALUATION AND QUALIFYING ACCOUNTS
Year Ended December 31, 1998
Additions
------------------------------
Balance Charged Charged Balance
Beginning PCS to to Other Other End of
of Year Restructuring Income Accounts Deductions Year
- ----------------------------------------------------------------------------------------
(in millions)
1998
Allowance for doubtful
accounts $-- $ 7.7(/1/) $13.7 $ -- $(10.7)(/3/) $ 10.7
-----------------------------------------------------
Valuation allowance--
deferred income tax
assets $-- $192.0(/2/) $ -- $16.2 $ -- $208.2
-----------------------------------------------------
There was no activity in the valuation and qualifying accounts for 1997 and
1996.
(/1/As)discussed in Note 3, the PCS Group's assets and liabilities were
recorded at their fair values on the PCS Restructuring date. Therefore, the
data presented in this schedule reflects activity since the PCS
Restructuring.
(/2/Represents)a valuation allowance for deferred income tax assets recorded in
the purchase price allocation related to the PCS Restructuring.
(/3/Accounts)written off, net of recoveries.
III-24