<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
DATE OF REPORT (DATE OF EARLIEST EVENT REPORTED): NOVEMBER 2, 1998
SPRINT CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
KANSAS 0-4721 48-0457967
-------------- ---------------- -------------------------------
(I.R.S. EMPLOYER IDENTIFICATION
(STATE OF INCORPORATION) (COMMISSION FILE NUMBER) NO.)
</TABLE>
<TABLE>
<S> <C>
2330 SHAWNEE MISSION PARKWAY,
WESTWOOD, KANSAS 66205
------------------------------- -------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (913) 624-3000
-----------------------------------------------
(FORMER NAME OR FORMER ADDRESS, IF CHANGED SINCE LAST REPORT)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
ITEM 5. OTHER EVENTS.
On October 14, 1998, Sprint Corporation ("Sprint") commenced mailing its
Proxy Statement/Prospectus (the "Proxy Statement") in connection with a
special meeting of stockholders of Sprint to be held November 13, 1998. Sprint
is asking its stockholders to vote upon and approve Sprint's tracking stock
proposal which provides for, among other things, (1) the creation of the PCS
Group and the FON Group, (2) Sprint's acquisition of 100% of the ownership and
control of the wireless telephony businesses currently operating under the
Sprint PCS(R) brand name (other than a 40.8% minority interest in the wireless
telephone business that serves the Los Angeles, San Diego and Las Vegas areas)
(the "PCS Restructuring"), (3) the tax-free recapitalization of Sprint's
outstanding publicly-traded common stock into two newly created classes of
Sprint common stock: PCS Stock and FON Stock (together with a similar
recapitalization of Sprint's outstanding Class A common stock, the
"Recapitalization"), and (4) the issuance of additional PCS Stock in an
underwritten initial public offering (the "IPO").
On October 28, 1998, Sprint announced that it had elected to proceed with
the Recapitalization at the closing of the PCS Restructuring and delay the
planned IPO due to current general market conditions. Sprint will continue to
evaluate market conditions and may proceed with a public offering of the PCS
Stock at a later date.
On October 29, 1998, Sprint announced that Sprint Capital Corporation, a
wholly-owned subsidiary of Sprint, will proceed with a debt offering of $2-3
billion of senior unsecured debt securities to be unconditionally guaranteed
by Sprint. The proceeds are expected to be used to repay existing
indebtedness.
Sprint is making available, as Exhibit 99.1, 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 updated to reflect (1) financial results and other information
for the nine months ended September 30, 1998, (2) the delay of the planned
IPO, and (3) the planned debt offering. Terms used in Exhibit 99.1 and not
defined therein have the meanings assigned to such terms in the Proxy
Statement.
Exhibit 99.1 to this Form 8-K is incorporated by reference into this Item 5
and the foregoing description of such documents are qualified in their
entirety by reference to such Exhibits.
ITEM 7. FINANCIAL STATEMENTS, PRO FORMA FINANCIAL INFORMATION AND EXHIBITS.
(c) Exhibits
<TABLE>
<C> <C> <S> <C>
23.1 Consent of Ernst & Young LLP
23.2 Consent of Deloitte & Touche LLP
99.1 Annex I --Sprint Corporation 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
</TABLE>
1
<PAGE>
<TABLE>
<C> <C> <S>
--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
99.2 Computation of Supplemental Pro Forma Ratios of Earnings to Fixed
Charges
</TABLE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, hereunto duly authorized.
SPRINT CORPORATION
By: /s/ Michael T. Hyde
----------------------------------
Name: Michael T. Hyde
Title: Assistant Secretary
Date: November 2, 1998
2
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Form S-4, No. 333-65173; Form S-3, No. 333-6-64241; Form S-3, No. 33-34567;
Form S-3, No. 33-48689; Form S-3, No. 33-58488; Form S-3, No. 33-64564; Form
S-3, No. 333-65649; Form S-8, No. 33-44255; Form S-8, No. 33-38761; Form S-8,
No. 33-31802; Form S-8, No. 2-97322; Form S-8, No. 2-71704; Form S-8, No. 33-
59316; Form S-8, No. 33-59318; Form S-8, No. 33-59322; Form S-8, No. 33-59324;
Form S-8, No. 33-59326; Form S-8, No. 33-59328; Form S-8, No. 33-53695; Form
S-8, No. 33-57911; Form S-8, No. 33-59349; Form S-8, No. 33-65149; Form S-8,
No. 33-25449; Form S-8, No. 333-42077; Form S-8, No. 333-46487; and Form S-8,
No. 333-46491) of Sprint Corporation and in the related Prospectuses of our
reports for Sprint Corporation and the FON Group dated February 3, 1998
(except Note 1, as to which the date is May 26, 1998) and our report for the
PCS Group dated May 26, 1998, included in this Current Report (Form 8-K).
We also consent to the references to our firm under the captions "Sprint
Corporation Selected Financial Data," "Historical PCS Group Selected Financial
Data," and "FON Group Selected Financial Data," included in this Current
Report (Form 8-K) which is incorporated by reference in the above Registration
Statements and in the related Prospectuses of Sprint Corporation.
Ernst & Young LLP
Kansas City, Missouri
November 2, 1998
<PAGE>
EXHIBIT 23.2
INDEPENDENT AUDITORS' CONSENTS
We consent to incorporation by reference in the Registration Statements (Nos.
333-6-64241, 333-65649, 33-34567, 33-48689, 33-58488, 33-64564 and 333-65649)
on Form S-3, the Registration Statement 333-65173 on Form S-4 and the
Registration Statements (Nos. 33-44255, 33-38761, 33-31802, 2-97322, 2-71704,
33-59316, 33-59318, 33-59322, 33-59324, 33-59326, 33-59328, 33-53695, 33-
57911, 33-59349, 33-65149, 33-25449, 333-42077, 333-46487 and 333-46491) on
Form S-8 of Sprint Corporation of our report dated February 3, 1998 on the
consolidated financial statements of Sprint Spectrum Holding Company, L.P. and
subsidiaries (which expresses an unqualified opinion and includes an
explanatory paragraph referring to the emergence from the development stage)
for each of the three years in the period ended December 31, 1997 appearing in
the consolidated financial statements of Sprint Corporation included in Form
8-K of Sprint Corporation.
We consent to incorporation by reference in the Registration Statements (Nos.
333-6-64241, 333-65649, 33-34567, 33-48689, 33-58488, 33-64564 and 333-65649)
on Form S-3, the Registration Statement 333-65173 on Form S-4 and the
Registration Statements (Nos. 33-44255, 33-38761, 33-31802, 2-97322, 2-71704,
33-59316, 33-59318, 33-59322, 33-59324, 33-59326, 33-59328, 33-53695, 33-
57911, 33-59349, 33-65149, 33-25449, 333-42077, 333-46487 and 333-46491) on
Form S-8 of Sprint Corporation of our report dated May 26, 1998 (August 6,
1998 as to Note 4) on the combined financial statements of Sprint Spectrum
Holding Company, L.P. and subsidiaries, MinorCo, L.P. and subsidiaries,
PhillieCo Partners I, L.P. and subsidiaries and PhillieCo Partners II, L.P.
and subsidiaries (which expresses an unqualified opinion and includes an
explanatory paragraph referring to the emergence from the development stage)
for each of the three years in the period ended December 31, 1997 appearing in
Form 8-K of Sprint Corporation. We also consent to the reference to us under
the heading "Selected Financial Data" on page II-35 of Form 8-K.
Deloitte & Touche LLP
Kansas City, Missouri
November 2, 1998
<PAGE>
EXHIBIT 99.1
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
------
<S> <C>
ANNEX I -- SPRINT CORPORATION CONSOLIDATED FINANCIAL INFORMATION........ I-1
Sprint Corporation Selected Financial Data............................ I-1
Sprint Corporation Management's Discussion and Analysis of Financial
Condition and Results of Operations.................................. I-2
Report of Independent Auditors........................................ I-15
Independent Auditors' Report.......................................... I-16
Sprint Corporation Consolidated Financial Statements and Notes
thereto.............................................................. I-17
Sprint Corporation Unaudited Pro Forma Condensed Combined Financial
Statements and
Notes thereto........................................................ I-43
ANNEX II -- PCS GROUP INFORMATION....................................... II-1
Business.............................................................. II-1
Historical PCS Group Selected Financial Data.......................... II-16
PCS Group Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ II-17
Report of Independent Auditors........................................ II-25
PCS Group Combined Financial Statements and Notes thereto............. II-26
Sprint Spectrum Holding Company Combined With MinorCo and PhillieCo
Selected Financial Data.............................................. II-35
Sprint Spectrum Holding Company Combined With MinorCo and PhillieCo
Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ II-36
Independent Auditors' Report.......................................... II-46
Sprint Spectrum Holding Company Combined with MinorCo and PhillieCo
Financial Statements and Notes thereto............................... II-47
PCS Group Unaudited Pro Forma Condensed Combined Financial Statements
and Notes thereto.................................................... II-69
ANNEX III -- FON GROUP INFORMATION...................................... III-1
Business.............................................................. III-1
FON Group Selected Financial Data..................................... III-9
FON Group Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................ III-10
Report of Independent Auditors........................................ III-25
FON Group Combined Financial Statements and Notes thereto............. III-26
</TABLE>
<PAGE>
SPRINT CORPORATION
SELECTED FINANCIAL DATA
The following unaudited table sets forth the Selected Financial Data of
Sprint Corporation and should be read in conjunction with Sprint's
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the Consolidated Financial Statements and Notes thereto. The
Selected Financial Data at December 31, 1997, 1996, 1995, 1994 and 1993, and
for each of the five years in the period ended December 31, 1997, have been
derived from the Consolidated Financial Statements of Sprint which have been
audited by Ernst & Young LLP, independent auditors. The Selected Financial
Data at September 30, 1998, and for the nine months ended September 30, 1998
and 1997, have been derived from the unaudited Consolidated Financial
Statements of Sprint, which have been prepared on the same basis as Sprint's
audited Consolidated Financial Statements and, in the opinion of management,
contain all adjustments, consisting of only normal recurring accruals,
necessary for a fair presentation of the financial position and results of
operations for these periods. Results for the nine months ended September 30,
1998 are not necessarily indicative of the results that may be expected for
the entire year.
<TABLE>
<CAPTION>
AT OR FOR THE
NINE MONTHS AT OR FOR THE
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
(IN MILLIONS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS
DATA
Net operating revenues.. $11,940.3 $11,024.9 $14,873.9 $13,887.5 $12,735.3 $11,964.8 $10,894.9
Operating income(1)..... 2,017.9 1,840.9 2,451.4 2,267.2 1,834.3 1,690.7 1,214.1
Income from continuing
operations(1), (2)..... 669.3 757.6 952.5 1,190.9 946.1 899.2 517.1
Earnings per common
share from continuing
operations(1), (2)
Basic.................. 1.55 1.76 2.21 2.82 2.71 2.59 1.51
Diluted................ 1.52 1.74 2.18 2.79 2.69 2.56 1.49
Dividends per common
share.................. 0.75 0.75 1.00 1.00 1.00 1.00 1.00
Basic weighted average
common shares.......... 430.7 430.3 430.2 421.7 348.7 346.1 341.0
CASH FLOW DATA
Net cash from operating
activities--continuing
operations(3).......... $ 2,950.0 $ 2,410.7 $ 3,379.0 $ 2,403.6 $ 2,609.6 $ 2,339.6 $ 2,007.8
Capital expenditures.... 2,992.1 1,903.9 2,862.6 2,433.6 1,857.3 1,751.6 1,429.8
BALANCE SHEET DATA
Total assets............ $20,453.8 $18,184.8 $16,826.4 $15,074.3 $14,425.2 $13,781.8
Property, plant and
equipment, net......... 13,502.2 11,494.1 10,464.1 9,715.8 10,258.8 9,883.1
Total debt (including
construction
obligations and short-
term borrowings)....... 5,549.4 3,879.6 3,273.9 5,668.9 4,927.7 5,084.1
Redeemable preferred
stock.................. 9.5 11.5 11.8 32.5 37.1 38.6
Common stock and other
stockholders' equity... 9,302.3 9,025.2 8,519.9 4,642.6 4,524.8 3,918.3
</TABLE>
- --------
SPRINT ADOPTED STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 128,
"EARNINGS PER SHARE" ("EPS"), AT YEAR-END 1997 (SEE NOTE 12 OF NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS). EPS AMOUNTS HAVE BEEN RESTATED TO COMPLY
WITH THIS NEW STANDARD. ALL EPS AMOUNTS DISCUSSED HEREIN REPRESENT "BASIC" EPS
AS DEFINED IN THE NEW STANDARD.
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 STOCKHOLDERS' EQUITY AS PREVIOUSLY REPORTED.
(1) During the nine months ended September 30, 1997 and year ended December
31, 1996, Sprint recorded nonrecurring charges of $20 and $60 million,
respectively, related to litigation within the long distance division.
These charges reduced income from continuing operations by $13 million
($0.03 per share) for the nine months ended September 30, 1997 and year
ended December 31, 1997 and $36 million ($0.09 per share) for the year
ended December 31, 1996.
During 1995, Sprint recorded a nonrecurring charge of $88 million related
to a restructuring within the local telecommunications division, which
reduced income from continuing operations by $55 million ($0.16 per share).
During 1993, Sprint recorded nonrecurring charges of $293 million related
to (a) transaction costs from the merger with Centel Corporation and
expenses of integrating and restructuring the operations of the two
companies and (b) a realignment and restructuring within the long distance
division. These charges reduced income from continuing operations by $193
million ($0.57 per share).
(2) During 1997, Sprint recognized gains of $45 million on sales of local
exchanges and a $26 million gain on the sale of an equity investment in an
equipment provider. These gains increased income from continuing
operations by $27 million ($0.06 per share) and $17 million ($0.04 per
share), respectively.
During 1994, Sprint recognized a $35 million gain on the sale of equity
securities, which increased income from continuing operations by $22
million ($0.06 per share).
During 1993, due to the enactment of the Revenue Reconciliation Act of
1993, Sprint adjusted its deferred income tax assets and liabilities to
reflect the increased tax rate. This adjustment reduced income from
continuing operations by $11 million ($0.03 per share).
(3) The 1996 amount was reduced by $600 million for cash required to terminate
an accounts receivable sales agreement.
I-1
<PAGE>
SPRINT CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Sprint Corporation (and with its subsidiaries "Sprint") has entered into a
restructuring agreement with the Cable Parents to restructure Sprint's
wireless PCS operations. Sprint will acquire the joint venture interests of
the Cable Parents in Sprint Spectrum Holdings and the joint venture interests
of TCI and Cox in PhillieCo. In exchange for these joint venture interests,
Sprint will issue to the Cable Parents a newly created class of Sprint Common
Stock, the PCS Stock. The PCS Stock is intended to reflect separately the
performance of these joint ventures and the domestic PCS operations of
Sprint's wholly-owned subsidiary, SprintCom. These operations, which after the
PCS Restructuring will be 100% owned by Sprint (subject to a 40.8% minority
interest in Cox PCS, the entity holding the PCS license for and conducting
operations in the Los Angeles/San Diego/Las Vegas MTA), will be referred to as
the PCS Group.
The excess of the purchase price to be paid to the Cable Parents in
connection with the PCS Restructuring over the fair value of the PCS assets to
be acquired will be allocated to goodwill and amortized over 40 years. The
portion of the purchase price allocated to the PCS Group's customer base asset
will be amortized over three years. For a preliminary allocation of the
purchase price to the assets acquired and liabilities assumed, see the
unaudited pro forma condensed combined financial statements of Sprint and
notes thereto included elsewhere in this Current Report on Form 8-K. A final
allocation is dependent on a study and analysis of the fair value of such
assets and liabilities, including such items as the PCS licenses and in-
process research and development projects, as well as the size of the customer
base at the closing date of the PCS Restructuring. To the extent the customer
base exceeds the size currently reflected in the pro forma financial
statements, the purchase price allocated to the customer base will likely
increase along with a corresponding increase in the amortization of the
customer base. Sprint is undertaking an analysis to determine whether in-
process research and development projects acquired in the PCS Restructuring
should be capitalized or expensed. This analysis is expected to be finalized
prior to the completion of the final purchase price allocation. To the extent
that it is determined through this analysis that some of the in-process
research and development projects should be expensed, a portion of the
purchase price will be allocated to these in-process research and development
projects and a nonrecurring, noncash charge will be recognized in the period
in which the charge occurs. Sprint is unable to determine the potential amount
of such a charge at this time. However, such a charge could be material to
Sprint's results of operations for the period in which the charge occurs. At
the present time, Sprint anticipates completing its final purchase price
allocation prior to year-end 1998.
The FON Stock, which will be created in the Recapitalization, is intended to
reflect the performance of all of Sprint's other operations, including its
long distance, local telecommunications and product distribution and directory
publishing divisions, emerging businesses and its interest in Global One.
These operations will be referred to as the FON Group.
Holders of FON Stock and PCS Stock will be subject to the risks associated
with an investment in a single corporation and all of Sprint's businesses,
assets and liabilities. Events attributable to the FON Group or the PCS Group
that affect Sprint's results of operations or financial condition could affect
the results of operations or financial position of the other group or the
market price of the FON Stock or PCS Stock. Any net losses of the FON Group or
the PCS Group, and dividends or distributions on, or repurchases of, FON
Stock, PCS Stock or preferred stock or other stock or interests will reduce
the funds of Sprint that are legally available for payment of future dividends
on the FON Stock and the PCS Stock.
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. Factors that could cause actual results to differ materially from
estimates or projections contained in the forward-looking statements include
(i) the effects of vigorous competition in the markets in which Sprint
operates; (ii) the costs and business
I-2
<PAGE>
risks associated with entering new markets necessary to provide seamless
services and to provide new services; (iii) the ability of the PCS Group to
establish a significant market presence; (iv) the uncertainties related to
Sprint's investments in Global One and other joint ventures; (v) the impact of
any unusual items resulting from ongoing evaluations of Sprint's business
strategies; (vi) requirements imposed on Sprint or latitude allowed its
competitors by the FCC or state regulatory commissions under the
Telecommunications Act of 1996; (vii) unexpected results of litigation filed
against Sprint; (viii) the impact of the Year 2000 issue and any related
noncompliance; (ix) 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; and (x) those factors
listed under "Risk Factors--The PCS Group" and "Risk Factors--The Tracking
Stocks" in the Proxy Statement.
The words "estimate", "project", "intend", "expect", "believe" and similar
expressions are intended to identify forward-looking statements. These
forward-looking statements are found at various places throughout Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. Sprint undertakes no
obligation to publicly release any revisions to these forward-looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events. Moreover, Sprint, through
senior management, may from time to time make forward-looking statements about
the matters described herein or other matters concerning Sprint.
GENERAL OVERVIEW OF THE FON GROUP
The principal activities of the FON Group include (i) its core businesses
consisting of domestic and international long distance communications, local
exchange communications, and product distribution and directory publishing
activities, (ii) its emerging businesses, which consist of the development of
new integrated communications services, consumer internet access services,
Sprint Paranet and Sprint International and (iii) Sprint's Global One
strategic international alliance, as well as other telecommunications
investments and partnerships.
In March 1996, Sprint completed the tax-free spinoff of Sprint's cellular
division ("Cellular") to Sprint common stockholders ("Spinoff"). See
"Liquidity and Capital Resources--Discontinued Operation" for more
information. The Spinoff is accounted for by Sprint in the FON Group.
GENERAL OVERVIEW OF THE PCS GROUP
The PCS Group includes Sprint's domestic wireless mobile telephony
activities and any other domestic PCS services, which include (i) the
investment in Sprint Spectrum Holdings and the investment in PhillieCo, both
of which are reflected on the equity basis and (ii) SprintCom. Upon completion
of the PCS Restructuring, the results of Sprint Spectrum Holdings and
PhillieCo will be reflected on the consolidated basis in the PCS Group
Combined Financial Statements.
Sprint Spectrum Holdings commenced initial commercial PCS operations late in
the fourth quarter of 1996, and emerged from the development stage during the
third quarter of 1997. SprintCom commenced initial operations in the third
quarter of 1998.
REGULATORY DEVELOPMENTS
See "Annex II--PCS Group Information--Business--Regulation" and "Annex III--
FON Group Information--Business--Regulation" for a complete discussion of the
regulatory developments that could have a future impact on Sprint.
RESULTS OF OPERATIONS
Sprint adopted Statement of Financial Accounting Standards ("SFAS") No. 128,
"Earnings per Share" ("EPS"), at year-end 1997 (see Note 12 of Notes to
Consolidated Financial Statements). EPS amounts have been restated to comply
with this new standard. All EPS amounts in the following discussions represent
"basic" EPS as defined in SFAS 128.
I-3
<PAGE>
CONSOLIDATED
Total net operating revenues for the nine months ended September 30, 1998
were $11.9 billion, an 8% increase from $11.0 billion for the same period in
1997. Total net operating revenues for 1997 were $14.9 billion, a 7% increase
from $13.9 billion in 1996. Total net operating revenues for 1996 increased 9%
over total net operating revenues for 1995 of $12.7 billion.
Income from continuing operations was $669 million ($1.55 per share) for the
first nine months of 1998 compared with $758 million ($1.76 per share) for the
first nine months of 1997. Income from continuing operations was $953 million
($2.21 per share) in 1997 compared with $1.2 billion ($2.82 per share) in 1996
and $946 million ($2.71 per share) in 1995. The following table sets forth the
combined income (loss) from continuing operations for the FON Group and the
PCS Group:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER YEAR ENDED
30, DECEMBER 31,
------------------ --------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
FON Group(1)................... $1,141.1 $1,014.9 $1,371.6 $1,310.6 $966.0
PCS Group...................... (471.8) (257.3) (419.1) (119.7) (19.9)
-------- -------- -------- -------- ------
Income from continuing
operations.................... $ 669.3 $ 757.6 $ 952.5 $1,190.9 $946.1
======== ======== ======== ======== ======
</TABLE>
- --------
(1) The FON Group income from continuing operations for the year ended
December 31, 1997 includes gains of $27 million on sales of local
exchanges ($0.06 per share) and a gain of $17 million on the sale of an
equity investment in an equipment provider ($0.04 per share). In addition,
during the nine months ended September 30, 1997 and year ended December
31, 1996 litigation charges were recorded within the long distance
division of $13 million and $36 million, respectively ($0.03 per share and
$0.09 per share, respectively). The year ended December 31, 1995 amounts
include a charge of $55 million for restructuring the local
telecommunications division ($0.16 per share).
FON GROUP
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Net operating revenues.. $11,940.3 $11,024.9 $14,873.9 $13,887.5 $12,735.3
Total operating
expenses............... 9,842.4 9,176.6 12,404.0 11,619.8 10,901.0
--------- --------- --------- --------- ---------
Operating income........ $ 2,097.9 $ 1,848.3 $ 2,469.9 $ 2,267.7 $ 1,834.3
========= ========= ========= ========= =========
Operating margin........ 17.6% 16.8% 16.6% 16.3% 14.4%
========= ========= ========= ========= =========
Capital expenditures.... $ 2,320.0 $ 1,835.7 $ 2,708.9 $ 2,433.6 $ 1,857.3
========= ========= ========= ========= =========
</TABLE>
For further detailed discussion regarding the results of operations of the
FON Group, refer to the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for the FON Group at Annex III.
Nine Months Ended September 30, 1998 and 1997
Net Operating Revenues
In the first nine months of 1998 net operating revenues increased 8% from
the same 1997 period. This mainly reflects growth of the FON Group's long
distance and local telecommunications divisions.
The long distance division's revenues for the nine months ended September
30, 1998 increased 9% from the same period in 1997. This growth is a result of
increases in all major market segments--residential, business and wholesale.
In general, the increase reflects strong minute growth and continued growth
within the data
I-4
<PAGE>
services market. The residential market increase reflects growth from the
Sprint Sense Anytime "10 by 24" product as well as international and prepaid
calling cards and calling card calls made by customers of local telephone
companies. The business market reflects growth in data services, toll-free and
direct distance-dialing toll calls. Growth in the small business market
benefited from the Sprint international business calling plan. The wholesale
market showed strong minute growth mainly from increased WATS calls.
The local telecommunications division's revenues for the nine months ended
September 30, 1998 increased 3% from the same period in 1997, after adjusting
for a transfer pricing change for transactions between affiliates. This growth
was primarily due to an increase in customer access lines. Local service
revenue increased 5% reflecting access line growth and continued demand for
network-based services as well as increases in private line services and
maintenance of customer wiring and equipment. Network access revenues
increased 1% primarily due to larger calling volumes partly offset by FCC-
mandated access rate reductions. Toll service revenues decreased 28% due to
extended local area calling plans and increased competition in the intrastate
long distance market. Other revenue increased mainly due to increased
equipment sales of business systems and data networks, growth in payphone
revenues and revenues from locating underground utility lines, as well as
increased commissions from the sale of Sprint's long distance services.
The product distribution and directory publishing division's revenues for
the nine months ended September 30, 1998 increased 19% from the same period in
1997, after adjusting for a transfer pricing change for transactions between
affiliates. This revenue growth was mainly due to increased sales to both non-
affiliates and affiliates as a result of lower pricing.
Revenues in the emerging businesses segment increased due to the acquisition
of Sprint Paranet in late 1997.
Operating Expenses
For the nine months ended September 30, 1998, operating expenses increased
7% from the same 1997 period.
The long distance division's operating expenses increased 6% largely due to
higher selling, general and administrative costs as a result of increased
marketing activities and promotions of products and services. Interconnection
costs decreased 3% reflecting lower unit costs for domestic and international
access to others' networks. Operations expense increased 10% primarily due to
increased data services growth.
The local telecommunications division's operating expenses increased 2%
caused primarily by an increase in selling, general and administrative
expenses. Costs of services and products decreased less than 1%. This reflects
continued cost control while still supporting customer access line growth and
increased equipment sales. Selling, general and administrative costs were
higher by 8% due to increased customer service costs from access line growth
and marketing costs to promote new products and services.
The product distribution and directory publishing division's operating
expense increase was mainly due to increased sales of telecommunications
equipment and distribution services to affiliates. This increase also reflects
Sprint's July 1998 acquisition of a sales force from another directory sales
company.
Costs incurred in the first nine months of 1998 were mainly due to the
development of ION and costs related to the network buildout and market
launches of the SprintCom PCS markets. SprintCom launched service in
Jacksonville and Tallahassee, Florida, in the 1998 third quarter and expects
to expand into several new markets by year-end. Sprint will continue to devote
significant resources through 1999 to develop ION as well as to fund the
network buildout and launch the SprintCom markets.
Years Ended December 31, 1997, 1996 and 1995
Net Operating Revenues
Net operating revenues increased 7% in 1997 and 9% in 1996. This mainly
reflects growth of the FON Group's long distance and local telecommunications
divisions for both years.
The long distance division's revenues increased 8% in 1997 and 14% in 1996.
This growth was a result of increases in all major market segments--
residential, business and wholesale. In general, the increase reflects strong
calling volume growth and continued growth within the data services market.
The residential market
I-5
<PAGE>
reflects the ongoing success of Sprint Sense(R) as well as growth in
international calls, prepaid phone cards and casual callers. The business
market reflects growth in data services, toll-free and direct distance-dialing
toll calls, and growth in small and medium business due to Sprint's Fridays
Free program. The wholesale market showed strong growth in both the domestic
and international markets.
The local telecommunications division's revenues increased 4% in 1997 and 9%
in 1996, after adjusting for a transfer pricing change for transactions
between affiliates. This growth was primarily due to an increase in customer
access lines. Local service revenue increased 10% in 1997 and 11% in 1996
reflecting economic growth in the division's service areas, an increase in
second-line services, an increase due to extended area calling plans, and
increased demand for advanced intelligent network services. Network access
revenues increased 2% in 1997 and 10% in 1996 primarily due to larger calling
volumes partly offset by FCC-mandated access rate reductions effective in July
1997. Toll service revenues decreased 19% in 1997 and 13% in 1996 due to
extended local area calling plans and increased competition in the intrastate
long distance market. Additionally, the division phased out its interexchange
long distance reseller services in 1997. Other revenue increased 10% in 1997
and 24% in 1996 mainly due to sales of telecommunications equipment.
The product distribution and directory publishing division's revenues
increased 19% in 1997 and 7% in 1996, after adjusting for a transfer pricing
change for transactions between affiliates. This growth was mainly due to
increased sales of telecommunications equipment and distribution services to
affiliates.
Revenues for the emerging businesses segment increased due to the
acquisition of Sprint Paranet in late 1997 and an increase in subscribers for
Sprint Internet access services.
Operating Expenses
Operating expenses increased 7% in 1997 and 1996 largely due to increased
revenue streams.
The long distance division's operating expenses increased 6% in 1997 and 12%
in 1996 primarily due to higher interconnection costs and operations expense.
Interconnection costs increased 6% in 1997 and 20% in 1996 due to strong
growth in calling volumes, partially offset by lower unit costs for domestic
and international access. Operations expense increased 18% in 1997, due to
FCC-mandated payments to public payphone providers, network equipment leasing
costs, costs related to data services growth and equipment sales as well as
overall revenue growth. Operations expense was relatively unchanged in 1996.
The local telecommunications division's increased operating expenses were
caused by an increase in costs of services, selling, general and
administrative expenses and depreciation. Costs of services and products
increased 3% in 1997 and 4% in 1996 mainly due to customer access line growth
and increased equipment sales whereas selling, general and administrative
costs increased due to access line growth and marketing costs to promote new
products and services. The increase in depreciation expense is due to
increased plant additions.
The product distribution and directory publishing division's operating
expense increase was mainly due to additional costs associated with the
increase in sales of telecommunications equipment and distribution services to
affiliates.
Costs incurred for the emerging businesses segment largely reflect
activities to develop or enter newly competitive domestic and international
markets, such as internet access and competitive local services.
PCS GROUP
The following table reflects the results of operations of the PCS Group,
which for the periods presented are comprised solely of the operations of
SprintCom. Sprint's investments in Sprint Spectrum Holdings and PhillieCo,
which are included in the PCS Group, were accounted for on the equity basis
and therefore no operations are reflected in the table below. Sprint's equity
in loss from its investments in Sprint Spectrum Holdings and PhillieCo are
discussed below, see "Sprint Spectrum Holdings and PhillieCo."
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<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
-------------- ----------------------
1998 1997 1997 1996 1995
------ ------ ------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Total operating expenses................ $ 80.0 $ 7.4 $ 18.5 $ 0.5 $ --
------ ------ ------ ------ ------
Operating loss.......................... $(80.0) $ (7.4) $(18.5) $ (0.5) $ --
====== ====== ====== ====== ======
Capital expenditures.................... $672.1 $ 68.2 $153.7 $ -- $ --
====== ====== ====== ====== ======
Purchase of PCS Licenses................ $ -- $460.1 $460.1 $ 84.0 $ --
====== ====== ====== ====== ======
Investments in and loans to Sprint
Spectrum Holdings and PhillieCo........ $193.5 $255.5 $405.9 $297.5 $910.9
====== ====== ====== ====== ======
</TABLE>
For further detailed discussion regarding the results of operations of the
PCS Group, refer to the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for the PCS Group and the "Sprint
Spectrum Holding Company Combined with MinorCo and PhillieCo Management's
Discussion and Analysis of Financial Condition and Results of Operations," at
Annex II.
Nine Months Ended September 30, 1998 and 1997
Operating Expenses
Operating expenses were $80 million for the nine months ended September 30,
1998 and $7 million for the same period in 1997. These consist of selling,
general and administrative expenses related to the network buildout for those
PCS licenses directly owned by Sprint. The increase in these expenses from
1997 to 1998 is a result of significant additional network buildout activities
during the 1998 period.
Years Ended December 31, 1997, 1996 and 1995
Operating Expenses
Operating expenses were $19 million for 1997 and $1 million for 1996. These
consist of selling, general and administrative expenses related to the network
buildout for those PCS licenses directly owned by Sprint. The increase in
these expenses from 1996 to 1997 is a result of the commencement of the
network buildout in the second half of 1997.
NONOPERATING ITEMS
INTEREST EXPENSE
The difference between the interest expense disclosed in the following table
and that disclosed in the consolidated financial statements relates to
interest expense on items such as deferred compensation, the employee stock
purchase plan, and customer deposits--items not related to borrowings. Sprint
has excluded the interest expense associated with these items so as not to
distort the calculation of the effective interest rate on borrowings. Interest
costs on borrowings consist of the following:
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Interest expense on
outstanding debt.......... $ 152.2 $ 117.1 $ 159.9 $ 161.2 $ 231.0
Interest expense related to
Cellular (1).............. -- -- -- 21.5 124.0
Capitalized interest costs. 74.7 69.7 93.0 104.0 57.0
--------- --------- -------- -------- --------
Total interest costs on
outstanding debt.......... $ 226.9 $ 186.8 $ 252.9 $ 286.7 $ 412.0
========= ========= ======== ======== ========
Average debt outstanding... $ 4,613.0 $ 3,156.4 $3,251.3 $3,604.9 $5,505.2
========= ========= ======== ======== ========
Effective interest rate.... 6.6% 7.9% 7.8% 8.0% 7.5%
========= ========= ======== ======== ========
</TABLE>
- --------
(1) Interest expense related to Cellular is included in "Discontinued
operation, net" on the Consolidated Statements of Income.
I-7
<PAGE>
Sprint capitalizes interest costs on its investment in the directly acquired
PCS licenses and the related network buildout. Through June 1997, Sprint also
capitalized interest costs on borrowings related to its investment in Sprint
Spectrum Holdings and PhillieCo. Sprint stopped capitalizing interest costs on
its investment in Sprint Spectrum Holdings and PhillieCo in July 1997 because
Sprint Spectrum Holdings and PhillieCo no longer qualified as development-
stage companies.
Average debt outstanding increased $1.4 billion in 1998 to support the
network buildout of the SprintCom PCS markets and to fund capital
contributions to Sprint Spectrum Holdings and PhillieCo and investments in
other Sprint affiliates. Average debt outstanding decreased $1.9 billion in
1996, generally because of repayments funded by a portion of the cash received
from FT and DT for their equity investments in Sprint and from Cellular's
repayment of intercompany debt in connection with the Spinoff.
Sprint's effective interest rate for the nine months ended September 30,
1998 decreased to 6.6% from 7.9% for the same period in 1997 mainly because of
an increase in short-term borrowings as a percentage of total debt
outstanding, which have lower interest rates. Sprint's effective interest rate
increased to 8.0% in 1996 from 7.5% in 1995, mainly because of the decline in
short-term borrowings as a percentage of total borrowings. Short-term
borrowings at September 30, 1998 and December 31, 1997 have been classified as
long-term debt because of Sprint's intent and ability, through unused credit
facilities, to refinance these borrowings.
GLOBAL ONE
Sprint's investment in Global One is accounted for on the equity basis in
the FON Group. Global One's revenues totaled $801 million for the first nine
months of 1998 compared with $810 million in the same period a year ago.
Sprint's losses associated with Global One totaled $120 million for the first
nine months of 1998 compared with $88 million a year ago.
Global One's revenues totaled $1.1 billion for 1997 compared to $800 million
in 1996. Sprint's losses associated with Global One totaled $162 million in
1997, $82 million in 1996 and $23 million in 1995. The increased losses in
1997 were due to higher operating costs within Global One's existing global
markets due to the slower-than-expected integration of the parent companies'
networks and start-up related costs.
In an effort to improve profitability, Global One is refocusing its efforts
to place more emphasis on multinational customers. In addition, it is
continuing to review its operations, implement expense controls, and focus on
improving the network infrastructure. Global One is in the process of
implementing its plan to address these items, which may result in one-time
charges.
SPRINT SPECTRUM HOLDINGS AND PHILLIECO
Sprint's equity ownership of Sprint Spectrum Holdings and PhillieCo, prior
to the PCS Restructuring, is accounted for on the equity basis in the PCS
Group. The combined revenues from Sprint Spectrum Holdings and PhillieCo
totaled $788 million for the first nine months of 1998 versus $111 million a
year ago. Sprint's share of the combined operating losses from Sprint Spectrum
Holdings and PhillieCo was $687 million for the first nine months of 1998
compared with $411 million a year ago. The increase in 1998 losses reflects
marketing and promotional costs (including losses on handset sales), and
operating costs to support a growing customer base. At September 30, 1998, the
combined customer base of Sprint Spectrum Holdings and PhillieCo exceeded 1.75
million customers. The venture continues to aggressively market to new
customers, which will result in higher losses in 1998 and 1999 compared with
1997.
Revenues from Sprint Spectrum Holdings and PhillieCo totaled $258 million in
1997 and $4 million in 1996. Sprint's share of operating losses from Sprint
Spectrum Holdings and PhillieCo was $660 million in 1997, $192 million in 1996
and $31 million in 1995. The increase in 1997 losses reflects marketing and
promotional costs to support a growing customer base.
Average monthly revenue per customer (ARPU) for the nine months ended
September 30, 1998 was $57 compared to $60 for the six months ended June 30,
1998. ARPU for the three months ended September 30,
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<PAGE>
1998 was $55. This average is expected to continue to decline (consistent with
industry projections) due to increased competition resulting from additional
wireless service providers entering the market and the addition of lower usage
subscribers to the PCS Group's subscriber base. Sprint Spectrum Holdings and
PhillieCo have adopted marketing plans that both target and encourage higher
usage and higher ARPU. Customer turnover rates and customer marketing costs
have been as expected at this stage of development and continue to be within
the range of results reported by other PCS providers. As the PCS markets
mature and the PCS Group gains additional scale, both of these measures are
expected by management to trend downward toward cellular industry levels.
OTHER INCOME (EXPENSE), NET
Other income (expense) consisted of the following:
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
------------------- ----------------------
1998 1997 1997 1996 1995
------ ------ ------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Dividend and interest income..... $ 49.1 $ 52.8 $ 75.4 $ 99.7 $ 12.6
Net gains on sales of assets..... -- -- 71.5 15.9 --
Loss on sales of accounts
receivable...................... -- -- -- (4.2) (38.6)
Other, net....................... (0.5) (1.0) (6.4) 3.9 (12.9)
--------- --------- ------ ------ ------
Total other income (expense),
net............................. $ 48.6 $ 51.8 $140.5 $115.3 $(38.9)
========= ========= ====== ====== ======
</TABLE>
Dividend and interest income for the nine months ended September 30, 1998
reflects interest earned on loans to unconsolidated affiliates. Dividend and
interest income for the first nine months of 1997 and for the years ended
December 31, 1997 and 1996 reflects income earned on the cash received from FT
and DT for their 1996 equity investment in Sprint as well as the repayment of
intercompany debt in connection with the Spinoff. Sprint has since invested
these funds in strategic initiatives and has decreased certain borrowings,
reducing the balance held in temporary investments. For the year ended
December 31, 1997, Sprint recognized pretax gains of $45 million on sales of
local exchanges and Sprint sold its equity interest in an equipment provider,
resulting in a $26 million pretax gain.
INCOME TAXES
Sprint's effective tax rates for the nine months ended September 30, were
37.7% in 1998 and 39.9% in 1997. Sprint's effective tax rates for the years
ended December 31 were 39.8% in 1997, 37.7% in 1996 and 36.1% in 1995. See
Note 5 of Notes to Consolidated Financial Statements for information about the
differences that cause the effective income tax rate to vary from the
statutory federal rate.
DISCONTINUED OPERATION, NET
Sprint recognized an after-tax loss of $3 million ($0.01 per share) in 1996
and after-tax income of $15 million ($0.04 per share) in 1995 related to its
investment in Cellular. Cellular was spun off to Sprint common stockholders in
March 1996 (see Note 15 of Notes to Consolidated Financial Statements).
EXTRAORDINARY ITEMS, NET
In March 1998, Sprint redeemed, prior to maturity, $115 million of debt with
a 9.25% interest rate. This resulted in a $4 million ($0.01 per share) after-
tax loss.
During 1996, Sprint redeemed, prior to maturity, $190 million of debt with
interest rates ranging from 6.0% to 9.5%. This resulted in a $5 million ($0.01
per share) after-tax loss.
At year-end 1995, Sprint adopted accounting principles for a competitive
marketplace and discontinued applying SFAS 71 to its local telecommunications
division (see Note 14 of Notes to Consolidated Financial Statements). This
resulted in an after-tax, noncash extraordinary charge of $565 million ($1.62
per share) in 1995.
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<PAGE>
FINANCIAL CONDITION
Sprint's consolidated assets totaled $20.5 billion at September 30, 1998,
$18.2 billion at year-end 1997 and $16.8 billion at year-end 1996. Net
property, plant and equipment increased $2.0 billion since year-end 1997
mainly because of capital expenditures, to support the core long distance and
local networks and expanded product and service offerings. Sprint's debt-to-
capital ratio was 37.3% at September 30, 1998 versus 30.0% at year-end 1997
and 27.7% at year-end 1996. See "Liquidity and Capital Resources" for
additional discussions of changes in Sprint's Consolidated Balance Sheets.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash flows from operating activities, which are Sprint's main source of
liquidity, were $3.0 billion for the first nine months of 1998 versus $2.4
billion for the first nine months of 1997 and were $3.4 billion in 1997, $2.4
billion in 1996 and $2.6 billion in 1995. The growth in operating cash flows
over these periods mainly reflects improved operating results in Sprint's core
businesses partly offset by increased losses from its emerging businesses.
During 1996, Sprint terminated an accounts receivable sales agreement, which
reduced cash flows by $600 million. Excluding this termination, 1996 cash
flows increased $394 million, mainly because of improved operating results in
all divisions.
Investing Activities
Sprint's investing activities from continuing operations used cash of $3.7
billion for the first nine months of 1998 and $3.2 billion for the first nine
months of 1997 and used cash of $4.5 billion in 1997, $3.1 billion in 1996 and
$2.9 billion in 1995. Capital expenditures, which are Sprint's largest
investing activity, totaled $3.0 billion for the first nine months of 1998 and
$1.9 billion for the first nine months of 1997 and totaled $2.9 billion in
1997, $2.4 billion in 1996 and $1.9 billion in 1995. Long distance division
capital expenditures were incurred mainly to enhance network reliability, meet
increased demand for data-related services, and upgrade capabilities for
providing new products and services. Local telecommunications division capital
expenditures were made to accommodate access line growth and expand
capabilities for providing enhanced services. Additional capital expenditures
relate primarily to the buildout of the SprintCom markets.
Investments in and loans to Sprint Spectrum Holdings and PhillieCo were $307
million in the first nine months of 1998 versus $410 million in the first nine
months of 1997 and were $706 million in 1997, $561 million in 1996 and $954
million in 1995. These capital contributions, loans and advances to Sprint
Spectrum Holdings and PhillieCo for the first nine months of 1998 and 1997 and
for the years 1997 and 1996 were used to fund its capital and operating
requirements. The 1995 contributions were mainly used to fund payments for PCS
licenses. Included in the loans to Sprint Spectrum Holdings for the 1997 nine-
month period and for the year ended December 31, 1997 are $154 million and
$300 million, respectively, borrowed from Sprint under a vendor financing
facility. In 1996, Sprint purchased $183 million (face value) of Sprint
Spectrum Senior Discount notes for $100 million. In addition, Sprint paid the
remaining $460 million for the SprintCom PCS licenses in the first nine months
of 1997, bringing the total payments to $544 million.
"Investments in and loans to other affiliates, net" includes net
contributions to Global One to fund operations as well as investments in other
affiliates.
In the first nine months of 1997, Sprint purchased the net assets of
Paranet, Inc. for $375 million (see Note 13 of Notes to Consolidated Financial
Statements).
Financing Activities
Sprint's financing activities provided cash of $705 million for the first
nine months of 1998, while financing activities for the same period in 1997
used cash of $238 million. Financing activities during the first nine months
of 1998 reflect proceeds from long-term debt of $946 million and increased
construction obligations of $429
I-10
<PAGE>
million, partly offset by payments on long-term debt of $247 million.
Financing activities in the first nine months of 1997 reflect an increase in
short-term borrowings of $195 million, offset by payments on long-term debt of
$111 million.
For the years ended December 31, Sprint's financing activities provided cash
of $72 million in 1997, $479 million in 1996 and $423 million in 1995. In
1997, Sprint borrowed $867 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 $1.4 billion
of cash from Cellular repaying intercompany debt, to reduce outstanding debt.
In 1995, Sprint increased its short-term borrowings by $1.1 billion to fund
commitments related to Sprint Spectrum Holdings and repay long-term debt.
Sprint paid common and preferred dividends totaling $292 million in the
first nine months of 1998, $275 million in the first nine months of 1997, $430
million in 1997, $420 million in 1996 and $352 million in 1995. Sprint's
indicated annual dividend rate on common stock is currently $1.00 per share.
Sprint purchased 3 million and 10 million treasury shares in 1997 and 1996,
respectively. Sprint continues to repurchase common shares on the open market
in 1998 to meet share issuance requirements for employee benefit plans and for
the conversion of preferred stock.
Discontinued Operation
In connection with the March 1996 Spinoff, Cellular repaid $1.4 billion of
intercompany debt owed to Sprint. Prior to the Spinoff, Cellular's investing
activities required net cash of $141 million and $325 million in 1996 and
1995, respectively, mainly to fund capital expenditures and acquire cellular
properties.
Capital Requirements
Sprint's investing activities, mainly consisting of capital expenditures and
investments in affiliates, and including funds required for Sprint Spectrum
Holdings and PhillieCo as a result of the PCS Restructuring, are expected to
require cash of $6.8 billion to $7.2 billion for 1998. Dividend payments are
expected to total $430 million in 1998.
Sprint expects to spend $6.5 billion to $6.8 billion on capital expenditures
in 1998. Of this total, the FON Group, primarily consisting of the long
distance and local telecommunications divisions, will require an estimated
$3.3 billion to $3.5 billion. The remainder will mainly be used to fund
operations and continue to fund the buildout of the network for the PCS Group.
Global One will require $300 to $400 million to fund operations and ongoing
development activities.
Sprint and the Cable Parents have loaned $400 million, based on respective
ownership interests, to fund the capital requirements of Sprint Spectrum
Holdings from the date of the signing of the Restructuring Agreement, May 26,
1998, through September 30, 1998. The PhillieCo Partners have loaned $50
million to PhillieCo to fund operating and working capital requirements and
capital expenditures through September 30, 1998. Sprint has also loaned $110.6
million to fund SprintCom's capital requirements as part of the Restructuring
Agreement through September 30, 1998. Sprint has been financing SprintCom with
Sprint's cash from operations, commercial paper borrowings and leases on
specific equipment. Sprint intends to continue to fund the buildout of the
SprintCom markets through the closing of the PCS Restructuring. The above
mentioned loans, totaling $510.6 million excluding loans to PhillieCo, will be
converted as of the date of the PCS Restructuring into 10-year preferred stock
of Sprint convertible into PCS Stock or, in the case of Sprint, Preferred
Inter-Group Interest. Such preferred stock may be redeemed with the proceeds
from an anticipated IPO, as further discussed below, but only to the extent
the net proceeds of the IPO exceed $500 million. See "The Tracking Stock
Proposal--Funding of the PCS Group Prior to Closing; The PCS Preferred Stock"
in the Proxy Statement.
Liquidity
Sprint currently uses the commercial paper market to fund its short-term
working capital needs. Sprint uses four commercial paper dealers to place the
paper at the most favorable rates and maturities. Sprint also uses the medium-
term note and long-term bond markets as well as other debt markets to fund its
needs. Sprint intends to
I-11
<PAGE>
borrow funds through the U.S. and international money and capital markets and
bank credit markets to fund capital expenditures, operating and working
capital requirements and to refinance existing Sprint PCS debt obligations,
after the PCS Restructuring.
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 replace its
previous $1.5 billion revolving credit facility. As of September 30, 1998,
Sprint could borrow $3.6 billion under these new facilities. Sprint also has a
separate five-year revolving credit facility with a bank. The unused capacity
under the committed portion of that facility was $100 million.
In October 1998, Sprint filed a shelf registration statement with the
Securities and Exchange Commission (SEC) for $8.0 billion of debt securities.
This shelf registration replaced $1.0 billion of Sprint's existing shelf
registration statements. Sprint currently expects to offer up to $3 billion
under the new shelf registration at approximately the same time as the PCS
Restructuring. There can be no assurance that such offering will be
consummated. Proceeds from the sale of securities under this shelf
registration statement will be used to repay short-term borrowings, refinance
existing long-term borrowings, and provide funds for working capital and new
capital expenditures for both the PCS Group and the FON Group.
Any borrowings Sprint may incur are ultimately limited by certain debt
covenants. Sprint could borrow up to $13.8 billion at September 30, 1998 under
the most restrictive of its debt covenants. Among other restrictions, Sprint
must maintain certain levels of consolidated net worth.
In late September, Sprint filed a registration statement with the SEC for an
IPO of shares of Series 1 PCS Stock. In late October, Sprint announced that it
elected to proceed with a tax-free recapitalization of Sprint's common stock
concurrent with the PCS Restructuring and delay the planned IPO. Sprint
decided to delay the IPO due to current general market conditions. Sprint will
continue to evaluate market conditions and may proceed with a public offering
of the Series 1 PCS Stock at a later date.
FT and DT have agreed to purchase PCS Stock as part of the PCS Restructuring
to maintain their combined 20% voting power. Proceeds from the exercise of
these Equity Purchase Rights are expected to total between $75 and $100
million. These proceeds will be used to fund working capital needs and the
continued buildout of the PCS Group's network.
Subsequent to the PCS Restructuring, financing activities for the Groups
will be managed by Sprint on a centralized basis. Loans from Sprint or any
member of the FON Group to any member of the PCS Group will be made at
interest rates and on other terms and conditions substantially equivalent to
the interest rates and other terms and conditions that the PCS Group would be
able to obtain from third parties (including the public markets) as a direct
or indirect wholly-owned subsidiary of Sprint, but without the benefit of any
guaranty by Sprint or any member of the FON Group. Such policy contemplates
that such loans will be made on the basis set forth above regardless of the
interest rates and other terms and conditions on which Sprint or members of
the FON Group may have acquired the subject funds. Any difference between
Sprint's borrowing rate and the rate charged to the PCS Group, which rates are
expected to be higher than the rates at which Sprint obtained such financing,
will be reflected in the FON Group Combined Financial Statements. This process
will be governed by the Tracking Stock Policies as overseen by the Capital
Stock Committee.
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.
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<PAGE>
Sprint's derivative transactions are used for hedging purposes only and
comply with Board-approved policies. Senior management receives monthly 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.
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.
YEAR 2000 ISSUE
SPRINT
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 or
resellers.
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 expects to substantially complete the
renovation of these computer systems, software applications and the majority
of the network elements and other business systems by year-end 1998. Year 2000
testing commenced in the third quarter of 1998 and will be completed during
1999. The FON Group is using both internal and external resources 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
appropriate warranties and assurances that those third parties are or will be
Year 2000 compliant.
Sprint expects to incur approximately $250 million in 1998 and 1999 to
complete its Year 2000 compliance program. If compliance is not achieved in a
timely manner by Sprint or any significant 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 and is addressing the most critical
applications first. Although Sprint intends to develop and implement, if
necessary, appropriate contingency plans to mitigate to the extent possible
the effects of any Year 2000 noncompliance, such plans may not be adequate and
the cost of Year 2000 compliance may be higher than $250 million.
AFFILIATES
Sprint's results of operations and financial condition could also be
materially adversely affected by the failure of its affiliates, including
Global One, to achieve Year 2000 compliance in a timely manner.
I-13
<PAGE>
As a result of the PCS Restructuring, Sprint will acquire management control
of Sprint PCS; therefore the following discussion provides additional
information related to the Year 2000 compliance efforts of the PCS Group.
The PCS Group is undertaking an inventory of its computer systems, network
elements, software applications, products and other business systems. These
inventories are targeted to be completed by year-end 1998. Once an item is
identified through the inventory process, its Year 2000 impact is assessed and
a plan is developed 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 is planning that Year 2000
compliance for these critical systems will 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. However, full compliance may not be achieved as planned
by the PCS Group and such third parties and the PCS Group may not receive
warranties and assurances from such third parties. The PCS Group relies on
third-party vendors for a significant number of its important operating and
computer system functions, and therefore is highly dependent on such third-
party vendors for the remediation of network elements, computer systems,
software applications and other business systems. In addition, the PCS Group
uses publicly available services that are acquired without contract (for
example, global positioning system timing signal) that may be subject to 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 compel
compliance. Based upon management's evaluations to date, it believes that the
total cost of modifications and conversions of the PCS Group's systems will
not be material, but such cost could become material because of the various
reasons described above, many of which are out of the PCS Group's control.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 18 of Notes to Consolidated Financial Statements for a discussion
of recently issued accounting pronouncements.
I-14
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sprint Corporation
We have audited the accompanying consolidated balance sheets of Sprint
Corporation ("Sprint") as of December 31, 1997 and 1996, and the related
consolidated statements of income, cash flows, and common stock and other
stockholders' equity for each of the three years in the period ended December
31, 1997. These financial statements are the responsibility of the management
of Sprint. Our responsibility is to express an opinion on these financial
statements based on our audits. The 1997 financial statements of Sprint
Spectrum Holding Company, L.P., a partnership in which Sprint has a 40%
interest, have been audited by other auditors whose report has been furnished
to us; insofar as our opinion on the 1997 consolidated financial statements
relates to data included for Sprint Spectrum Holding Company, L.P., it is
based solely on their report. In the consolidated financial statements,
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.
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, 1997 and 1996, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.
As discussed in Note 14 to the consolidated financial statements, Sprint
discontinued accounting for the operations of its local telecommunications
division in accordance with Statement of Financial Accounting Standards No.
71, "Accounting for the Effects of Certain Types of Regulation," in 1995.
Ernst & Young LLP
Kansas City, Missouri
February 3, 1998, except for Note 1, as
to which the date is May 26, 1998
I-15
<PAGE>
INDEPENDENT AUDITORS' REPORT
Partners of Sprint Spectrum Holding Company, L.P.
Kansas City, Missouri
We have audited the consolidated balance sheets of Sprint Spectrum Holding
Company, L.P. and subsidiaries ("the Partnership") as of December 31, 1997 and
1996, and the related consolidated statements of operations, changes in
partners' capital and cash flows for the three years in the period ended
December 31, 1997. These financial statements are the responsibility of the
Partnership's management. Our responsibility is to express an opinion on these
consolidated financial statements 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 consolidated financial position of Sprint Spectrum
Holding Company, L.P. and subsidiaries at December 31, 1997 and 1996, and the
results of their operations and their cash flows for the three years then
ended, in conformity with generally accepted accounting principles.
The Partnership was in the development stage at December 31, 1996; during
the year ended December 31, 1997, the Partnership completed its development
activities and commenced its planned principal operations.
Deloitte & Touche LLP
Kansas City, Missouri
February 3, 1998
I-16
<PAGE>
SPRINT CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
NET OPERATING REVENUES.. $11,940.3 $11,024.9 $14,873.9 $13,887.5 $12,735.3
OPERATING EXPENSES
Costs of services and
products............. 5,691.3 5,523.7 7,451.0 6,912.9 6,504.9
Selling, general and
administrative....... 2,802.0 2,395.1 3,245.2 3,116.4 2,842.1
Depreciation and
amortization......... 1,429.1 1,265.2 1,726.3 1,591.0 1,466.4
Restructuring costs... -- -- -- -- 87.6
--------- --------- --------- --------- ---------
Total operating
expenses............. 9,922.4 9,184.0 12,422.5 11,620.3 10,901.0
--------- --------- --------- --------- ---------
OPERATING INCOME........ 2,017.9 1,840.9 2,451.4 2,267.2 1,834.3
Interest expense........ (185.6) (133.3) (187.2) (196.7) (260.7)
Equity in loss of Global
One.................... (120.0) (88.3) (162.1) (82.1) (22.9)
Equity in loss of Sprint
Spectrum Holdings and
PhillieCo.............. (686.5) (410.6) (659.6) (191.8) (31.4)
Other income (expense),
net.................... 48.6 51.8 140.5 115.3 (38.9)
--------- --------- --------- --------- ---------
Income from continuing
operations before
income taxes........... 1,074.4 1,260.5 1,583.0 1,911.9 1,480.4
Income taxes............ (405.1) (502.9) (630.5) (721.0) (534.3)
--------- --------- --------- --------- ---------
INCOME FROM CONTINUING
OPERATIONS............. 669.3 757.6 952.5 1,190.9 946.1
Discontinued operation,
net.................... -- -- -- (2.6) 14.5
Extraordinary items,
net.................... (4.4) -- -- (4.5) (565.3)
--------- --------- --------- --------- ---------
NET INCOME.............. 664.9 757.6 952.5 1,183.8 395.3
Preferred stock
dividends.............. (0.8) (0.8) (1.0) (1.3) (2.6)
--------- --------- --------- --------- ---------
Earnings applicable to
common stock........... $ 664.1 $ 756.8 $ 951.5 $ 1,182.5 $ 392.7
========= ========= ========= ========= =========
BASIC EARNINGS PER
COMMON SHARE
Continuing operations. $ 1.55 $ 1.76 $ 2.21 $ 2.82 $ 2.71
Discontinued
operation............ -- -- -- (0.01) 0.04
Extraordinary items... (0.01) -- -- (0.01) (1.62)
--------- --------- --------- --------- ---------
Total................... $ 1.54 $ 1.76 $ 2.21 $ 2.80 $ 1.13
========= ========= ========= ========= =========
Basic weighted average
common shares.......... 430.7 430.3 430.2 421.7 348.7
========= ========= ========= ========= =========
DILUTED EARNINGS PER
COMMON SHARE
Continuing operations. $ 1.52 $ 1.74 $ 2.18 $ 2.79 $ 2.69
Discontinued
operation............ -- -- -- (0.01) 0.04
Extraordinary items... (0.01) -- -- (0.01) (1.61)
--------- --------- --------- --------- ---------
Total................... $ 1.51 $ 1.74 $ 2.18 $ 2.77 $ 1.12
========= ========= ========= ========= =========
Diluted weighted average
common shares.......... 438.7 436.1 436.5 427.0 351.3
========= ========= ========= ========= =========
DIVIDENDS PER COMMON
SHARE.................. $ 0.75 $ 0.75 $ 1.00 $ 1.00 $ 1.00
========= ========= ========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
I-17
<PAGE>
SPRINT CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN MILLIONS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- --------------------
1998 1997 1996
------------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets
Cash and equivalents..................... $ 47.7 $ 101.7 $ 1,150.6
Accounts receivable, net of allowance for
doubtful accounts of $166.0 (unaudited),
$146.7 and $117.4....................... 2,515.8 2,495.6 2,343.6
Inventories.............................. 349.9 352.0 305.3
Prepaid expenses......................... 216.3 159.1 150.0
Notes and other receivables.............. 407.8 443.4 101.9
Other.................................... 206.4 199.6 181.5
--------- --------- ---------
Total current assets................... 3,743.9 3,751.4 4,232.9
Investments in equity securities........... 420.2 303.0 254.5
Property, plant and equipment
Long distance communications services.... 9,133.0 8,245.5 7,467.8
Local communications services............ 14,817.2 14,011.5 13,368.7
Other.................................... 2,309.2 953.9 574.3
--------- --------- ---------
Total property, plant and equipment...... 26,259.4 23,210.9 21,410.8
Less accumulated depreciation............ 12,757.2 11,716.8 10,946.7
--------- --------- ---------
Net property, plant and equipment...... 13,502.2 11,494.1 10,464.1
Investment in and advances to Sprint
Spectrum Holdings and PhillieCo........... 610.1 989.6 1,242.9
Investments in and advances to other
affiliates................................ 634.0 459.1 284.2
Other assets............................... 1,543.4 1,187.6 347.8
--------- --------- ---------
Total.................................. $20,453.8 $18,184.8 $16,826.4
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Current maturities of long-term debt..... $ 80.6 $ 131.0 $ 99.1
Short-term borrowings.................... -- -- 200.0
Accounts payable......................... 1,099.0 1,100.1 1,026.7
Accrued interconnection costs............ 564.7 672.7 709.0
Accrued taxes............................ 399.2 270.7 189.2
Advance billings......................... 213.3 202.9 199.7
Other.................................... 849.0 699.4 770.6
--------- --------- ---------
Total current liabilities.............. 3,205.8 3,076.8 3,194.3
Construction obligations................... 429.0 -- --
Long-term debt............................. 5,039.8 3,748.6 2,974.8
Deferred credits and other liabilities
Deferred income taxes and investment tax
credits................................. 1,029.2 1,016.5 846.9
Postretirement and other benefit
obligations............................. 1,067.4 947.4 919.7
Other.................................... 370.8 358.8 359.0
--------- --------- ---------
Total deferred credits and other
liabilities........................... 2,467.4 2,322.7 2,125.6
Redeemable preferred stock................. 9.5 11.5 11.8
Common stock and other stockholders' equity
Common stock, par value $2.50 per share,
1,000.0 shares authorized, 350.3 shares
issued, and 344.5 (unaudited), 343.8 and
343.9 shares outstanding................ 875.7 875.7 875.7
Class A common stock, par value $2.50 per
share, 500.0 shares authorized, 86.2
shares issued and outstanding........... 215.6 215.6 215.6
Capital in excess of par or stated value. 4,490.8 4,457.7 4,425.9
Retained earnings........................ 4,012.7 3,693.1 3,222.4
Treasury stock, at cost, 5.8 (unaudited),
6.5 and 6.4 shares...................... (396.1) (292.9) (262.2)
Other.................................... 103.6 76.0 42.5
--------- --------- ---------
Total common stock and other
stockholders' equity.................. 9,302.3 9,025.2 8,519.9
--------- --------- ---------
Total.................................. $20,453.8 $18,184.8 $16,826.4
========= ========= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
I-18
<PAGE>
SPRINT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER YEAR ENDED
30, DECEMBER 31,
------------------ ----------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................. $ 664.9 $ 757.6 $ 952.5 $1,183.8 $ 395.3
Adjustments to reconcile net
income to net cash provided
by operating activities:
Equity in net losses of
affiliates............... 824.9 506.9 843.7 273.7 39.1
Extraordinary items, net.. 1.1 -- -- 4.9 565.3
Depreciation and
amortization............. 1,429.1 1,265.2 1,726.3 1,591.0 1,466.4
Deferred income taxes and
investment tax credits... 20.8 217.2 165.7 (10.3) 5.8
Net (gains) losses on
sales of assets.......... -- -- (93.2) 7.5 4.2
Changes in assets and
liabilities:
Accounts receivable,
net.................... (20.2) (92.9) (127.0) (982.1) (135.4)
Inventories and other
current assets......... (28.0) (37.2) (94.4) 15.7 (38.6)
Accounts payable and
other current
liabilities............ 124.1 (195.5) 18.0 362.0 178.1
Noncurrent assets and
liabilities, net....... (69.0) (14.3) (18.4) (25.5) 123.0
Other, net................ 2.3 3.7 5.8 (17.1) 6.4
-------- -------- -------- -------- --------
Net cash provided by
continuing operations...... 2,950.0 2,410.7 3,379.0 2,403.6 2,609.6
Net cash provided (used) by
cellular division.......... -- -- -- (0.1) 162.5
-------- -------- -------- -------- --------
Net cash provided by
operating activities....... 2,950.0 2,410.7 3,379.0 2,403.5 2,772.1
-------- -------- -------- -------- --------
INVESTING ACTIVITIES
Capital expenditures........ (2,992.1) (1,903.9) (2,862.6) (2,433.6) (1,857.3)
Purchase of PCS licenses.... -- (460.1) (460.1) (84.0) --
Investments in and loans to
Sprint Spectrum Holdings
and PhillieCo.............. (307.1) (410.0) (706.3) (561.0) (954.1)
Investments in and advances
to other affiliates, net... (395.3) (98.5) (385.5) (81.4) (37.8)
Paranet acquisition......... -- (375.0) (375.0) -- --
Proceeds from sales of
assets..................... -- -- 292.3 2.1 6.7
Other, net.................. (14.0) 33.8 (2.3) 42.4 (17.1)
-------- -------- -------- -------- --------
Net cash used by continuing
operations................. (3,708.5) (3,213.7) (4,499.5) (3,115.5) (2,859.6)
Repayment by cellular
division of intercompany
advances................... -- -- -- 1,400.0 --
Net cash used by cellular
division................... -- -- -- (140.7) (324.6)
-------- -------- -------- -------- --------
Net cash used by investing
activities................. (3,708.5) (3,213.7) (4,499.5) (1,856.2) (3,184.2)
-------- -------- -------- -------- --------
FINANCING ACTIVITIES
Payments on long-term debt.. (246.7) (110.6) (135.0) (433.1) (630.0)
Proceeds from long-term
debt....................... 945.6 -- 866.5 9.4 260.7
Change in construction
obligations................ 429.0 -- -- -- --
Net change in short-term
borrowings................. -- 194.7 (200.0) (1,986.8) 1,109.5
Proceeds from Class A common
stock issued............... -- -- -- 3,661.3 --
Dividends paid.............. (291.6) (274.5) (430.0) (419.6) (351.5)
Treasury stock purchased.... (235.4) (128.8) (144.5) (407.2) --
Other, net.................. 103.6 81.0 114.6 55.1 33.9
-------- -------- -------- -------- --------
Net cash provided (used) by
financing activities....... 704.5 (238.2) 71.6 479.1 422.6
-------- -------- -------- -------- --------
Increase (Decrease) in Cash
and Equivalents............ (54.0) (1,041.2) (1,048.9) 1,026.4 10.5
Cash and Equivalents at
Beginning of Period........ 101.7 1,150.6 1,150.6 124.2 113.7
-------- -------- -------- -------- --------
Cash and Equivalents at End
of Period.................. $ 47.7 $ 109.4 $ 101.7 $1,150.6 $ 124.2
======== ======== ======== ======== ========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
I-19
<PAGE>
SPRINT CORPORATION
CONSOLIDATED STATEMENTS OF COMMON STOCK AND OTHER STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
CAPITAL IN
EXCESS OF
COMMON CLASS A PAR OR
SHARES COMMON COMMON STATED RETAINED TREASURY
OUTSTANDING STOCK STOCK VALUE EARNINGS STOCK OTHER TOTAL
----------- ------- ------- ---------- --------- -------- ------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BEGINNING 1995 BALANCE.. 348.3 $ 871.4 $ -- $ 942.9 $ 2,730.6 $ (9.6) $ (10.5) $ 4,524.8
Net income.............. -- -- -- -- 395.3 -- -- 395.3
Common stock dividends.. -- -- -- -- (348.9) -- -- (348.9)
Common stock issued..... 0.6 1.4 -- 13.5 -- -- -- 14.9
Treasury stock issued... 0.3 -- -- -- (3.5) 9.6 -- 6.1
Change in unrealized
holding gains on
investments, net....... -- -- -- -- -- -- 54.6 54.6
Other, net.............. -- 0.1 -- 3.6 (0.6) -- (7.3) (4.2)
----- ------- ------- --------- --------- -------- ------- ---------
ENDING 1995 BALANCE..... 349.2 872.9 -- 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..... 1.1 2.5 -- 17.5 -- -- -- 20.0
Class A common stock
issued................. 86.2 -- 215.6 3,436.3 -- -- -- 3,651.9
Treasury stock
purchased.............. (10.1) -- -- -- -- (407.2) -- (407.2)
Treasury stock issued... 3.7 -- -- -- (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..... 430.1 875.7 215.6 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.............. (3.0) -- -- -- -- (144.5) -- (144.5)
Treasury stock issued... 2.9 -- -- -- (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..... 430.0 875.7 215.6 4,457.7 3,693.1 (292.9) 76.0 9,025.2
Net income (unaudited).. -- -- -- -- 664.9 -- -- 664.9
Common stock dividends
(unaudited)............ -- -- -- -- (258.6) -- -- (258.6)
Class A common stock
dividends (unaudited).. -- -- -- -- (64.7) -- -- (64.7)
Treasury stock purchased
(unaudited)............ (3.9) -- -- -- -- (260.2) -- (260.2)
Treasury stock issued
(unaudited)............ 4.6 -- -- 0.5 (12.8) 149.4 -- 137.1
Other, net (unaudited).. -- -- -- 32.6 (9.2) 7.6 27.6 58.6
----- ------- ------- --------- --------- -------- ------- ---------
SEPTEMBER 30, 1998
BALANCE (unaudited).... 430.7 $ 875.7 $ 215.6 $ 4,490.8 $ 4,012.7 $ (396.1) $ 103.6 $ 9,302.3
===== ======= ======= ========= ========= ======== ======= =========
</TABLE>
See accompanying Notes to Consolidated Financial Statements.
I-20
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. RESTRUCTURING AND RECAPITALIZATION PLANS
Sprint Corporation ("Sprint") has entered into a restructuring agreement
with Tele-Communications, Inc. ("TCI"), Comcast Corporation ("Comcast") and
Cox Communications, Inc. ("Cox," and together with TCI and Comcast the "Cable
Parents") to restructure Sprint's wireless personal communications services
("PCS") operations (the "PCS Restructuring"). Sprint will acquire the joint
venture interests of TCI, Comcast and Cox in Sprint Spectrum Holding Company,
L.P. and MinorCo, L.P. (together, "Sprint Spectrum Holdings") and the joint
venture interests of TCI and Cox in PhillieCo Partners I, L.P. and PhillieCo
Partners II, L.P. (together, "PhillieCo"). In exchange for these joint venture
interests, Sprint will issue to the Cable Parents a newly created class of
Sprint Common Stock (the "PCS Stock"). The PCS Stock is intended to reflect
separately the performance of these joint ventures and the domestic PCS
operations of Sprint's wholly-owned subsidiaries, SprintCom, Inc. and
SprintCom Equipment Company, L.P. (together, "SprintCom"). These operations,
which after the PCS Restructuring will be 100% owned by Sprint (subject to a
40.8% minority interest in the entity holding the PCS license for and
conducting operations in the Los Angeles/San Diego/Las Vegas MTA), will be
referred to as the PCS Group.
The FON Stock, which will be created in the Recapitalization, is intended to
reflect the performance of all of Sprint's other operations, including its
long distance, local telecommunications and product distribution and directory
publishing divisions, emerging businesses and its interest in Global One.
These operations will be referred to as the FON Group.
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. Investments in entities in which
Sprint exercises significant influence, but does not control, are accounted
for using the equity method (see Note 3).
The consolidated financial statements are prepared according to generally
accepted accounting principles ("GAAP"). 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.
The unaudited interim financial information presented has been prepared
according to GAAP and the rules and regulations of the Securities and Exchange
Commission. In management's opinion, the information presented reflects all
adjustments (consisting only of normal recurring accruals) necessary to
present fairly Sprint's consolidated financial position, results of operations
and cash flows.
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 stockholders' equity as previously reported.
Sprint applied Statement of Financial Accounting Standards ("SFAS") No. 71,
"Accounting for the Effects of Certain Types of Regulation," to its financial
statements until December 1995. Under SFAS 71, revenues and related net income
resulting from transactions between Sprint's nonregulated operations and its
regulated local exchange carriers were not eliminated from the consolidated
financial statements. Revenues from these intercompany transactions were $262
million in 1995. All other significant intercompany transactions have been
eliminated.
Classification of Operations
FON GROUP
The principal activities of the FON Group include (i) its core businesses
consisting of domestic and international long distance communications, local
exchange communications, and product distribution and
I-21
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
directory publishing activities, (ii) its emerging businesses, which consist
of the development of new integrated communications services, consumer
internet access services, Sprint Paranet and Sprint International and (iii)
Sprint's Global One strategic international alliance, as well as other
telecommunications investments and partnerships.
PCS GROUP
The PCS Group includes Sprint's domestic wireless mobile telephony
activities and any other domestic PCS services, which include (i) the
investment in Sprint Spectrum Holdings and the investment in PhillieCo, both
of which are reflected on the equity basis and (ii) SprintCom. Upon completion
of the PCS Restructuring, the results of Sprint Spectrum Holdings and
PhillieCo will be reflected on the consolidated basis in the PCS Group
Combined Financial Statements.
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 $225
million at year-end 1997 and $127 million at year-end 1996. Sprint had
sufficient funds available to fund these outstanding checks when they were
presented for payment.
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
"Common stock and other stockholders' equity--Other," net of related income
taxes.
Inventories
Inventories are stated at the lower of cost (principally first-in, first-out
method) or market.
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. Repairs and maintenance costs are expensed as
incurred.
Depreciation
The cost of property, plant and equipment is generally depreciated on a
straight-line basis over estimated economic useful lives. Prior to Sprint's
discontinued use of SFAS 71 at year-end 1995, the cost of property, plant and
equipment for the local division had been generally depreciated on a straight-
line basis over lives prescribed by regulatory commissions.
Income Taxes
Sprint records deferred income taxes based on certain temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and amounts used for tax purposes. Investment tax credits
I-22
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
related to regulated telephone property, plant and equipment have been
deferred and are being amortized over the estimated useful lives of the
related assets.
Capitalized Interest
Sprint capitalizes interest costs related to constructing capital assets,
and to its investments in Sprint Spectrum Holdings and affiliates and its
directly owned PCS licenses. Sprint stopped capitalizing interest on its
investment in Sprint Spectrum Holdings and affiliates in July 1997 because
Sprint Spectrum Holdings and affiliates no longer qualified as development-
stage companies. Capitalized interest totaled $93 million in 1997, $104
million in 1996 and $57 million in 1995.
3. INVESTMENTS
INVESTMENTS IN EQUITY SECURITIES
The cost of investments in equity securities was $105 million at year-end
1997 and 1996. Gross unrealized holding gains were $198 million at year-end
1997 and $149 million at year-end 1996.
INVESTMENTS IN AND LOANS TO AFFILIATES
Investments accounted for using the equity method mainly consist of Sprint's
investments in Sprint Spectrum Holdings, PhillieCo and Global One.
Sprint is a 40% partner in Sprint Spectrum Holdings, a partnership with TCI,
Comcast and Cox and a 47.1% partner in PhillieCo, a partnership with TCI and
Cox. Sprint Spectrum Holdings and PhillieCo are building the nation's first
single-technology, state-of-the-art wireless network to provide PCS across the
United States. See Note 1 for more information regarding the PCS
Restructuring, which will result in Sprint acquiring the interests of TCI,
Comcast and Cox in Sprint Spectrum Holdings and TCI and Cox in PhillieCo.
Combined, summarized financial information (100% basis) for Sprint Spectrum
Holdings and PhillieCo accounted for using the equity method is as follows (in
millions):
<TABLE>
<CAPTION>
NINE MONTHS AT OR FOR THE
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- --------- -------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Results of operations
Net operating revenues.... $ 788.0 $ 110.5 $ 258.0 $ 4.2 $ --
========= ========= ========= ======== =======
Operating loss............ $(1,455.8) $ (869.0) $(1,379.7) $ (357.6) $ (66.9)
========= ========= ========= ======== =======
Net loss.................. $(1,692.0) $(1,021.5) $(1,632.7) $ (444.6) $(112.7)
========= ========= ========= ======== =======
Financial position
Current assets............ $ 417.9 $ 401.8
Noncurrent assets......... 6,640.0 4,041.8
--------- --------
Total..................... $ 7,057.9 $4,443.6
========= ========
Current liabilities....... $ 834.5 $ 471.2
Noncurrent liabilities.... 4,289.4 1,412.5
Partners' equity.......... 1,934.0 2,559.9
--------- --------
Total..................... $ 7,057.9 $4,443.6
========= ========
</TABLE>
I-23
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
At year-end 1997 and 1996, Sprint's investment in Sprint Spectrum Holdings,
including advances and a vendor financing loan, totaled $1.2 billion.
In 1996, Sprint purchased $183 million (face value) of Sprint Spectrum
Senior Discount notes for $100 million. The bonds mature in 2006. At year-end
1997 and 1996, the accreted cost of the notes was $118 and $104 million and
gross unrealized holding gains totaled $24 and $18 million, respectively. This
investment has been included in "Current assets--Other" on the Consolidated
Balance Sheets.
Sprint is also a partner in Global One, a joint venture with France Telecom
S.A. ("FT") and Deutsche Telekom AG ("DT") formed to provide seamless
telecommunications services to business, residential and carrier markets
worldwide. Sprint is a one-third 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. At year-end 1997, Sprint's share of underlying equity in Global
One's net assets exceeded the carrying value of Sprint's investment in Global
One by $158 million. This difference is being amortized through January 2001.
Combined, summarized financial information (100% basis) for Global One and
all other affiliates accounted for using the equity method is as follows (in
millions):
<TABLE>
<CAPTION>
NINE MONTHS AT OR FOR THE
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- --------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Results of operations
Net operating revenues....... $ 1,680.6 $ 1,535.4 $1,937.6 $1,723.7 $779.5
========= ========= ======== ======== ======
Operating income (loss)...... $ (375.9) $ (473.1) $ (782.5) $ (436.4) $ 8.6
========= ========= ======== ======== ======
Net income (loss)............ $ (495.4) $ (494.4) $ (826.3) $ (399.7) $ 22.1
========= ========= ======== ======== ======
Financial position
Current assets............... $1,913.6 $ 958.9
Noncurrent assets............ 4,221.0 2,737.5
-------- --------
Total........................ $6,134.6 $3,696.4
======== ========
Current liabilities.......... $1,965.7 $ 714.3
Noncurrent liabilities....... 2,105.8 629.6
Partners' equity............. 2,063.1 2,352.5
-------- --------
Total........................ $6,134.6 $3,696.4
======== ========
</TABLE>
Sprint's investment in Global One, including advances, totaled $93 and $38
million at year-end 1997 and 1996, respectively.
4. EMPLOYEE BENEFIT PLANS
DEFINED BENEFIT PENSION PLAN
Substantially all Sprint employees are covered by a noncontributory defined
benefit pension plan. Benefits for plan participants represented by collective
bargaining units are based on negotiated schedules of defined amounts. For
participants not covered by collective bargaining agreements, the plan
provides pension benefits based on years of service and participants'
compensation.
I-24
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Sprint's policy is to make annual plan contributions equal to an actuarially
determined amount consistent with applicable 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. At
year-end 1997, the plan's assets consisted mainly of investments in corporate
equity securities and U.S. government and corporate debt securities.
The net pension cost (credit) consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C>
Service cost--benefits earned during the period..... $ 61.7 $ 65.4 $ 51.8
Interest cost on projected benefit obligation....... 148.9 138.5 129.7
Actual return on plan assets........................ (448.5) (353.0) (472.1)
Net amortization and deferral....................... 240.0 159.4 287.9
------- ------- -------
Net pension cost (credit)........................... $ 2.1 $ 10.3 $ (2.7)
======= ======= =======
Discount rate....................................... 7.75% 7.25% 8.50%
Expected long-term rate of return on plan assets.... 9.50% 9.50% 9.50%
Anticipated composite rate of future compensation
increases.......................................... 4.75% 4.25% 5.00%
</TABLE>
At year-end, the funded status and amounts recognized in the Consolidated
Balance Sheets for the plan were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(IN MILLIONS)
<S> <C> <C>
Actuarial present value of benefit obligations
Vested benefit obligation.............................. $(1,966.7) $(1,713.6)
========= =========
Accumulated benefit obligation......................... $(2,129.6) $(1,864.1)
========= =========
Projected benefit obligation............................. $(2,240.9) $(1,967.0)
Plan assets at fair value................................ 2,929.4 2,584.2
--------- ---------
Plan assets in excess of the projected benefit
obligation.............................................. 688.5 617.2
Unrecognized net gains................................... (585.2) (481.8)
Unrecognized prior service cost.......................... 105.4 100.4
Unamortized transition asset............................. (122.1) (147.1)
--------- ---------
Prepaid pension cost..................................... $ 86.6 $ 88.7
========= =========
Discount rate............................................ 7.25% 7.75%
Anticipated composite rate of future compensation
increases............................................... 4.25% 4.75%
</TABLE>
DEFINED CONTRIBUTION PLANS
Sprint sponsors defined contribution employee savings plans covering
substantially all employees. Participants may contribute portions of their pay
to the plans. For employees represented by collective bargaining units, Sprint
matches contributions based on negotiated amounts. Sprint also matches
contributions of employees not covered by collective bargaining agreements.
For those participants, Sprint matches their contributions in Sprint common
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 matching contributions based on the performance of Sprint
common stock compared to other telecommunications companies' stock. Sprint's
matching contributions were $54 million in 1997, $56 million in 1996 and $51
million in 1995. At year-end 1997, the plans held 20 million Sprint common
shares.
I-25
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
POSTRETIREMENT BENEFITS
Sprint provides postretirement benefits (principally medical benefits) to
substantially all 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 net postretirement benefits cost consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
(IN MILLIONS)
<S> <C> <C> <C>
Service cost--benefits
earned during the year. $20.8 $21.7 $22.2
Interest on accumulated
postretirement benefit
obligation............. 52.3 49.9 58.7
Net amortization and
deferral............... (19.4) (13.7) (9.4)
----- ----- -----
Net postretirement
benefits cost.......... $53.7 $57.9 $71.5
===== ===== =====
Discount rate........... 7.75% 7.25% 8.50%
</TABLE>
For measurement purposes, the assumed 1997 weighted average annual health
care cost trend rate was 9%, gradually decreasing to an ultimate level of 5%
by 2005. A 1% increase in the rate would have increased the 1997 net
postretirement benefits cost by an estimated $12 million.
Amounts included in the Consolidated Balance Sheets at year-end are as
follows:
<TABLE>
<CAPTION>
1997 1996
------ ------
(IN MILLIONS)
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees...................................................... $328.3 $277.9
Active plan participants--
Fully eligible.............................................. 145.2 127.6
Other....................................................... 269.9 320.7
------ ------
743.4 726.2
Unrecognized prior service benefit.............................. 5.4 5.7
Unrecognized net gains.......................................... 190.0 178.7
------ ------
Accrued postretirement benefits cost............................ $938.8 $910.6
====== ======
Discount rate................................................... 7.25% 7.75%
</TABLE>
The assumed 1998 annual health care cost trend rate was 8.5%, gradually
decreasing to an ultimate level of 5% by 2005. A 1% increase in the rate would
have increased the 1997 accumulated postretirement benefit obligation by an
estimated $61 million.
I-26
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
5. INCOME TAXES
Income tax expense allocated to continuing operations consists of the
following:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Current income tax expense
Federal............................................... $385.9 $655.4 $437.4
State................................................. 78.9 75.9 91.1
------ ------ ------
Total current........................................... 464.8 731.3 528.5
------ ------ ------
Deferred income tax expense (benefit)
Federal............................................... 174.3 (22.2) 45.9
State................................................. (4.8) 23.5 (23.6)
Amortization of deferred investment tax credits......... (3.8) (11.6) (16.5)
------ ------ ------
Total deferred.......................................... 165.7 (10.3) 5.8
------ ------ ------
Total................................................... $630.5 $721.0 $534.3
====== ====== ======
</TABLE>
The differences that caused Sprint's effective income tax rates to vary from
the statutory federal rate of 35% were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Income tax expense at the statutory rate............... $554.1 $669.2 $518.1
Less investment tax credits included in income......... 3.8 11.6 16.5
------ ------ ------
Expected federal income tax expense after investment
tax credits........................................... 550.3 657.6 501.6
Effect of state income taxes, net of federal income tax
effect................................................ 48.2 64.6 43.9
Equity in losses of foreign joint ventures............. 36.4 8.6 --
Other, net............................................. (4.4) (9.8) (11.2)
------ ------ ------
Income tax expense, including investment tax credits... $630.5 $721.0 $534.3
====== ====== ======
Effective income tax rate.............................. 39.8% 37.7% 36.1%
====== ====== ======
</TABLE>
Income tax expense (benefit) allocated to other items was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -------
(IN MILLIONS)
<S> <C> <C> <C>
Discontinued operation................................ $ -- $ 7.0 $ 31.2
Extraordinary items................................... -- (2.9) (437.4)
Unrealized holding gains on investments (1)........... 4.4 1.7 30.7
Stock ownership, purchase and options arrangements
(1).................................................. (26.2) (14.1) (7.5)
</TABLE>
- --------
(1) These amounts have been recorded directly to "Common stock and other
stockholders' equity--Other."
I-27
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 1997
and 1996, along with the income tax effect of each, were as follows:
<TABLE>
<CAPTION>
1997 DEFERRED 1996 DEFERRED
INCOME TAX INCOME TAX
------------------ ------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Property, plant and equipment............. $ -- $1,488.8 $ -- $1,304.3
Postretirement and other benefits......... 376.1 -- 360.3 --
Reserves and allowances................... 111.3 -- 115.6 --
Unrealized holding gains on investments... -- 61.7 -- 57.3
Other, net................................ 108.5 -- 106.8 --
------ -------- ------ --------
595.9 1,550.5 582.7 1,361.6
Less valuation allowance.................. 11.8 -- 13.7 --
------ -------- ------ --------
Total..................................... $584.1 $1,550.5 $569.0 $1,361.6
====== ======== ====== ========
</TABLE>
The valuation allowance related to deferred income tax assets decreased $2
million in 1997 and $4 million in 1996 and 1995.
Management believes it is more likely than not that these deferred income
tax assets, net of the 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.
At year-end 1997, Sprint 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, Sprint had tax benefits of $49 million
related to state operating loss carryforwards. The loss carryforwards expire
in varying amounts per year from 1998 through 2012.
I-28
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
6. BORROWINGS
LONG-TERM DEBT
Long-term debt at year-end was as follows:
<TABLE>
<CAPTION>
MATURING 1997 1996
------------ -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Corporate
Senior notes
8.1% to 9.8%............................... 1998 to 2002 $ 475.3 $ 475.3
9.5%....................................... 2003 to 2007 200.0 200.0
Debentures
9.0% to 9.3%............................... 2019 to 2022 350.0 350.0
Notes payable and commercial paper -- 866.5 --
Other
5.4% to 8.9% (1)........................... 1998 to 2006 237.5 194.9
Long Distance Division
Vendor financing agreements
7.4% to 8.9%............................... 1997 to 1999 23.8 44.8
Other
6.2% to 8.4%............................... 1997 to 2007 16.5 23.1
Local Telecommunications Division
First mortgage bonds
2.0% to 7.8%............................... 1997 to 2002 452.3 487.0
4.0% to 7.8%............................... 2003 to 2007 346.0 346.8
6.9% to 9.8%............................... 2008 to 2012 116.7 116.7
6.9% to 8.8%............................... 2013 to 2017 169.6 169.8
8.8% to 9.9%............................... 2018 to 2022 244.9 245.7
7.1% to 8.4%............................... 2023 to 2027 145.0 145.0
Debentures and notes
5.8% to 9.6%............................... 1998 to 2020 237.0 275.3
Other
2.0% to 9.8%............................... 1998 to 2006 4.6 6.2
Unamortized debt discount...................... (6.1) (6.7)
-------- --------
3,879.6 3,073.9
Less current maturities........................ 131.0 99.1
-------- --------
Long-term debt................................. $3,748.6 $2,974.8
======== ========
</TABLE>
- --------
(1) Notes may be exchanged at maturity for Southern New England
Telecommunications Corporation (SNET) common shares owned by Sprint, or for
cash. Based on SNET's closing market price, had the notes matured at year-
end 1997, they could have been exchanged for 3.8 million SNET shares. At
year-end 1997, Sprint held 4.2 million SNET shares, which have been
included in "Investments in equity securities" on the Consolidated Balance
Sheets.
I-29
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Long-term debt maturities, excluding reclassified short-term borrowings,
during each of the next five years are as follows (in millions):
<TABLE>
<S> <C>
1998............................................................... $131.0
1999............................................................... 33.4
2000............................................................... 693.3
2001............................................................... 40.8
2002............................................................... 354.5
</TABLE>
Property, plant and equipment with a total cost of $12.9 billion is either
pledged as security for first mortgage bonds and certain notes or is
restricted for use as mortgaged property.
During 1996, Sprint redeemed, prior to scheduled maturities, $190 million of
debt with interest rates ranging from 6.0% to 9.5%. This resulted in a $5
million after-tax extraordinary loss.
SHORT-TERM BORROWINGS
At year-end 1997, Sprint had borrowed $618 million of bank notes payable and
$249 million of commercial paper. Though these borrowings are renewable at
various dates throughout the year, they have been classified as long-term debt
because of Sprint's intent and ability, through unused credit facilities, to
refinance these borrowings. Commercial paper and certain bank notes payable
are supported by Sprint's revolving credit facility with a syndicate of
domestic and international banks. Other notes payable relate to a separate
revolving credit facility that Sprint executed with a bank in 1997. At year-
end 1997, Sprint's unused lines of credit totaled $1.1 billion.
Bank notes outstanding at year-end 1997 and 1996 had weighted average
interest rates of 6.1% and 5.9%, respectively. At year-end 1997, the weighted
average interest rate of commercial paper was 6.8%.
OTHER
Sprint was in compliance with all restrictive or financial covenants
relating to its debt arrangements at year-end 1997.
7. REDEEMABLE PREFERRED STOCK
Sprint has approximately 22 million authorized preferred shares, including
nonredeemable preferred stock. The redeemable preferred stock outstanding, at
year-end, is as follows:
<TABLE>
<CAPTION>
1997 1996
----- -----
(IN
MILLIONS,
EXCEPT PER
SHARE AND
SHARE DATA)
<S> <C> <C>
Fifth series--stated value $100,000 per share, shares--95,
voting, cumulative 6% annual dividend rate.................... $ 9.5 $ 9.5
Other--stated value $100 per share, shares--19,493 and 22,800,
4.7% annual dividend rate..................................... 2.0 2.3
----- -----
Total...................................................... $11.5 $11.8
===== =====
</TABLE>
Sprint's Fifth series preferred stock must be redeemed in full in 2003. If
less than full dividends have been paid for four consecutive dividend periods,
or if dividends in arrears exceed an amount equal to the dividends for six
dividend periods, the Fifth series preferred stockholder may elect a majority
of directors standing for election until all dividends in arrears have been
paid.
I-30
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
8. COMMON STOCK
COMMON STOCK
At year-end 1997, common stock reserved for future grants under stock option
plans or for future issuances under various other arrangements was as follows:
<TABLE>
<CAPTION>
SHARES
-------------
(IN MILLIONS)
<S> <C>
Employees Stock Purchase Plan............................... 6.4
Employee savings plans...................................... 3.4
Automatic Dividend Reinvestment Plan........................ 1.2
Officer and key employees' and directors' stock options..... 8.2
Conversion of preferred stock and other..................... 1.4
----
Total................................................... 20.6
====
</TABLE>
Under a Shareholder Rights Plan, one preferred stock purchase right is
attached to each common and Class A common share. Each right is exercisable
only if certain takeover events occur. Each right will initially entitle the
holder to purchase 1/1000 of a share (a Unit) of a no par Preferred Stock-
Sixth Series, Junior Participating (Preferred Stock) at $225 per Unit or, in
certain cases, common stock. The Preferred Stock 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 common dividends.
No Preferred Stock shares were issued or outstanding at year-end 1997. The
rights may be redeemed by Sprint at $0.01 per right and will expire in June
2007, unless extended. On June 29, 1998, the Sprint Board approved an
amendment to Sprint's Shareholder Rights Plan to be effective on the filling
of the PCS Stock Amendment with the Kansas Secretary of State. See Note 1 for
a discussion of the PCS Restructuring, which necessitated the PCS Stock
Amendment.
During 1997, 1996 and 1995, Sprint declared and paid annual common stock
dividends of $1.00 per share. The most restrictive covenant related to common
dividends results from Sprint's $1.5 billion revolving credit agreement. Among
other restrictions, this agreement requires Sprint to maintain specified
levels of consolidated net worth. Due to this requirement, $2.7 billion of
Sprint's $3.7 billion consolidated retained earnings was effectively
restricted from the payment of dividends at year-end 1997. 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, $567 million of those subsidiaries' $1.3 billion total retained
earnings was restricted at year-end 1997. The flow of cash in the form of
advances from the subsidiaries to Sprint is generally not restricted.
During 1990, the Savings Plan Trust, an employee savings plan, acquired
common stock from Sprint in exchange for a $75 million promissory note payable
to Sprint. The note bears interest at 9% and is to be repaid from common stock
dividends received by the plan and contributions made to the plan by Sprint
according to plan provisions. The remaining $34 million note receivable
balance at year-end 1997 is reflected as a reduction to "Common stock and
other stockholders' equity--Other."
CLASS A COMMON STOCK
In January 1996, FT and DT acquired shares of a new class of convertible
preference stock for a combined total of $3.0 billion. This resulted in FT and
DT each holding 7.5% of Sprint's voting power. In April 1996, following the
spinoff of Sprint's cellular division (Cellular) (see Note 15), the preference
stock was converted into Class A common stock, and FT and DT each acquired
additional Class A common shares. Following their combined investment of $3.7
billion, FT and DT each own Class A common shares with 10% of Sprint's voting
power. During 1997, Sprint declared and paid Class A common dividends of $1.00
per share. During 1996, preference dividends totaled $0.16 per share, and
Class A common dividends totaled $0.75 per share.
I-31
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
FT and DT, as Class A common stockholders, have the right in most
circumstances to proportionate representation on Sprint's Board of Directors.
They may also purchase additional Class A common shares 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 investment agreement with Sprint and
related agreements). 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.
9. STOCK-BASED COMPENSATION
Sprint's Management Incentive Stock Option Plan (MISOP) provides for the
granting of 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 Sprint's common
stock on the grant date. At year-end 1997, authorized shares under this plan
approximated 11 million. This amount increased by approximately 3 million
shares on January 1, 1998.
The Sprint Corporation Stock Option Plan (SOP) provides for the granting of
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 Sprint's common stock on the
grant date. At year-end 1997, authorized shares under this plan approximated
20 million.
Every two years, the Employees Stock Purchase Plan (ESPP) offers all
employees the election to purchase Sprint common stock at a price equal to 85%
of the market value on the grant or exercise date, whichever is less. At year-
end 1997, authorized shares under this plan approximated 18 million.
In 1996, Sprint adopted the pro forma disclosure requirements under SFAS No.
123, "Accounting for Stock-based Compensation," and continued to apply
Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued
to Employees," to its stock option and employee stock purchase plans. Under
APB 25, Sprint has recognized no compensation expense related to these plans.
Pro forma net income and earnings per share (EPS) 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 and ESPP shares
elected after 1994 will continue to vest over the next several years. In
addition, compensation expense resulting from the spinoff of Cellular
(Spinoff) (see Note 15) will decline over the next several years.
Sprint's pro forma net income and EPS were as follows:
<TABLE>
<CAPTION>
1997(1) 1996(1) 1995
------- ------- -----
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C> <C>
Pro forma net income...................................... $ 908 $1,158 $ 388
===== ====== =====
Pro forma basic EPS....................................... $2.11 $ 2.74 $1.11
===== ====== =====
</TABLE>
- --------
(1) Pro forma net income was reduced by $3 million ($0.01 per share) in 1997
and $6 million ($0.01 per share) in 1996 due to additional compensation
resulting from modifications to terms of options and ESPP share elections
made in connection with the Spinoff.
I-32
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
During 1996, Sprint employees elected to purchase 2.8 million ESPP shares
with a weighted average fair value (using the Black-Scholes pricing model) of
$10.06 per share. No ESPP shares were offered in 1997 or 1995.
The following tables reflect the weighted average fair value per option
granted during the year, as well as the significant weighted average
assumptions used in determining those fair values using the Black-Scholes
pricing model:
<TABLE>
<CAPTION>
MISOP SOP
----- ------
<S> <C> <C>
1997
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
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
1995
Fair value on grant date....................................... $6.67 $ 8.73
Risk-free interest rate........................................ 6.9% 7.2%
Expected volatility............................................ 23.3% 23.3%
Expected dividend yield........................................ 2.5% 2.5%
Expected life (years).......................................... 4 6
</TABLE>
Stock option plan activity was as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
PER SHARE
SHARES (1) EXERCISE PRICE (1)
---------- ------------------
(IN MILLIONS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Outstanding, beginning of 1995.............. 9.3 $24.67
Granted................................... 4.3 24.69
Exercised................................. (0.8) 19.81
Forfeited/Expired......................... (0.5) 27.06
----
Outstanding, year-end 1995.................. 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
==== ======
</TABLE>
- --------
(1) Due to the Spinoff, the shares and related exercise prices have been
adjusted to maintain both the total fair market value of common stock
underlying the options, and the relationship between the market value of
Sprint's common stock and the option's exercise price.
Outstanding options held by Cellular employees were converted into options
and grants to purchase Cellular common stock and are not included in the
above table.
I-33
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
After adjustment for the Spinoff, options exercisable at year-end 1996 and
1995 were 8.4 and 6.4 million, respectively. At year-end 1996, the weighted
average exercise price for exercisable options was $27.77. The following table
summarizes outstanding and exercisable options at year-end 1997:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-------------------------------- ----------------------
WEIGHTED
AVERAGE
NUMBER REMAINING WEIGHTED WEIGHTED
OUTSTANDING CONTRACTUAL AVERAGE NUMBER AVERAGE
RANGE OF (IN LIFE EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES MILLIONS) (IN YEARS) PRICE (IN MILLIONS) PRICE
- --------------- ----------- ----------- -------- ------------- --------
<S> <C> <C> <C> <C> <C>
$11.92--$14.96 0.1 2.2 $14.31 0.1 $14.31
$15.18--$19.24 0.1 3.7 17.91 0.1 17.91
$20.08--$24.50 2.7 6.2 23.71 1.7 23.30
$25.11--$29.96 1.8 4.7 27.38 1.4 26.80
$30.22--$39.94 5.0 7.6 35.16 3.0 34.28
$40.06--$49.88 7.3 8.5 44.88 1.9 43.33
$50.31--$58.38 1.7 7.4 51.92 0.1 51.69
</TABLE>
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 (Network 2000) on its breach of
contract claim against Sprint. The arbitrators directed Sprint to pay one-half
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.
Sprint filed an action in federal district court seeking to have the
arbitration panel's award struck down, modified, or corrected, and asking the
court to enter an order regarding the distribution of the award. In April
1997, the court denied Sprint's request that the arbitration award be struck
down and granted Network 2000's request that the award be confirmed.
In June 1997, Sprint recorded an additional $20 million charge in connection
with 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 number of
potential class members have decided not to participate in the settlement and
another group of potential class members have appealed from the order
approving the class action settlement.
Various 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 result in a material effect on Sprint's
consolidated financial statements.
CONTINGENCIES
On January 1, 1998, a "Deadlock Event" occurred due to the failure of the
Sprint Spectrum Holdings partnership board to approve the proposed Sprint
Spectrum Holdings budget and business plan. Under the partnership agreement,
if a partner refers the issue for resolution pursuant to specified procedures
and it remains unresolved, buy/sell provisions can be triggered, which could
result in Sprint either increasing or selling its partnership interest.
Discussions among the partners about restructuring their interests in Sprint
Spectrum Holdings have resulted in the partners entering into a restructuring
agreement (see Note 1).
I-34
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
OPERATING LEASES
Minimum rental commitments at year-end 1997 for all noncancelable operating
leases, consisting mainly of leases for data processing equipment and real
estate, are as follows (in millions):
<TABLE>
<S> <C>
1998............................................................... $324.1
1999............................................................... 276.4
2000............................................................... 174.2
2001............................................................... 119.1
2002............................................................... 97.1
Thereafter......................................................... 243.7
</TABLE>
Gross rental expense totaled $410 million in 1997, $401 million in 1996 and
$402 million in 1995. Rental commitments for subleases, contingent rentals and
executory costs were not significant.
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 estimated fair values presented at year-end
1997, those amounts have not been comprehensively revalued for purposes of
these financial statements since that date. Therefore, estimates of fair value
after year-end 1997 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:
<TABLE>
<CAPTION>
1997 1996
-------------------- --------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Financial assets
Cash and equivalents............... $ 101.7 $ 101.7 $1,150.6 $1,150.6
Investment in affiliate debt
securities........................ 142.4 142.4 122.5 122.5
Investments in equity securities... 303.0 303.0 254.5 254.5
Financial liabilities
Short-term borrowings.............. -- -- 200.0 200.0
Long-term debt
Corporate........................ 2,129.3 2,301.8 1,220.2 1,348.9
Long distance division........... 40.3 41.7 67.9 69.0
Local telecommunications
division........................ 1,710.0 1,812.3 1,785.8 1,846.9
Other financial instruments
Interest rate swap agreements...... -- 0.3 -- 0.2
Foreign currency contracts......... (0.6) (0.6) (0.5) (0.5)
</TABLE>
The carrying values of Sprint's cash and equivalents approximate fair value
at year-end 1997 and 1996. The estimated fair value of Sprint's investments in
debt and equity securities is based on quoted market prices. The estimated
fair value of Sprint'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. The estimated fair value of interest rate swap
agreements is the amount Sprint would receive to terminate the swap agreements
at year-end 1997 and 1996, taking into account the then-current interest
rates. The estimated fair value of foreign currency contracts is the
replacement cost of the contracts at year-end 1997 and 1996, taking into
account the then-current foreign currency exchange rates.
I-35
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
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 related 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 $150 and $350 million outstanding at year-end 1997 and 1996,
respectively. Net interest expense (income) related to interest rate swap
agreements was $(200,000) in 1997, $2 million in 1996 and $(400,000) in 1995.
There were no deferred gains or losses related to any terminated interest rate
swap agreements at year-end 1997, 1996 or 1995.
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 $29 and $46 million of open forward
contracts to buy various foreign currencies at year-end 1997 and 1996,
respectively. Sprint had $14 and $3 million of outstanding open purchase
option contracts to call various foreign currencies at year-end 1997 and 1996,
respectively. The premium paid for an option is expensed as incurred. The fair
value of an option is recorded as an asset at the end of each period. The
forward contracts and options open at year-end 1997 and 1996 all had original
maturities of six months or less. The net gain or loss recorded to reflect the
fair value of these contracts is recorded in the period incurred. Total net
losses of $40,000 in 1997, $400,000 in 1996 and $1 million in 1995 were
recorded related to foreign currency transactions and contracts.
12. EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board (FASB) issued
SFAS No. 128, "Earnings per Share." This new standard simplifies the EPS
calculation and makes the U.S. standard for computing EPS more consistent with
international accounting standards. Sprint adopted SFAS 128 at year-end 1997.
EPS for prior years has been restated to comply with SFAS 128.
Under SFAS 128, primary EPS was replaced with a simpler calculation called
basic EPS. Basic EPS is calculated by dividing income available to common
stockholders by the weighted average common shares outstanding. Previously,
primary EPS was based on the weighted average of both outstanding and issuable
shares assuming all dilutive options had been exercised. Under SFAS 128, fully
diluted EPS has not changed significantly, but has been renamed diluted EPS.
Diluted EPS includes the effect of all potentially dilutive securities, such
as options and convertible preferred stock.
Sprint's convertible preferred stock dividends were $0.5 million in 1997,
1996 and 1995. Dilutive securities, such as options (see Note 9), included in
the calculation of diluted weighted average common shares were 6.3 million
shares in 1997, 5.3 million shares in 1996 and 2.6 million shares in 1995.
Dilutive securities represented 8.0 and 5.8 million shares (unaudited) for the
nine months ended September 30, 1998 and 1997, respectively.
I-36
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
13. PARANET ACQUISITION
On September 30, 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. Sprint could pay up to an additional
$70 million if Sprint Paranet meets certain financial targets through 1998.
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 will be amortized on a straight-line basis over four to 10 years.
14. ADOPTION OF ACCOUNTING PRINCIPLES FOR A COMPETITIVE MARKETPLACE
At year-end 1995, Sprint determined that its local telecommunications
division no longer met the criteria necessary for the continued use of SFAS
71. As a result, 1995 operating results included a noncash, extraordinary
charge of $565 million, net of income tax benefits of $437 million. The
decision to discontinue using SFAS 71 was based on changes in the regulatory
framework and the convergence of competition in the telecommunications
industry.
The 1995 extraordinary charge recognized when Sprint discontinued using SFAS
71 consisted of the following:
<TABLE>
<CAPTION>
PRETAX AFTER-TAX
-------- ---------
(IN MILLIONS)
<S> <C> <C>
Increase in accumulated depreciation.................. $ 979.1 $607.9
Recognition of switch software asset.................. (99.5) (61.7)
Elimination of other net regulatory asset............. 123.1 76.3
-------- ------
Total............................................. $1,002.7 622.5
========
Tax-related net regulatory liabilities................ (43.9)
Accelerated amortization of investment tax credits.... (13.3)
------
Extraordinary charge.................................. $565.3
======
</TABLE>
15. SPINOFF OF CELLULAR DIVISION
In March 1996, Sprint completed the tax-free spinoff of Cellular to Sprint
common stockholders. 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.
I-37
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Cellular's net operating results, as summarized below, 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 and
$13 million in 1995, were reallocated to Sprint's other operating segments.
<TABLE>
<CAPTION>
1996(1) 1995
------- -------
(IN MILLIONS)
<S> <C> <C>
Net operating revenues.................................. $190.2 $ 834.4
Operating expenses...................................... 156.0 675.6
------ -------
Operating income........................................ 34.2 158.8
Interest expense........................................ (21.5) (124.0)
Other income (expense), net............................. (8.3) 10.9
------ -------
Income before income taxes.............................. 4.4 45.7
Income taxes............................................ (7.0) (31.2)
------ -------
Income (Loss) from cellular division.................... $ (2.6) $ 14.5
====== =======
</TABLE>
- --------
(1) 1996 reflects Cellular's operating results only through the date of the
Spinoff.
16. SEGMENT INFORMATION
The FON Group operates in four industry segments: the long distance
division, the local telecommunications division, the product distribution and
directory publishing division and emerging businesses. Sprint's corporate
assets mainly included investments and loans to affiliates, cash and temporary
investments and general corporate assets. In 1995, corporate assets also
included the net assets of the discontinued cellular division. The long
distance division provides domestic and international voice, video and data
communications services. The local telecommunications division provides local
exchange services, access to Sprint's local exchange facilities, sales of
telecommunications equipment and long distance within specified geographical
areas. The product distribution and directory publishing division provides
wholesale distribution services of telecommunications products and publishes
and markets white and yellow page telephone directories. Emerging businesses,
which consists of the development of new integrated communications services,
consumer Internet access services, Sprint Paranet and Sprint International.
The businesses comprising the PCS Group operate in a single segment. The PCS
Group is building the nation's first single-technology, all-digital, state-of-
the-art wireless network to provide PCS across the United States. PCS uses
digital technology, which has sound quality superior to existing cellular
technology and is less susceptible to interference and eavesdropping. PCS also
offers features such as voice mail and Caller ID.
I-38
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Industry segment financial information follows:
<TABLE>
<CAPTION>
PRODUCT
DISTRIBUTION
LONG LOCAL & DIRECTORY
DISTANCE TELECOMMUNICATIONS PUBLISHING EMERGING INTERSEGMENT
DIVISION DIVISION DIVISION BUSINESSES PCS CORPORATE ELIMINATIONS TOTAL
-------- ------------------ ------------ ---------- ------- --------- ------------ ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1997
Net operating
revenues(1)........... $8,954.8 $5,290.2 $1,454.3 $ 57.4 $ -- $ -- $(882.8) $14,873.9
Depreciation and
amortization.......... 716.7 934.1 8.2 23.3 -- 44.0 -- 1,726.3
Operating expenses..... 7,857.3 3,896.2 1,274.4 221.9 18.5 -- (845.8) 12,422.5
Operating income(loss). 1,097.5 1,394.0 179.9 (164.5) (18.5) -- (37.0) 2,451.4
Operating margin....... 12.3% 26.4% 12.4% -- -- -- -- 16.5%
Capital expenditures... 1,218.1 1,258.4 10.5 79.6 153.7 142.3 -- 2,862.6
Identifiable assets.... 6,464.6 7,609.7 519.0 585.9 1,693.1 1,312.5 -- 18,184.8
1996
Net operating
revenues(2)........... $8,302.1 $5,126.8 $1,225.4 $ 0.5 $ -- $ -- $(767.3) $13,887.5
Depreciation and
amortization.......... 633.3 909.1 7.2 0.5 -- 40.9 -- 1,591.0
Operating expenses..... 7,378.1 3,789.8 1,123.8 63.8 0.5 -- (735.7) 11,620.3
Operating income(loss). 924.0 1,337.0 101.6 (63.3) (0.5) -- (31.6) 2,267.2
Operating margin....... 11.1% 26.1% 8.3% -- -- -- -- 16.3%
Capital expenditures... 1,133.7 1,142.6 9.4 49.9 -- 98.0 -- 2,433.6
Identifiable assets.... 5,997.7 7,425.4 446.1 54.3 1,259.8 1,643.1 -- 16,826.4
1995
Net operating
revenues(3)........... $7,277.4 $4,690.0 $1,147.6 $ -- $ -- $ -- $(379.7) $12,735.3
Depreciation and
amortization.......... 581.6 835.6 7.4 -- -- 41.8 -- 1,466.4
Operating expenses..... 6,570.6 3,649.2 1,060.9 -- -- -- (379.7) 10,901.0
Operating income....... 706.8 1,040.8 86.7 -- -- -- -- 1,834.3
Operating margin....... 9.7% 22.2% 7.6% -- -- -- -- 14.4%
Capital expenditures... 861.7 950.8 7.8 -- -- 37.0 -- 1,857.3
Identifiable assets.... 4,799.0 6,962.0 395.4 -- 973.7 1,944.2 -- 15,074.3
</TABLE>
- --------
(1) Includes intercompany revenues eliminated in consolidation in 1997 of $3.3
million, $309.0 million and $570.5 million for the long distance division,
local telecommunications division and product distribution and directory
publishing division, respectively.
(2) Includes intercompany revenues eliminated in consolidation in 1996 of
$30.9 million, $410.5 million and $325.9 million for the long distance
division, local telecommunications division and product distribution and
directory publishing division, respectively.
(3) Includes intercompany revenues eliminated in consolidation in 1995 of
$38.9 million, $266.4 million and $336.8 million for the long distance
division, local telecommunications division and product distribution and
directory publishing division, respectively. Also included in 1995 were
intercompany revenues of $262.4 million not eliminated under SFAS 71.
Operating income (loss) represents sales and other revenues less operating
expenses, and excludes interest expense, equity in losses of unconsolidated
ventures, other income (expense) and income taxes.
Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between affiliates to more accurately reflect market pricing. The
main effect of the pricing change was to reduce "net operating revenues" of
the local telecommunications division and reduce "operating expenses" of the
product distribution and directory publishing division. Had this change been
effective as of January 1, 1995, the operating income for the local
telecommunications division would have been $1.3 billion, $1.2 billion and
$1.1 billion in 1997, 1996 and 1995, respectively. The operating income for
the product distribution and directory publishing division would have been
$228 million, $198 million and $180 million in 1997, 1996 and 1995,
respectively.
I-39
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
17. ADDITIONAL FINANCIAL INFORMATION
SUPPLEMENTAL CASH FLOWS INFORMATION (IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
------------------- --------------------
1998 1997 1997 1996 1995
--------- --------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash paid for:
Interest (net of amounts
capitalized)
Continuing operations............. $ 174.1 $ 133.2 $197.9 $212.1 $263.5
========= ========= ====== ====== ======
Cellular division................. $ -- $ -- $ -- $ 21.5 $124.0
========= ========= ====== ====== ======
Income taxes........................ $ 279.1 $ 288.5 $365.8 $695.3 $532.8
========= ========= ====== ====== ======
Noncash activities:
Capital lease obligations........... $ 438.1 $ 30.1 $ 30.1 $ -- $ --
========= ========= ====== ====== ======
Tax benefit from stock options
exercised.......................... $ 37.8 $ 19.5 $ 26.2 $ 14.1 $ 7.5
========= ========= ====== ====== ======
Net book value of assets and
liabilities contributed to Global
One................................ $ -- $ -- $ -- $ 73.3 $ --
========= ========= ====== ====== ======
Common stock issued under Sprint's
ESPP............................... $ 73.8 $ -- $ 5.2 $ 65.2 $ 3.0
========= ========= ====== ====== ======
</TABLE>
During 1996, Sprint completed the Spinoff (see Note 15) which had no
immediate effect on cash flows other than Cellular's repayment of $1.4 billion
in intercompany debt owed to Sprint.
SUPPLEMENTAL RELATED PARTY TRANSACTIONS
Sprint provided various voice, data and administrative services to Global
One totaling $415 million in 1997 and $361 million in 1996. In addition,
Global One provided data and administrative services to Sprint totaling $114
million in 1997 and $130 million in 1996. At year-end 1997 and 1996, Sprint's
receivable from Global One was $154 and $163 million, respectively, and
Sprint's payable to Global One was $104 and $49 million, respectively.
RESTRUCTURING CHARGE
In 1995, Sprint's local telecommunications division recorded an $88 million
restructuring charge, which reduced income from continuing operations by $55
million ($0.16 per share). The restructuring plan included the planned
elimination over several years of approximately 1,600 positions, mainly in the
network and finance functions. Through 1997, most of the positions have been
eliminated resulting in termination benefit payments of $42 million, with the
remainder to be paid in 1998 and 1999.
18. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information." This new standard requires companies
to disclose segment data based on how management makes decisions about
allocating resources to segments and how it measures segment performance. SFAS
131 requires companies to disclose a measure of segment profit or loss
(operating income, for example), segment assets, and reconciliations to
consolidated totals. It also requires entity-wide disclosures about a
company's products and services, its major customers and the material
countries in which it holds assets and reports revenues. Sprint will adopt
SFAS 131 in its 1998 year-end financial statements. This statement is not
expected to have a significant effect on Sprint's reported segments.
I-40
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
In February 1998, the FASB issued SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits." SFAS 132 standardizes the
disclosure requirements for pensions and postretirement benefits where
practical. It also eliminates certain disclosures and requires additional
information on changes in benefit obligations and fair values of plan assets.
Sprint will adopt SFAS 132 in its 1998 year-end financial statements. SFAS 132
is not expected to have a significant effect on Sprint's pension and
postretirement benefit plan disclosures.
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires all derivatives to be
recorded on the balance sheet as either assets or liabilities and measured at
fair value. Gains or losses resulting from changes in the values of the
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. Sprint will adopt SFAS 133
beginning January 1, 2000. This statement is not expected to have a material
impact on Sprint.
19. SUBSEQUENT EVENTS (UNAUDITED)
BORROWINGS
During the first nine months of 1998, Sprint increased its short-term
borrowings by $946 million. These borrowings, however, have been classified as
long-term debt because of Sprint's intent and ability, through unused credit
facilities, to refinance them on a long-term basis. The borrowings have
weighted average interest rates of 5.8%. Sprint also increased its
construction obligations by $429 million since year-end 1997.
In August 1998, Sprint entered into new revolving credit facilities with
syndicates of banks totaling $5.0 billion. These facilities support Sprint's
commercial paper operations and replace its previous $1.5 billion revolving
credit facility. At September 30, 1998, $3.6 billion was available under these
facilities.
In October 1998, Sprint filed a shelf registration statement with the SEC
for $8.0 billion of debt securities. This replaced $1.0 billion of Sprint's
previous shelf registration statements totaling $1.1 billion. Sprint currently
expects to offer up to $3 billion under the new shelf at approximately the
same time as the PCS Restructuring.
OTHER
In April 1998, Sprint signed an agreement to sell approximately 80,000
residential and business access lines in rural Illinois. Sprint expects to
complete the sale of these properties, which is subject to regulatory
approval, and record the related gain in November 1998.
In October 1998, Sprint's Board of Directors declared common and Class A
common stock dividends of $0.25 per share payable December 28, 1998.
20. COMPREHENSIVE INCOME (UNAUDITED)
In 1998, Sprint adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS
130 establishes standards for the reporting and display of comprehensive
income and its components. Comprehensive income includes all changes in equity
during a period except those due to owner investments and distributions. It
includes items such as foreign currency translation adjustments, and
unrealized gains and losses on available-for-sale securities. This standard
does not change the display or components of present-day net income; rather,
comprehensive income is displayed as a separate statement in the Consolidated
Statements of Comprehensive Income and as an additional component in the
Consolidated Balance Sheets, and the Consolidated Statement of Common Stock
and Other Shareholders' Equity.
Total comprehensive income amounted to $671 million during the first nine
months of 1998 and $770 million during the first nine months of 1997.
I-41
<PAGE>
SPRINT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
21. QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
QUARTER
-----------------------------------
1ST 2ND 3RD 4TH
-------- -------- -------- --------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C>
1997
Net operating revenues(1)................ $3,578.5 $3,667.5 $3,778.9 $3,849.0
Operating income(1), (2)................. 604.7 595.5 640.7 610.5
Income before extraordinary items(2),
(3)..................................... 290.0 255.9 211.7 194.9
Net income............................... 290.0 255.9 211.7 194.9
EPS from income before extraordinary
items(4)
Basic.................................. $ 0.67 $ 0.59 $ 0.49 $ 0.45
Diluted................................ $ 0.67 $ 0.59 $ 0.49 $ 0.45
<CAPTION>
QUARTER
-----------------------------------
1ST 2ND 3RD 4TH
-------- -------- -------- --------
(IN MILLIONS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C> <C>
1996
Net operating revenues(1)................ $3,335.3 $3,471.3 $3,502.5 $3,578.4
Operating income(1), (2)................. 574.9 580.9 598.9 512.5
Income before extraordinary items(2)..... 309.3 316.8 316.2 246.0
Net income............................... 309.3 316.8 312.4 245.3
EPS from income before extraordinary
items(4)
Basic.................................. $ 0.78 $ 0.74 $ 0.73 $ 0.57
Diluted................................ $ 0.77 $ 0.73 $ 0.73 $ 0.56
</TABLE>
- --------
(1) Consolidated net operating revenues and operating expenses reflect certain
reclassifications to conform to the current presentation. These
reclassifications had no effect on operating income or net income.
(2) In the 1997 second quarter and the 1996 fourth quarter, Sprint recorded
nonrecurring charges of $20 and $60 million, respectively, related to
litigation within the long distance division. These charges reduced income
from continuing operations by $13 million ($0.03 per share) and $36
million ($0.09 per share), respectively (see Note 10).
(3) In the 1997 fourth quarter, Sprint recognized gains of $45 million on
sales of local exchanges and a $26 million gain on the sale of an equity
investment in an equipment provider. These gains increased income from
continuing operations by $27 million ($0.06 per share) and $17 million
($0.04 per share), respectively.
(4) Sprint adopted SFAS 128 at year-end 1997 (see Note 12). All EPS amounts
comply with this new standard.
I-42
<PAGE>
SPRINT CORPORATION
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma condensed combined financial statements
are presented to give effect to (1) the PCS Restructuring whereby Sprint will
acquire the joint venture interests of the Cable Parents in Sprint Spectrum
Holdings and the joint venture interests of TCI and Cox in PhillieCo, in
exchange for shares of Series 2 PCS Stock, and the exercise of Equity Purchase
Rights by FT and DT in connection with the PCS Restructuring and (2) the tax-
free Recapitalization of Sprint's common stock to be effected by reclassifying
each share of Sprint's Existing Common Stock into 1/2 share of Series 1 PCS
Stock and one share of Series 1 FON Stock and by reclassifying each share of
DT Class A Stock held by DT and each share of Existing Class A Common Stock
held by FT so that each share represents an equity interest in the FON Group
and an equity interest in the PCS Group, together with a right to cause Sprint
to initially issue one share of Series 3 FON Stock and 1/2 share of Series 3
PCS Stock. For purposes of these pro forma financial statements, the proceeds
from the sale of additional shares to FT and DT are assumed to be used for
working capital needs and to fund the buildout of the PCS network. If the debt
issuance discussed below is completed, all or a portion of such proceeds may
instead be used to retire existing indebtedness of the PCS Group. The
acquisitions of the Cable Parents' interests in Sprint Spectrum Holdings and
PhillieCo will be accounted for using the purchase method of accounting. The
pro forma condensed combined financial statements included herein do not give
effect to the proposed initial public offering ("IPO") of the Series 1 PCS
Stock and there can be no assurance that the IPO will occur.
Sprint currently anticipates conducting a debt offering of up to $3 billion
at approximately the same time as the PCS Restructuring. Sprint currently
expects that the proceeds from the proposed debt issuance will be used to
repay indebtedness. The pro forma condensed combined financial statements
included herein do not give effect to the proposed debt issuance. There can be
no assurance that such debt issuance will occur.
The unaudited pro forma condensed combined statements of income include the
historical results of Sprint and the historical combined results of Sprint
Spectrum Holdings and PhillieCo for the year ended December 31, 1997 and the
nine months ended September 30, 1998, and include the effect of the PCS
Restructuring, Recapitalization and exercise of Equity Purchase Rights by FT
and DT as though such transactions had occurred on January 1, 1997. The
unaudited pro forma condensed combined balance sheet is based upon the
historical balance sheet of Sprint and the historical combined balance sheet
of Sprint Spectrum Holdings and PhillieCo as of September 30, 1998. The
historical balance sheet amounts have been adjusted to reflect the PCS
Restructuring, Recapitalization and exercise of Equity Purchase Rights by FT
and DT as though such transactions had occurred on September 30, 1998. Certain
historical amounts have been reclassified to conform to the pro forma
presentation. These reclassifications had no effect on the results of
operations or stockholders' equity as previously reported.
The pro forma condensed combined statements of income are not necessarily
indicative of what actual results of operations would have been had the
transactions occurred at the beginning of the periods presented nor do they
purport to indicate the results of future operations. The unaudited pro forma
condensed combined financial statements should be read in conjunction with the
historical financial statements of Sprint and the historical combined
financial statements of Sprint Spectrum Holdings and PhillieCo included
elsewhere in this Current Report on Form 8-K.
I-43
<PAGE>
SPRINT CORPORATION
PRO FORMA CONDENSED COMBINED BALANCE SHEET
SEPTEMBER 30, 1998
(Unaudited, in millions)
<TABLE>
<CAPTION>
HISTORICAL
COMBINED
SPRINT PRO FORMA ADJUSTMENTS
HISTORICAL SPECTRUM ------------------------------
SPRINT HOLDINGS AND PCS
CORP. PHILLIECO RESTRUCTURING RECAPITALIZATION PRO FORMA
---------- ------------ ------------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets
Cash and equivalents... $ 47.7 $ 325.3 $ (26.5)A $ 428.8
82.3 F
Accounts receivable,
net................... 2,515.8 195.3 (47.1)D 2,664.0
Inventories............ 349.9 177.8 527.7
Notes and other re-
ceivables............. 407.8 -- 407.8
Prepaid expenses and
other current assets.. 422.7 44.1 (153.6)C 313.2
--------- -------- -------- ---------
Total current assets... 3,743.9 742.5 (144.9) 4,341.5
Investments in equity
securities............. 420.2 -- 420.2
Property, plant and
equipment, net......... 13,502.2 4,531.9 18,034.1
Investment in and ad-
vances to Sprint Spec-
trum Holdings and
PhillieCo. ............ 610.1 -- (293.4)B --
(182.0)B
(134.7)E
Investments in and ad-
vances to other affil-
iates.................. 634.0 -- 634.0
Intangibles, net
PCS licenses........... 544.5 2,829.1 3,373.6
Customer base.......... -- -- 500.0 A 500.0
Goodwill............... 346.6 -- 3,127.6 A 3,474.2
Other assets............ 652.3 422.9 182.0 B 1,257.2
--------- -------- -------- ------- ---------
Total................... $20,453.8 $8,526.4 $3,054.6 $ -- $32,034.8
========= ======== ======== ======= =========
LIABILITIES AND STOCK-
HOLDERS' EQUITY
Current liabilities
Current maturities of
long-term debt........ $ 80.6 $ 124.5 $ 205.1
Partner advances....... -- 185.0 $ (134.7)E 50.3
Accounts payable....... 1,099.0 287.1 1,386.1
Accrued interconnec-
tion costs............ 564.7 -- 564.7
Accrued taxes.......... 399.2 -- 399.2
Advance billings....... 213.3 -- 213.3
Other.................. 849.0 476.4 (47.1)D 1,278.3
--------- -------- -------- ---------
Total current liabili-
ties.................. 3,205.8 1,073.0 (181.8) 4,097.0
Construction obliga-
tions.................. 429.0 575.7 1,004.7
Long-term debt.......... 5,039.8 6,001.2 60.5 A 10,963.5
(138.0)C
Deferred credits and
other liabilities
Deferred income taxes
and investment tax
credits............... 1,029.2 -- 443.0 A 1,472.2
Postretirement and
other benefit obliga-
tions................. 1,067.4 -- 1,067.4
Other.................. 370.8 84.9 455.7
--------- -------- -------- ---------
Total deferred credits
and other liabili-
ties.................. 2,467.4 84.9 443.0 2,995.3
Redeemable preferred
stock.................. 9.5 -- 9.5
Limited partner inter-
est in consolidated
subsidiary............. -- 65.8 65.8
Common stock and other
stockholders' equity
Common stock
Common stock.......... 875.7 -- $(875.7)H --
Class A common stock.. 215.6 -- 215.6
FON Group............. -- -- 700.6 H 700.6
PCS Group............. -- -- 195.1 A 175.1 H 375.1
4.9 F
Preferred stock........ -- -- 240.0 G 240.0
Capital in excess of
par or stated value... 4,490.8 4,611.0 3,094.9 A 7,663.1
(2,526.6)A
(1,844.4)B
77.4 F
(240.0)G
Retained earnings...... 4,012.7 (3,885.2) 2,334.2 A 4,012.7
1,551.0 B
Treasury stock, at
cost.................. (396.1) -- (396.1)
Other.................. 103.6 -- (15.6)C 88.0
--------- -------- -------- ------- ---------
Total common stock and
other stockholders'
equity................ 9,302.3 725.8 2,870.9 -- 12,899.0
--------- -------- -------- ------- ---------
Total................... $20,453.8 $8,526.4 $3,054.6 $ -- $32,034.8
========= ======== ======== ======= =========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial
Statements.
I-44
<PAGE>
SPRINT CORPORATION
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
NINE MONTHS ENDED SEPTEMBER 30, 1998
(Unaudited, in millions, except per share data)
<TABLE>
<CAPTION>
HISTORICAL
COMBINED
SPRINT PRO FORMA ADJUSTMENTS
HISTORICAL SPECTRUM ------------------------------
SPRINT HOLDINGS AND PCS
CORP. PHILLIECO RESTRUCTURING RECAPITALIZATION PRO FORMA
---------- ------------ ------------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
NET OPERATING REVENUES.. $11,940.3 $ 787.9 $12,728.2
OPERATING EXPENSES
Costs of services and
products............... 5,691.3 783.0 6,474.3
Selling, general and
administrative......... 2,802.0 931.6 3,733.6
Depreciation and amor-
tization............... 1,429.1 529.2 $ 5.2 I 2,147.1
58.6 J
125.0 K
--------- --------- ------ ---------
Total operating ex-
penses................. 9,922.4 2,243.8 188.8 12,355.0
--------- --------- ------ ---------
OPERATING INCOME
(LOSS)................. 2,017.9 (1,455.9) (188.8) 373.2
Interest expense........ (185.6) (358.3) 36.0 L (491.9)
11.2 M
4.8 N
Equity in loss of
Global One............. (120.0) -- (120.0)
Equity in loss of
Sprint Spectrum Hold-
ings and PhillieCo..... (686.5) -- 681.3 I --
5.2 I
Other income............ 48.6 23.2 (11.2)M 60.6
Minority interest....... -- 99.0 99.0
--------- --------- ------ ---------
Income (loss) before
income taxes and
extraordinary item..... 1,074.4 (1,692.0) 538.5 (79.1)
Income taxes............ (405.1) -- 399.0 O 27.2
33.3 P
--------- --------- ------ ---------
INCOME (LOSS) FROM
CONTINUING OPERATIONS.. 669.3 (1,692.0) 970.8 (51.9)
Preferred stock divi-
dends.................. (0.8) -- (5.4)Q (6.2)
--------- --------- ------ ---------
Earnings (loss) appli-
cable to common stock.. $ 668.5 $(1,692.0) $965.4 $ (58.1)
========= ========= ====== =========
Earnings (loss) appli-
cable to common stock:
Sprint Corporation..... $ 668.5 $ --
FON Group.............. -- 1,132.0
PCS Group.............. -- (1,190.1)
--------- ---------
$ 668.5 $ (58.1)
========= =========
BASIC EARNINGS (LOSS)
PER COMMON SHARE FROM
CONTINUING OPERATIONS:
Sprint Corporation..... $ 1.55 $ --
========= =========
FON Group.............. $ -- $ 2.63
========= =========
PCS Group.............. $ -- $ (2.86)
========= =========
Basic weighted average
common shares:
Sprint Corporation..... 430.7 -- R
========= =========
FON Group.............. -- 430.7 S
========= =========
PCS Group.............. -- 415.4 T
========= =========
DILUTED EARNINGS (LOSS)
PER COMMON SHARE FROM
CONTINUING OPERATIONS:
Sprint Corporation..... $ 1.52 $ --
========= =========
FON Group.............. $ -- $ 2.58
========= =========
PCS Group.............. $ -- $ (2.86)
========= =========
Diluted weighted aver-
age common shares:
Sprint Corporation..... 438.7 -- R
========= =========
FON Group.............. -- 438.7 S
========= =========
PCS Group.............. -- 415.4 T
========= =========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial
Statements.
I-45
<PAGE>
SPRINT CORPORATION
PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME
YEAR ENDED DECEMBER 31, 1997
(Unaudited, in millions, except per share data)
<TABLE>
<CAPTION>
HISTORICAL
COMBINED
SPRINT PRO FORMA ADJUSTMENTS
HISTORICAL SPECTRUM ------------------------------
SPRINT HOLDINGS AND PCS
CORP. PHILLIECO RESTRUCTURING RECAPITALIZATION PRO FORMA
---------- ------------ ------------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
NET OPERATING REVENUES.. $14,873.9 $ 258.0 $15,131.9
OPERATING EXPENSES
Costs of services and
products............... 7,451.0 574.3 8,025.3
Selling, general and
administrative......... 3,245.2 747.1 3,992.3
Depreciation and
amortization........... 1,726.3 316.3 $ 3.5 I 2,291.0
78.2 J
166.7 K
--------- --------- ------ ---------
Total operating
expenses............... 12,422.5 1,637.7 248.4 14,308.6
--------- --------- ------ ---------
OPERATING INCOME (LOSS). 2,451.4 (1,379.7) (248.4) 823.3
Interest expense........ (187.2) (123.5) 12.6 L (278.2)
13.5 M
6.4 N
Equity in loss of Global
One.................... (162.1) -- (162.1)
Equity in loss of Sprint
Spectrum Holdings and
PhillieCo.............. (659.6) -- 656.1 I --
3.5 I
Equity in loss of
unconsolidated
partnership............ -- (168.9) (168.9)
Other income............ 140.5 39.4 (13.5) M 166.4
--------- --------- ------ ---------
Income (loss) before
income taxes........... 1,583.0 (1,632.7) 430.2 380.5
Income taxes............ (630.5) -- 383.1 O (189.4)
58.0 P
--------- --------- ------ --- ---------
NET INCOME (LOSS)....... 952.5 (1,632.7) 871.3 191.1
Preferred stock
dividends.............. (1.0) -- (7.2) Q (8.2)
--------- --------- ------ ---------
Earnings applicable to
common stock........... $ 951.5 $(1,632.7) $864.1 $ 182.9
========= ========= ====== =========
Earnings (loss)
applicable to common
stock:
Sprint Corporation..... $ 951.5 $ --
FON Group.............. -- 1,373.6
PCS Group.............. -- (1,190.7)
--------- ---------
$ 951.5 $ 182.9
========= =========
BASIC EARNINGS (LOSS)
PER COMMON SHARE:
Sprint Corporation..... $ 2.21 $ --
========= =========
FON Group.............. $ -- $ 3.19
========= =========
PCS Group.............. $ -- $ (2.87)
========= =========
Basic weighted average
common shares:
Sprint Corporation .... 430.2 -- R
========= =========
FON Group.............. -- 430.2 S
========= =========
PCS Group.............. -- 415.1 T
========= =========
DILUTED EARNINGS (LOSS)
PER COMMON SHARE:
Sprint Corporation..... $ 2.18 $ --
========= =========
FON Group.............. $ -- $ 3.15
========= =========
PCS Group.............. $ -- $ (2.87)
========= === =========
Diluted weighted average
common shares:
Sprint Corporation..... 436.5 -- R
========= =========
FON Group.............. -- 436.5 S
========= =========
PCS Group.............. -- 415.1 T
========= =========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial
Statements.
I-46
<PAGE>
SPRINT CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following adjustments have been made in the preparation of the unaudited
pro forma condensed combined financial statements:
Pro Forma Balance Sheet Adjustments
A To record the purchase of the remaining 60% of Sprint Spectrum Holdings and
52.9% of PhillieCo. The consideration given in connection with the purchase
will be shares of Series 2 PCS Stock (195.1 million shares, par value
$1.00) and warrants to purchase additional shares of Series 2 PCS Stock.
The preliminary purchase price is based on the estimated market value of
the PCS Group and will be updated at the time of the PCS Restructuring. The
market value of the PCS Group will be determined based on the market value
of the securities issued in the Recapitalization. The excess of the
purchase price over the fair value of net assets to be acquired has been
preliminarily calculated as follows (in millions):
<TABLE>
<S> <C>
Preliminary purchase price....................................... $3,290.0
Transaction costs................................................ 26.5
Net assets to be acquired........................................ (192.4)
Customer base.................................................... (500.0)
Step-up in long-term debt to fair value.......................... 60.5
Deferred taxes on acquired assets and liabilities................ 443.0
--------
Goodwill......................................................... $3,127.6
========
</TABLE>
The carrying amounts of the assets to be acquired and liabilities to be
assumed are assumed for purposes of the preliminary purchase price
allocation to approximate fair market value, except for certain long-term
debt of Sprint Spectrum that has been recorded at fair value. A portion of
the purchase price was attributed to the customers acquired in the Sprint
Spectrum Holdings and PhillieCo acquisitions. In addition, deferred taxes
have been recorded for the difference in the book and tax bases of the
assets acquired and liabilities assumed. The above assumptions as to the
fair value of the net assets acquired are based upon information available
at the time of the preparation of these pro forma condensed combined
financial statements.
A final allocation of the purchase price to the assets acquired and
liabilities assumed is dependent on a study and analysis of the fair value
of such assets and liabilities, including such items as the PCS licenses
and in-process research and development projects, as well as the size of
the customer base at the closing date. Management expects the only
assumptions that could potentially be subject to material change are those
regarding customer base and in-process research and development. The amount
of the purchase price allocated to the customer base in the pro forma
condensed combined financial statements is based on the size of the
customer base at September 30, 1998. To the extent the customer base at the
closing date exceeds the size of the customer base at September 30, 1998,
the purchase price allocated to the customer base will likely increase
along with a corresponding increase in the amortization of the customer
base. Based on current projections of an increase in the customer base at
November 30, 1998, pro forma net income (loss) from continuing operations
for the nine months ended September 30, 1998 and the year ended December
31, 1997 would be $(63.6) million and $175.4 million, respectively, and the
respective loss per share of the PCS Group would be $(2.89) and $(2.91) for
the same periods. Sprint is undertaking an analysis to determine whether
in-process research and development projects acquired in the PCS
Restructuring should be capitalized or expensed. This analysis is expected
to be finalized prior to the completion of the final purchase price
allocation. To the extent that it is determined through this analysis that
some of the in-process research and development projects should be
expensed, a portion of the purchase price will be allocated to these in-
process research and development projects and a nonrecurring, noncash
charge will be recognized in the period in which the charge
I-47
<PAGE>
SPRINT CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS--
(CONTINUED)
occurs. Sprint is unable to determine the potential amount of such charge
at this time. However, such a charge could be material to Sprint's results
of operations for the period in which the charge occurs. Such a write-off
would reduce the amount of purchase price allocated to goodwill, which
would result in lower amortization expense being recognized over the life
assigned to the goodwill. Such a write-off would not impact future cash
flows. At the present time, Sprint anticipates completing its final
purchase price allocation prior to year-end 1998.
B To eliminate Sprint's historical investment in Sprint Spectrum Holdings and
PhillieCo, accounted for by Sprint on the equity method of accounting
($293.4 million), and to reclassify interest capitalized as part of that
investment to other assets ($182.0 million).
C To eliminate Sprint's investment in Sprint Spectrum bonds ($153.6 million)
and the related unrealized gain ($15.6 million).
D To eliminate Sprint's payable to Sprint Spectrum Holdings.
E To eliminate Sprint's advances to PhillieCo.
F To record the exercise of Equity Purchase Rights by FT and DT (4.9 million
shares, par value $1.00). As a result of the issuance of Series 2 PCS Stock
to the Cable Parents in exchange for their interests in Sprint Spectrum
Holdings and PhillieCo, the sale of these additional shares is required in
order for FT and DT to maintain their combined 20% voting interest in
Sprint. For purposes of these pro forma financial statements, all of the
proceeds are assumed to be used for working capital needs and to fund the
buildout of the PCS network. If the offering of debt securities referred to
above is completed, all or a portion of the proceeds from the sale of
additional shares to FT and DT may be used to reduce long-term debt. If all
of the proceeds are used to repay such debt, the pro forma balance of long-
term debt and cash and equivalents would be $10,881.2 million and $346.5
million, respectively. If long-term debt is repaid, deferred financing
costs associated with such debt would be written off, resulting in pro
forma balances of $1,255.2 million and $4,010.7 million for other assets
and retained earnings, respectively. Additionally, interest expense would
be reduced, resulting in pro forma interest expense and income tax expense
(benefit) of $486.8 million and ($25.2) million, respectively, for the nine
months ended September 30, 1998 and $270.7 million and $192.3 million,
respectively, for the year ended December 31, 1997.
G To reflect PCS Preferred Stock issued to the Cable Parents in exchange for
funding provided between the date of the Restructuring Agreement (May 26,
1998) and September 30, 1998. See "The Tracking Stock Proposal--Funding of
the PCS Group Prior to Closing; The PCS Preferred Stock" in the Proxy
Statement.
H To record the effects of the Recapitalization of Sprint's Existing Common
Stock into one share of Series 1 FON Stock, par value $2.00 (350.3 million
shares) and 1/2 share of Series 1 PCS Stock, par value $1.00 (175.1 million
shares).
Pro Forma Statement of Income Adjustments
I To eliminate Sprint's equity in the losses of Sprint Spectrum Holdings and
PhillieCo, historically accounted for by Sprint on the equity method of
accounting ($681.3 million for the nine months ended September 30, 1998 and
$656.1 million for the year ended December 31, 1997). The amortization of
interest previously capitalized on Sprint's equity investment in Sprint
Spectrum Holdings and PhillieCo has been reclassified to depreciation and
amortization expense ($5.2 million for the nine months ended September 30,
1998 and $3.5 million for the year ended December 31, 1997).
I-48
<PAGE>
SPRINT CORPORATION
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS--
(CONTINUED)
J To reflect the amortization of the goodwill recorded in connection with the
purchase of the remaining interests in Sprint Spectrum Holdings and
PhillieCo, which is being amortized over 40 years. The goodwill associated
with the acquisition of the remaining interests in Sprint Spectrum Holdings
and PhillieCo is directly related to both the acquisition of the PCS
licenses and the ongoing ability of the businesses to provide wireless
telecommunications services using these licenses. The 40-year life for
goodwill is consistent with the 40-year amortization period being used for
the PCS licenses.
K To reflect the amortization of the customer base recorded in connection
with the purchase of the remaining interests in Sprint Spectrum Holdings
and PhillieCo, which is being amortized over three years.
L To reduce interest expense resulting from the utilization of increased
current tax benefits (related to the acquisition of the remaining interest
in Sprint Spectrum Holdings and PhillieCo and the resulting consolidation
of these entities). The increased current tax benefits are assumed to
reduce Sprint's tax liability and Sprint's required borrowings. The
computation of the current tax benefit is performed on a quarterly basis,
and the resulting amount is applied to reduce the debt balance and,
therefore, interest expense, from that date forward. Interest expense is
computed using the weighted-average interest rate on the debt assumed to be
repaid, or not incurred, as appropriate. Such debt would have amounted to
$762.1 million and $375.3 million as of September 30, 1998 and December 31,
1997, respectively.
M To eliminate interest income recorded by Sprint and interest expense
recorded by Sprint Spectrum Holdings related to Sprint's investment in
Sprint Spectrum bonds.
N To reflect the amortization of the purchase price adjustment related to
long-term debt (see Note A).
O To record the income tax benefit, using the statutory income tax rate,
relating to the consolidation of the remaining interests in Sprint Spectrum
Holdings and PhillieCo.
P To record the impact on income taxes of pro forma adjustments K through N,
using the statutory income tax rate.
Q To reflect dividends at an assumed annual rate of 3% on PCS Preferred Stock
issued to the Cable Parents. As of September 30, 1998, $240.0 million of
funding by the Cable Parents between the date of the Restructuring
Agreement (May 26, 1998) and September 30, 1998 was assumed to be exchanged
for shares of PCS Preferred Stock. For a discussion of how the actual
dividend rate will be determined, see "Description of Capital Stock--
Description of PCS Preferred Stock; Preferred Inter-Group Interest" in the
Proxy Statement.
R The weighted average common shares outstanding for Sprint are eliminated in
the Recapitalization.
S The weighted average common shares outstanding for the FON Group reflect
the Recapitalization of Sprint's Existing Common Stock into shares of
Series 1 FON Stock on a share for share basis, including the FON Stock
attributes of the Class A Common Stock.
T The weighted average common shares outstanding for the PCS Group reflect
(1) the issuance of Series 2 PCS Stock to the Cable Parents in the PCS
Restructuring (195.1 million shares), (2) the Recapitalization of Sprint's
Existing Common Stock into 1/2 share of Series 1 PCS Stock, including the
PCS Stock attributes of the Class A Common Stock (215.4 million shares for
the nine months ended September 30, 1998 and 215.1 million shares for the
year ended December 31, 1997) and (3) the exercise of Equity Purchase
Rights by FT and DT in connection with the PCS Restructuring (4.9 million
shares).
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<PAGE>
ANNEX II--PCS GROUP INFORMATION
BUSINESS
The PCS Stock, when issued, is intended to track the performance of the PCS
Group. The following description should be read in conjunction with the PCS
Group financial statements and the notes thereto provided elsewhere in this
Annex. The term "Sprint Spectrum Holdings" refers to Sprint Spectrum Holding
Company, L.P., and to MinorCo, L.P. and their subsidiaries. Currently, the
partners of Sprint Spectrum Holdings are Sprint Enterprises, L.P., which has a
40% partnership interest, TCI Spectrum Holdings, Inc., which has a 30%
partnership interest, and Comcast Telephony Services and Cox Telephony
Partnership, each of which has a 15% partnership interest. The partners are
subsidiaries of Sprint, TCI, Comcast and Cox, respectively. The principal
subsidiaries of Sprint Spectrum Holdings are Sprint Spectrum, Cox PCS and APC.
The term "Sprint Spectrum" refers to Sprint Spectrum L.P., and its
subsidiaries. The term "Cox PCS" refers to Cox Communications PCS, L.P. and
its subsidiaries. The term "APC" refers to American PCS, L.P. and its
subsidiaries. The term "PhillieCo" refers to PhillieCo Partners I, L.P. and
PhillieCo Partners II, L.P. and their subsidiaries. Currently, the partners of
PhillieCo are Sprint Enterprises, L.P., which has a 47.1% partnership
interest, TCI Philadelphia Holdings, Inc., which has a 35.3% partnership
interest, and Cox Communications Wireless, Inc., which has a 17.6% partnership
interest. The partners of PhillieCo are subsidiaries of Sprint, TCI and Cox,
respectively. The term "SprintCom" refers to SprintCom, Inc. and SprintCom
Equipment Company, L.P., which are subsidiaries of Sprint.
GENERAL OVERVIEW OF THE PCS GROUP
The PCS Group, which markets its wireless telephony products and services
under the Sprint and Sprint PCS brand names, operates the only 100% digital
PCS wireless network in the United States with licenses to provide service
nationwide utilizing a single frequency band and a single technology. The PCS
Group owns licenses to provide service to the entire United States population,
including Puerto Rico and the U.S. Virgin Islands. At October 30, 1998, the
PCS Group operated PCS systems in 176 metropolitan markets within the United
States, including 39 of the 50 largest metropolitan areas in the United
States. By the end of the first half of 1999, the PCS Group expects to operate
PCS systems in all of the 50 largest metropolitan areas and 80 of the 100
largest metropolitan areas in the United States. The PCS Group currently
provides nationwide service through a combination of (i) operating its own
digital network in major metropolitan areas, (ii) affiliating with other
companies, primarily in and around smaller metropolitan areas, (iii) roaming
on analog cellular networks of other providers using Dual-Band/Dual-Mode
Handsets and (iv) roaming on digital PCS networks of other CDMA-based
providers. Since launching the first commercial PCS service in the
United States in November 1995, the PCS Group has experienced rapid customer
growth, providing service to more than 1.75 million customers as of September
30, 1998.
MEMBERS OF THE PCS GROUP
The PCS Group consists of the following entities: (i) Sprint Spectrum
Holdings (which includes Sprint Spectrum, Cox PCS and APC); (ii) PhillieCo;
and (iii) SprintCom.
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<PAGE>
Certain other information concerning the PCS Group (after giving effect to
the Tracking Stock Proposal), including the number of Pops covered by licenses
held by the PCS Group, is set forth in the chart below:
<TABLE>
<CAPTION>
SPRINT
ENTITY POPS(1) OWNERSHIP(2) LICENSES
------ ------------- ------------ --------
(IN MILLIONS)
<S> <C> <C> <C>
Sprint Spectrum Holdings
Sprint Spectrum....... 155.9 100.0% 30 MTAs
Cox PCS(/3/).......... 21.0 59.2 Los Angeles-San Diego-Las Vegas MTA
APC................... 8.3 100.0 Washington D.C.-Baltimore MTA
PhillieCo............... 9.2 100.0 Philadelphia MTA
SprintCom............... 74.9 100.0 139 BTAs
-----
Total............... 269.3
=====
</TABLE>
- --------
/1/ Based upon 1997 population data supplied by Equifax Inc.
/2/ Assumes that the transactions contemplated by the Tracking Stock
Proposal are completed.
/3/ Pops data for Cox PCS includes 100% of its Pops, not the PCS Group's
proportional interest. Sprint Spectrum Holdings' current 59.2%
ownership interest in Cox PCS will not be affected by the Tracking
Stock Proposal. Sprint Spectrum Holdings 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 Holdings to
purchase Cox's remaining partnership interest in Cox PCS. Commencing in
2001, Sprint Spectrum Holdings will have the right to require that Cox
sell all of its remaining partnership interest in Cox PCS to Sprint
Spectrum Holdings. See "The Tracking Stock Proposal--Amendments to the
Cox PCS Agreements" in the Proxy Statement.
Sprint Spectrum. Sprint Spectrum owns PCS licenses covering 30 MTAs, which
were acquired in the FCC's A and B Block auction in March 1995 for $2.1
billion. Sprint Spectrum's licenses cover approximately 155.9 million Pops,
which include 31 of the 50 largest United States metropolitan areas such as
New York, San Francisco, Detroit, Dallas/Fort Worth and Boston. Sprint
Spectrum launched commercial PCS operations in the fourth quarter of 1996.
Sprint Spectrum Holding Company L.P. and MinorCo. L.P. are the general partner
and limited partner, respectively, of Sprint Spectrum.
Cox PCS. In December 1994, the FCC granted Cox PCS a license for the Los
Angeles-San Diego-Las Vegas MTA, which covers approximately 21.0 million Pops.
The FCC ultimately set a purchase price of $252.0 million for the license. Cox
PCS launched commercial service in the San Diego area in December 1996, in the
Los Angeles area in November 1997 and in Las Vegas in October 1998. In
December 1996, Cox PCS entered into an affiliation agreement with Sprint
Spectrum under which Cox PCS agreed to market its wireless services under the
Sprint PCS brand name.
Sprint Spectrum Holdings currently owns 59.2% of Cox PCS. Sprint Spectrum
Holdings and Cox have entered into an arrangement whereby Cox may require
Sprint Spectrum Holdings to purchase Cox's partnership interests in Cox PCS,
which could result in the acquisition by Sprint Spectrum Holdings of all
remaining partnership interests in Cox PCS. Commencing in 2001, Sprint
Spectrum Holdings will have the right to require that Cox sell its remaining
partnership interests in Cox PCS to Sprint Spectrum Holdings. Cox has given
Sprint Spectrum Holdings notice to start the appraisal process related to a
potential put of all or a portion of Cox's remaining partnership interest to
Sprint Spectrum Holdings. See "The Tracking Stock Proposal--Amendments to the
Cox PCS Agreements" in the Proxy Statement.
APC. In December 1994, the FCC granted APC a license for the Washington
D.C.-Baltimore MTA, which covers approximately 8.3 million Pops. The FCC
ultimately set a purchase price of $102.3 million for the license. APC
launched commercial service in November 1995 using GSM technology, becoming
the nation's first commercially operational PCS system, and in April 1998, APC
launched commercial service on its CDMA system that overlays nearly all of the
existing GSM system. In January 1995, Sprint Spectrum Holdings acquired a
49.0% interest in APC. Through capital contributions, Sprint Spectrum Holdings
increased its interest to 58.3% and became the managing partner of APC in
November 1997. In January 1998, Sprint Spectrum Holdings acquired the
remaining 41.7% interest in APC.
II-2
<PAGE>
PhillieCo. Sprint, TCI and Cox formed PhillieCo to acquire a PCS license for
the Philadelphia MTA. FCC spectrum limitations placed on wireless providers
prevented Comcast, a partner in Sprint Spectrum Holdings that already owned a
cellular license for the Philadelphia metropolitan area, from owning an
interest in a PCS license for the Philadelphia MTA indirectly through Sprint
Spectrum Holdings. The PCS license for the Philadelphia MTA was acquired in
the FCC's A and B Block auction in March 1995 for $85.0 million. PhillieCo's
license covers approximately 9.2 million Pops. PhillieCo launched commercial
operations in April 1997.
SprintCom. Sprint, with the consent of the Cable Parents, formed SprintCom,
a wholly owned subsidiary of Sprint, to acquire PCS licenses for all of the
geographic areas not covered by licenses held by any other entity within the
PCS Group. In January 1997, SprintCom acquired licenses for $544 million in
the FCC's D and E Block auctions to provide PCS service in 139 BTAs, including
13 of the 50 largest United States metropolitan areas such as Atlanta, Chicago
and Houston, thereby completing the PCS Group's nationwide license coverage.
The SprintCom licenses cover approximately 74.9 million Pops. The PCS Group
launched service in certain of the SprintCom markets in August 1998 and
intends to reach approximately 38.6 million additional Pops during the first
half of 1999 (or approximately 50% coverage of SprintCom's licensed Pops). The
timing of launch in individual markets will be determined by various factors,
principally zoning and microwave relocation issues, equipment delivery and
network optimization schedules and local market and competitive
considerations. SprintCom has entered into an agreement with PrimeCo to
acquire PrimeCo's Hawaii wireless business, including the CDMA network and
customer base. Subject to the receipt of FCC approval, the transaction is
expected to close in the first quarter of 1999.
THE WIRELESS COMMUNICATIONS INDUSTRY
Wireless communications systems use a variety of radio frequencies to
transmit voice and data. Broadly defined, the wireless communications industry
includes one-way radio applications, such as paging or beeper services, and
two-way radio applications, such as cellular, PCS and ESMR networks.
Historically, each application has been licensed and operates in a distinct
radio frequency block.
In the wireless communications industry there are two principal services
licensed by the FCC for transmitting two-way, real time voice and data
signals: "cellular" and "PCS." Cellular, which uses the 800 MHz frequency
block, is the predominant form of wireless voice communications service
utilized by subscribers today. Cellular systems are predominantly analog-based
systems, although digital technology has been introduced in most metropolitan
markets. Analog-based systems send signals in which the transmitted signal
resembles the input signal, while in digital systems the input signal is coded
into a binary form before the signal is transmitted.
In 1993, the FCC allocated the 1900 MHz frequency block of the radio
spectrum for the provision of a new wireless personal communications service,
commonly known as PCS. PCS differs from traditional analog cellular telephone
service principally in that PCS systems operate at a higher frequency and
employ advanced digital technology. Digital systems convert voice or data
signals into a stream of digits that permit a single radio channel to carry
multiple simultaneous transmissions. Digital systems also achieve greater
frequency reuse than analog systems resulting in greater capacity than analog
systems. This enhanced capacity, along with enhancements in digital protocols,
allows digital-based wireless technologies (whether using PCS or cellular
frequencies) to offer new and enhanced services, and more robust data
transmission (such as greater clarity, better security, facsimile, electronic
mail and connecting notebook computers with computer/data networks).
Cellular service was first introduced in the United States in 1983. As of
December 31, 1997, according to the Cellular Telecommunications Industry
Association ("CTIA"), there were 55.3 million wireless telephone subscribers
in the United States, representing an overall wireless penetration rate of
20.6% and a subscriber growth rate of 25.6% from December 31, 1996.
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<PAGE>
The following table sets forth certain statistics for the domestic wireless
telephone industry as a whole, as published by the CTIA.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------
1997 1996 1995 1994 1993
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Total Service Revenues (in
billions)..................... $ 27.5 $ 23.6 $ 19.1 $ 14.2 $ 10.9
Ending Wireless Subscribers (in
millions)..................... 55.3 44.0 33.8 24.1 16.0
Subscriber Growth.............. 25.6% 30.4% 40.0% 50.8% 45.1%
Average Monthly Revenue per
Subscriber.................... $ 41.12 $ 44.66 $ 47.59 $ 51.48 $ 58.74
Ending Penetration............. 20.6% 16.5% 12.8% 9.2% 6.2%
</TABLE>
Paul Kagan Associates estimates that the number of cellular and PCS wireless
service subscribers will reach 89.2 million by the year 2000. Management
believes that a significant portion of the predicted growth in the consumer
market for wireless telecommunications will result from anticipated declines
in costs of service, increased functional versatility, and increased awareness
of the productivity, convenience and privacy benefits associated with the
services provided by PCS providers, which are the first direct wireless
competitors of cellular providers to offer all-digital mobile networks.
Management also believes that the rapid growth of notebook computers and
personal digital assistants, combined with emerging software applications for
delivery of electronic mail, fax and database searching, will contribute to
the growing demand for wireless service.
Wireless communications systems, whether PCS or cellular, are divided into
multiple geographic areas, known as "cells." In both PCS and cellular systems,
each cell contains a transmitter, a receiver and signaling equipment (the
"Cell Site"). The Cell Site is connected by microwave or landline telephone
lines to a switch that uses computers to control the operation of the cellular
or PCS communications system for the entire service area. The system controls
the transfer of calls from cell to cell as a subscriber's handset travels,
coordinates calls to and from handsets, allocates calls among the cells within
the system and connects calls to the local landline telephone system or to a
long distance carrier. Wireless communications providers establish
interconnection agreements with local exchange carriers and interexchange
carriers, thereby integrating their system with the existing landline
communications system. Because the signal strength of a transmission between a
handset and a Cell Site declines as the handset moves away from the Cell Site,
the switching office and the Cell Site monitor the signal strength of calls in
progress. When the signal strength of a call declines to a predetermined
level, the switching office may "hand off" the call to another Cell Site where
the signal strength is stronger.
Wireless digital signal transmission is accomplished through the use of
various forms of frequency management technology or "air interface protocols."
The FCC has not mandated a universal air interface protocol for PCS systems.
PCS systems operate under one of three principal air interface protocols:
CDMA, TDMA and GSM. TDMA and GSM are both time division multiple access
systems but are incompatible with each other and with CDMA, which is a code
division multiple access system and is incompatible with both GSM and TDMA.
Accordingly, a subscriber of a system that utilizes CDMA technology is unable
to use a CDMA handset when travelling in an area not served by CDMA-based PCS
operators, unless the customer carries a Dual Band/Dual-Mode Handset that
permits the customer to use the analog cellular system in that area. The same
issue would apply to users of TDMA or GSM systems. This is also true for PCS
customers seeking to roam in a PCS service area served by other operators that
do not use CDMA as their air interface protocol.
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:
Operate a Nationwide Digital Wireless Network. The PCS Group is the only PCS
provider in the United States with a 100% digital PCS wireless network with
licenses to provide services nationwide utilizing a single frequency band and
a single technology. Management believes that the PCS Group's all-digital
network provides
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<PAGE>
its customers with consistency of service and features in all of its markets.
The scope of its network also allows the PCS Group to provide its customers
with flexible pricing and promotions on a national basis while retaining local
flexibility. In addition, the operating scale of the PCS Group's network is
expected to result in significant cost advantages in purchasing power,
operations and marketing. The PCS Group plans to complete the initial phase of
construction in its SprintCom markets, including Chicago, Atlanta and Houston,
by the end of the first half of 1999.
Leverage Sprint's National Brand. Management believes that using the
established Sprint brand contributes significantly to consumer confidence in,
and acceptance of, the PCS Group's products and services. As competition in
the wireless industry intensifies, management believes that the power of a
strong national brand will play an increasingly important role in consumers'
purchase decisions.
Utilize State-of-the-Art CDMA Technology. The PCS Group utilizes a state-of-
the-art PCS network using CDMA digital technology which, management believes,
provides significant operating and customer benefits relative to analog and
other digital technologies. Management believes, based on studies by CDMA
manufacturers, that its implementation of CDMA digital technology will
eventually provide system capacity that is approximately 7 to 10 times greater
than that of analog technology and approximately 3 times greater than that of
TDMA and GSM systems, resulting in significant operating and cost efficiencies
which can be passed on to customers. Additionally, management believes that
CDMA technology provides call quality that is superior to that of other
wireless technologies.
Deliver Superior Value to its Customers. In marketing its services, the PCS
Group emphasizes the superior voice quality and functional capabilities of its
wireless service compared to that of analog cellular service. In addition, the
PCS Group bundles its basic service offering with a package of sophisticated
features which either cannot be offered by analog cellular providers or for
which they typically charge their customers separately. The PCS Group also
offers several innovative pricing plans that allow its customers to select
billing plans that suit their usage patterns, none of which requires customers
to sign a long-term service contract. The PCS Group recently introduced new
all-inclusive nationwide service plans that offer a single rate for local and
long distance calls to anywhere in the United States made on the Sprint PCS
network. Management believes that its ability to provide wireless service at
competitive prices without long-term contracts is an important marketing
advantage.
Grow Customer Base Using Multiple Distribution Channels. The PCS Group seeks
to maximize customer growth in each market by utilizing multiple distribution
channels. As of October 5, 1998, the PCS Group had its products for sale in
approximately 6,385 third-party retail locations nationwide, including
retailers such as RadioShack, Circuit City and Best Buy. The PCS Group plans
to have approximately 8,000 third-party retail locations by the end of the
first half of 1999. The PCS Group also seeks innovative distribution channels
through which to market its products, such as the Sprint Store-Within-A-Store
at RadioShack which includes an exclusive arrangement pursuant to which the
only PCS products offered by RadioShack-owned stores in the markets in which
the PCS Group has launched operations are the PCS Group's products. In
addition, as of September 30, 1998, the PCS Group operated 135 Sprint PCS
retail locations. The PCS Group plans to operate approximately 200 Sprint PCS
retail locations by the end of the first half of 1999. The PCS Group also uses
telemarketing, direct sales and cross-marketing and continually evaluates
other alternative distribution channels including sales agency, resale, and
other arrangements.
Continue Network Expansion. The PCS Group plans to continue the expansion of
its existing network. In addition, the PCS Group is expanding its wireless
coverage, primarily in and around smaller metropolitan areas in the United
States where it does not intend to serve customers with its own network, by
pursuing affiliation arrangements with other companies. These companies have
agreed to build networks in portions of the PCS Group's licensed coverage area
at such companies' own expense. Such networks are expected to be built using
the same technological standards as those of the PCS Group network. These
companies will sell PCS Group services under the Sprint PCS brand name in
exchange for a fee and will be required to maintain certain quality standards
to be established by the PCS Group. As of October 20, 1998, the PCS Group had
entered into agreements with 11 companies covering an aggregate of
approximately 24.5 million Pops in 18 states.
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<PAGE>
MARKETING
The PCS Group's principal marketing strategy is to differentiate itself
through its state-of-the-art network, Sprint brand name, a variety of
sophisticated features, attractive and simple pricing plans, superior customer
service and the ability to bundle Sprint PCS service with the
telecommunications services offered by the FON Group.
The Sprint Brand Name. The PCS Group prominently features the nationally
recognized Sprint brand name and logo on its products and services. The PCS
Group believes that the use of the Sprint brand name will continue to be a
distinct marketing advantage.
Customer Care. The PCS Group considers quality customer care to be a
critical element of its marketing and operating philosophy. In an effort to
minimize service disruptions to customers, the PCS Group's national network
control center in Lenexa, Kansas continually monitors the performance of its
PCS network and provides rapid response for system maintenance needs. A total
of approximately 2,150 customer care representatives in Fort Worth, Texas, Rio
Rancho, New Mexico and in other customer care centers located in Irvine,
California and Herndon, Virginia are available to address customers' questions
about PCS service, activation, changing personal options and other service
options on a 24 hour/7 day a week basis. The PCS Group also uses a vendor to
provide additional customer care support. Customer care representatives are
accessible from any point within the network on a PCS Group handset at no
charge or can be accessed by any other telephone by calling a toll-free
number. All customer care service representatives undergo a required initial
training regimen and participate in ongoing training programs designed to meet
customer needs. In order to meet the demand for customer care, the PCS Group
intends to launch a fifth customer care center in a location yet to be
determined by the middle of 1999. This customer care center is expected to
have 1,000 customer care representatives by the middle of 1999.
Pricing. The PCS Group's pricing strategy is based on simple,
straightforward service plans. The PCS Group's consumer pricing plans are
typically structured with competitive monthly recurring charges, large local
calling areas, enhanced service features (such as voicemail, caller ID, call
waiting and three-way calling) and competitive per-minute rates. Lower per-
minute rates relative to analog cellular providers are possible in part
because the CDMA system has greater capacity, thereby enabling the PCS Group
to market high usage customer plans at lower prices. The PCS Group also offers
its customers savings through expanded home service area plans and other
special pricing features, like "first incoming minute free." Two national
pricing plans, Home Rate USASM and Toll-Free USASM, which were launched in
1997, are examples of how the PCS Group offers customers creative pricing.
Home Rate USA allows customers traveling to other PCS Group markets to have
their home market rate apply. Effective October 1, 1998, Home Rate USA became
a standard feature on all Sprint PCS rate plans for new customers. Toll-Free
USA essentially eliminates uncertainty about long distance cost by providing
1,000 domestic minutes of long distance calls per month for a fixed fee.
On October 1, 1998, Sprint PCS introduced new all-inclusive nationwide
service plans that offer a single rate for local and long distance calls in
the United States anytime, anywhere on the Sprint PCS network. The new service
plans offer customers long distance calling at no additional charge and offer
more included minutes than prior Sprint PCS plans that can be used anywhere on
the Sprint PCS network.
Advertising and Promotions. The PCS Group leverages Sprint's substantial
investment in national advertising to build its brand awareness. The PCS Group
uses national as well as regional television, radio, print, outdoor and other
advertising campaigns using the Sprint and Sprint PCS brand names to promote
its products. In its advertising and promotional campaigns, the PCS Group
emphasizes its superior voice quality as "the clear alternative to cellular"
and the simplicity of its rate structure compared to other service providers.
The PCS Group also runs numerous promotional campaigns which provide customers
with benefits such as additional features at the same rate or free minutes of
use for limited time periods.
Sponsorships. The PCS Group is a sponsor of numerous selective, broad-based
national, regional and local events, including the National Football League
and Treadway IndyCar Racing. These sponsorships provide the PCS Group with
brand name and product recognition in high profile events, provide a forum for
sales and promotional events and enhance the PCS Group's local presence.
II-6
<PAGE>
Bundling of Services and Cross-Marketing with the FON Group. The PCS Group
intends to take advantage of the complete array of communications services
offered by the FON Group by bundling its PCS service with other FON Group
products, such as long distance and local service. The PCS Group also plans to
actively cross-market with the FON Group's divisions and capitalize on the
size and breadth of its customer base in long distance and local service. Any
benefits that may result from such bundling or cross-marketing will be shared
with the FON Group pursuant to the Tracking Stock Policies. The FON Group and
the PCS Group expect to consider cross-marketing opportunities, which may
include sales agency, resale or other arrangements that would be implemented
in accordance with the Tracking Stock Policies.
SALES AND DISTRIBUTION
The PCS Group uses multiple distribution channels to market its products and
services, including its own retail stores, third-party retail stores, its own
direct sales force, telemarketing and cross-marketing. The PCS Group expects
its retail channels to be the largest contributor to customer additions. The
PCS Group will continue to evaluate alternative distribution channels in the
future.
Sprint PCS Retail Stores. As of September 30, 1998, the PCS Group had opened
135 Sprint PCS retail locations. At a Sprint PCS retail store, trained sales
representatives assist customers in acquiring their PCS handsets and choosing
their rate plan and also offer after-sales support. The PCS Group plans to
operate 200 Sprint PCS retail locations in operation by the end of the first
half of 1999.
Third Party Retail Stores. As of October 5, 1998, the PCS Group sold its
products and services in approximately 6,385 third party retail locations. The
PCS Group expects to increase the number of third-party retail stores to
approximately 8,000 retail locations by the end of the first half of 1999. The
PCS Group provides training and support for the retailer's sales personnel.
The PCS Group launched its third party retail distribution channel in 1995
with RadioShack, which as of August 31, 1998 sold Sprint PCS products in
approximately 2,892 locations and had approximately 25,500 of its employees
trained in PCS sales. Many RadioShack stores contain a Sprint Store-Within-A-
Store which sells PCS Group and FON Group products and services. In addition
to RadioShack, the PCS Group has third-party distribution arrangements with
major national and regional retailers, including Office Max, Office Depot,
Circuit City, Best Buy, Dillard's, The May Company Department Stores, Car
Toys, Fred Meyer, Sam's Wholesale Clubs, Ritz Camera and The Good Guys.
Direct Sales Force. The PCS Group has divided its direct sales force into
the business-to-business sales force and the national sales team. The
business-to-business sales force is locally based and targets businesses
within the local coverage area. The national sales team targets large
companies who purchase their wireless products and services on a national
basis.
Telemarketing and Other Channels. The PCS Group operates an inbound
telemarketing effort and also distributes its services through cross-marketing
efforts with Sprint.
SERVICES AND FEATURES
The PCS Group currently offers several value-added services and features
that generally are not offered by analog cellular providers and are offered by
digital competitors to varying extents:
Enhanced Features. The PCS Group's standard service includes a number of
enhanced features that are not generally offered on most traditional analog
cellular phones without additional cost, including Call Waiting, Caller ID,
Call Forwarding and Three-Way Calling.
Messaging Services. The PCS Group offers a number of message services,
including voicemail and numeric paging. The PCS Group is in the process of
extending the benefits of its nationwide voice messaging service platform by
offering Enhanced Voicemail which will permit customers who purchase the
service to send, reply to and forward messages to other PCS Group voicemail
customers. Enhanced Voicemail was available to most PCS Group customers at the
end of the third quarter of 1998.
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<PAGE>
Call Security and Privacy. Digital wireless communications systems permit
users to make private business and personal calls with significantly lower
risk of cloning and eavesdropping than on analog-based systems. PCS Group
customers using Dual-Band/Dual-Mode Handsets in analog mode do not have the
benefit of digital security.
Data Services. The PCS Group introduced text messaging data services in
select markets in 1998 with full roll out expected in 1999. Text messaging
allows customers to receive alpha-numeric messages of up to 100 characters in
length. Senders are able to create messages via the Sprint PCS web site, e-
mail or personal computer software. Another data service expected to be
launched in 1999 will permit customers to connect their data capable handsets
using a data cable to a personal computer and use their handsets to connect to
a landline network at speeds up to 14.4 Kbps. Data capable handsets can also
provide facsimile data services.
Dual-Band/Dual-Mode Handsets. Through Dual-Band/Dual-Mode Handsets, the PCS
Group offers customers the ability to make and receive calls on both PCS and
cellular frequency bands utilizing the appropriate digital or analog
technology. These advanced handsets allow roaming on cellular networks in
areas where the PCS Group's digital service is not offered. Generally, Dual-
Band/Dual-Mode Handsets are more costly than single-band/single-mode handsets
because of the need for two radios rather than one radio, and currently, the
smallest Dual-Band/Dual-Mode Handset is larger and heavier than the smallest
single-band/single-mode handset. See "--Network--Roaming Agreements."
Extended Battery Life. CDMA digital handsets use advanced battery technology
and have lower power requirements than analog cellular and other digital
technologies. The PCS Group believes that this feature increases usage,
especially for incoming calls, as the handset can be left on longer than
handsets for analog cellular and other digital systems. However, Dual-
Band/Dual-Mode Handsets do not have longer battery life when operating in
analog mode.
NETWORK
Network Buildout and Expansion. The initial buildout of the PCS Group's
network involved systems design, acquisition and construction of cell sites,
equipment procurement and installation, interconnection with other
communications providers, microwave relocation and implementation of advanced
management and information systems. As of July 31, 1998, the PCS Group's
network was able to provide service in areas covering 108 million Pops, or 40%
of total Pops. Although there continues to be significant buildout activity,
the emphasis and focus in many of the markets served by the PCS Group shifted
during 1997 from an initial network buildout process to network operations.
The PCS Group is actively constructing its network in the SprintCom markets,
which include 13 of the 50 largest metropolitan areas in the United States
(including Chicago, Atlanta and Houston). When the initial buildout of
SprintCom markets is complete (which is expected to occur by the end of the
first half of 1999), the PCS Group expects to have network coverage of 40.7
million Pops in addition to the 108 million Pops already covered by the PCS
Group network. With respect to the SprintCom markets, of the approximately
3,200 sites budgeted for the SprintCom buildout, approximately 3,065 sites are
leased and construction has commenced on approximately 2,805 sites as of
October 24, 1998.
The PCS Group's principal network objective is to maximize the quality of
coverage (i.e., sound quality and in-building penetration) and depth of
coverage (i.e., network availability when a customer wants to make a call).
The PCS Group evaluates coverage expansion within its markets in commercial
operation on a market-by-market basis and considers, among other things,
population and traffic density, FCC coverage requirements, capital
requirements and the ability to cluster groups of markets.
The PCS Group selected CDMA digital technology because of its increased
customer capacity relative to other technologies, higher quality of
transmission and expected long term lower infrastructure and ongoing support
costs. The PCS Group believes that CDMA provides significant advantages over
competing air interface
II-8
<PAGE>
protocols including superior voice quality, cost effectiveness, increased
functionality and greater security and capacity. The PCS Group believes that
CDMA is the leading digital wireless air interface protocol in North America.
Affiliation Agreements. The PCS Group also intends to expand network
coverage by contracting with other companies that desire to build and manage
portions of the nationwide network for the PCS Group. See "--Strategy--
Continue Network Expansion."
Roaming Agreements. The PCS Group has entered into roaming agreements with
various analog cellular carriers encompassing 90% of the geographic area
covered by cellular service in the United States (85% when counting agreements
that have been implemented). Pursuant to these roaming agreements, PCS Group
customers who have Dual-Band/Dual-Mode Handsets have the ability to roam
automatically in many areas where PCS service is not or will not be available.
The PCS Group's network does not allow for call hand-off between the PCS
Group's network and another wireless network, thus requiring a customer to end
a call in progress and initiate a new call when leaving the PCS Group's
network and entering another wireless network. In geographic areas not covered
by an automatic roaming agreement in which there is an analog cellular
provider, customers may roam manually (i.e. by providing an operator with a
credit card number). The PCS Group also has negotiated roaming agreements with
other CDMA PCS carriers who provide service in some of the geographic areas
not covered by the PCS Group's network. The PCS Group intends to continue to
expand the ability for its customers to roam both domestically and
internationally. The quality of the service provided by a network provider
during a roaming call may not approximate the quality of the service provided
by the PCS Group, the price of a roaming call may not be competitive with the
prices of other wireless companies for such a call and the customer may not be
able to use any of the advanced features (e.g. voice mail notification) the
customer enjoys when making calls from within the network of the PCS Group.
Vendors. The PCS Group selected Lucent Technologies, Inc., Northern Telecom,
Inc. and Motorola to provide the PCS technology for its wireless network
because of their extensive experience in wireless technology and their
willingness to guarantee delivery in accordance with specifications developed
by the PCS Group. These vendors provide the PCS Group with infrastructure
equipment including switches, base station controllers and PCS transmitters
and receivers and in certain cases vendor financing. The PCS Group also
contracts with various vendors for the supply of towers, cabling, hardware and
software and other equipment necessary to support the network.
The PCS Group has entered into purchase agreements with most major
manufacturers of CDMA handsets, of which two also currently provide the PCS
Group with Dual-Band/Dual-Mode Handsets. The PCS Group intends to enter into
additional agreements with other handset vendors in the future.
In mid-October 1998, Sprint PCS introduced the Sprint PCS Touchpoint (TM)
phone manufactured by DENSO exclusively for Sprint PCS. The Sprint PCS
Touchpoint has a built-in mouse that Sprint believes makes it easier to use.
The mouse is the first of its kind for a wireless phone. The Sprint PCS
Touchpoint phone also has a larger display than most other wireless phones.
The phone delivers text messaging service with a user-friendly interface
available.
The PCS Group purchases long distance services from Sprint at wholesale
rates which the PCS Group uses in providing long distance services to its
customers, and intends to continue to purchase such services from the FON
Group. The PCS Group intends to purchase long distance services only from the
FON Group. Subsequent to the PCS Restructuring, such purchases will be
effected in accordance with the Tracking Stock Policies. See "The Tracking
Stock Proposal--The Tracking Stock Policies" in the Proxy Statement.
COMPETITION
Competition for customers among wireless providers is based principally upon
the services and features offered, the technical quality of the wireless
system, the distribution system for products and services, customer service,
system coverage, capacity and price. Such competition may increase to the
extent that licenses are transferred from smaller stand-alone operations to
larger, better capitalized and more experienced wireless communications
operations that may be able to offer customers certain network advantages
similar to those offered by the PCS Group.
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<PAGE>
The PCS Group competes with other two-way wireless service providers,
including cellular and, in some markets, PCS operators and resellers. The PCS
Group also competes with paging, ESMR dispatch and conventional mobile
telephone companies in its markets. Potential users of PCS systems may find
their communications needs satisfied by other current and developing
technologies. One or two-way paging or beeper services that feature voice
messaging and data display as well as tone-only service may be adequate for
potential customers who do not need to speak to the caller.
The PCS Group directly competes with existing cellular service providers in
its markets, many of which have been operational for a number of years, have
greater local geographical coverage, and some of which have significantly
greater financial resources than those of the PCS Group and offer attractive
pricing options for service and a wider variety of handset options. A major
competitor recently introduced a nationwide flat-rate plan that may be viewed
by customers as more attractive than PCS Group plans. In addition, certain
competitors may be able to offer coverage in areas not served by the PCS
Group's network or, because of their calling volumes or their affiliations
with, or ownership of, wireless providers, may be able to offer roaming rates
that are lower than those offered by the PCS Group. Also, the significant
competition among wireless providers, including new entrants, is expected to
cause a downward pressure on prices for service and equipment. The PCS Group
believes, however, that its service and product offerings are superior to its
competitors' service and product offerings because (i) its CDMA technology
offers better call quality and clarity compared to analog and digital cellular
systems, (ii) it offers competitive pricing through a variety of options to
suit individual customers' calling needs and (iii) it is expanding and
improving its nationwide network, customer care system and handset options.
The PCS Group also faces competition from "resellers" which provide wireless
service to customers but do not hold FCC licenses or own facilities. Instead,
the reseller buys blocks of wireless telephone numbers and capacity from a
licensed carrier and resells service through its own distribution network to
the public. Thus, a reseller is both a customer of a wireless licensee's
services and also a competitor of that and other licensees. The FCC requires
all cellular and PCS licensees to permit resale of carrier service to a
reseller.
In the future, the PCS Group expects to face increased competition from
entities providing similar services using other communications technologies,
including satellite-based telecommunications and wireless cable systems. While
some of these technologies and services are currently operational, others are
being developed or may be developed in the future.
Over the past several years the FCC has and will continue to auction large
amounts of wireless spectrum that could be used to compete with the PCS
Group's services. Based upon increased competition, the PCS Group anticipates
that market prices for two-way wireless services generally will decline in the
future. The PCS Group competes to attract and retain customers principally on
the basis of services and features, the size and location of its service
areas, network coverage and reliability, customer care and pricing. The PCS
Group's ability to compete successfully also depends, in part, on its ability
to anticipate and respond to various competitive factors affecting the
industry, including new services that may be introduced, changes in consumer
preferences, demographic trends, economic conditions and discount pricing
strategies by competitors.
REGULATION
The FCC regulates the licensing, construction, operation, acquisition and
interconnection arrangements of wireless telecommunications systems in the
United States. The FCC has promulgated, and is in the process of promulgating,
a series of rules, regulations and policies to, among other things, (i) grant
or deny licenses for PCS frequencies, (ii) grant or deny PCS license renewals,
(iii) rule on assignments and/or transfers of control of PCS licenses, (iv)
govern the interconnection of PCS networks with other wireless and wireline
carriers, (v) establish access and universal service funding provisions, (vi)
impose fines and forfeitures for violations of any of the FCC's rules, and
(vii) 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 (40% if a small business or rural telephone company))
in broadband PCS, cellular and SMR licenses totaling more than 45 MHz in any
geographic area.
Transfers and Assignments of PCS Licenses. The FCC must give prior approval
to the assignment of, or transfers involving, substantial changes in ownership
or control of a PCS license. Non-controlling interests in an
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<PAGE>
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.
Conditions of PCS Licenses. All PCS licenses are granted for 10-year terms
conditioned upon timely compliance with the FCC's buildout requirements.
Pursuant to the FCC's buildout requirements, all 30 MHz broadband MTA
licensees must construct facilities that offer coverage to one-third of the
population within 5 years and to two-thirds of the population within 10 years,
and all 10 MHz broadband PCS licensees must construct facilities that offer
coverage to at least one-quarter of the population within 5 years or make a
showing of "substantial service" within that 5 year period. Rule violations
could result in license revocations or fines.
PCS License Renewal. PCS licensees can renew their licenses for additional
10 year terms. PCS renewal applications are not subject to auctions. However,
under the FCC's rules, third parties may oppose renewal applications and/or
file competing applications. If one or more competing applications are filed,
a renewal application will be subject to a comparative renewal hearing. The
FCC's rules afford PCS renewal applicants involved in comparative renewal
hearings with a "renewal expectancy." The renewal expectancy is the most
important comparative factor in a comparative renewal hearing and is
applicable if the PCS renewal applicant has: (i) provided "substantial
service" during its license term; and (ii) substantially complied with all
applicable laws and FCC rules and policies. The FCC's rules define
"substantial service" in this context as service that is sound, favorable and
substantially above the level of mediocre service that might minimally warrant
renewal.
Interconnection. The FCC has the authority to order interconnection between
CMRS providers and any other common carrier. The FCC's authority further
preempts the authority of any state public service commission over the rates
and entry of CMRS providers in the market place. The FCC has ordered local
exchange carriers to provide reciprocal compensation to CMRS providers for the
termination of traffic.
Using these new rules, the PCS Group has negotiated interconnection
agreements with all of the major regional Bell operating companies, GTE and
several smaller independent local exchange carriers. These agreements have
lowered rates for interconnection and created revenues resulting from
termination charges on the Sprint PCS network. The PCS Group is continuing to
negotiate agreements with other independent local exchange carriers.
Other FCC Requirements. In June 1996, the FCC adopted rules that prohibit
broadband PCS providers from unreasonably restricting or disallowing resale of
their services or unreasonably discriminating against resellers. Resale
obligations will automatically expire on November 24, 2002. The FCC is also
considering whether wireless providers should be required to offer unbundled
communications capacity to resellers who intend to operate their own switching
facilities.
The FCC also adopted rules in June 1996 that require local exchange and most
CMRS carriers to program their networks to allow customers to change service
providers without changing telephone numbers, which is referred to as service
provider number portability. The FCC required that most CMRS providers be able
to deliver calls from their networks to ported numbers anywhere in the country
by December 31, 1998. The FCC also recently stayed for nine months the
following number portability requirements: (1) CMRS providers must be able to
offer their own customers number portability in their switches in the 100
largest metropolitan areas including the ability to support nationwide roaming
by March 31, 2000, instead of June 30, 1999 and (2) carriers must request
number portability capability in the top 100 metropolitan areas by June 30,
1999 instead of September 30, 1998. Capital expenditures required for the PCS
Group to comply with number portability rules are currently estimated to range
from $100 million to $300 million. The CTIA has petitioned the FCC to forbear
entirely from requiring any CMRS provider to provide number portability
capability to its own customers until at least after the five-year build-out
period (from the date of the applicable license) for PCS carriers has expired.
The FCC recently adopted rules permitting broadband PCS and other CMRS
providers greater flexibility to provide innovative services, such as wireless
local loop and other fixed services that would directly compete with the
wireline services of LECs. The FCC also has proposed a rebuttable presumption
that any wireless service provided under a CMRS provider's license would be
considered to come within the definition of CMRS and
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<PAGE>
consequently regulated as CMRS. In June 1996, the FCC adopted rules requiring
broadband PCS and other CMRS providers to implement enhanced emergency 911
capabilities within 18 months after the effective date of the FCC's rules. In
December 1997, the FCC revised these rules to extend the compliance deadline
for phase I until October 1, 1998 and for phase II until October 1, 2001 for
digital CMRS carriers to ensure access for customers using devices for the
hearing-impaired. Currently the PCS Group and other wireless carriers are in
compliance with phase I and are analyzing various technical methods for
complying with phase II.
Communications Assistance for Law Enforcement Act ("CALEA"). The
Communications Assistance for Law Enforcement Act, enacted in 1994 to preserve
electronic surveillance capabilities authorized by Federal and state law,
requires telecommunications carriers to meet certain "assistance capability
requirements" by October 25, 1998. The FCC recently, however, granted a
blanket extension of that deadline until June 30, 2000, because CALEA
compliant equipment is not yet available. CALEA provides that a
telecommunications carrier meeting industry CALEA standards shall have safe
harbor for purposes of compliance with CALEA. Toward the end of 1997
telecommunications industry standard-setting organizations agreed to a joint
standard to implement CALEA's capability requirements, known as J-STD-025.
Although the PCS Group is able to offer traditional electronic surveillance
capabilities to law enforcement, it, as well as the other participants in the
wireless industry, could not meet the requirements of J-STD-025 by October 25,
1998, given software and hardware changes that are yet to be developed and
implemented by switch manufacturers.
In addition, the FCC is considering petitions from numerous parties to
establish and implement technical compliance standards pursuant to CALEA
requirements. The FCC recently announced that it will be issuing a Further
Notice of Proposed Rulemaking tentatively concluding that J-STD-025 is
deficient and that the industry must provide certain other capabilities to
comply with CALEA.
Other Federal Regulations. Wireless systems must comply with certain FCC and
FAA regulations regarding the siting, lighting and construction of transmitter
towers and antennas. In addition, certain FCC environmental regulations may
cause certain cell site locations to become subject to regulation under the
National Environmental Policy Act. The FCC is required to implement the Act by
requiring carriers to meet certain land use and radio frequency standards.
Review of Universal Service Requirements. The FCC and the states are re-
quired to establish a "universal service" program to ensure that affordable,
quality telecommunications services are available to all Americans. Although
the PCS Group is challenging in federal court the authority of the states to
collect universal service contributions from CMRS providers, at present the
PCS Group is required to contribute to the federal universal service program
as well as existing state programs. The FCC has determined that the PCS
Group's "contribution" to the federal universal service program is a variable
percentage of "end-user telecommunications revenues." Although many states are
likely to adopt a similar assessment methodology, the states are free to cal-
culate telecommunications service provider contributions in any manner they
choose as long as the process is not inconsistent with the FCC's rules. At the
present time it is not possible to predict the extent of the PCS Group's total
federal and state universal service assessments or ability to recover from the
universal service fund.
Partitioning; Disaggregation. The FCC has modified its rules to allow
broadband PCS licensees to partition their market areas and/or to disaggregate
their assigned spectrum and to transfer partial market areas or spectrum
assignments to eligible third parties.
Wireless Facilities Siting. States and localities are not permitted to
regulate the placement of wireless facilities so as to "prohibit" the
provision of wireless services or to "discriminate" among providers of such
services. In addition, so long as a wireless system complies with the FCC's
rules, states and localities are prohibited from using radio frequency health
effects as a basis to regulate the placement, construction or operation of
wireless facilities. The FCC is considering numerous requests for preemption
of local actions affecting wireless facilities siting.
Equal Access. Wireless providers are not required to provide equal access to
common carriers for toll services. However, the FCC is authorized to require
unblocked access to toll carriers subject to certain conditions.
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<PAGE>
Deregulation. The FCC is required to forbear from applying any statutory or
regulatory provision if it is not necessary to keep telecommunications rates
and terms reasonable or to protect customers. Correspondingly, a state may not
apply a statutory or regulatory provision that the FCC decides not to apply.
In addition, the FCC must review its telecommunications regulations every two
years to determine if any can be eliminated or modified as no longer in the
public interest as a result of increased competition.
EMPLOYEES
At October 24, 1998, the PCS Group employed approximately 10,100 people.
None of the PCS Group employees is represented by a labor union. Management
believes that the PCS Group's employee relations are good. The PCS Group
engages independent contractors to perform a variety of functions, including
construction and maintenance of the PCS Group's network, research,
advertising, and information technology.
FACILITIES
The PCS Group leases space for base station towers and switch sites for its
nationwide network. As of September 30, 1998, the PCS Group had under lease
(or options to lease) approximately 10,900 cell sites. In addition, the PCS
Group leases approximately 174 facilities of which 64 house 83 switch sites
with the remaining 110 other facilities leased for the PCS Group headquarters
in Kansas City, Missouri, customer care facilities in Herndon, Virginia, Ft.
Worth, Texas, Rio Rancho, New Mexico and Irvine, California, as well as
numerous sales and marketing offices.
PATENTS, TRADEMARKS AND SERVICE MARKS
Sprint owns various trademarks utilized by the PCS Group. Sprint expects to
apply for and develop trademarks, service marks and patents for the benefit of
the PCS Group in the ordinary course of business. Sprint is a registered
trademark of Sprint and Sprint PCS is a registered service mark of Sprint,
both of which are utilized by the PCS Group on a royalty-free basis under
trademark license agreements.
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.
ENVIRONMENT
The PCS Group's environmental compliance expenditures primarily result from
the operation of standby power generators for its telecommunications equipment
and compliance with various environmental rules during network buildout and
operations. The expenditures arise in connection with standards compliance or
permits which are usually related to generators, batteries or fuel storage.
The PCS Group's environmental compliance expenditures have not been material
to its financial statements or to its operations and are not expected to have
any future material adverse effects.
LEGAL PROCEEDINGS
The PCS Group is involved in various legal proceedings incidental to the
conduct of its business. The PCS Group has been involved in various legal
proceedings in various states concerning the imposition of moratoria on the
processing or approval of permits for wireless telecommunication 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, have a material
adverse effect on the PCS Group. In addition, the PCS Group is involved in 11
purported class actions of which six involve claims arising from network
quality issues, three involve claims concerning billing practices and two
involve claims arising from the CDMA network overlay of the GSM network in the
Washington, D.C./Baltimore MTA. The only case that has been certified as a
class action is one of the claims involving the CDMA network overlay of the
GSM network, and the PCS Group is vigorously opposing such certification and
the certification of any of the other cases. While it is not possible to
determine the ultimate disposition of each of these proceedings, the PCS Group
believes, after consultation with legal counsel, that the outcome of such
proceedings, individually and in the aggregate, will not have a material
adverse effect on the PCS Group's financial condition or results of operations
or cash flows.
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MANAGEMENT
The following table sets forth the members of the senior management of
Sprint Spectrum Holdings who are expected to have similar functions in the PCS
Group. For a list of the executive officers of Sprint, see "Executive Officers
and Directors of Sprint" in this Proxy Statement. The ages set forth below are
as of September 30, 1998.
<TABLE>
<CAPTION>
NAME AGE POSITION
------------------------------------ --- ----------------------------------
<S> <C> <C>
Ronald T. LeMay..................... 52 Chairman
Andrew Sukawaty..................... 43 Chief Executive Officer
Arthur A. Kurtze.................... 53 Chief Operating Officer
Bernard A. Bianchino................ 50 Chief Business Development Officer
William J. Gunter................... 56 Chief Financial Officer
F. Edward Mattix.................... 45 Chief Public Relations Officer
Charles E. Levine................... 45 Chief Sales and Marketing Officer
Joseph M. Gensheimer................ 46 General Counsel and Secretary
</TABLE>
RONALD T. LEMAY was first elected President and Chief Operating Officer of
Sprint in February 1996 and became Chairman of Sprint Spectrum Holdings in May
1998. Mr. LeMay is also a director of Ceridian Corporation, Imation
Corporation, and Yellow Corporation. 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 Holdings from 1995 to 1996. From 1989 to 1995, he
served as President and Chief Operating Officer--Long Distance Division. Mr.
LeMay served on the Sprint Board from 1993 until he went to work for Waste
Management, Inc. He was re-elected to the Sprint Board in December 1997.
ANDREW SUKAWATY was appointed Chief Executive Officer of Sprint Spectrum
Holdings effective September 2, 1996. Prior to joining Sprint Spectrum
Holdings, 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 U.K. in
1993. Prior to joining Mercury One-2-One, Mr. Sukawaty held numerous positions
for US WEST, Inc., including: Chief Operating Officer of US WEST Paging,
President of Coastel, a cellular communications company, and Vice President
and branch manager for US WEST Cellular. He also held marketing positions with
AT&T and Northwestern Bell Telephone Company. He is a director of PowerWave
Technologies Inc., a wireless systems infrastructure component manufacturer,
and serves on the boards and executive committees of the Cellular
Telecommunications Industry Association and the Personal Communications
Industry Association.
ARTHUR A. KURTZE was appointed Chief Operating Officer of Sprint Spectrum
Holdings in June 1995. Prior to joining Sprint Spectrum Holdings, Mr. Kurtze
was Senior Vice President--Operations for Sprint's Local Telecommunications
Division. Prior to joining Sprint in March 1993, Mr. Kurtze was Executive Vice
President in charge of strategic planning and corporate development for Centel
Corp. Mr. Kurtze joined Centel in 1972 and served in various positions there,
including Vice President of Centel Communications Co., Vice President-- Staff
of Centel Business Systems, Vice President--Market Planning for Centel Corp.,
Group Vice President of Centel Cable Television Co. and Senior Vice
President--Planning and Technology.
BERNARD A. BIANCHINO was appointed Chief Business Development Officer of
Sprint Spectrum Holdings in September 1995. Most recently, Mr. Bianchino was
Executive Vice President, General Counsel and External Affairs for Qwest
Communications Corporation. He served as Vice President--Law for Sprint from
1992 to 1994 and as General Attorney, Vice President and Associate General
Counsel for US Sprint Communications
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<PAGE>
Company from 1986 to 1992. From 1978 to 1986, Mr. Bianchino was counsel to a
number of affiliates of Exxon Corporation in its Enterprises Group, including
Reliance Comm/Tec (now RELTEC) and Exxon Office Systems. Prior to joining
Exxon, he was an attorney with the United States Department of Energy. Mr.
Bianchino is a director of Geoworks Corporation.
WILLIAM J. GUNTER was named Chief Financial Officer of Sprint Spectrum
Holdings in October 1998. Most recently Mr. Gunter was Senior Vice President
of Finance for Sprint's Long Distance Division, a position he held since 1993.
Prior to that, Mr. Gunter had served in various staff and management positions
for Sprint since 1969.
F. EDWARD MATTIX was named Chief Public Relations Officer of Sprint Spectrum
Holdings in April 1996. Prior to joining Sprint Spectrum Holdings, he was Vice
President--Public Relations for US WEST Communications, Inc. Mr. Mattix served
in various management level positions relating to public relations or
governmental affairs since joining US WEST, Inc. in 1976.
CHARLES E. LEVINE was appointed Chief Sales and Marketing Officer of Sprint
Spectrum Holdings in January 1997. Mr. Levine joined Sprint Spectrum Holdings
in January 1997 as Chief Marketing Officer. Prior to joining Sprint Spectrum
Holdings, Mr. Levine was President of Octel Link, a voice mail equipment and
services provider, and Senior Vice President of Octel Services from 1994 to
1996. From 1993 to 1994, he was President and Chief Executive Officer of CAD
Forms Technology a developer of hardware and software products for mobile
computing. Prior to joining CAD Forms Technology, Mr. Levine held numerous
positions with AT&T Corporation from 1986 to 1993, including Vice President,
General Business Systems, Products and New Services; Vice President, Consumer
Products, Product Management; and Director, Consumer Products, Product
Management. Mr. Levine has also served in management positions for General
Electric Corporation and Proctor & Gamble Company. Mr. Levine is a director of
Viisage Technology.
JOSEPH M. GENSHEIMER was named General Counsel and Secretary of Sprint
Spectrum Holdings in October 1995. Mr. Gensheimer is responsible for all legal
and regulatory functions. Prior to joining Sprint Spectrum Holdings, he was
Senior Counsel for IBM's mainframe and supercomputer divisions. Mr. Gensheimer
served in various legal management positions after joining IBM in 1988. Prior
to joining IBM, he was General Counsel and Secretary of RealCom Communications
Corporation, a telecommunications services provider. From 1982 to 1984, Mr.
Gensheimer was Senior Attorney and Assistant Secretary for GTE Corporation.
Prior to joining GTE, he was an associate at Morgan, Lewis & Bockius and an
attorney for the United States Department of Justice.
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HISTORICAL PCS GROUP
SELECTED FINANCIAL DATA
The following unaudited table sets forth historical Selected Financial Data
of SprintCom and Sprint's investments in Sprint Spectrum Holdings and
PhillieCo. The investments in Sprint Spectrum Holdings (which includes Sprint
Spectrum, Cox PCS and APC) and PhillieCo during the periods shown have been
accounted for on the equity basis. The results of SprintCom, a wholly-owned
subsidiary of Sprint, are accounted for on a consolidated basis. Subsequent to
the PCS Restructuring, the results of Sprint Spectrum Holdings and PhillieCo
will be accounted for on a consolidated basis in the PCS Group Combined
Financial Statements. The Selected Financial Data set forth below should be
read in conjunction with the PCS Group Management's Discussion and Analysis of
Financial Condition and Results of Operations and the PCS Group Combined
Financial Statements and Notes thereto (the "PCS Group Historical Financial
Statements"). The Selected Financial Data at December 31, 1997 and 1996 and
for each of the three years in the period ended December 31, 1997, have been
derived from the PCS Group Historical Financial Statements, which have been
audited by Ernst & Young LLP, independent auditors. The Selected Financial
Data at December 31, 1995 and 1994, at September 30, 1998, for the year ended
December 31, 1994 and for the nine months ended September 30, 1998 and 1997,
have been derived from the unaudited PCS Group Historical Financial
Statements. The unaudited PCS Group Historical Financial Statements have been
prepared on the same basis as the audited PCS Group Historical Financial
Statements and, in the opinion of management, contain all adjustments,
consisting of only normal recurring accruals, necessary for a fair
presentation of the financial position and results of operations for these
periods. Results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the entire
year.
<TABLE>
<CAPTION>
AT OR FOR THE
NINE MONTHS
ENDED SEPTEMBER AT OR FOR THE
30, YEAR ENDED DECEMBER 31,
----------------- -----------------------------------
1998 1997 1997 1996 1995 1994(1)
-------- ------- -------- -------- ------ -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS
DATA
Operating loss.......... $ (80.0) $ (7.4) $ (18.5) $ (0.5) $ -- $ --
Equity in loss of Sprint
Spectrum Holdings and
PhillieCo.............. (686.5) (410.6) (659.6) (191.8) (31.4) --
Net loss................ (471.8) (257.3) (419.1) (119.7) (19.9) --
CASH FLOW DATA
Net cash provided (used)
by operating
activities............. $ (193.0) $ 25.8 $ 37.5 $ (0.5) $ -- $ --
Capital expenditures.... 672.1 68.2 153.7 -- -- --
Purchase of PCS
licenses............... -- 460.1 460.1 84.0 -- --
Investment in and loans
to Sprint Spectrum
Holdings and PhillieCo,
net.................... 193.5 255.5 405.9 297.5 910.9 51.1
BALANCE SHEET DATA
Total assets............ $2,494.2 $1,693.1 $1,259.8 $973.7 $51.1
Property, plant and
equipment, net......... 1,327.2 177.3 -- -- --
Investment in Sprint
Spectrum Holdings and
PhillieCo.............. 475.4 968.4 1,175.8 973.7 51.1
Construction and capital
lease obligations
(including short-term
borrowings)............ 859.7 -- -- -- --
Group equity............ 831.0 1,385.9 1,187.6 965.7 51.1
</TABLE>
- --------
(1) The PCS Group had no operations prior to 1994.
Holders of FON Stock and PCS Stock will be subject to the risks associated
with an investment in a single corporation and all of Sprint's businesses,
assets and liabilities. Events attributable to the FON Group or the PCS Group
that affect Sprint's results of operations or financial condition could affect
the results of operations or financial position of the other group or the
market price of the FON Stock or PCS Stock. Any net losses of the FON Group or
the PCS Group, and dividends or distributions on, or repurchases of, FON
Stock, PCS Stock or preferred stock or other stock or interests will reduce
the funds of Sprint that are legally available for payment of future dividends
on the FON Stock and the PCS Stock.
II-16
<PAGE>
PCS GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
Sprint Corporation (and with its subsidiaries "Sprint") has entered into a
restructuring agreement with the Cable Parents to restructure Sprint's
wireless PCS operations. Sprint will acquire the joint venture interests of
the Cable Parents in Sprint Spectrum Holdings and the joint venture interests
of TCI and Cox in PhillieCo. In exchange for these joint venture interests,
Sprint will issue to the Cable Parents a newly created class of Sprint Common
Stock, the PCS Stock. The PCS Stock is intended to reflect separately the
performance of these joint ventures and the PCS operations of Sprint's wholly
owned subsidiary, SprintCom. These operations, which after the PCS
Restructuring will be 100% owned by Sprint (subject to a 40.8% minority
interest in Cox PCS, the entity holding the PCS license for and conducting
operations in the Los Angeles/San Diego/Las Vegas MTA), will be referred to as
the PCS Group.
The excess of the purchase price to be paid to the Cable Parents in
connection with the PCS Restructuring over the fair value of the PCS assets to
be acquired will be allocated to goodwill and amortized over 40 years. The
portion of the purchase price allocated to the PCS Group's customer base asset
will be amortized over three years. For a preliminary allocation of the
purchase price to the assets acquired and liabilities assumed, see the
unaudited pro forma condensed combined financial statements of the PCS Group
and notes thereto included elsewhere in this Current Report on Form 8-K. A
final allocation is dependent on a study and analysis of the fair value of
such assets and liabilities, including such items as the PCS licenses and in-
process research and development projects, as well as the size of the customer
base at the closing date of the PCS Restructuring. To the extent the customer
base exceeds the size currently reflected in the pro forma financial
statements, the purchase price allocated to the customer base will likely
increase along with a corresponding increase in the amortization of the
customer base. Sprint is undertaking an analysis to determine whether in-
process research and development projects acquired in the PCS Restructuring
should be capitalized or expensed. This analysis is expected to be finalized
prior to the completion of the final purchase price allocation. To the extent
that it is determined through this analysis that some of the in-process
research and development projects should be expensed, a portion of the
purchase price will be allocated to these in-process research and development
projects and a nonrecurring, noncash charge will be recognized in the period
in which the charge occurs. Sprint is unable to determine the potential amount
of such a charge at this time. However, such a charge could be material to the
PCS Group's results of operations for the period in which the charge occurs.
At the present time, Sprint anticipates completing its final purchase price
allocation prior to year-end 1998.
The FON Stock, which will be created in the Recapitalization, is intended to
reflect the performance of all of Sprint's other operations, including its
long distance, local telecommunications and product distribution and directory
publishing divisions, emerging businesses and its interest in Global One.
These operations will be referred to as the FON Group.
Holders of FON Stock and PCS Stock will be subject to the risks associated
with an investment in a single corporation and all of Sprint's businesses,
assets and liabilities. Events attributable to the FON Group or the PCS Group
that affect Sprint's results of operations or financial condition could affect
the results of operations or financial position of the other group or the
market price of the FON Stock or PCS Stock. Any net losses of the FON Group or
the PCS Group, and dividends or distributions on, or repurchases of, FON
Stock, PCS Stock or preferred stock or other stock or interests will reduce
the funds of Sprint that are legally available for payment of future dividends
on the FON Stock and the PCS Stock.
The PCS Group Historical Financial Statements include the combined
historical balance sheets, results of operations and cash flows of SprintCom
and Sprint's investment in Sprint Spectrum Holdings and PhillieCo. All
significant intragroup financial transactions have been eliminated; however,
transactions between the FON Group and the PCS Group have not been eliminated.
II-17
<PAGE>
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. Factors that could cause actual results to differ materially from
estimates or projections contained in the forward-looking statements include
(i) the effects of vigorous competition in the markets in which the PCS Group
operates; (ii) the costs and business risks associated with entering new
markets necessary to provide seamless service and to provide new services;
(iii) the ability of the PCS Group to establish a significant market presence;
(iv) the impact of any unusual items resulting from ongoing evaluations of the
PCS Group's business strategies; (v) the potential impacts of changes in
regulations on the PCS Group; (vi) unexpected results of litigation filed
against Sprint; (vii) the impact of the Year 2000 issue and any related
noncompliance; (viii) the possibility of one or more of the markets in which
Sprint competes being affected by changes in political, economic or other
factors such as monetary policy, legal and regulatory changes or other
external factors over which Sprint or the PCS Group have no control; and (ix)
those factors listed under "Risk Factors--The PCS Group" and "Risk Factors--
The Tracking Stocks" in the Proxy Statement.
The words "estimate", "project", "intend", "expect", "believe" and similar
expressions are intended to identify forward-looking statements. These
forward-looking statements are found at various places throughout Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. Sprint undertakes no
obligation to publicly release any revisions to these forward-looking
statements to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events. Moreover, Sprint, through
senior management, may from time to time make forward-looking statements about
the matters described herein or other matters concerning Sprint.
THE PCS GROUP
The PCS Group includes Sprint's domestic wireless mobile telephony services
and any other domestic PCS services, which includes (i) Sprint's investment in
Sprint Spectrum Holdings and Sprint's investment in PhillieCo, both of which
are reflected on the equity basis in the PCS Group Historical Financial
Statements and (ii) SprintCom, which is reflected on a consolidated basis in
the PCS Group Historical Financial Statements. Upon completion of the PCS
Restructuring, the operating results of Sprint Spectrum Holdings and PhillieCo
will be reflected in the PCS Group Combined Financial Statements along with
SprintCom.
The PCS Group, which markets its wireless telephony products and services
under the Sprint and Sprint PCS brand names, operates the only 100% digital
PCS wireless network in the United States with licenses to provide service
nationwide utilizing a single frequency band and a single technology. The PCS
Group owns licenses to provide service to the entire United States population,
including Puerto Rico and the U.S. Virgin Islands. As of October 30, 1998, the
PCS Group operated PCS systems in 176 metropolitan markets within the United
States, including 39 of the 50 largest metropolitan areas in the United
States. The PCS Group already provides nationwide service through a
combination of (i) operating its own digital network in major metropolitan
areas in the United States, (ii) affiliating with other companies, primarily
in and around smaller metropolitan areas in the United States, (iii) roaming
on analog cellular networks of other providers using Dual-Band/Dual-Mode
Handsets and (iv) roaming on digital PCS networks of other CDMA-based
providers.
Sprint Spectrum Holdings commenced commercial PCS operations late in the
fourth quarter of 1996, and emerged from the development stage during the
third quarter of 1997. PhillieCo commenced commercial operations in April 1997
and SprintCom commenced initial operations in the third quarter of 1998.
REGULATORY DEVELOPMENTS
See "PCS Group Information--Business--Regulation" for a discussion of
regulatory developments that could have a future impact on the PCS Group.
II-18
<PAGE>
SEASONALITY
The wireless industry, including the PCS Group, has experienced a trend of
generating a significantly higher number of subscriber additions and handset
sales in the fourth quarter of each year as compared to the other three fiscal
quarters. A number of factors contribute to this trend, including the
increasing use of retail distribution, which is dependent on the year-end
holiday shopping season, the timing of new product and service announcements
and introductions, competitive pricing pressures and aggressive marketing and
sales promotions. There can be no assurance that strong fourth quarter results
for subscriber additions and handset sales will continue for the wireless
industry or the PCS Group. The PCS Group's fourth quarter subscriber additions
and handset sales could be adversely impacted by a variety of reasons,
including the PCS Group's inability to match or beat pricing plans offered by
competitors, the failure to adequately promote the PCS Group's products,
services and pricing plans or the failure to have an adequate supply or
selection of handsets. If fourth quarter results of the PCS Group fail to
significantly improve upon subscriber additions and handset sales from the
year's previous quarters, the PCS Group's results for the year could be
materially adversely affected.
RESULTS OF OPERATIONS
As stated above, the PCS Group Historical Financial Statements include the
operations of SprintCom while the investments in Sprint Spectrum Holdings and
PhillieCo are accounted for on the equity basis. The information included
herein should be read in conjunction with the PCS Group Combined Financial
Statements and the Sprint Spectrum Holding Company Combined with MinorCo and
PhillieCo Financial Statements appearing elsewhere in this Annex II.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
----------------- -------------------------
1998 1997 1997 1996 1995
------- -------- ------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Total operating expenses.......... $ 80.0 $ 7.4 $ 18.5 $ 0.5 $ --
------- -------- ------- ------- -------
Operating loss.................... $ (80.0) $ (7.4) $ (18.5) $ (0.5) $ --
======= ======== ======= ======= =======
Equity in loss of Sprint Spectrum
Holdings and PhillieCo........... $(686.5) $ (410.6) $(659.6) $(191.8) $(31.4)
======= ======== ======= ======= =======
</TABLE>
Nine Months Ended September 30, 1998 and 1997
Operating Expenses
Operating expenses were $80 million for the first nine months of 1998 and $7
million for the same 1997 period. These expenses consist of selling, general
and administrative expenses associated with the network buildout for the PCS
licenses in the SprintCom markets, which are directly owned by Sprint. The
increase in these expenses from 1997 to 1998 is a result of significant
additional network buildout activities during the 1998 period.
Equity in Loss of Sprint Spectrum Holdings and PhillieCo
Sprint's share of combined losses from Sprint Spectrum Holdings and
PhillieCo was $687 million for the first nine months of 1998 compared with
$411 million for the same period in 1997. The increase in 1998 losses reflects
marketing and promotional costs, including losses on handset sales, to support
a growing customer base and the launching of service in additional markets.
Pro Forma PCS Group
In order to provide a more meaningful discussion and analysis of the
underlying operating results of the PCS Group businesses, the preceding
discussion of the PCS Group Historical Financial Statements is supplemented
with a discussion of the pro forma results of operations and financial
condition of the PCS Group as such information is deemed necessary to
facilitate an understanding of the operating results and financial condition
of Sprint's equity investments.
II-19
<PAGE>
Net operating revenues for the PCS Group on a pro forma basis were $788
million for the first nine months of 1998. Revenues include subscriber
revenues (including monthly recurring charges and usage charges), roaming
revenues and sales of handsets and accessory equipment. Revenues have
increased as a direct result of the growth in the number of subscribers. As
part of the PCS Group's marketing plans, handsets are normally sold at prices
substantially below the PCS Group's cost.
Cost of revenues for the PCS Group on a pro forma basis totaled $783 million
for the first nine months of 1998. Cost of revenues consists principally of
handset and accessory costs, interconnection costs and switch and cell site
expenses, including maintenance, site rental and utilities.
The PCS Group's average monthly service revenue per subscriber (ARPU) for
the nine-month period ended September 30, 1998 was approximately $57 compared
to $60 for the six months ended June 30, 1988. ARPU for the three months ended
September 30, 1998 was $55. This average is expected to continue to decline
(consistent with industry projections) due to increased competition resulting
from additional wireless service providers entering the market and the
addition of lower usage subscribers to the PCS Group's subscriber base. The
PCS Group has adopted marketing plans that both target and encourage higher
usage and higher ARPU. The PCS Group's customer churn rates and customer
marketing costs have been higher than cellular industry averages, but are
within the range management expected at this stage of development. As the PCS
markets mature and the PCS Group gains additional scale, management expects
both of these measures to trend downward toward cellular industry levels.
Customer churn can be attributed to several factors, including but not limited
to, network coverage and reliability issues (e.g. blocked calls, dropped
calls, handset problems), non-use of phones, change of employment,
affordability, customer care concerns and other competitive factors.
The PCS Group is currently operating in 39 of the largest 50 metropolitan
areas in the United States. Subscribers totaled more than 1.75 million at
September 30, 1998. The PCS Group plans to continue to aggressively obtain new
customers, which will likely continue to result in higher losses.
Years Ended December 31, 1997, 1996 and 1995
Operating Expenses
Operating expenses were $19 million for 1997 and $1 million for 1996. These
expenses consist of selling, general and administrative expenses related to
the network buildout for the PCS licenses in the SprintCom markets, which are
directly owned by Sprint. The increase in these expenses from 1996 to 1997 is
a result of the commencement of the network buildout in the second half of
1997.
Equity in Loss of Sprint Spectrum Holdings and PhillieCo
Sprint's share of combined losses from Sprint Spectrum Holdings and
PhillieCo was $660 million for 1997 compared with $192 million for 1996 and
$31 million for 1995. The increased losses reflect marketing and promotional
costs, including losses on handset sales, to support a growing customer base
and the launching of service in additional markets. The PCS Group plans to
continue to aggressively obtain new customers, which will likely continue to
result in higher losses in 1998 compared to 1997.
Pro Forma PCS Group
In order to provide a more meaningful discussion and analysis of the
underlying operating results of the PCS Group businesses, the preceding
discussion of the PCS Group Historical Financial Statements is supplemented
with a discussion of the pro forma results of operations and financial
condition of the PCS Group as such information is deemed necessary to
facilitate an understanding of the operating results and financial condition
of Sprint's equity investments.
Net operating revenues for the PCS Group on a pro forma basis totaled $258
million in 1997. The majority of the PCS Group's revenues in 1997 was
generated in the third and fourth quarters and include both service revenues
and the sales of handsets and accessory equipment. Revenues include subscriber
revenues (including
II-20
<PAGE>
monthly recurring charges and usage charges), roaming revenues and sales of
handsets and accessory equipment. As part of the PCS Group's marketing plans,
handsets are normally sold at prices substantially below the PCS Group's cost.
Cost of revenues for the PCS Group on a pro forma basis totaled $574 million
in 1997. Cost of revenues consists principally of handset and accessory costs,
interconnection costs, and switch and cell site expenses, including
maintenance, site rental and utilities. Increases in the volume of handsets
sold and increases in interconnection costs related to increased customer
usage were the drivers of these costs in 1997.
NONOPERATING ITEMS
Income Taxes
The PCS Group's effective tax rate was 38.4% for the first nine months of
1998 and 1997. The PCS Group's effective tax rates for the years ended
December 31 were 38.2% in 1997, 37.8% in 1996 and 36.6% in 1995. See Note 4 of
Notes to PCS Group Historical Financial Statements for information about the
differences that cause the effective income tax rate to vary from the
statutory federal rate.
LIQUIDITY AND CAPITAL RESOURCES
The PCS Group's primary uses of cash historically have been to fund initial
operating losses, capital expenditures, the acquisition of PCS licenses and
microwave relocation costs. Net losses for the PCS Group were $472 million and
$257 million for the nine months ended September 30, 1998 and 1997,
respectively, and were $419 million, $120 million and $20 million for the
years ended December 31, 1997, 1996 and 1995, respectively. Capital
expenditures for the PCS Group totaled $672 million and $68 million for the
nine months ended September 30, 1998 and 1997, respectively, and were $154
million for the year ended December 31, 1997. Capital expenditures for Sprint
Spectrum Holdings and PhillieCo totaled $1.1 billion and $1.6 billion for the
nine months ended September 30, 1998 and 1997, respectively, and totaled $2.1
billion, $1.4 billion and $32 million for the years ended December 31, 1997,
1996 and 1995, respectively. Capital expenditures were incurred primarily to
fund the buildout of the PCS Group's network. The entities comprising the PCS
Group have also spent a total of approximately $3.1 billion to acquire the PCS
licenses.
Historically, the primary sources of funds for the entities comprising the
PCS Group have been long-term public debt, bank facilities, vendor financing
arrangements, partner loans and capital contributions. Long-term debt
outstanding, including construction obligations and capital lease obligations,
for the PCS Group totaled $860 million at September 30, 1998. Long-term debt
outstanding, including vendor financing and construction obligations, for
Sprint Spectrum Holdings and PhillieCo totaled $6.7 billion at September 30,
1998. The entities comprising the PCS Group have used vendor financing
arrangements to fund the purchase of the equipment and software manufactured
by the vendors as well as a substantial part of the construction labor and
ancillary equipment (e.g., towers, antennae) required to construct the
network. These facilities serve as a primary financing source for the buildout
of the network. For a discussion of certain other debt arrangements see
"Sprint Spectrum Holding Company Combined with MinorCo and PhillieCo--
Management's Discussion and Analysis of Financial Condition and Results of
Operations--Liquidity and Capital Resources" in this Annex II.
The continued expansion of Sprint Spectrum Holdings' network and buildout of
the SprintCom network as well as the marketing and distribution of Sprint PCS
products and services will continue to require substantial capital. The PCS
Group currently estimates that capital expenditures during the period July
1998 through December 1999 will total approximately $3.2 billion to $4.0
billion. Capital expenditures for the network buildout include switches, base
stations, towers, antennae, radio frequency engineering, cell site
construction and microwave relocation. Actual amounts of the funds required
may vary materially from these estimates and additional funds would be
required in the event of significant departures from the current business
plan, unforeseen delays, cost overruns, unanticipated expenses, regulatory
changes, engineering design changes and other technological risks. Additional
funds will be required to fund anticipated operating losses, working capital
requirements and debt service requirements. In addition, funds may be required
to remain current with technological changes and developments.
II-21
<PAGE>
In addition to the above capital requirements, under the Sprint Spectrum
Holdings' partnership agreement with Cox, Cox has the right to require that
Sprint Spectrum Holdings acquire all or part of Cox's remaining interest in
Cox PCS based on the fair market value at the time of such acquisition.
Subsequent to December 31, 1997, Cox elected to exercise this right and put an
additional 10.2% ownership interest in Cox PCS to Sprint Spectrum Holdings,
which Sprint Spectrum Holdings acquired as of June 8, 1998 for approximately
$80 million. Sprint Spectrum Holdings also became managing partner of Cox PCS
on June 8, 1998. This put gave Sprint Spectrum Holdings a controlling interest
of 59.2% in Cox PCS. Cox may put certain remaining interests in Cox PCS to
Sprint Spectrum Holdings through December 2008. Cox has given Sprint Spectrum
Holdings notice to start the appraisal process related to a potential put of
all or a portion of Cox's remaining partnership interest to Sprint Spectrum
Holdings. See "The Tracking Stock Proposal--Amendments to the Cox PCS
Agreements" in the Proxy Statement.
Sprint expects that significant payments pursuant to the Tax Sharing
Agreement will be made from the FON Group to the PCS Group in light of the
substantial operating losses that the PCS Group is expected to incur in the
near future. Such payments are intended to reflect the PCS Group's incremental
cumulative effect on Sprint's federal and state tax liability and tax credit
position.
Sprint and the Cable Parents have loaned $400 million, based on respective
ownership interests, to fund the capital requirements of Sprint Spectrum
Holdings from the date of the signing of the PCS Restructuring Agreement, May
26, 1998, through September 30, 1998. The PhillieCo Partners have loaned $50
million to PhillieCo to fund operating and working capital requirements and
capital expenditures through September 30, 1998. Sprint has also loaned $110.6
million to fund SprintCom's capital requirements as part of the Restructuring
Agreement through September 30, 1998. Sprint has been financing SprintCom with
Sprint's cash from operations, commercial paper borrowings and leases on
specific equipment. Sprint intends to continue to fund the buildout of the
SprintCom markets through the closing of the PCS Restructuring. The above
mentioned loans, totaling $510.6 million excluding loans to PhillieCo, will be
converted into 10-year preferred stock of Sprint convertible into PCS Stock
or, in the case of Sprint, Preferred Inter-Group Interest. Such preferred
stock may be redeemed with the proceeds from an anticipated IPO, as further
discussed below, but only to the extent the net proceeds of the IPO exceed
$500 million. See "The Tracking Stock Proposal--Funding of the PCS Group Prior
to Closing; The PCS Preferred Stock" in the Proxy Statement.
Sprint currently uses the commercial paper market to fund its short-term
working capital needs. Sprint uses four commercial paper dealers to place the
paper at the most favorable rates and maturities. Sprint also uses the medium-
term note and long-term bond markets as well as other debt markets to fund its
working capital needs. Sprint intends to borrow 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 and to
refinance existing debt obligations of the PCS Group.
Financing activities for the Groups will be managed by Sprint on a
centralized basis. Pursuant to the Tracking Stock Policies, loans from Sprint
or any member of the FON Group to any member of the PCS Group will be made at
interest rates and on other terms and conditions substantially equivalent to
the interest rates and other terms and conditions that the PCS Group would be
able to obtain from third parties (including the public markets) as a direct
or indirect wholly-owned subsidiary of Sprint, but without the benefit of any
guaranty by Sprint or any member of the FON Group. Such policy contemplates
that such loans will be made on the basis set forth above regardless of the
interest rates and other terms and conditions on which Sprint or members of
the FON Group may have acquired the subject funds. Any difference between
Sprint's borrowing rates and the rates charged to the PCS Group, which rates
are expected to be higher than the rates at which Sprint obtained such
financing, will be reflected in the FON Group Combined Financial Statements.
This process will be governed by the Tracking Stock Policies as overseen by
the Capital Stock Committee.
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 replace its
II-22
<PAGE>
previous $1.5 billion revolving credit facility. As of September 30, 1998,
Sprint could borrow $3.6 billion under these new facilities. Sprint also has a
separate five-year revolving credit facility with a bank. The unused capacity
under the committed portion of that facility was $100 million.
In October 1998, Sprint filed a shelf registration statement with the
Securities and Exchange Commission (SEC) for $8.0 billion of debt securities.
This shelf registration replaced $1.0 billion of Sprint's existing shelf
registration statements. Sprint currently expects to offer up to $3 billion
under the new shelf registration at approximately the same time as the PCS
Restructuring. There can be no assurance that such offering will be
consummated. Proceeds from the sale of securities under this shelf
registration statement will be used to repay existing indebtedness.
In late September, Sprint filed a registration statement with the SEC for an
IPO of shares of Series 1 PCS Stock. In late October, Sprint announced that it
elected to proceed with a tax-free recapitalization of Sprint's common stock
concurrent with the PCS Restructuring and delay the planned IPO. Sprint
decided to delay the IPO due to current general market conditions. Sprint will
continue to evaluate market conditions and may proceed with a public offering
of the Series 1 PCS Stock at a later date.
FT and DT have agreed to purchase PCS Stock as part of the PCS Restructuring
to maintain their combined 20% voting power. Proceeds from the exercise of
these Equity Purchase Rights are expected to total between $75 and $100
million. These proceeds will be used to fund working capital needs and the
continued buildout of the PCS Group's network.
FINANCIAL STRATEGIES
For information on general hedging policies, interest rate risk management,
foreign exchange risk management and quantitative and qualitative disclosures
about market risk, see "Sprint--Management's Discussion and Analysis of
Financial Condition and Results of Operations--Financial Strategies" located
in Annex I.
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 or resellers.
The PCS Group is undertaking an inventory of its computer systems, network
elements, software applications, products and other business systems. These
inventories are targeted to be completed by year-end 1998. Once an item is
identified through the inventory process, its Year 2000 impact is assessed and
a plan is developed 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 is planning that Year 2000
compliance for these critical systems will 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. However, full compliance may not be achieved as planned
by the PCS Group and such third parties and the PCS Group may not receive
warranties and assurances from such third parties. The PCS Group relies on
third-party vendors for a significant number of its important operating and
computer system functions and therefore is highly dependent on such third-
party vendors for the remediation of network elements, computer systems,
software applications and other business systems. In addition, the PCS Group
uses publicly available services that are acquired without contract (for
example, global positioning system timing signal) that may be subject to 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 compel
compliance. Based upon management's
II-23
<PAGE>
evaluations to date, it believes that the total cost of modifications and
conversions of the PCS Group's systems will not be material, but such cost
could become material because of the various reasons described above, many of
which are out of the PCS Group's control.
If compliance is not achieved in a timely manner, the Year 2000 issue could
have a material adverse effect on the PCS Group's operations. However, the PCS
Group is focusing on identifying and addressing all aspects of its operations
that may be affected by the Year 2000 issue and is addressing the most
critical applications first. The PCS Group intends to develop and implement,
if necessary, appropriate contingency plans to mitigate to the extent possible
the effects of any Year 2000 noncompliance.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 8 of Notes to PCS Group Combined Financial Statements for a
discussion of recently issued accounting pronouncements.
II-24
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sprint Corporation
We have audited the accompanying combined balance sheets of the PCS Group
(as described in Note 2) as of December 31, 1997 and 1996, and the related
combined statements of operations and cash flows for each of the three years
in the period ended December 31, 1997. These financial statements are the
responsibility of the management of Sprint Corporation ("Sprint"). Our
responsibility is to express an opinion on these financial statements based on
our audits. The combined financial statements of Sprint Spectrum Holding
Company, L.P., MinorCo., L.P., PhillieCo Partners I, L.P. and PhillieCo
Partners II, L.P., (the "Partnerships") have been audited by other auditors
whose report has been furnished to us; insofar as our opinion on the combined
financial statements of the PCS Group relates to data included for the
Partnerships, it is based solely on their report. The PCS Group has a 40%
interest in Sprint Spectrum Holding Company, L.P. and MinorCo., L.P. and a
47.1% interest in PhillieCo Partners I, L.P. and PhillieCo Partners II, L.P.
In the combined financial statements, the PCS Group's combined equity in the
Partnerships is stated at $781 million and $1,032 million at December 31, 1997
and 1996, respectively, and the PCS Group's combined equity in the net loss of
Sprint Spectrum Holding Company, L.P. and PhillieCo, L.P. is stated at $656
million, $192 million and $31 million for the years ended December 31, 1997,
1996 and 1995, respectively.
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 PCS Group at
December 31, 1997 and 1996, and the combined results of its operations and its
cash flows for each of the three years in the period ended December 31, 1997,
in conformity with generally accepted accounting principles.
As more fully discussed in Note 2, the combined financial statements of the
PCS Group should be read in connection with the audited consolidated financial
statements of Sprint.
Ernst & Young LLP
Kansas City, Missouri
May 26, 1998
II-25
<PAGE>
PCS GROUP
COMBINED STATEMENTS OF OPERATIONS
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER YEAR ENDED DECEMBER
30, 31,
---------------- ------------------------
1998 1997 1997 1996 1995
------- ------- ------- ------- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING EXPENSES
Selling, general and administrative
expenses.......................... $ 78.2 $ 7.4 $ 18.5 $ 0.5 $ --
Depreciation and amortization...... 1.8 -- -- -- --
------- ------- ------- ------- ------
Total operating expenses........... 80.0 7.4 18.5 0.5 --
------- ------- ------- ------- ------
OPERATING LOSS (80.0) (7.4) (18.5) (0.5) --
Equity in loss of Sprint Spectrum
Holdings and PhillieCo............ (686.5) (410.6) (659.6) (191.8) (31.4)
------- ------- ------- ------- ------
Loss before income taxes........... (766.5) (418.0) (678.1) (192.3) (31.4)
Income tax benefit................. 294.7 160.7 259.0 72.6 11.5
------- ------- ------- ------- ------
NET LOSS .......................... $(471.8) $(257.3) $(419.1) $(119.7) $(19.9)
======= ======= ======= ======= ======
</TABLE>
See accompanying Notes to Combined Financial Statements.
II-26
<PAGE>
PCS GROUP
COMBINED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- -----------------
1998 1997 1996
------------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Prepaid expenses and other current assets...... $ 32.8 $ 2.9 $ --
Property, plant and equipment, net............. 1,327.2 177.3 --
Investments in Sprint Spectrum Holdings and
PhillieCo..................................... 475.4 968.4 1,175.8
Investment in PCS licenses..................... 544.5 544.5 84.0
Other noncurrent assets ....................... 114.3 -- --
-------- -------- --------
Total...................................... $2,494.2 $1,693.1 $1,259.8
======== ======== ========
LIABILITIES AND GROUP EQUITY
Current liabilities
Current maturities of long-term debt ........ $ 42.5 $ -- $ --
Accounts payable............................. 20.2 17.8 --
Advance from the FON Group................... 410.0 -- --
Payable to Sprint Spectrum Holdings.......... 47.1 19.0 --
Accrued expenses and other current
liabilities................................. 7.3 20.8 --
-------- -------- --------
Total current liabilities.................. 527.1 57.6 --
Construction obligations....................... 429.0 -- --
Capital lease obligations...................... 388.2 -- --
Deferred income taxes and other liabilities.... 318.9 249.6 72.2
Group equity................................... 831.0 1,385.9 1,187.6
-------- -------- --------
Total...................................... $2,494.2 $1,693.1 $1,259.8
======== ======== ========
</TABLE>
See accompanying Notes to Combined Financial Statements.
II-27
<PAGE>
PCS GROUP
COMBINED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED
SEPTEMBER 30, DECEMBER 31,
------------------ ----------------------------
1998 1997 1997 1996 1995
-------- -------- --------- -------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss..................... $ (471.8) $ (257.3) $ (419.1) $ (119.7) $ (19.9)
Adjustments to reconcile net
loss to net cash provided
(used) by operating
activities:
Equity in net losses of
affiliates................ 686.5 410.6 659.6 191.8 31.4
Depreciation and
amortization.............. 1.8 -- -- -- --
Deferred income taxes...... 56.9 191.2 175.7 64.2 8.0
Current tax benefit
utilized by the FON Group. (351.6) (351.9) (434.7) (136.8) (19.5)
Changes in assets and
liabilities:
Prepaid expenses and
other current assets.... (29.9) (2.2) (2.9) -- --
Accounts payable and
other current
liabilities............. 17.0 35.4 57.6 -- --
Noncurrent assets and
liabilities, net........ (101.9) -- 1.3 -- --
-------- -------- --------- -------- -------
Net cash provided (used) by
operating activities........ (193.0) 25.8 37.5 (0.5) --
-------- -------- --------- -------- -------
INVESTING ACTIVITIES
Capital expenditures......... (672.1) (68.2) (153.7) -- --
Purchase of PCS licenses..... -- (460.1) (460.1) (84.0) --
Investments in and loans to
Sprint Spectrum Holdings and
PhillieCo................... (193.5) (255.5) (405.9) (297.5) (910.9)
-------- -------- --------- -------- -------
Net cash used by investing
activities.................. (865.6) (783.8) (1,019.7) (381.5) (910.9)
-------- -------- --------- -------- -------
FINANCING ACTIVITIES
Advance from the FON Group... 410.0 -- -- -- --
Contributions from (to) the
FON Group................... (124.6) 406.1 547.5 245.2 891.4
Current tax benefit utilized
by the FON Group............ 351.6 351.9 434.7 136.8 19.5
Change in construction
obligations................. 429.0 -- -- -- --
Other........................ (7.4) -- -- -- --
-------- -------- --------- -------- -------
Net cash provided by
financing activities........ 1,058.6 758.0 982.2 382.0 910.9
-------- -------- --------- -------- -------
INCREASE (DECREASE) IN CASH
AND EQUIVALENTS............. -- -- -- -- --
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD......... -- -- -- -- --
-------- -------- --------- -------- -------
CASH AND EQUIVALENTS AT END
OF PERIOD................... $ -- $ -- $ -- $ -- $ --
======== ======== ========= ======== =======
NONCASH INVESTING AND
FINANCING ACTIVITIES
Assets acquired under a
capital lease obligation.... $ 438.1 $ -- $ -- $ -- $ --
======== ======== ========= ======== =======
</TABLE>
See accompanying Notes to Combined Financial Statements.
II-28
<PAGE>
PCS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
1. RECAPITALIZATION PLAN
Sprint Corporation (and with its subsidiaries "Sprint") has entered into a
restructuring agreement with Tele-Communications, Inc. ("TCI"), Comcast
Corporation ("Comcast") and Cox Communications, Inc. ("Cox," and together with
TCI and Comcast the "Cable Parents") to restructure Sprint's wireless personal
communications services ("PCS") operations (the "PCS Restructuring"). Sprint
will acquire the joint venture interests of TCI, Comcast and Cox in Sprint
Spectrum Holding Company, L.P. and MinorCo, L.P. (together, "Sprint Spectrum
Holdings") and the joint venture interests of TCI and Cox in PhillieCo
Partners I, L.P. and PhillieCo Partners II, L.P. (together, "PhillieCo"). In
exchange for these joint venture interests, Sprint will issue to the Cable
Parents a newly created class of Sprint Common Stock (the "PCS Stock"). The
PCS Stock is intended to reflect separately the performance of these joint
ventures and the domestic PCS operations of Sprint's wholly-owned
subsidiaries, SprintCom, Inc. and SprintCom Equipment Company, L.P. (together,
"SprintCom"). These operations will be referred to as the PCS Group.
The FON Stock, which will be created in the Recapitalization, is intended to
reflect the performance of all of Sprint's other operations, including its
long distance, local telecommunications and product distribution and directory
publishing divisions, emerging businesses and its interest in Global One.
These operations will be referred to as the FON Group.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Combination and Presentation
The Combined Financial Statements of the PCS Group together with the
Combined Financial Statements of the FON Group (the "Groups") comprise all of
the accounts included in the corresponding Consolidated Financial Statements
of Sprint. The entities which comprise the PCS Group are commonly controlled
companies. Investments in entities in which the PCS Group exercises
significant influence, but does not control, are accounted for using the
equity method (see Note 3). The separate Group Combined Financial Statements
give effect to the accounting policies that will be applicable upon
implementation of the PCS Restructuring. The separate Groups' Combined
Financial Statements have been prepared on a basis that management believes to
be reasonable and appropriate and include: (i) the combined historical balance
sheets, results of operations and cash flows of the businesses that comprise
each of the Groups with all significant intragroup amounts and transactions
eliminated and (ii) in the case of the FON Group Combined Financial
Statements, corporate assets and liabilities and related transactions of
Sprint. Transactions between the PCS Group and the FON Group have not been
eliminated.
The Combined Financial Statements of the PCS Group provide holders of PCS
stock with financial information regarding the underlying businesses of the
PCS Group. Notwithstanding the allocation of assets and liabilities (including
contingent liabilities) and stockholders' equity between the PCS Group and the
FON Group for the purpose of preparing the respective financial statements of
such Groups, investors in PCS Stock and FON Stock are stockholders of Sprint
and are subject to risks associated with an investment in a single company and
all of Sprint's businesses, assets and liabilities. Sprint retains all
beneficial ownership and control of the assets and operations of the FON Group
and, after the PCS Restructuring, the PCS Group (subject to a minority
interest). Financial effects arising from either Group that affect Sprint's
results of operations or financial condition could affect the results of
operations or financial position of the other Group or market price of the
class of common stock relating to the other Group. Any net losses of the PCS
Group or the FON Group, and dividends or distributions on, or repurchases of,
PCS Stock or FON Stock, will reduce the funds of Sprint legally available for
payment of dividends on both the PCS Stock and the FON Stock. Accordingly, the
PCS Group Combined Financial Statements should be read in conjunction with
Sprint's Consolidated Financial Statements and the FON Group Combined
Financial Statements.
II-29
<PAGE>
PCS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The PCS Group Combined Financial Statements are prepared according to
generally accepted accounting principles ("GAAP"). 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.
The unaudited interim financial information presented has been prepared
according to GAAP and the rules and regulations of the Securities and Exchange
Commission for interim reporting. In management's opinion, the information
presented reflects all adjustments (consisting only of normal recurring
accruals) necessary to present fairly the interim combined financial position,
results of operations and cash flows of the PCS Group.
Classification of Operations
The PCS Group includes Sprint's domestic wireless mobile telephony
activities and any other domestic PCS services, which includes (i) the
investment in Sprint Spectrum Holdings and the investment in PhillieCo, both
of which are reflected on the equity basis and (ii) SprintCom. Upon completion
of the PCS Restructuring, the results of Sprint Spectrum Holdings and
PhillieCo will be reflected on a consolidated basis in the PCS Group Combined
Financial Statements.
Sprint Spectrum Holdings, PhillieCo and SprintCom are building the nation's
first single-technology, all digital, state-of-the-art wireless network to
provide PCS across the United States operating on one frequency. PCS uses
digital technology, which has sound quality superior to analog cellular
technology and is less susceptible to interference and eavesdropping. PCS also
offers features such as voicemail and Caller ID.
Earnings Per Share
Historical earnings per share are omitted from the Combined Statements of
Operations because the PCS Stock was not part of the capital structure of
Sprint for the periods presented. See the Sprint Consolidated Financial
Statements in Annex I for information regarding earnings per share based on
Sprint's existing capital structure. Following implementation of the PCS
Restructuring, the method of calculating earnings per share for the PCS Group
will reflect the terms of the proposed amendments to Sprint's articles of
incorporation. Earnings per share will be computed by dividing the net income
or loss of the PCS Group by the weighted average number of shares of PCS Stock
and dilutive securities, such as warrants and options, outstanding during the
applicable period.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost and consists primarily of
construction work in progress. Generally, ordinary asset retirements and
disposals are charged against accumulated depreciation with no gain or loss
recognized. Repairs and maintenance costs are expensed as incurred. Once
operations of SprintCom commence, property, plant and equipment will be
depreciated on a straight-line basis over their estimated economic useful
lives. The PCS Group launched service in certain of the SprintCom markets
during the third quarter of 1998.
Investment in PCS Licenses
The PCS Group has acquired licenses from the Federal Communications
Commission ("FCC") to operate as a PCS service provider. These licenses are
recorded at cost and will be amortized over a 40-year period commencing with
the initiation of service in a specific geographic area. The FCC grants
licenses for terms of up to ten years, and generally grants renewals for
additional 10-year terms if the licensee has complied with its license
obligations. The PCS Group believes it will be able to secure renewal of the
PCS licenses that are held by the entities comprising the PCS Group. The PCS
Group launched service in certain of the SprintCom markets during the third
quarter of 1998.
II-30
<PAGE>
PCS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
Income Taxes
The PCS Group records deferred income taxes based on certain temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and amounts used for tax purposes.
The operations of the PCS Group are included in the consolidated federal
income tax return of Sprint. The PCS Group's federal income tax represents the
difference between the Sprint consolidated federal income tax and the FON
Group's federal income tax. The related current tax benefits generated from
the inclusion of the PCS Group operating losses in the Sprint consolidated
federal income tax return have been reflected as contributions from the FON
Group to the PCS Group in the PCS Group combined statements of cash flow. The
PCS Group's state tax is computed using a methodology consistent with that
used to compute federal income tax.
Capitalized Interest
Sprint capitalized interest costs related to its investments in Sprint
Spectrum Holdings and PhillieCo until July 1997, at which time Sprint Spectrum
Holdings and PhillieCo no longer qualified as development-stage companies.
Amounts capitalized totaled $46 million, $96 million, and $43 million at
December 31, 1997, 1996, and 1995, respectively. The capitalized interest on
the investments in Sprint Spectrum Holdings and PhillieCo was contributed to
and is being amortized by the PCS Group.
In addition, Sprint capitalizes interest costs associated with the network
buildout of SprintCom. Interest capitalized for the year ended December 31,
1997 was $24 million. Such interest was also contributed to and will be
amortized by the PCS Group.
3. INVESTMENTS IN SPRINT SPECTRUM HOLDINGS AND PHILLIECO
Sprint has a 40% interest in Sprint Spectrum Holdings and a 47.1% interest
in PhillieCo, respectively. These investments are accounted for using the
equity method. Combined, summarized financial information (100% basis) of
these entities is as follows (in millions):
<TABLE>
<CAPTION>
NINE MONTHS AT OR FOR THE
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- --------- -------- -------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Results of operations
Net operating
revenues............. $ 788.0 $ 110.5 $ 258.0 $ 4.2 $ --
========= ========= ========= ======== =======
Operating loss........ $(1,455.8) $ (869.0) $(1,379.7) $ (357.6) $ (66.9)
========= ========= ========= ======== =======
Net loss.............. $(1,692.0) $(1,021.5) $(1,632.7) $ (444.6) $(112.7)
========= ========= ========= ======== =======
Financial position
Current assets........ $ 417.9 $ 401.8
Noncurrent assets..... 6,640.0 4,041.8
--------- --------
Total................. $ 7,057.9 $4,443.6
========= ========
Current liabilities... $ 834.5 $ 471.2
Noncurrent
liabilities.......... 4,289.4 1,412.5
Partners' equity...... 1,934.0 2,559.9
--------- --------
Total................. $ 7,057.9 $4,443.6
========= ========
</TABLE>
II-31
<PAGE>
PCS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
4. INCOME TAXES
Income tax benefit consists of the following:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C>
Current income tax benefit
Federal...................................... $(414.1) $(122.8) $(16.3)
State........................................ (20.6) (14.0) (3.2)
------- ------- ------
Total current.................................. (434.7) (136.8) (19.5)
------- ------- ------
Deferred income tax expense (benefit)
Federal...................................... 187.0 59.4 5.8
State........................................ (11.3) 4.8 2.2
------- ------- ------
Total deferred................................. 175.7 64.2 8.0
------- ------- ------
Total income tax benefit....................... $(259.0) $ (72.6) $(11.5)
======= ======= ======
</TABLE>
The differences that caused the effective income tax rates to vary from the
statutory federal rate of 35% were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Income tax benefit at the statutory rate........ $(237.3) $(67.3) $(11.0)
Effect of
State income taxes, net of federal income tax
effect....................................... (20.7) (6.0) (0.7)
Other, net.................................... (1.0) 0.7 0.2
------- ------ ------
Income tax benefit.............................. $(259.0) $(72.6) $(11.5)
======= ====== ======
Effective income tax rate....................... 38.2% 37.8% 36.6%
======= ====== ======
</TABLE>
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 and for its share of similar temporary
differences of Sprint Spectrum Holdings and PhillieCo. The sources of the
differences that give rise to the deferred income tax assets and liabilities
at December 31, 1997 and 1996, along with the income tax effect of each, were
as follows:
<TABLE>
<CAPTION>
1997 DEFERRED 1996 DEFERRED
INCOME TAX INCOME TAX
------------------ ------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Property, plant and equipment.......... $ -- $183.0 $ -- $28.5
Capitalized interest................... -- 83.6 -- 55.8
Reserves and allowances................ 8.2 -- 2.2 --
Operating loss carryforwards........... 24.1 -- 8.9 --
Other, net............................. -- 13.6 1.0 --
----- ------ ----- -----
Total.................................. $32.3 $280.2 $12.1 $84.3
===== ====== ===== =====
</TABLE>
Management believes it is more likely than not that the deferred income tax
asset will be realized based on current income tax laws and expectations of
future taxable income stemming from the reversal of the existing deferred tax
liability. 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 this
deferred income tax asset.
At December 31, 1997, the PCS Group had recorded tax benefits of $37 million
related to state operating loss carryforwards. The loss carryforwards expire
in varying amounts per year from 2000 through 2012.
II-32
<PAGE>
PCS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
5. PCS GROUP EQUITY
Following is a reconciliation of the PCS Group's equity (in millions):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER YEAR ENDED
30, DECEMBER 31,
------------------ --------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period..................... $1,385.9 $1,187.6 $1,187.6 $ 965.8 $ 51.1
Net loss.................... (471.8) (257.3) (419.1) (119.7) (19.9)
Contributions from the FON
Group...................... 268.5 804.3 1,052.1 478.3 954.1
Equity transfers to the FON
Group...................... (351.6) (351.9) (434.7) (136.8) (19.5)
-------- -------- -------- -------- ------
Balance at end of period.... $ 831.0 $1,382.7 $1,385.9 $1,187.6 $965.8
======== ======== ======== ======== ======
</TABLE>
6. COMMITMENTS AND CONTINGENCIES
Litigation, Claims and Assessments
The holders of PCS Stock will be stockholders of Sprint and will continue to
be subject to all of the risks associated with an investment in Sprint,
including any legal proceedings and claims affecting 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 result in a material effect on the PCS Group's Combined
Financial Statements.
Commitments
In the third and fourth quarters of 1997, SprintCom entered into procurement
and services contracts with Motorola and Nortel, respectively, for equipment,
software and certain engineering services. These contracts provide for an
initial term of five years with renewals for additional one-year periods.
Pricing for the initial equipment, software and engineering services has been
established in the procurement contracts. The procurement contracts provide
for payment terms based on delivery dates and various acceptance milestones.
In the event of delay in delivering equipment or services, the procurement
contracts provide for certain amounts to be paid to SprintCom by the vendor.
The minimum commitments for the initial term are approximately $300 million
and $200 million for Motorola and Nortel, respectively, for PCS CDMA 1900 MHz
equipment and software.
Sprint and the Cable Parents have agreed to loan up to $400 million, based
on respective ownership interests, to fund the capital requirements of Sprint
Spectrum Holdings from the date of the signing of the PCS Restructuring
agreement through the closing date of the PCS Restructuring. The PhillieCo
Partners have agreed to lend up to $50 million to PhillieCo to fund operating
and working capital requirements and capital expenditures prior to closing.
Sprint has also agreed to loan up to $110.6 million to fund SprintCom's
capital requirements during the same period. Sprint has been financing
SprintCom with cash from operations, commercial paper borrowings and leases on
specific equipment. Sprint intends to continue to fund the buildout of the
SprintCom markets through the closing of this transaction. The above mentioned
loans to Sprint Spectrum Holdings and SprintCom totaling $510.6 million, may
be repaid from the proceeds of an anticipated IPO, but only to the extent the
net proceeds of the IPO exceed $500 million. It is Sprint's intent to complete
the IPO concurrently with the PCS Restructuring. There can be no assurance
that the IPO will occur. In the event the loans remain outstanding after the
IPO, the remaining balance will be converted into 10-year preferred stock (or,
in the case of Sprint, a preferred inter-group interest).
II-33
<PAGE>
PCS GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
Operating Leases
Minimum rental commitments at December 31, 1997 for all non-cancelable
operating leases, consisting mainly of leases for cell and switch sites and
office space, are as follows (in millions):
<TABLE>
<S> <C>
1998................................................................ $18.9
1999................................................................ 13.3
2000................................................................ 13.4
2001................................................................ 13.4
2002................................................................ 8.0
Thereafter.......................................................... 5.1
</TABLE>
Gross rental expense aggregated $4 million for the year ended December 31,
1997. Certain cell and switch site leases contain renewal options (generally
for terms of five years) that may be exercised from time to time and are
excluded from the above amounts.
7. ADDITIONAL FINANCIAL INFORMATION
Related Party Transactions
Sprint Spectrum L.P. provides general management, engineering, procurement,
accounting and other related services to SprintCom. Sprint Spectrum L.P. is
currently building out the network infrastructure in certain BTA markets where
SprintCom was awarded licenses. For the year ended December 31, 1997, Sprint
Spectrum L.P. provided $29 million in services to SprintCom, the majority of
which are capitalized as property, plant and equipment within the Combined
Balance Sheets of the PCS Group.
Certain members of the FON Group provide management, printing/mailing and
warehousing services to the PCS Group. Charges to the PCS Group for such
services totaled $17 million, $12 million, and $3 million, for the years ended
December 31, 1997, 1996 and 1995, respectively.
8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 131, "Disclosures
about Segments of an Enterprise and Related Information." This new standard
requires companies to disclose segment data based on how management makes
decisions about allocating resources to segments and how it measures segment
performance. SFAS 131 requires companies to disclose a measure of segment
profit or loss (operating income, for example), segment assets, and
reconciliations to consolidated totals. It also requires entity-wide
disclosures about a company's products and services, its major customers and
the material countries in which it holds assets and reports revenues. Sprint
will adopt SFAS 131 in its December 31, 1998 financial statements. This
statement is not expected to have a significant effect on the PCS Group, as it
only operates within one segment under the new standard.
9. SUBSEQUENT EVENTS (UNAUDITED)
Subsequent to December 31, 1997, SprintCom entered into leveraged lease
arrangements for certain telecommunications equipment. The leveraged leases
are accounted for as capital leases. Lease obligations of $438 million have
been recorded under these arrangements as of September 30, 1998. The PCS Group
has also increased its construction obligations by $429 million since December
31, 1997.
In October 1998, Sprint filed a shelf registration statement with the SEC
for $8.0 billion of debt securities. This replaced $1.0 billion of Sprint's
previous shelf registration statements totaling $1.1 billion. Sprint currently
expects to offer up to $3 billion under the new shelf at approximately the
same time as the PCS Restructuring.
II-34
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
SELECTED FINANCIAL DATA
The following unaudited table sets forth Selected Financial Data of Sprint
Spectrum Holding Company, MinorCo and PhillieCo. The following should be read
in conjunction with the Sprint Spectrum Holding Company Combined with MinorCo
and PhillieCo Management's Discussion and Analysis of Financial Condition and
Results of Operations, and the Sprint Spectrum Holding Company Combined with
MinorCo and PhillieCo Financial Statements and Notes thereto. The Selected
Financial Data at December 31, 1997 and 1996 and for each of the three years
in the period ended December 31, 1997 have been derived from the Sprint
Spectrum Holding Company Combined with MinorCo and PhillieCo Financial
Statements, which have been audited by Deloitte & Touche LLP, independent
auditors. The Selected Financial Data at December 31, 1995 and 1994, at
September 30, 1998, for the year ended December 31, 1994, and for the nine
months ended September 30, 1998 and 1997 have been derived from the unaudited
Sprint Spectrum Holding Company Combined with MinorCo and PhillieCo Financial
Statements. The unaudited Sprint Spectrum Holding Company Combined with
MinorCo and PhillieCo Financial Statements have been prepared on the same
basis as the audited Sprint Spectrum Holding Company Combined with MinorCo and
PhillieCo Financial Statements and, in the opinion of management, contain all
adjustments, consisting of only normal recurring accruals, necessary for a
fair presentation of the financial position and results of operations for
these periods. Results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the entire
year.
<TABLE>
<CAPTION>
AT OR FOR THE
NINE MONTHS AT OR FOR THE
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- --------------------------------------
1998 1997 1997 1996 1995 1994(1)
--------- --------- --------- -------- -------- -------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS
DATA
Net operating revenues.. $ 788.0 $ 110.5 $ 258.0 $ 4.2 $ -- $ --
Operating loss.......... (1,455.8) (869.0) (1,379.7) (357.6) (66.9) (3.3)
Net loss................ (1,692.0) (1,021.5) (1,632.7) (444.6) (112.7) (3.3)
CASH FLOW DATA
Net cash used in
operating activities... $ 1,301.4 $ 606.4 $ 848.2 $ 172.4 $ 16.9 $ 0.5
Capital expenditures.... 1,107.7 1,632.8 2,124.6 1,419.2 31.8 0.5
Purchase of PCS
licenses............... -- -- -- -- 2,085.8 118.4
BALANCE SHEET DATA
Total assets............ $ 8,526.4 $ 7,057.9 $4,443.6 $2,329.3 $123.9
Property, plant and
equipment, net......... 4,531.9 3,538.2 1,441.6 32.0 0.4
Long-term debt and
construction
obligations (including
short-term borrowings). 6,701.4 4,273.8 1,401.2 -- --
</TABLE>
- --------
(1) Sprint Spectrum Holding Company, MinorCo and PhillieCo had no operations
prior to 1994.
II-35
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion and analysis should be read in conjunction with the
combined financial statements of Sprint Spectrum Holding Company, L.P. and
subsidiaries, MinorCo, L.P. and subsidiaries, PhillieCo Partners I, L.P. and
subsidiaries and PhillieCo Partners II, L.P. and subsidiaries (collectively,
the "Company" or the "Partnerships") which offer services as Sprint PCS.
Sprint Spectrum Holding Company, L.P. ("Holdings") and MinorCo, L.P.
("MinorCo") are limited partnerships formed by subsidiaries (the "Partners")
of Sprint Corporation ("Sprint"), Tele-Communications, Inc. ("TCI"), Cox
Communications, Inc. ("Cox"), and Comcast Corporation ("Comcast", and together
with Sprint, TCI and Cox, the "Parents"). Holdings is the 99% general partner
of, and is consolidated with, its subsidiaries, including NewTelco, L.P.
("NewTelco"), American PCS, L.P. ("APC") and Sprint Spectrum L.P., which, in
turn, has several subsidiaries. Sprint Spectrum L.P.'s subsidiaries are Sprint
Spectrum Equipment Company, L.P. ("EquipmentCo"), Sprint Spectrum Realty
Company, L.P. ("RealtyCo"), Sprint Spectrum Finance Corporation ("FinCo"), and
WirelessCo. MinorCo holds the minority ownership interests of 1% in NewTelco,
Sprint Spectrum L.P., EquipmentCo, RealtyCo and WirelessCo at September 30,
1998, December 31, 1997 and 1996, and APC at September 30, 1998 and December
31, 1997. Holdings owns a 59.2% interest in, and is consolidated with, Cox
Communications PCS, L.P. ("Cox PCS") at September 30, 1998.
PhillieCo Partners I, L.P. ("PhillieCo I") and PhillieCo Partners II, L.P.
("PhillieCo II") are limited partnerships formed by subsidiaries of Sprint,
TCI and Cox (the "PhillieCo Parents"). PhillieCo I is the 99% general partner
of, and is consolidated with, its subsidiaries, including PhillieCo Sub, L.P.
("PhillieCo Sub") and PhillieCo, L.P. ("PhillieCo"). PhillieCo II holds the
minority ownership interests of 1% in PhillieCo Sub and PhillieCo.
The following information includes certain estimates, projections and other
forward-looking statements. There can be no assurances of future performance
and actual results may differ materially from those in the forward-looking
statements. Factors which could cause actual results to differ materially from
estimates or projections contained in forward-looking statements include:
. the establishment of a market for new digital personal communications
services ("PCS");
. the introduction of competitive service plans and pricing and other
effects of vigorous competition in the markets in which the Company
currently operates or intends to market its services;
. the impact of technological change which may diminish the value of
existing equipment which may, in turn, result in the need to incur
additional costs to upgrade previously sold communications equipment;
. the cost of entering new markets necessary to provide services;
. the impact of any unusual items resulting from ongoing evaluations of
the Company's business strategies;
. the impact of changes brought about by possible restructuring of
partners' ownership interests;
. the effects of unanticipated delays or problems with the development of
technologies and systems used by the Company;
. requirements imposed on the Company and its competitors by the Federal
Communications Commission ("FCC") and state regulatory commissions under
the Telecommunications Act of 1996;
. the impact of the Year 2000 issue and any related noncompliance;
. the possibility of one or more of the markets in which the Company will
compete being impacted by variations in political, economic or other
factors over which the Company has no control;
. the effects of unanticipated delays resulting from zoning or other
disputes with municipalities; and
. unexpected results in litigation.
II-36
<PAGE>
GENERAL
LICENSE AND NETWORK COVERAGE--The Company through Sprint Spectrum L.P.
acquired PCS licenses in the FCC's A Block and B Block PCS auction, which
concluded in March 1995, to provide service to 30 major trading areas ("MTAs")
covering 155.9 million Pops. Additionally, Cox contributed to the Company,
effective February 6, 1997, a PCS license for the Omaha MTA covering 1.7
million Pops. The Company has also affiliated with and expects to continue to
affiliate with other PCS providers. Pursuant to affiliation agreements, each
affiliated PCS service provider uses the Sprint(R) and Sprint PCS(R) brand
names, trademarks of Sprint Communications Company L.P. ("Sprint
Communications").
In 1997 the Company commenced service in all of the MTAs in which it owns a
license and expects to continue to incur additional construction costs as it
expands coverage in existing license areas. Additionally, the Company will
require substantial working capital to fund operating activities, including
the up-front customer acquisition costs. The extent to which the Company is
able to generate operating revenue and earnings is dependent on a number of
business factors, including maintaining existing financing, generating
operating revenues, and attaining profitable levels of market demand for the
Company's products and services.
AFFILIATIONS--The following is a detail of affiliates in which the Partners
have an ownership interest and to which Sprint Spectrum L.P. provides
management services.
APC--Holdings and MinorCo own 99.75% and 0.25%, respectively, of the
partnership interests in APC. APC, through subsidiaries, owns a PCS license
for and operates both a broadband CDMA network and GSM network in the
Washington D.C./Baltimore MTA, which covers approximately 8.3 million Pops.
APC launched CDMA service in April 1998.
Cox PCS--Holdings also owns a 59.2% general partnership interest in and is
the managing partner of Cox PCS, a limited partnership that owns a PCS license
for the Los Angeles/San Diego/Las Vegas MTA covering 21.0 million Pops. Cox,
which previously owned this license, contributed the license to Cox PCS on
March 31, 1997. Sprint Spectrum L.P. signed an affiliation agreement with Cox
PCS on December 31, 1996. Through December 2008, Cox may put certain remaining
interests in Cox PCS to Holdings. Cox has given Sprint Spectrum Holdings
notice to start the appraisal process related to a potential put of all or a
portion of Cox's remaining partnership interest to Sprint Spectrum Holdings.
SprintCom, Inc. ("SprintCom")--SprintCom, a wholly-owned subsidiary of
Sprint, participated in the FCC's D and E Block auction which ended in January
1997, and was awarded licenses for 139 of 493 BTAs, covering approximately
74.9 million Pops, all of which are geographic areas not covered by the
Company's owned PCS licenses or licenses owned by APC or Cox PCS. In
accordance with the Amended and Restated Agreement of Limited Partnership of
MajorCo, L.P. (renamed Sprint Spectrum Holding Company, L.P. ) dated January
31, 1996, SprintCom is required to offer to enter into an affiliation
agreement with Holdings with respect to such BTA licenses pursuant to which
SprintCom's systems in such areas would be included in the Company's national
PCS network, although a final agreement has not yet been reached. In the
interim, Sprint Spectrum L.P. has been providing buildout services in certain
BTA markets where SprintCom was awarded PCS licenses and is being reimbursed
for such services, which include engineering, management, purchasing,
accounting, and other related services. SprintCom intends to market its
products and services as Sprint PCS.
Other--In June 1998, the Company and its affiliates also entered into
various management agreements with other companies pursuant to which such
other companies (each a "Manager") will build networks in portions of the
Company's licensed coverage area and then affiliate the Manager's network with
the Company's network. These Manager networks will be built using the same
technological standards as those of the Company, and the Managers will use the
Sprint PCS brand name to market their services and will be required to
maintain certain quality standards to be established by the Company. The
Company and affiliates entered into additional agreements in the third quarter
and intend to continue to enter into additional management agreements as a
means of expanding its existing network.
ROAMING--The Company has entered into roaming agreements with various analog
cellular providers in the United States and Canada. Additionally, the Company
has negotiated roaming arrangements with other
II-37
<PAGE>
CDMA PCS carriers who provide service in certain geographic areas not
currently covered by the CDMA network of Sprint Spectrum L.P. and its
affiliates. As a result, customers with dual-mode handsets capable of
transmitting over cellular and CDMA PCS frequencies have the ability to roam
in areas where Sprint PCS service is not available and where there are roaming
agreements.
EMERGENCE FROM DEVELOPMENT STAGE AND CONTINUING RISK FACTORS
EMERGENCE FROM DEVELOPMENT STAGE--Prior to the third quarter of 1997, the
Company reported its operations as a development stage enterprise. During the
development stage, the Company incurred expenditures in conjunction with PCS
license acquisitions, initial design and construction of the PCS network,
engineering, marketing, administrative and other start-up expenses. The
Company has now commenced service in all of the MTAs in which it owns a
license and expects to continue to incur additional construction costs as it
expands coverage in existing license areas. Additionally, the Company will
require substantial working capital to fund initial operating activities,
including up-front customer acquisition costs. The extent to which the Company
is able to generate operating revenue and earnings is dependent on a number of
business factors, including maintaining existing financing, generating
operating revenues and attaining profitable levels of market demand for the
Company's products and services.
DEADLOCK EVENT--The proposed budgets for fiscal year 1998 were not approved
by the Holdings or PhillieCo I partnership boards, which resulted in the
occurrence of a "Deadlock Event" as of January 1, 1998 under the Holdings and
PhillieCo I Partnership Agreements. Holdings is the sole general partner of
Sprint Spectrum L.P. PhillieCo I is the sole general partner of PhillieCo Sub.
Under the Holdings and PhillieCo I Partnership Agreements, if one of the
Partners refers the budget issue to the chief executive officers of the
Parents for resolution pursuant to specified procedures and the issue remains
unresolved, buy/sell provisions would be triggered which may result in the
purchase by one or more of the Partners of the interest of the other partners,
or, in certain circumstances, the liquidation of Holdings and PhillieCo I and
their subsidiaries. Discussions among the Partners about restructuring their
interests in Holdings and PhillieCo I, in lieu of triggering such buy/sell
procedures, have resulted in the Partners entering into the Restructuring
Agreement. See "PCS Restructuring" below and "The Tracking Stock Proposal--The
Restructuring Agreement" in the Proxy Statement for a discussion of the
Restructuring Agreement.
BUSINESS PLAN--The Company's business plan will require additional capital
financing prior to the end of 1998, to the extent the PCS Restructuring is not
approved by Sprint's shareholders. Sources of funding for the Company's
further financing requirements may include additional vendor financing, public
offerings or private placements of equity and/or debt securities, commercial
bank loans and/or capital contributions from the partners. There can be no
assurance that any additional financing can be obtained on a timely basis and
on terms acceptable to the Company and its partners and within limitations
contained in the Notes (as defined hereafter), the agreements governing the
Secured Financing and any new financing arrangements. Failure to obtain any
such financing could result in the delay or abandonment of the Company's
development and expansion plans and expenditures, the failure to meet
regulatory requirements or other potential adverse consequences.
PCS RESTRUCTURING--Sprint has entered into the Restructuring Agreement with
TCI, Comcast, and Cox to restructure Sprint's PCS operations subject to Sprint
stockholder and FCC approvals. If the PCS Restructuring occurs as planned,
Sprint will acquire the joint venture interests of TCI, Comcast and Cox in
Holdings and MinorCo and the joint venture interests of TCI and Cox in
PhillieCo I and II. In exchange for these joint venture interests, Sprint will
issue to TCI, Comcast, and Cox shares of Series 2 PCS Stock.
YEAR 2000 ISSUE--The "Year 2000" issue affects the Company'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 Company's customers, vendors or resellers.
II-38
<PAGE>
The Company is undertaking an inventory of its computer systems, network
elements, software applications, products and other business systems. These
inventories are targeted to be completed by year-end 1998. Once an item is
identified through the inventory process, its Year 2000 impact is assessed and
a plan is developed to address any required renovation. The Company is using
both internal and external resources to identify, correct or reprogram, and
test its systems for Year 2000 compliance. It is planning that Year 2000
compliance for these critical systems will be achieved in 1999. The Company 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. However, full compliance may not be achieved as planned
by the PCS Group and such third parties and the PCS Group may not receive
warranties and assurances from such third parties. The Company relies on the
third-party vendors for a significant number of its important operating and
computer system functions and therefore is highly dependent on such third-
party vendors for the remediation of network elements, computer systems,
software applications and other business systems. In addition, the Company
uses publicly available services that are acquired without contract (e.g.,
global positioning system timing signal) that may be subject to the Year 2000
issue. While the Company believes these systems will be Year 2000 compliant,
the Company has no contractual or other right to compel compliance. Based upon
management's evaluations to date, it believes that the total cost of
modifications and conversions of the PCS Group's systems will not be material,
but such cost could become material because of the various reasons described
above, many of which are out of the PCS Group's control.
If compliance is not achieved in a timely manner, the Year 2000 issue could
have a material adverse effect on the Company's operations. However, the
Company is focusing on identifying and addressing all aspects of its
operations that may be affected by the Year 2000 issue and is addressing the
most critical applications first. Sprint intends to develop and implement, if
necessary, appropriate contingency plans to mitigate to the extent possible
the effects of any Year 2000 noncompliance.
LIQUIDITY AND CAPITAL RESOURCES
The continued expansion of the Company's PCS network and the marketing and
distribution of the Company's PCS products and services will continue to
require substantial capital. Actual amounts of the funds required may vary in
the event of unforeseen delays, cost overruns, unanticipated expenses,
regulatory changes, engineering design changes and other technological risks.
The Company currently has limited sources of revenue to meet its capital
requirements and has relied upon capital contributions, third party debt and
public debt. The Holdings Partnership Agreement provides for planned aggregate
equity capital contributions of approximately $4.2 billion by the Partners
("Total Mandatory Contributions"). Total Mandatory Contributions include
agreed upon values attributable to the contributions of certain additional PCS
licenses by a Partner. The Total Mandatory Contributions amount is required to
be contributed in accordance with capital contribution schedules to be set
forth in approved annual budgets. The partnership board of Holdings may
request capital contributions to be made in the absence of an approved budget
or more quickly than provided for in an approved budget, but always subject to
the Total Mandatory Contributions limit. Throughout 1997, the Partners
continued to make such capital contributions by mutual agreement in the
absence of an approved budget for 1997. However, the Partners have no such
obligation in the absence of an approved budget, and there can be no assurance
the Partners will reach such an agreement or approve the 1998 proposed budget.
See "Emergence From Development Stage and Continuing Risk Factors--Deadlock
Event" for further discussion related to absence of an approved budget. As of
September 30, 1998, the Partners have fulfilled their capital contribution
commitments under the Holdings Partnership Agreement.
In October 1996 and as amended in December 1997, Sprint Spectrum L.P.
entered into a credit agreement with The Chase Manhattan Bank, as
administrative agent for a group of lenders, for a $2.0 billion senior secured
credit facility (the "Bank Facility"). The proceeds of the Bank Facility are
to be used to finance working capital needs, subscriber acquisition costs,
capital expenditures and other general purposes of Sprint Spectrum L.P. The
Bank Facility consists of a $300 million term loan commitment and a revolving
credit commitment of $1.7 billion. As of September 30, 1998 and December 31,
1997, $300 million had been borrowed under the term loan. As of September 30,
1998 and December 31, 1997, $1.6 billion and $605 million had been borrowed
under the revolving credit facility, respectively, with $100 million and $1.1
billion remaining available, respectively. There were no borrowings under the
revolving credit commitment at December 31, 1996.
II-39
<PAGE>
Also in October 1996, Sprint Spectrum L.P. entered into credit agreements
for up to an aggregate of $3.1 billion of senior secured multiple drawdown
term loan facilities from two of its network infrastructure equipment vendors.
As amended in April and November 1997, the Nortel facility provides $1.3
billion in senior secured loans. The Lucent facility, as amended in May and
December 1997, provides $1.8 billion in senior secured loans (together the
"Vendor Financing" and together with the Bank Facility, the "Secured
Financing"). The Company is using the proceeds from the Vendor Financing to
fund the purchase of the equipment and software manufactured by the vendors as
well as a substantial part of the construction and ancillary equipment (e.g.,
towers, antennae, cable) required to construct the Company's PCS network.
These facilities serve as the primary financing mechanism for the buildout of
the network. The Company has borrowed $2.5 billion and $1.6 billion under such
facilities at September 30, 1998 and December 31, 1997, respectively, of which
$300 million was syndicated to Sprint.
The Bank Facility agreement and the Vendor Financing agreements contain
certain restrictive financial and operating covenants, including, among other
requirements, maximum debt ratios (including debt to total capitalization),
limitations on capital expenditures, limitations on additional indebtedness
and limitations on dividends and other payment restrictions affecting certain
restricted subsidiaries. The loss of the right to use the Sprint trademark,
the termination or non-renewal of any FCC license that reduces population
coverage below specified limits, or changes in controlling interest in the
Company, as defined, among other provisions, constitute events of default.
Borrowings under the Secured Financing are secured by Sprint Spectrum L.P.'s
interest in WirelessCo, RealtyCo and EquipmentCo and certain other personal
and real property (the "Shared Lien"). The Shared Lien equally and ratably
secures the Bank Facility and the Vendor Financing. The Secured Financing is
jointly and severally guaranteed by WirelessCo, RealtyCo and EquipmentCo and
is non-recourse to the Partners.
In August 1996, Sprint Spectrum L.P. and FinCo issued $250 million aggregate
principal amount of the 11% Senior Notes and $500 million aggregate principal
amount at maturity of 12 1/2% Senior Discount Notes (together, the "Notes").
The Senior Discount Notes were issued at a discount to their aggregate
principal amount at maturity and generated proceeds of approximately $273
million. Cash interest on the Senior Notes will accrue at a rate of 11% per
annum and is payable semi-annually in arrears on each February 15 and August
15, commencing February 15, 1997. Cash interest will not accrue or be payable
on the Senior Discount Notes prior to August 15, 2001. Thereafter, cash
interest on the Senior Discount Notes will accrue at a rate of 12 1/2% per
annum and will be payable semi-annually in arrears on each February 15 and
August 15, commencing February 15, 2002. FinCo was formed solely to be a co-
obligor of the Notes. FinCo has only nominal assets and no operations or
revenues, and Sprint Spectrum L.P. will be responsible for payment of the
Notes. On August 15, 2001, Sprint Spectrum L.P. will be required to redeem an
amount equal to $384.772 per $1,000 principal amount at maturity of each
Senior Discount Note then outstanding ($192 million in aggregate principal
amount at maturity, assuming all of the Senior Discount Notes remain
outstanding at such date). The proceeds of approximately $509 million from the
issuance of the Notes (net of approximately $14 million of underwriting
discounts, commissions, and offering expenses) were used to fund capital
expenditures, including the buildout of the nationwide PCS network, to fund
working capital requirements, to fund operating losses and for other
partnership purposes. Sprint purchased, and continues to hold, approximately
$183 million principal amount at maturity of the Senior Discount Notes. The
Notes contain certain restrictive covenants, including, among other
requirements limitations on additional indebtedness, limitations on restricted
payments, limitations on liens, and limitations on dividends and other payment
restrictions affecting restricted subsidiaries.
The Company is obligated to the FCC for $102 million for the receipt of the
commercial PCS license covering the Washington D.C./Baltimore MTA. In March
1996, the FCC determined that interest on the amount due would begin to accrue
on March 8, 1996, at an interest rate of 7.75%. Beginning with the first
payment due in April 1996, the FCC granted two years of interest-only payments
followed by three years of principal and interest payments.
II-40
<PAGE>
In February 1997 and as amended in January 1998 and September 1998, American
PCS Communications, LLC entered into credit facilities of $420 million,
consisting of a term loan facility of $220 million and a reducing revolving
credit facility of $200 million (together, the "APC Credit Agreement"). As of
September 30, 1998 and December 31, 1997, $220 million had been borrowed under
the term loan. As of September 30, 1998 and December 31, 1997, $200 million
and $141.4 million had been borrowed under the revolving credit facility,
respectively, with $58.6 million remaining available as of December 31, 1997.
There was no remaining availability under the facility at September 30, 1998.
The APC Credit Agreement is secured by first priority liens on all the equity
interests held by American PCS Communications, LLC in its direct subsidiaries,
including the equity interests of the subsidiaries which will hold APC's PCS
license and certain real property interests and equipment and a first priority
security interest in, and mortgages on, substantially all other intangible and
tangible assets of APC and subsidiaries. The APC Credit Agreement matures
February 7, 2005, with an interest rate of LIBOR plus 2.25%.
The APC Credit Agreement, as amended, contains covenants which require APC
to maintain certain levels of wireless subscribers, as well as other financial
and non-financial requirements. The covenants require American PCS
Communications, LLC to enter into interest rate contracts on a quarterly basis
to protect and limit the interest rate on 40% of its aggregate debt
outstanding.
Both the FCC debt and the APC Credit Agreement relate specifically to the
Washington D.C./Baltimore MTA, however, these agreements should be considered
on a combined basis consistent with other Company obligations.
On February 25, 1998 Cox PCS entered into an $800 million, nine-year
revolving and term loan agreement (the "Cox Credit Facility") with a bank
syndicate. The Cox Credit Facility consists of a revolving line of credit in
an aggregate principal amount of $400 million and two term loan facilities
with aggregate principal amounts of $200 million each. At September 30, 1998,
$400 million had been borrowed under the term loan facilities at a weighted
average interest rate of 8.13%. The Cox Credit Facility grants Cox PCS an
option to expand the credit facility up to an additional $750 million from
time to time, upon Cox PCS meeting certain requirements. The proceeds from the
loan are intended to repay the PCS license debt, finance working capital
needs, subscriber acquisition costs, capital expenditures and other general
purposes of Cox PCS. Provisions of the Cox Credit Facility required the
transfer of certain of Cox PCS' assets into special-purpose subsidiaries of
Cox PCS to facilitate the collateralization of substantially all of Cox PCS'
assets.
Furthermore, the amounts advanced under the Cox Credit Facility are
guaranteed by each of the subsidiaries. The Cox Credit Facility also requires
that Cox PCS meet certain operational and financial covenants. Amounts
borrowed under the facility are to be repaid based on scheduled repayment
dates defined in the credit agreement plus interest at a variable rate (as
defined).
In conjunction with the assignment of the PCS license covering the Los
Angeles/San Diego/Las Vegas MTA to Cox PCS, Cox PCS assumed the related debt
payable to the FCC. The debt required eight interest-only payments beginning
April 30, 1996 through January 31, 1998. The debt requires repayment in equal
quarterly installments of $23.7 million representing both principal and
interest. The debt is collateralized by the PCS license, bears interest at
7.75% per annum and matures on January 31, 2001. As of September 30, 1998,
remaining principal outstanding under the debt totaled approximately $213.9
million.
At December 31, 1997, the partners of PhillieCo I had advanced $45 million
to PhillieCo I for general operating purposes. Subsequent to December 31, 1997
and through September 30, 1998, the partners advanced an additional $50
million to PhillieCo I. Additionally, during that same period, Sprint advanced
an additional $90 million to PhillieCo I. These advances accrue interest at
rates from prime to prime plus 1 5/8%. All of the above advances have maturity
dates of the earliest of the following events: (i) the 90th day following the
closing date of the restructuring of the partnership, or (ii) if the
restructuring does not occur, the date of the closing of the buy/sell
arrangements that would occur under the partnership agreement in connection
with the deadlock event discussed above, or (iii) December 31, 1999.
II-41
<PAGE>
The Company's business plan will require additional capital financing prior
to the end of 1998. Sources of funding for the Company's further financing
requirements may include additional vendor financing, public offerings or
private placements of equity and/or debt securities, commercial bank loans
and/or capital contributions from the Partners. There can be no assurance that
any additional financing can be obtained on a timely basis and on terms
acceptable to the Company and its Partners and within limitations contained in
the Notes, the agreements governing the Secured Financing and any new
financing arrangements. Failure to obtain any such financing could result in
the delay or abandonment of the Company's development and expansion plans and
expenditures, the failure to meet regulatory requirements or other potential
adverse consequences. See Note 10 to the Combined Financial Statements of
Sprint Spectrum Holding Company Combined with MinorCo and PhillieCo (the
"Combined Financial Statements") included herein for a discussion of the PCS
Restructuring and its potential impact on future sources of liquidity.
In connection with the PCS Restructuring and Recapitalization, Sprint and
the Cable Parents have loaned $400 million, based on respective ownership
interests, to fund the capital requirements of Holdings and its affiliates,
including the Company, from the date of the signing of the Restructuring
Agreement through September 30, 1998. These loans will be converted into 10-
year preferred stock convertible into PCS Stock or, in the case of Sprint
Preferred Inter-Group Interest. Such preferred stock may be redeemed with the
proceeds from an anticipated IPO, as further discussed below, but only to the
extent the net proceeds of the IPO exceed $500 million.
Subsequent to the PCS Restructuring, Sprint intends to borrow funds and then
allocate the borrowings to the PCS Group depending upon its capital structure
and funding needs. Sprint will lend to the PCS Group at interest rates and on
other terms and conditions substantially equivalent to those which the PCS
Group could obtain from third parties as a direct or indirect wholly-owned
subsidiary of Sprint, but without the benefit of any guaranty by Sprint.
For the year ended December 31, 1995, the Company used cash of $16.9 million
in operating activities, which consisted of the operating loss of $112.7
million offset by the equity in loss of unconsolidated partnership of $46.2
million and a net change in working capital of $47.5 million. Cash used in
investing activities totaled $2.3 billion, consisting mainly of the purchase
of PCS licenses.
For the year ended December 31, 1996, the Company used cash of $172.4
million in operating activities, which consisted of the operating loss of
$444.6 million offset by the equity in loss of unconsolidated partnership of
$96.9 million and a net change in working capital of $140.5 million. Cash used
in investing activities totaled $2.0 billion, consisting mainly of capital
expenditures and microwave relocation costs of $1.6 billion and advances to
APC, prior to acquisition, of $232.0 million.
For the year ended December 31, 1997, the Company used cash of $848.2
million in operating activities, which consisted of the operating loss of $1.6
billion offset by equity in loss of unconsolidated partnership of $168.9
million, depreciation and amortization of $316.9 million and a net change in
working capital of $217.4 million. As discussed above, the Company has
required (and expects to continue to require) significant working capital to
fund the operations supporting the network buildout and service launch. Cash
used in investing activities totaled $2.3 billion, consisting mainly of
capital expenditures and microwave relocation costs, also discussed above.
Cash flow from financing activities totaled $3.2 billion during 1997, and
included partner capital contributions of $1.0 billion, net proceeds from term
loans and vendor financing of $1.8 billion, and net borrowings under a
revolving credit facility of $605 million after deduction of long-term debt
issuance costs. The Company's available financing sources are described more
fully above.
For the nine months ended September 30, 1998, the Company used cash of
approximately $1.3 billion in operating activities, which consisted of the
operating loss of $1.7 billion less depreciation and amortization of $529.2
million and a net change in working capital of $117.2 million. Cash used in
investing activities totaled $1.2 billion for the nine months ended September
30, 1998, consisting of capital expenditures, the completion of the purchase
of APC (net of cash acquired), the purchase of an additional 10.2% of Cox PCS
(net of cash acquired), the investment in unconsolidated partnerships and
microwave relocation costs. Cash flow from financing activities totaled $2.7
billion for the nine months ended September 30, 1998, and included net
proceeds
II-42
<PAGE>
from long-term debt financing of $1.3 billion and net borrowings under a
revolving credit facility of $1.0 billion. The Company's available financing
sources are more fully described above. See Note 10 to the Combined Financial
Statements included herein for a discussion of the PCS Restructuring and its
potential impact on future sources of liquidity.
SEASONALITY
The wireless industry, including the Company, has experienced a trend of
generating a significantly higher number of subscriber additions and handset
sales in the fourth quarter of each year as compared to the other three fiscal
quarters. A number of factors contribute to the trend, including the
increasing use of retail distribution, which is dependent on the year-end
holiday shopping season, the timing of new product and service announcements
and introductions, competitive pricing pressures and aggressive marketing and
sales promotions. There can be no assurance that strong fourth quarter results
for subscriber additions and handset sales will continue for the wireless
industry or the Company. The Company's fourth quarter subscriber additions and
handset sales could be adversely impacted by a variety of reasons, including
the Company's inability to match or beat pricing plans offered by competitors,
the failure to adequately promote the Company's products, services and pricing
plans or the failure to have an adequate supply or selection of handsets. If
fourth quarter results of the Company fail to significantly improve upon
subscriber additions and handset sales from the year's previous quarters, the
Company's results for the year could be materially adversely affected.
RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1995
The Company incurred a loss of $112.7 million for the year ended December
31, 1995, which included equity in APC loss of $46.2 million. There was no
amortization of licenses during the period as PCS service had not been
launched commercially.
FOR THE YEAR ENDED DECEMBER 31, 1996
The Company incurred a loss of $444.6 million for the year ended December
31, 1996, which included equity in APC loss of $96.9 million. Certain network
equipment had been placed in service and amortization of PCS licenses and
microwave relocation costs in the launched markets commenced.
The Company commenced initial commercial operations for its PCS services
late in the fourth quarter of 1996 and, as a result, had generated minimal
operating revenues. Cost of revenues consisted principally of switch and cell
site expenses, including site rental, utilities and access charges. Such costs
were incurred prior to service launch during the network buildout and testing
phases.
Selling, general and administrative expenses increased from $66.7 million
for the year ended December 31, 1995 to $313.6 million for the year ended
December 31, 1996. Selling expenses increased $36.9 million in 1996 due to
costs incurred in preparation of and during the initial commercial service
launch. Such costs included participation with Sprint in an NFL sponsorship,
development and production expenses associated with advertisements in various
media (i.e., television, radio, print), and the development of printed
brochures to promote the Company's products and services.
General and administrative expenses increased from $66.7 million for the
year ended December 31, 1995 to $276.7 million for the year ended December 31,
1996 due principally to increases in salary and related benefits, leased
computer equipment and related expenses and professional and consulting fees.
Salaries and benefits and leased computer equipment and related expenses
increased due to an increase in employee headcount. Professional and
consulting fees increased due to the use of consultants and other experts to
assist with the development of the Company's sophisticated information systems
(including systems to handle customer care,
II-43
<PAGE>
billing, network management and financial and administrative services),
development and rollout of training programs for the Company's sales force,
and various other projects associated with the development of the corporate
infrastructure.
Depreciation and amortization expense increased from $0.2 million for the
year ended December 31, 1995 to $11.3 million for the year ended December 31,
1996 as certain network equipment had been placed in service and amortization
of PCS licenses and microwave relocation costs in the launched markets
commenced.
FOR THE YEAR ENDED DECEMBER 31, 1997
Operating Revenues/Margin
The Company emerged from the development stage in the third quarter of 1997.
The majority of the revenue was generated in the third and fourth quarters and
includes both service revenues and the sales of handsets and accessory
equipment through multiple distribution channels (including Sprint PCS retail
stores, telemarketing, and business channels) and to third party vendors. Cost
of revenues consists principally of handset and accessory costs,
interconnection costs and switch and cell site expenses, including maintenance
site rental and utilities. As part of the Company's marketing plans, handsets
are normally sold at prices substantially below the Company's cost.
Average monthly revenue per subscriber for 1997 was approximately $64,
excluding APC and Cox PCS. This average is expected to decline in the future
(consistent with industry projections) due to increased competition resulting
from additional wireless service providers entering the market.
Selling, General and Administrative Expenses
The Company's selling, general and administrative expenses for the year were
$747.1 million compared to $313.6 million for 1996. Selling expenses increased
$176.2 million due to costs incurred during the initial commercial service
launch in various markets and to costs incurred in conjunction with local and
national advertising for existing markets. Such costs include participation
with Sprint in an NFL sponsorship, development and production expenses
associated with advertisements in various media (i.e., television, radio,
print), and the development of printed brochures to promote the Company's
products and services. The Company expects selling expenses will continue to
increase in 1998 as the Company expands its sales and marketing activities.
General and administrative expenses increased $257.3 million due principally
to increases in salary and related benefits, computer equipment and related
expenses and professional and consulting fees. Salaries and benefits, computer
equipment and related expenses increased due to an increase in employee
headcount. These additional employees were added during 1997 to support the
continued growth of the Company. Professional and consulting fees increased
due to the use of consultants and other experts to assist with the continuing
development and enhancement of the Company's sophisticated information
systems, continued rollout and tailoring of employee training, and various
other projects.
Depreciation and Amortization
Depreciation and amortization expense for 1997 was $316.3 million compared
to $11.3 million for 1996. This increase occurred as network equipment in
launched markets has been placed in service and amortization of PCS licenses
and microwave relocation costs in those same markets commenced.
Other Income/Expense
Interest income increased from $8.6 million for the year ended December 31,
1996 to $27.8 million for the year ended December 31, 1997 as the average
daily invested cash balance increased during the comparative periods due to
the receipt in the prior year of partner equity contributions in advance of
capital and operational requirements. Additionally, Holdings received $15.8
million of interest in conjunction with APC's repayment of advances from
Holdings.
II-44
<PAGE>
Interest expense increased to $123.5 million for the year ended December 31,
1997, compared to $0.3 million for 1996. The balance of the Company's
construction accounts eligible for interest capitalization declined during the
year as markets launched commercial service and equipment was placed in
service. Additionally, interest expense continues to increase as borrowings
increase.
Sprint Spectrum L.P. participates in an affiliation agreement with Cox PCS.
Fees earned under this agreement of $1.1 million for the year ended December
31, 1997 are included in other income. No fees were earned in 1996.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
Operating Revenues/Margin
Revenues and cost of revenues of $788.0 million and $783.0 million,
respectively, for the first nine months of 1998 were higher than the revenues
and cost of revenues of $110.5 million and $308.3 million, respectively, for
the first nine months of 1997, due to increases in the number of markets
launched and in the number of subscribers. Revenues include service and the
sales of handsets and accessory equipment through multiple distribution
channels (including Sprint PCS retail stores, telemarketing, and business
channels) and to third party vendors. Cost of revenues consists principally of
handset and accessory costs, interconnection costs and switch and cell site
expenses, including site rental and utilities. As part of the Company's
marketing plans, handsets are normally sold at prices substantially below the
Company's cost.
Selling, General and Administrative Expenses
The Company's selling, general and administrative expenses for the first
nine months of 1998 were $931.6 million compared to $481.3 million for the
first nine months of 1997. For the nine months ended September 30, 1998,
selling expenses increased $178.0 million over the same period in 1997 due to
costs incurred in conjunction with local and national advertising for existing
markets. Such costs include participation with Sprint in an NFL sponsorship,
development and production expenses associated with advertisements in various
media (i.e., television, radio, print), the development of printed brochures
to promote the Company's products and services, and sales incentive programs.
The Company expects selling expenses will continue to increase as the Company
expands its sales and marketing activities.
General and administrative expenses for the first nine months of 1998
increased $272.3 million compared to the same period of 1997 due principally
to increases in salary and related benefits, computer equipment and related
expenses and professional and consulting fees. Salaries and benefits, computer
equipment and related expenses increased due to an increase in employee
headcount. These additional employees have been added over the last year to
support the continued growth of the Company. Professional and consulting fees
increased due to the use of consultants and other experts to assist with the
continuing development and enhancement of the Company's information systems,
continued rollout and tailoring of employee training, and various other
projects.
Depreciation and Amortization
Depreciation and amortization expense for the first nine months of 1998 was
$529.2 million compared to $189.9 million for the same period in the prior
year as network equipment in launched markets has been placed in service and
amortization of PCS licenses and microwave relocation costs in those same
markets commenced.
Other Income/Expense
Interest expense increased to $358.3 million for the nine months ended
September 30, 1998, compared to $55.6 million for the same period in 1997. The
balance of the Company's construction accounts eligible for interest
capitalization declined during the period as markets launched commercial
service and equipment was placed in service. Additionally, interest expense
continues to increase as borrowings increase.
II-45
<PAGE>
INDEPENDENT AUDITORS' REPORT
Partners of Sprint Spectrum Holding Company, L.P., MinorCo, L.P., PhillieCo
Partners I, L.P. and PhillieCo
Partners II, L.P.
Kansas City, Missouri
We have audited the accompanying combined balance sheets of Sprint Spectrum
Holding Company, L.P. and subsidiaries, MinorCo, L.P. and subsidiaries,
PhillieCo Partners I, L.P. and subsidiaries, and PhillieCo Partners II, L.P.
and subsidiaries (the "Partnerships") as of December 31, 1997 and 1996, and
the related combined statements of operations, changes in partners' capital,
and cash flows for the three years in the period ended December 31, 1997.
These financial statements are the responsibility of the Partnerships'
management. Our responsibility is to express an opinion on these combined
financial statements 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, such combined financial statements present fairly, in all
material respects, the financial position of the Partnerships at December 31,
1997 and 1996, and the results of their operations and their cash flows for
the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
The Partnerships were in the development stage at December 31, 1996; during
the year ended December 31, 1997, the Partnerships completed their development
activities and commenced their planned principal operations.
Deloitte & Touche LLP
Kansas City, Missouri
May 26, 1998
(August 6, 1998 as to Note 4)
II-46
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
COMBINED BALANCE SHEETS
(in thousands)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- -----------------------
1998 1997 1996
------------- ----------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.............. $ 325,325 $ 124,886 $ 71,098
Accounts receivable, net............... 165,508 116,415 3,315
Receivable from affiliates............. 29,754 43,006 13,375
Inventory.............................. 177,859 103,894 72,414
Prepaid expenses and other assets, net. 44,077 29,648 14,951
Note receivable--unconsolidated
partnership........................... -- -- 226,670
----------- ----------- ----------
Total current assets.................. 742,523 417,849 401,823
INVESTMENT IN PCS LICENSES, net......... 2,829,087 2,386,799 2,207,903
INVESTMENTS IN UNCONSOLIDATED
PARTNERSHIP(S)......................... -- 273,541 179,086
PROPERTY, PLANT AND EQUIPMENT, net...... 4,531,850 3,538,238 1,441,627
MICROWAVE RELOCATION COSTS, net......... 325,602 271,612 135,802
MINORITY INTEREST....................... -- 56,667 --
OTHER ASSETS, net....................... 97,310 113,153 77,403
----------- ----------- ----------
TOTAL ASSETS............................ $ 8,526,372 $ 7,057,859 $4,443,644
=========== =========== ==========
LIABILITIES AND PARTNERS' CAPITAL
CURRENT LIABILITIES:
Advances from partners................. $ 185,000 $ 45,000 $ 167,819
Accounts payable....................... 287,082 446,263 214,205
Payable to affiliate................... 1,648 11,933 5,626
Accrued interest....................... 95,132 59,605 34,057
Accrued expenses....................... 379,638 237,123 49,482
Current maturities of long-term debt... 124,491 34,562 49
----------- ----------- ----------
Total current liabilities............. 1,072,991 834,486 471,238
CONSTRUCTION OBLIGATIONS................ 575,725 705,280 714,934
LONG-TERM DEBT, net..................... 6,001,217 3,533,954 686,192
OTHER NONCURRENT LIABILITIES............ 84,835 50,103 11,356
COMMITMENTS AND CONTINGENCIES
LIMITED PARTNER INTEREST IN CONSOLIDATED
SUBSIDIARY............................. 65,777 -- --
PARTNERS' CAPITAL AND ACCUMULATED
DEFICIT:
Partners' capital...................... 4,611,025 4,127,244 3,120,479
Accumulated deficit.................... (3,885,198) (2,193,208) (560,555)
----------- ----------- ----------
Total partners' capital............... 725,827 1,934,036 2,559,924
----------- ----------- ----------
TOTAL LIABILITIES AND PARTNERS' CAPITAL. $ 8,526,372 $ 7,057,859 $4,443,644
=========== =========== ==========
</TABLE>
See notes to combined financial statements.
II-47
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
COMBINED STATEMENTS OF OPERATIONS
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
------------------------ ---------------------------------
1998 1997 1997 1996 1995
----------- ----------- ----------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING REVENUES...... $ 787,953 $ 110,528 $ 258,029 $ 4,175 $ --
OPERATING EXPENSES:
Cost of revenues....... 783,023 308,292 574,343 36,824 --
Selling, general and
administrative........ 931,606 481,290 747,084 313,629 66,719
Depreciation and amor-
tization.............. 529,166 189,924 316,276 11,297 211
----------- ----------- ----------- --------- ---------
Total operating
expenses............ 2,243,795 979,506 1,637,703 361,750 66,930
----------- ----------- ----------- --------- ---------
LOSS FROM OPERATIONS.... (1,455,842) (868,978) (1,379,674) (357,575) (66,930)
OTHER INCOME (EXPENSE):
Interest income........ 24,467 24,636 27,817 8,593 476
Interest expense....... (358,321) (55,568) (123,490) (323) --
Other income (expense). (1,268) 3,907 5,108 1,586 (19)
Equity in loss of
unconsolidated
partnerships.......... -- (125,455) (168,935) (96,850) (46,206)
----------- ----------- ----------- --------- ---------
Total other expense.. (335,122) (152,480) (259,500) (86,994) (45,749)
----------- ----------- ----------- --------- ---------
NET LOSS BEFORE MINORITY
INTEREST............... (1,790,964) (1,021,458) (1,639,174) (444,569) (112,679)
MINORITY INTEREST....... 98,974 -- 6,521 -- --
----------- ----------- ----------- --------- ---------
NET LOSS................ $(1,691,990) $(1,021,458) $(1,632,653) $(444,569) $(112,679)
=========== =========== =========== ========= =========
</TABLE>
See notes to combined financial statements.
II-48
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
COMBINED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
---------------------- ----------------------------------
1998 1997 1997 1996 1995
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
PARTNERS' CAPITAL:
Balance at beginning of
period................. $4,127,244 $3,120,479 $3,120,479 $2,391,801 $ 128,795
Contributions of
capital................ 483,781 648,728 1,018,500 728,678 2,263,006
Return of capital....... -- (11,735) (11,735) -- --
---------- ---------- ---------- ---------- ----------
Balance at end of
period................. 4,611,025 3,757,472 4,127,244 3,120,479 2,391,801
ACCUMULATED DEFICIT:
Balance at beginning of
period................. (2,193,208) (560,555) (560,555) (115,986) (3,307)
Net loss................ (1,691,990) (1,021,458) (1,632,653) (444,569) (112,679)
---------- ---------- ---------- ---------- ----------
Balance at end of
period................. (3,885,198) (1,582,013) (2,193,208) (560,555) (115,986)
---------- ---------- ---------- ---------- ----------
TOTAL PARTNERS' CAPITAL. $ 725,827 $2,175,459 $1,934,036 $2,559,924 $2,275,815
========== ========== ========== ========== ==========
</TABLE>
See notes to combined financial statements.
II-49
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
COMBINED STATEMENTS OF CASH FLOWS
(in thousands)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
------------------------ -----------------------------------
1998 1997 1997 1996 1995
----------- ----------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
CASH FLOWS FROM OPERAT-
ING ACTIVITIES:
Net loss............... $(1,691,990) $(1,021,458) $(1,632,653) $ (444,569) $ (112,679)
Adjustments to recon-
cile net loss to net
cash provided by
(used in) operating
activities:
Equity in loss of
unconsolidated
partnership .......... -- 125,455 168,935 96,850 46,206
Minority interest...... (98,974) -- (6,521) -- --
Loss on disposition of
non-network
equipment............. 2,161 -- -- -- --
Depreciation and
amortization.......... 529,166 189,924 316,854 11,278 242
Amortization of debt
discount and issuance
costs................. 40,694 35,328 49,061 14,008 --
Changes in assets and
liabilities, net of
effects of
acquisition of APC:
Receivables.......... (7,004) (83,003) (132,026) (16,350) (147)
Inventory............ (64,293) (9,374) (27,398) (72,413) --
Prepaid expenses and
other assets........ (1,120) (10,130) (12,965) (22,513) (178)
Accounts payable and
accrued expenses.... (44,798) 153,182 389,740 251,791 47,836
Other noncurrent
liabilities......... 34,733 13,652 38,747 9,500 1,856
----------- ----------- ----------- ---------- ----------
Net cash used in
operating
activities......... (1,301,425) (606,424) (848,226) (172,418) (16,864)
CASH FLOWS FROM
INVESTING ACTIVITIES:
Capital expenditures... (1,107,684) (1,632,828) (2,124,556) (1,419,216) (31,806)
Microwave relocation
costs, net............ (45,254) (104,411) (123,816) (135,828) --
Purchase of PCS
licenses.............. -- -- -- -- (2,085,794)
Purchase of APC, net of
cash acquired......... (28,906) -- (6,764) -- --
Purchase of Cox PCS,
net of cash acquired.. (28,300) -- -- -- --
Investment in
unconsolidated
partnerships.......... -- (112,695) (191,171) (190,390) (131,752)
Loan to unconsolidated
partnership........... -- (81,114) (111,468) (231,964) (655)
Payment received on
loan to unconsolidated
partnership........... -- 246,670 246,670 5,949 --
----------- ----------- ----------- ---------- ----------
Net cash used in
investing
activities......... (1,210,144) (1,684,378) (2,311,105) (1,971,449) (2,250,007)
CASH FLOWS FROM
FINANCING ACTIVITIES:
Advances from partners. 140,000 45,000 45,000 167,819 --
Net borrowing under
revolving credit
agreement............. 1,018,571 370,000 605,000 -- --
Proceeds from issuance
of long-term debt..... 1,314,242 1,327,553 1,763,045 674,200 --
Change in construction
obligations........... (183,193) 176,383 (9,654) 714,934 --
Payments on long-term
debt.................. (61,393) (169,308) (170,809) (24) --
Debt issuance costs.... -- (20,000) (20,000) (71,791) --
Partner capital
contributions......... 483,781 642,499 1,012,272 728,678 2,263,006
Return of capital...... -- (11,735) (11,735) -- --
----------- ----------- ----------- ---------- ----------
Net cash provided by
financing
activities......... 2,712,008 2,360,392 3,213,119 2,213,816 2,263,006
----------- ----------- ----------- ---------- ----------
INCREASE (DECREASE) IN
CASH AND CASH
EQUIVALENTS............ 200,439 69,590 53,788 69,949 (3,865)
CASH AND CASH
EQUIVALENTS, beginning
of period.............. 124,886 71,098 71,098 1,149 5,014
----------- ----------- ----------- ---------- ----------
CASH AND CASH
EQUIVALENTS, end of
period................. $ 325,325 $ 140,688 $ 124,886 $ 71,098 $ 1,149
=========== =========== =========== ========== ==========
SUPPLEMENTAL DISCLOSURE
OF CASH FLOW
INFORMATION:
. Interest paid, net
of amount capital-
ized................ $ 169,115 $ 12,226 $ 35,629 $ 323 $ --
NON-CASH INVESTING AND
FINANCING ACTIVITIES:
. Accrued interest of
$139,000 and $51,673
related to vendor
financing was con-
verted to long-term
debt during the nine
months ended Septem-
ber 30, 1998 and the
year ended December
31, 1997, respec-
tively.
. A PCS license cover-
ing the Omaha MTA
and valued at $6,229
was contributed to
the Company by Cox
Communications dur-
ing the nine months
ended September 30,
1997 and the year
ended December 31,
1997.
</TABLE>
See notes to combined financial statements.
II-50
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
1. ORGANIZATION
The accompanying combined financial statements present a combination of the
consolidated financial statements of Sprint Spectrum Holding Company, L.P. and
subsidiaries, MinorCo, L.P. and subsidiaries, PhillieCo Partners I, L.P. and
subsidiaries and PhillieCo Partners II, L.P. and subsidiaries (collectively,
the "Company" or the "Partnerships") which offer services as Sprint PCS.
The unaudited interim financial information presented has been prepared
according to generally accepted accounting principles and the rules and
regulations of the Securities and Exchange Commission for interim reporting.
In management's opinion, the information presented reflects all adjustments
(consisting only of normal recurring accruals) necessary to present fairly the
interim financial position, results of operations and cash flows of the
Company.
SPRINT SPECTRUM HOLDING COMPANY, L.P.--Sprint Spectrum Holding Company, L.P.
("Holdings") is a limited partnership formed in Delaware on March 28, 1995, by
Sprint Enterprises, L.P., TCI Spectrum Holdings, Inc., Cox Telephony
Partnership and Comcast Telephony Services (together the "Partners"). Holdings
was formed pursuant to a reorganization of the operations of an existing
partnership, WirelessCo, L.P. ("WirelessCo") which transferred certain
operating functions to Holdings. The Partners are subsidiaries of Sprint
Corporation ("Sprint"), Tele-Communications, Inc. ("TCI"), Cox Communications,
Inc. ("Cox"), and Comcast Corporation ("Comcast", and together with Sprint,
TCI and Cox, the "Parents"), respectively.
The Partners of Holdings and MinorCo, L.P. have the following ownership
interests as of December 31, 1997, and 1996 and September 30, 1998:
<TABLE>
<S> <C>
Sprint Enterprises, L.P.............................................. 40%
TCI Spectrum Holdings, Inc........................................... 30%
Cox Telephony Partnership............................................ 15%
Comcast Telephony Services........................................... 15%
</TABLE>
Each Partner's ownership interest consists of a 99% general partner interest
and a 1% limited partnership interest.
Holdings is the 99% general partner of, and is consolidated with, its
subsidiaries, including NewTelco, L.P. ("NewTelco") and Sprint Spectrum L.P.,
which, in turn, has several subsidiaries. Sprint Spectrum L.P.'s subsidiaries
are Sprint Spectrum Equipment Company, L.P. ("EquipmentCo"), Sprint Spectrum
Realty Company, L.P. ("RealtyCo"), Sprint Spectrum Finance Corporation
("FinCo"), and WirelessCo. On May 15, 1996, EquipmentCo was formed to lease or
own wireless communication network equipment, and RealtyCo was formed to lease
or own real property on which wireless communication facilities are to be
located. FinCo was formed on May 20, 1996 to be a co-obligor of the debt
obligations discussed in Note 5.
The results of American PCS, L.P. ("APC") are consolidated from November
1997, the date the Federal Communications Commission ("FCC") approved Holdings
as the new managing partner (Note 4). APC, through subsidiaries, owns a PCS
license for and operates a broadband GSM (global system for mobile
communications) in the Washington D.C./Baltimore Major Trading Area ("MTA"),
and has launched a code division multiple access ("CDMA") overlay for nearly
all of its existing GSM PCS system. APC includes American PCS Communications,
LLC, APC PCS, LLC, APC Realty and Equipment Company, LLC and American Personal
Communications Holdings, Inc.
As discussed in Note 4, Holdings became the managing partner of Cox
Communications PCS, L.P. ("Cox PCS") in June 1998. Cox PCS results have been
included in the combined statements of operations from January 1, 1998. Cox
PCS, through subsidiaries, holds a PCS license for and operates a PCS system
in the Los Angeles-San Diego-Las Vegas MTA. Cox PCS includes Cox PCS License,
L.L.C., Cox PCS Assets, L.L.C., and PCS Leasing Co., L.P.
II-51
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
MINORCO, L.P. ("MINORCO")--MinorCo holds the minority ownership interests of
1% in NewTelco, Sprint Spectrum L.P., EquipmentCo, RealtyCo and WirelessCo at
September 30, 1998, December 31, 1997 and 1996, and APC at September 30, 1998
and December 31, 1997.
PHILLIECO PARTNERS--The consolidated financial statements of PhillieCo
Partners I, L.P. ("PhillieCo I") and subsidiaries, included in these combined
financial statements, include the accounts of PhillieCo I and its consolidated
subsidiaries, including PhillieCo Sub, L.P. ("PhillieCo Sub") and PhillieCo,
L.P ("PhillieCo").
The consolidated financial statements of PhillieCo Partners II, L.P.
("PhillieCo II") and subsidiaries, included in these combined financial
statements, include the accounts of PhillieCo II and its minority investment
interests in PhillieCo Sub, L.P. and PhillieCo, L.P.
PhillieCo Sub was formed by PhillieCo I and PhillieCo II, both of which were
formed by Sprint Enterprises, L.P., TCI Philadelphia Holdings, Inc. and Cox
Communications Wireless, Inc. (together the "PhillieCo Partners"). PhillieCo
Sub was formed pursuant to a reorganization under which the PhillieCo Partners
transferred their ownership interests in PhillieCo, which was formed in
Delaware on October 24, 1994, to PhillieCo I and PhillieCo II. The PhillieCo
Partners are subsidiaries of Sprint, TCI and Cox, respectively.
The PhillieCo Partners have the following ownership interest as of December
31, 1997 and 1996 and September 30, 1998:
<TABLE>
<S> <C>
Sprint Enterprises, L.P............................................ 47.1%
TCI Philadelphia Holdings, Inc..................................... 35.3%
Cox Communications Wireless, Inc................................... 17.6%
</TABLE>
Each PhillieCo partner's ownership interest consists of a 99% general
partner interest and a 1% limited partnership interest.
VENTURE FORMATION AND AFFILIATED PARTNERSHIPS--A Joint Venture Formation
Agreement (the "Formation Agreement"), dated as of October 24, 1994, and
subsequently amended as of March 28, 1995, and January 31, 1996, was entered
into by the Parents, pursuant to which the Parents agreed to form certain
entities to (i) provide national wireless telecommunications services,
including acquisition and development of PCS licenses, (ii) develop a PCS
wireless system in the Los Angeles-San Diego-Las Vegas MTA, and (iii) take
certain other actions.
On October 24, 1994, WirelessCo was formed and on March 28, 1995, additional
partnerships were formed consisting of Holdings, MinorCo, NewTelco, and Sprint
Spectrum L.P. The Partners' ownership interests in WirelessCo were initially
held directly by the Partners as of October 24, 1994, the formation date of
WirelessCo, but were subsequently contributed to Holdings and then to Sprint
Spectrum L.P. on March 28, 1995.
SPRINT SPECTRUM HOLDING COMPANY, L.P. PARTNERSHIP AGREEMENT--The Amended and
Restated Agreement of Limited Partnership of MajorCo, L.P. (now known as
Holdings), dated as of January 31, 1996 (the "Holdings Agreement"), among
Sprint Enterprises, L.P., TCI Spectrum Holdings, Inc., Comcast Telephony
Services and Cox Telephony Partnership provides that the purpose of Holdings
is to engage in wireless communications services.
The Holdings Agreement generally provides for the allocation of profits and
losses according to each Partner's proportionate percentage interest, after
giving effect to special allocations. After special allocations, profits are
allocated to partners to the extent of and in proportion to cumulative net
losses previously allocated. Losses are allocated, after considering special
allocations, according to each Partner's allocation of net profits previously
allocated.
II-52
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
The Holdings Agreement provides for planned capital contributions by the
Partners ("Total Mandatory Contributions") of $4.2 billion, which includes
agreed upon values attributable to the contributions of certain additional PCS
licenses by a Partner. The Total Mandatory Contributions amount is required to
be contributed in accordance with capital contribution schedules to be set
forth in approved annual budgets. The partnership board of Holdings may
request capital contributions to be made in the absence of an approved budget
or more quickly than provided for in an approved budget, but always subject to
the Total Mandatory Contributions limit. The proposed budget for fiscal 1998
has not yet been approved by the partnership board, which has resulted in the
occurrence of a Deadlock Event (as defined) under the Holdings Agreement as of
January 1, 1998. If the 1998 proposed budget is not approved through
resolution procedures set forth in the Holdings Agreement, certain specified
buy/sell procedures may be triggered which may result in a restructuring of
the partners' interest in Holdings or, in limited circumstances, liquidation
of Holdings. See Note 10 for further discussion regarding a restructuring of
the partnership structure. As of September 30, 1998 and December 31, 1997,
approximately $4.2 billion and $4.0 billion, respectively, of the Total
Mandatory Contributions had been contributed by the Partners to Holdings and
its affiliated partnerships, of which approximately $3.3 billion had been
contributed to Sprint Spectrum L.P.
PHILLIECO PARTNERSHIP AGREEMENT--The Second Amended and Restated Agreement
of Limited Partnership of PhillieCo, L.P., (the "PhillieCo Agreement") dated
as of March 12, 1997, among PhillieCo Sub and PhillieCo II provides that the
purpose of PhillieCo is to engage in wireless communications services in the
Philadelphia MTA. The PhillieCo Agreement provides for the governance and
administration of partnership business, allocation of profits and losses
(including provisions for special and curative allocations), tax allocations,
transactions with partners, disposition of partnership interests and other
matters. The PhillieCo Agreement provides for additional capital contributions
to be made in accordance with capital contribution schedules to be set forth
in approved annual budgets.
The PhillieCo Agreement generally provides for the allocation of profits and
losses according to each Partner's proportionate percentage interest, after
giving effect to special allocations. After special allocations, profits are
allocated to partners to the extent of and in proportion to cumulative net
losses previously allocated. Losses are allocated, after considering special
allocations, according to each Partner's allocation of net profits previously
allocated.
EMERGENCE FROM DEVELOPMENT STAGE COMPANY--Prior to the third quarter of
1997, the Company reported its operations as a development stage enterprise.
The Company has commenced service in all of the MTAs in which it owns a
license. As a result, the Company is no longer considered a development stage
enterprise, and the balance sheets and statements of operations and of cash
flows are no longer presented in development stage format.
Management believes that the Company will incur additional losses in 1998
and require additional financial resources to support the current level of
operations and the remaining network buildout for the year ended December 31,
1998. Management believes the Company has the ability to obtain the required
levels of financing through additional financing arrangements or additional
equity funding from the partners.
DEADLOCK EVENT--The proposed budgets for fiscal year 1998 were not approved
by the Holdings or PhillieCo I partnership boards, which resulted in the
occurrence of a "Deadlock Event" as of January 1, 1998 under the Holdings and
PhillieCo I Partnership Agreements. Holdings is the sole general partner of
Sprint Spectrum L.P. PhillieCo I is the sole general partner of PhillieCo Sub.
Under the Holdings and PhillieCo I Partnership Agreements, if one of the
partners refers the budget issue to the chief executive officers of the
Parents for resolution pursuant to specified procedures and the issue remains
unresolved, buy/sell provisions would be triggered which may result in the
purchase by one or more of the partners of the interest of the other partners,
or, in certain circumstances, the liquidation of Holdings and PhillieCo I and
their subsidiaries. See further discussions regarding a restructuring of the
partnership structure in Note 10.
II-53
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION--The financial statements are presented on a combined
basis as the Partnerships are under common management for all periods
presented. The assets, liabilities, results of operations and cash flows of
entities in which the Company has a controlling interest have been
consolidated. All significant intercompany accounts and transactions have been
eliminated.
MINORITY INTERESTS--In November 1997, concurrent with the APC acquisition
discussed in Note 4, American Personal Communications II, L.P. ("APC II")
became the minority owner in APC. APC II has been allocated approximately $6.5
million in losses in APC since the date of acquisition. Prior to November
1997, APC II, as majority owner, had been allocated approximately $50 million
in losses in excess of its investment. At December 31, 1997, after
consolidation of APC, the total of such losses, approximately $56.7 million,
was recorded as minority interest in the Partnerships' combined balance sheet.
This treatment reflects that APC II continued to be responsible for funding
its share of losses until January 1, 1998 when Holdings and MinorCo acquired
the remaining interest in APC.
In addition, in June 1998, concurrent with the Cox PCS acquisition discussed
in Note 4, Cox Pioneer Partnership ("CPP") became the minority owner in Cox
PCS with CPP's remaining ownership-interest in Cox PCS being recorded as
minority interest in the combined balance sheet. CPP has been allocated
approximately $99.0 million in losses in Cox PCS since the date of
acquisition. Losses attributable to Cox incurred from January 1, 1998 through
May 1998 are included in minority interest in the combined statements of
operations.
TRADEMARK AGREEMENT--Sprint(R) and Sprint PCS(R) are the registered
trademark and service mark, respectively, of Sprint Communications Company
L.P. Sprint(R) and Sprint PCS(R) are licensed to Holdings on a royalty-free
basis pursuant to trademark license agreements between Holdings and Sprint
Communications Company L.P.
REVENUE RECOGNITION--Operating revenues for PCS services are recognized as
service is rendered. Operating revenues for equipment sales are recognized at
the time the equipment is delivered to a customer or an unaffiliated agent.
COST OF EQUIPMENT--The Company uses multiple distribution channels for its
inventory, including third-party retailers, Company-owned retail stores, its
direct sales force and telemarketing. Cost of equipment varies by distribution
channel and includes the cost of multiple models of handsets, related
accessory equipment, and warehousing and shipping expenses.
CASH AND CASH EQUIVALENTS--The Company considers all highly liquid
instruments with original maturities of three months or less to be cash
equivalents. The Company maintains cash and cash equivalents in financial
institutions with the highest credit ratings.
ACCOUNTS RECEIVABLE--Accounts receivable are net of an allowance for
doubtful accounts of approximately $23.9 million, $9.3 million and $0.2
million, at September 30, 1998 and December 31, 1997 and 1996, respectively.
INVENTORY--Inventory consists of wireless communication equipment (primarily
handsets). Inventory is stated at lower of cost (on a first-in, first-out
basis) or replacement value. Any losses on the sales of handsets are
recognized at the time of sale.
PROPERTY, PLANT AND EQUIPMENT--Property, plant and equipment are stated at
cost or fair value at the date of acquisition. Construction work in progress
represents costs incurred to design and construct the PCS network. Repair and
maintenance costs are charged to expense as incurred. When network equipment
is retired, or otherwise disposed of, its book value, net of salvage, is
charged to accumulated depreciation. When non-network equipment is sold,
retired or abandoned, or otherwise disposed of, the cost and accumulated
depreciation are relieved and any gain or loss is recognized. Property, plant
and equipment are depreciated using the straight-line method based on
estimated useful lives of the assets. Depreciable lives range from 3 to 20
years.
II-54
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
EQUIPMENT UNDER CAPITAL LEASES--APC leases certain of its office and other
equipment under capital lease agreements. The assets and liabilities under
capital leases are recorded at the lesser of the present value of aggregate
future minimum lease payments, including estimated bargain purchase options,
or the fair value of the assets under lease. Assets under these capital leases
are depreciated over their estimated useful lives of 5 to 7 years.
INVESTMENT IN PCS LICENSES--During 1994 and 1995, the Federal Communications
Commission ("FCC") auctioned PCS licenses in specific geographic service
areas. The FCC grants licenses for terms of up to ten years, and generally
grants renewals in 10-year terms if the licensee has complied with its license
obligations. The Company believes it will be able to secure renewal of the PCS
licenses held by its subsidiaries. PCS licenses are amortized over estimated
useful lives of 40 years once placed in service. Accumulated amortization for
PCS licenses totaled approximately $91.8 million, $46.8 million and $1.7
million as of September 30, 1998, December 31, 1997, and 1996, respectively.
There was no amortization in 1995.
MICROWAVE RELOCATION COSTS--The Company has also incurred costs associated
with microwave relocation in the construction of the PCS network. Microwave
relocation costs are amortized over the remaining life of the PCS licenses.
Accumulated amortization for microwave relocation costs totaled approximately
$10.6 million and $5.3 million as of September 30, 1998 and December 31, 1997,
respectively. There was no amortization in 1996 or 1995.
INTANGIBLE ASSETS--The ongoing value and remaining useful life of intangible
assets are subject to periodic evaluation. The Company currently expects the
carrying amounts to be fully recoverable. Impairments of intangibles and long-
lived assets are assessed based on an undiscounted cash flow methodology.
CAPITALIZED INTEREST--Interest costs associated with the construction of
capital assets (including the PCS licenses) incurred during the period of
construction are capitalized. The total interest costs capitalized in the nine
months ended September 30, 1998 was approximately $50.9 million, and was
approximately $100.0 million and $30.5 million in 1997 and 1996, respectively.
There were no amounts capitalized in 1995.
DEBT ISSUANCE COSTS--Included in other assets are costs associated with
obtaining financing. Such costs are capitalized and amortized to interest
expense over the term of the related debt instruments using the effective
interest method. Accumulated amortization for the nine months ended September
30, 1998 was approximately $23.8 million, and was approximately $13.4 million
and $1.9 million for the years ended December 31, 1997 and 1996, respectively.
There was no amortization in 1995.
OPERATING LEASES--Rent expense is recognized on the straight-line basis over
the life of the lease agreement, including renewal periods. Lease expense
recognized in excess of cash expended is included in non-current liabilities
in the combined balance sheet.
MAJOR CUSTOMER--The Company markets its products through multiple
distribution channels, including Company-owned retail stores and third-party
retail outlets. The Company's subscribers are disbursed throughout the United
States. Sales to one third-party retail customer represented approximately 21%
and 88% of operating revenues in the combined statements of operations for the
years ended December 31, 1997 and 1996, respectively. The Company reviews the
credit history of retailers prior to extending credit and maintains allowances
for potential credit losses. The Company believes that its risk from
concentration of credit is limited.
INCOME TAXES--The Company has not provided for federal or state income taxes
since such taxes are the responsibility of the individual Partners.
FINANCIAL INSTRUMENTS--The carrying value of the Company's short-term
financial instruments, including cash and cash equivalents, receivables from
customers and affiliates and accounts payable approximates fair value. The
fair value of the Company's long-term debt is based on quoted market prices
for the same issues or current rates offered to the Company for similar debt.
A summary of the fair value of the Company's long-term debt at December 31,
1997 and 1996 is included in Note 5.
II-55
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
The fair value of the interest rate contracts is the estimated net amount
that APC would pay to terminate the contracts at the balance sheet date. The
fair value of the fixed rate loans is estimated using discounted cash flow
analysis based on APC's current incremental borrowing rate at which similar
borrowing agreements would be made under current conditions.
DERIVATIVE FINANCIAL INSTRUMENTS--Derivative financial instruments (interest
rate contracts) are utilized by APC to reduce interest rate risk. APC has
established a control environment which includes risk assessment and
management approval, reporting and monitoring of derivative financial
instrument activities. APC does not hold or issue derivative financial
instruments for trading purposes.
The differentials to be received or paid under interest rate contracts that
are matched against underlying debt instruments and qualify for settlement
accounting are recognized in income over the life of the contracts as
adjustments to interest expense. Gains and losses on terminations of interest
rate contracts are recognized as other income or expense when terminated in
conjunction with the retirement of associated debt. Gains and losses on
terminations of interest rate contracts not associated with the retirement of
debt are deferred and amortized to interest expense over the remaining life of
the associated debt to the extent that such debt remains outstanding.
COMPREHENSIVE INCOME--In June 1997, the Financial Accounting Standards Board
issued Statement of financial Accounting Standards No. 130, Reporting
Comprehensive Income, ("SFAS No. 130") which establishes standards for
reporting and disclosure of comprehensive income and its components (revenues,
expenses, gains and losses). SFAS No. 130 is effective for fiscal years
beginning after December 15, 1997 and requires reclassification of financial
statements for earlier periods to be provided for comparative purposes. The
Company's total comprehensive loss for all periods presented herein did not
differ from those amounts reported as net loss in the combined statements of
operations.
USE OF ESTIMATES--The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
RECLASSIFICATIONS--Certain reclassifications have been made to the 1996 and
1995 combined financial statements to conform to the 1997 combined financial
statement presentation.
3. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following at September 30,
1998, December 31, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- ----------------------
1998 1997 1996
------------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Land.................................. $ 3,288 $ 1,445 $ 905
Buildings and leasehold improvements.. 901,164 641,167 86,496
Fixtures and office furniture......... 309,419 168,301 68,520
Network equipment..................... 3,319,669 2,335,965 255,691
Telecommunications plant--construction
work in progress..................... 706,343 653,133 1,039,620
---------- ---------- ----------
5,239,883 3,800,011 1,451,232
Less accumulated depreciation......... (708,033) (261,773) (9,605)
---------- ---------- ----------
$4,531,850 $3,538,238 $1,441,627
========== ========== ==========
</TABLE>
II-56
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
Depreciation expense on property, plant and equipment for the nine months
ended September 30, 1998 was approximately $471.4 million and was
approximately $251.9 million, $9.6 million, and $0.2 million for the years
ended December 31, 1997, 1996 and 1995, respectively.
4. INVESTMENTS IN PARTNERSHIPS
APC--On January 9, 1995, WirelessCo acquired a 49% limited partnership
interest in APC. In September 1997, Holdings increased its ownership in APC to
58.3% through additional capital contributions of approximately $30 million,
and became the managing partner upon FCC approval in November 1997. As of
January 1, 1998, Holdings and MinorCo increased their ownership percentages to
99.75% and 0.25%, respectively, of the partnership interests for approximately
$30 million.
The acquisition increasing ownership to 58.3% and subsequently to 100% was
accounted for as a purchase and, accordingly, the operating results of APC
have been consolidated since the date of the FCC's approval of the
acquisition. In conjunction with the acquisition in November 1997, liabilities
were assumed as follows with the remaining minority interest acquired on
January 1, 1998 (in millions):
<TABLE>
<S> <C>
Assets acquired.................................................... $503
Cash paid.......................................................... (30)
Minority interest.................................................. 50
----
Liabilities assumed................................................ $523
====
</TABLE>
The purchase price was allocated to the assets acquired and the liabilities
assumed based on an estimate of fair value.
The following unaudited pro forma financial information assumes the
acquisition had occurred on January 1 of each year and that Holdings had owned
100% of APC and consolidated its results in the financial statements:
<TABLE>
<CAPTION>
1997 1996
----------- ---------
<S> <C> <C>
Net sales............................................ $ 364,460 $ 76,013
Net loss (before minority interest).................. (1,716,142) (554,976)
</TABLE>
Pro forma data does not purport to be indicative of the results that would
have been obtained had these events actually occurred at the beginning of the
periods presented and is not intended to be a projection of future results.
Prior to acquisition of controlling interest, Holdings' investment in APC
was accounted for under the equity method. The partnership agreement between
Holdings and APC II specified that losses were allocated based on percentage
ownership interests and certain other factors. In January 1997, Holdings and
APC II amended the APC partnership agreement with respect to the allocation of
profits and losses. For financial reporting purposes, profits and losses were
allocated in proportion to Holdings' and APC II's respective partnership
interests, except for costs related to stock appreciation rights and interest
expense attributable to the FCC interest payments which were allocated
entirely to APC II. Losses of approximately $60 million, $97 million and $46
million for the years ended December 31, 1997, 1996 and 1995, respectively,
are included in equity in losses of unconsolidated subsidiaries during the
period prior to the acquisition of controlling interest.
COX PCS--On December 31, 1996, Holdings acquired a 49% limited partner
interest in Cox PCS. CPP held a 50.5% general and a 0.5% limited partner
interest and was the general and managing partner. Holdings increased its
ownership in Cox PCS to 59.2% through an additional capital contribution of
approximately $80.6 million and became managing partner upon FCC approval in
June, 1998. This increase in ownership was the result of CPP exercising its
right under the partnership agreement to require that Holdings acquire all or
part of CPP's interest in Cox PCS based on fair market value at the time of
the transaction. Through December 2008, CPP may put any remaining interest in
Cox PCS to Holdings.
II-57
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
The acquisition increasing ownership to 59.2% was accounted for as a
purchase. The operating results of Cox PCS have been consolidated since
January 1, 1998. The following table reflects the value of Cox PCS' assets and
liabilities at the date of acquisition:
<TABLE>
<S> <C>
Assets acquired.............................. $ 724,834
Cash paid.................................... (80,558)
Minority interest............................ (103,780)
---------
Liabilities assumed.......................... $ 540,496
=========
</TABLE>
The purchase price was allocated to the assets acquired and the liabilities
assumed based on an estimate of fair value.
The following unaudited proforma information assumes the acquisition had
occurred on January 1, 1997, and that Holdings had consolidated Cox PCS
results in the financial statements:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Net sales................................. $ 295,395
Net loss (before minority interest)....... (1,757,821)
</TABLE>
Pro forma data does not purport to be indicative of the results that would
have been obtained had these events actually occurred at the beginning of the
periods presented and is not intended to be a projection of future results.
Prior to the acquisition of controlling interest, Holdings' investment in
Cox PCS was accounted for under the equity method.
Under the terms of the partnership agreement, CPP and the Company are
obligated to, among other things: (a) upon FCC consent to the assumption and
recognition of the license payment obligations by Cox PCS, CPP is obligated to
make capital contributions in an amount equal to such liability and related
interest (the PCS license covering the Los Angeles-San Diego MTA was
contributed to Cox PCS in March 1997); (b) Holdings is obligated to make
capital contributions of approximately $368.9 million to Cox PCS; (c) Holdings
is not obligated to make any cash capital contributions upon the assumption by
Cox PCS of the FCC payment obligations until CPP has contributed cash in an
amount equal to the aggregate principal and interest of such obligations; and,
(d) CPP and Holdings are obligated to make additional capital contributions in
an amount equal to such partner's percentage interest times the amount of
additional capital contributions being requested.
As of December 31, 1997, approximately $348.2 million in equity, including
$2.45 million to PCS Leasing Co, L.P. ("LeasingCo"), a subsidiary of Cox PCS,
had been contributed to Cox PCS by the Company. Through December 31, 1996,
$168 million had been contributed to Cox PCS. Losses are allocated to the
partners based on their ownership percentages. Losses of approximately $108
million for the year ended December 31, 1997, are included in equity in losses
of unconsolidated partnerships during the year prior to the acquisition of
controlling interest. Subsequent to December 31, 1997, Holdings completed its
funding obligation to Cox PCS under the partnership agreement. Concurrent with
this funding, Holdings paid approximately $33.2 million in interest that had
accrued on the unfunded capital obligation.
Additionally, Holdings increased its ownership to 59.2% and became general
partner in LeasingCo. LeasingCo was formed to acquire, construct or otherwise
develop equipment and other personal property to be leased to Cox PCS.
Holdings is not obligated to make additional capital contributions to
LeasingCo beyond the initial funding of approximately $2.45 million.
II-58
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
5. LONG-TERM DEBT AND BORROWING ARRANGEMENTS
Long-term debt consists of the following as of September 30, 1998 and
December 31, 1997 and 1996 (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- -------------------
1998 1997 1996
------------- ---------- --------
(UNAUDITED)
<S> <C> <C> <C>
11% Senior Notes due in 2006............. $ 250,000 $ 250,000 $250,000
12 1/2% Senior Discount Notes due in
2006, net of unamortized discount of
$147,035 at September 30, 1998; $177,720
and $214,501 at December 31, 1997 and
1996, respectively...................... 352,965 322,280 285,499
Credit Facility--term loans.............. 300,000 300,000 150,000
Credit Facility--revolving credit........ 1,565,000 605,000 --
Vendor Financing......................... 2,527,002 1,612,914 --
APC Senior Secured Term Loan Facility.... 220,000 220,000 --
APC Senior Secured Reducing Revolving
Credit Facility......................... 200,000 141,429 --
APC--Due To FCC, net of unamortized
discount of $8,992 at September 30, 1998
and $11,989 at December 31, 1997........ 77,844 90,355 --
Cox PCS Credit Facility.................. 400,000 -- --
Cox PCS--Due to FCC...................... 213,855 -- --
Other.................................... 19,042 26,538 742
---------- ---------- --------
Total debt............................... 6,125,708 3,568,516 686,241
Less current maturities.................. 124,491 34,562 49
---------- ---------- --------
Long-term debt........................... $6,001,217 $3,533,954 $686,192
========== ========== ========
</TABLE>
SENIOR NOTES AND SENIOR DISCOUNT NOTES--In August 1996, Sprint Spectrum L.P.
and Sprint Spectrum Finance Corporation (together, the "Issuers") issued $250
million aggregate principal amount of 11% Senior Notes due 2006 ("the Senior
Notes"), and $500 million aggregate principal amount at maturity of 12 1/2%
Senior Discount Notes due 2006 (the "Senior Discount Notes" and, together with
the Senior Notes, the "Notes"). The Senior Discount Notes were issued at a
discount to their aggregate principal amount at maturity and generated
proceeds of approximately $273 million. Cash interest on the Senior Notes
accrues at a rate of 11% per annum and is payable semi-annually in arrears on
each February 15 and August 15, commencing February 15, 1997. Cash interest
will not accrue or be payable on the Senior Discount Notes prior to August 15,
2001. Thereafter, cash interest on the Senior Discount Notes will accrue at a
rate of 12 1/2% per annum and will be payable semi-annually in arrears on each
February 15 and August 15, commencing February 15, 2002.
On August 15, 2001, the Issuers will be required to redeem an amount equal
to $384.772 per $1,000 principal amount at maturity of each Senior Discount
Note then outstanding ($192 million in aggregate principal amount at maturity,
assuming all of the Senior Discount Notes remain outstanding at such date).
The Notes are redeemable at the option of the Issuers, in whole or in part,
at any time on or after August 15, 2001 at the redemption prices set forth
below, respectively, plus accrued and unpaid interest, if any, to the
redemption date, if redeemed during the 12 month period beginning on August 15
of the years indicated below:
<TABLE>
<CAPTION>
SENIOR NOTES SENIOR DISCOUNT NOTES
YEAR REDEMPTION PRICE REDEMPTION PRICE
---- ---------------- ---------------------
<S> <C> <C>
2001.................................. 105.500% 110.000%
2002.................................. 103.667% 106.500%
2003.................................. 101.833% 103.250%
2004 and thereafter................... 100.000% 100.000%
</TABLE>
II-59
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
In addition, prior to August 15, 1999, the Issuers may redeem up to 35% of
the originally issued principal amount of the Notes with the net proceeds of
one or more public equity offerings, provided that at least 65% of the
originally issued principal amount at maturity of the Senior Notes and Senior
Discount Notes would remain outstanding immediately after giving effect to
such redemption. The redemption price of the Senior Notes is equal to 111.0%
of the principal amount of the Senior Notes so redeemed, plus accrued and
unpaid interest, if any, to the redemption date. The redemption price of the
Senior Discount Notes is equal to 112.5% of the accreted value at the
redemption date of the Senior Discount Notes so redeemed.
The Notes contain certain restrictive covenants, including (among other
requirements) limitations on additional indebtedness, limitations on
restricted payments, limitations on liens, and limitations on dividends and
other payment restrictions affecting certain restricted subsidiaries.
BANK CREDIT FACILITY--Sprint Spectrum L.P. (the "Borrower") entered into an
agreement with The Chase Manhattan Bank ("Chase") as agent for a group of
lenders for a $2 billion bank credit facility dated October 2, 1996. The
proceeds of this facility are to be used to finance working capital needs,
subscriber acquisition costs, capital expenditures and other general Borrower
purposes.
The facility consists of a revolving credit commitment of $1.7 billion and a
$300 million term loan commitment. In December 1997, certain terms relating to
the financial and operating conditions were amended. As of September 30, 1998,
$1.6 billion had been drawn under the revolving credit facility at a weighted
average interest rate of 8.19% with $100 million remaining available. As of
December 31, 1997, $605 million had been drawn under the revolving credit
facility at a weighted average interest rate of 8.42%, with $1.1 billion
remaining available. There were no borrowings under the revolving credit
commitment as of December 31, 1996. Commitment fees for the revolving portion
of the agreement are payable quarterly based on average unused revolving
commitments.
The revolving credit commitment expires July 13, 2005. Availability will be
reduced in quarterly installments ranging from $75 million to $175 million
commencing January 2002. Further reductions may be required after January 1,
2002 to the extent that the Borrower meets certain financial conditions.
The term loans are due in sixteen consecutive quarterly installments
beginning January 2002 in aggregate principal amounts of $125,000 for each of
the first fifteen payments with the remaining aggregate outstanding principal
amount of the term loans due as the last installment.
Interest on the term loans and/or the revolving credit loans is at the
applicable LIBOR rate plus 0.625% ("Eurodollar Loans"), or the greater of the
prime rate or 0.5% plus the Federal Funds effective rate, ("ABR Loans"), at
the Borrower's option. The interest rate may be adjusted downward for
improvements in the bond rating and/or leverage ratios. Interest on ABR Loans
and Eurodollar Loans with interest period terms in excess of 3 months is
payable quarterly. Interest on Eurodollar Loans with interest period terms of
less than 3 months is payable on the last day of the interest period. As of
September 30, 1998, and December 31, 1997 and 1996, the weighted average
interest rate on the term loans was 8.20%, 8.39% and 8.19%, respectively.
Borrowings under the Bank Credit Facility are secured by the Borrower's
interests in WirelessCo, RealtyCo and EquipmentCo and certain other personal
and real property (the "Shared Lien"). The Shared Lien equally and ratably
secures the Bank Credit Facility, the Vendor Financing agreements (discussed
below) and certain other indebtedness of the Borrower. The credit facility is
jointly and severally guaranteed by WirelessCo, RealtyCo and EquipmentCo and
is non-recourse to the Parents and the Partners.
The Bank Credit Facility agreement and Vendor Financing agreements contain
certain restrictive financial and operating covenants, including (among other
requirements) maximum debt ratios (including debt to total
II-60
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
capitalization), limitations on capital expenditures, limitations on
additional indebtedness and limitations on dividends and other payment
restrictions affecting certain restricted subsidiaries. The loss of the right
to use the Sprint trademark, the termination or non-renewal of any FCC license
that reduces population coverage below specified limits, or certain changes in
controlling interest in the Borrower, as defined, among other provisions,
constitute events of default.
VENDOR FINANCING--As of October 2, 1996, the Company entered into financing
agreements with Northern Telecom, Inc. ("Nortel") and Lucent Technologies,
Inc. ("Lucent" and together with Nortel, the "Vendors") for multiple drawdown
term loan facilities totaling $1.3 billion and $1.8 billion, respectively. The
proceeds of such facilities are to be used to finance the purchase of goods
and services provided by the Vendors. Additionally, the commitments allow for
the conversion of accrued interest into additional principal. Such conversions
do not reduce the availability under the commitments. Interest accruing on the
debt outstanding at December 31, 1997, can be converted into additional
principal through February 8, 1999 and March 30, 1999, for Lucent and Nortel,
respectively.
In April 1997 and November 1997, the Company amended the terms of its
financing agreement with Nortel. The amendments provide for a syndication of
the financing commitment between Nortel, several banks and other vendors (the
"Nortel Lenders"), and the modification of certain operating and financial
covenants. The commitment provides financing in two phases. During the first
phase, the Nortel Lenders will finance up to $800 million. Under the second
phase, the Nortel Lenders will finance up to an additional $500 million upon
the achievement of certain operating and financial conditions, as amended. As
of September 30, 1998, $856.3 million, including converted accrued interest of
$67.2 million, had been borrowed at a weighted average interest rate 8.78%
with $510.9 million remaining available. At December 31, 1997, $630 million,
including converted accrued interest of $18.6 million, had been borrowed at a
weighted average interest rate of 8.98% with $189 million remaining available
under the first phase. In addition, the Company paid $20 million in
origination fees upon the initial drawdown under the first phase and will be
obligated to pay additional origination fees on the date of the initial
drawdown loan under the second phase. There were no borrowings under the
Nortel facility at December 31, 1996.
In May 1997 and December 1997, the Company amended the terms of its
financing agreement with Lucent. The amendments provide for a syndication of
the financing commitment between Lucent, Sprint and other banks and vendors
(the "Lucent Lenders"), and the modification of certain operating and
financial covenants. The Lucent Lenders have committed to financing up to $1.5
billion through December 31, 1997, and up to an aggregate of $1.8 billion
thereafter. The Company pays a facility fee on the daily amount of certain
loans outstanding under the agreement, payable quarterly. The Lucent agreement
terminates June 30, 2001. As of September 30, 1998, the Company had borrowed
approximately $1.7 billion, including converted accrued interest of $123.5
million, with $252.8 million remaining available under the Lucent facility, at
a weighted average interest rate of 8.70%. As of December 31, 1997, the
Company had borrowed approximately $983 million, including converted accrued
interest of $33.1 million, under the Lucent facility at a weighted average
interest rate of 8.94%, with $850 million remaining available. There were no
borrowings under the Lucent facility at December 31, 1996.
The principal amounts of the loans drawn under both the Nortel and Lucent
agreements are due in twenty consecutive quarterly installments, commencing on
the date which is thirty-nine months after the last day of such "Borrowing
Year" (defined in the agreements as any one of the five consecutive 12-month
periods following the date of the initial drawdown of the loan). The aggregate
amount due each year is equal to percentages ranging from 10% to 30%
multiplied by the total principal amount of loans during each Borrowing Year.
The agreements provide two borrowing rate options. During the first phase of
the Nortel agreement and throughout the term of the Lucent agreement "ABR
Loans" bear interest at the greater of the prime rate or 0.5% plus the Federal
Funds effective rate, plus 2%. "Eurodollar Loans" bear interest at the London
interbank
II-61
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
(LIBOR) rate (any one of the 30-, 60- or 90-day rates, at the discretion of
the Company), plus 3%. During the second phase of the Nortel agreement, ABR
Loans bear interest at the greater of the prime rate or 0.5% plus the Federal
Funds effective rate, plus 1.5%; and Eurodollar loans bear interest at the
LIBOR rate plus 2.5%. Interest from the date of each loan through one year
after the last day of the Borrowing Year is added to the principal amount of
each loan. Thereafter, interest is payable quarterly.
Borrowings under the Vendor Financing are secured by the Shared Lien. The
Vendor Financing is jointly and severally guaranteed by WirelessCo, RealtyCo,
and EquipmentCo and is non-recourse to the Parents and the Partners.
Certain amounts included under construction obligations on the combined
balance sheets may be financed under the Vendor Financing agreements.
APC DUE TO FCC--The Company is obligated to the FCC for $102 million for the
receipt of the commercial PCS license covering the Washington D.C./Baltimore
MTA. In March 1996, the FCC determined that interest on the amount due would
begin to accrue on March 8, 1996, at an interest rate of 7.75%. Beginning with
the first payment due in April 1996, the FCC granted two years of interest-
only payments followed by three years of principal and interest payments.
Based on the interest and payment provisions determined by the FCC and the
Company's incremental borrowing rate for similar debt at the time the debt was
issued, the Company has accrued interest beginning upon receipt of the license
at an effective rate of 13%.
APC SENIOR SECURED CREDIT FACILITIES--As of February 7, 1997, American PCS
Communications, LLC entered into credit facilities of $420 million, consisting
of a term loan facility of $220 million and a reducing revolving credit
facility of $200 million (together, the "Credit Agreement"). The Credit
Agreement is secured by first priority liens on all the equity interests held
by American PCS Communications LLC in its direct subsidiaries, including the
equity interests of the subsidiaries which will hold APC's PCS license and
certain real property interest and equipment and a first priority security
interest in, and mortgages on, substantially all other intangible and tangible
assets of APC and subsidiaries. The Credit Agreement matures February 7, 2005,
with an interest rate of LIBOR plus 2.25%. The interest rate may be stepped
down over the term of the credit agreement based on the ratio of outstanding
debt to earnings before interest, tax, depreciation and amortization. Proceeds
from the Credit Agreement were used to repay the outstanding financing from
Holdings as of the closing date of the credit agreement, capital expenditures
for the communications systems, general working capital requirements, and net
operating losses.
The Credit Agreement contains covenants which require APC to maintain
certain levels of wireless subscribers, as well as other financial and non-
financial requirements.
In January 1998 APC completed negotiations with its lenders to amend the
Credit Agreement. As amended, the Credit Agreement contains certain covenants
which, among other things, contain certain restrictive financial and operating
covenants including, maximum debt ratios (including debt to total
capitalization) and limitations on capital expenditures. The covenants require
American PCS Communications, LLC to enter into interest rate contracts on a
quarterly basis to protect and limit the interest rate on 40% of its aggregate
debt outstanding.
COX PCS CREDIT FACILITY--On February 25, 1998 Cox PCS entered into a $800
million, nine-year revolving and term loan agreement (the "Cox Credit
Facility") with a bank syndicate. The Cox Credit Facility consists of a
revolving line of credit in an aggregate principal amount of $400 million and
two term loan facilities with aggregate principal amounts of $200 million
each. At September 30, 1998, $400 million had been borrowed under the term
loan facilities at a weighted average interest rate of 8.13%. The Cox Credit
Facility grants Cox PCS an option to expand the credit facility up to an
additional $750 million from time to time, upon Cox PCS meeting certain
requirements. The proceeds from the loan are intended to repay the PCS license
debt, finance working capital needs, subscriber acquisition costs, capital
expenditures and other general purposes of Cox PCS.
II-62
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
Provisions of the Cox Credit Facility required the transfer of certain of Cox
PCS' assets into the special purpose subsidiaries of Cox PCS to facilitate the
collateralization of substantially all of Cox PCS' assets.
Furthermore, the amounts advanced under the Cox Credit Facility are
guaranteed by each of the special purpose subsidiaries. The Cox Credit
Facility also requires that Cox PCS meet certain operational and financial
covenants. Cox PCS is in compliance as of February 25, 1998 (the funding
date). Amounts borrowed under the facility are to be repaid based on scheduled
repayment dates defined in the credit agreement plus interest at a variable
rate (as defined).
COX PCS DUE TO FCC--In conjunction with the assignment of the PCS license
covering the Los Angeles-San Diego-Las Vegas MTA by CPP to Cox PCS, Cox PCS
assumed the related debt payable to the FCC. The debt requires eight interest-
only payments beginning April 30, 1996 through January 31, 1998. Commencing
April 30, 1998, the debt requires repayment in equal quarterly installments of
$23.7 million representing both principal and interest. The debt is
collateralized by the PCS license above, bears interest at 7.75% per annum and
matures on January 31, 2001.
OTHER DEBT--At December 31, 1997 and September 30, 1998, other debt included
a note payable to Lucent for the financing of debt issuance costs, a note
payable for certain leasehold improvements, and capital leases acquired in the
purchase of APC. Maturities on the debt range from 3 to 10 years, at interest
rates from 8.32% to 21%.
INTEREST RATE CONTRACTS--As of September 30, 1998, APC had entered into ten
interest rate contracts with an aggregate notional value of $134 million. As
of December 31, 1997, APC had entered into nine interest rate contracts (swaps
and a collar), with an aggregate notional amount of $122 million. Under the
agreements APC pays a fixed rate and receives a variable rate such that it
will protect APC against interest rate fluctuations on a portion of its
variable rate debt. The fixed rates paid by APC on the interest rate swap
contracts range from approximately 5.97% to 6.8%. Option features contained in
certain of the swaps operate in a manner such that the interest rate
protection in some cases is effective only when rates are outside a certain
range. Under the collar arrangement, APC will receive 6.19% when LIBOR falls
below 6.19% and pay 8% when LIBOR exceeds 8%. The contracts expire in 2001.
The fair value of the interest rate contracts at September 30, 1998 and
December 31, 1997 was an unrealized loss of approximately $4.8 million and
$1.3 million, respectively. The notional amounts represent reference balances
upon which payments and receipts are based and consequently are not indicative
of the level of risk or cash requirements under the contracts. APC has
exposure to credit risk to the counterparty to the extent it would have to
replace the interest rate swap contract in the market when and if a
counterparty were to fail to meet its obligations. The counterparties to all
contracts are primary dealers that meet APC's criteria for managing credit
exposures.
FAIR VALUE--The estimated fair value of the Company's long-term debt at
December 31, 1997 and 1996 is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
------------------- -------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
11% Senior Notes.................... $250,000 $280,650 $250,000 $270,625
12 1/2% Senior Discount Notes....... 322,280 389,300 285,499 337,950
Credit facility--term loans......... 300,000 300,000 150,000 151,343
Credit facility--revolver........... 605,000 605,000 -- --
Vendor facility--Lucent............. 983,299 983,299 -- --
Vendor facility--Nortel............. 629,615 629,615 -- --
APC Senior Secured Term Loan
Facility........................... 220,000 220,000 -- --
APC Senior Secured Reducing
Revolving Credit Facility.......... 141,429 141,429 -- --
FCC debt............................ 90,355 98,470 -- --
</TABLE>
II-63
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
At December 31, 1997, scheduled maturities of long-term debt and capital
leases during each of the next five years are as follows (in thousands):
<TABLE>
<CAPTION>
LONG-TERM DEBT CAPITAL LEASES
-------------- --------------
<S> <C> <C>
1998........................................... $ 29,800 $5,411
1999........................................... 40,425 3,667
2000........................................... 53,624 591
2001........................................... 395,291 42
2002........................................... 583,113 --
------
9,711
Less interest.................................. (898)
------
Present value of minimum lease payments........ $8,813
======
</TABLE>
6. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES--Minimum rental commitments as of December 31, 1997, for
all noncancelable operating leases, consisting principally of leases for cell
and switch sites and office space, for the next five years, are as follows (in
thousands):
<TABLE>
<S> <C>
1998............................................................ $139,890
1999............................................................ 135,940
2000............................................................ 109,081
2001............................................................ 66,168
2002............................................................ 21,655
</TABLE>
Gross rental expense for cell and switch sites aggregated approximately
$106.5 million for the nine months ended September 30, 1998, and $97.1 million
and $13.6 million for the years ended December 31, 1997 and 1996,
respectively. There was no cell or switch site rental expense for the year
ended December 31, 1995. Gross rental expense for office space approximated
$37.4 million for the nine months ended September 30, 1998, and $34.1 million,
$11.7 million, and $0.7 million for the years ended December 31, 1997, 1996,
and 1995, respectively. Certain cell and switch site leases contain renewal
options (generally for terms of 5 years) that may be exercised from time to
time and are excluded from the above amounts.
PROCUREMENT CONTRACTS--On January 31, 1996, the Company entered into
procurement and services contracts with AT&T Corp. (subsequently assigned to
Lucent) and Nortel for the engineering and construction of a PCS network. Each
contract provides for an initial term of ten years with renewals for
additional one-year periods. The Vendors must achieve substantial completion
of the PCS network within an established time frame and in accordance with
criteria specified in the procurement contracts. Pricing for the initial
equipment, software and engineering services has been established in the
procurement contracts. The procurement contracts provide for payment terms
based on delivery dates, substantial completion dates, and final acceptance
dates. In the event of delay in the completion of the PCS network, the
procurement contracts provide for certain amounts to be paid to the Company by
the Vendors. The minimum commitments for the initial term are $0.8 billion and
$1.0 billion from Lucent and Nortel, respectively, which include, but are not
limited to, all equipment required for the establishment and installation of
the PCS network.
On May 8, 1998, the Company amended its procurement and services agreement
with Lucent. The amendment provides for an additional pricing structure for
certain equipment, software and engineering services purchased by the Company
from Lucent after January 1, 1998. Major original contract provisions,
including but not limited to, the length of the contract and the payment
terms, have not been amended. The minimum commitment under the amendment is
approximately $353 million.
II-64
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
HANDSET PURCHASE AGREEMENTS--In June, 1996, the Company entered into a
three-year purchase and supply agreement with a vendor for the purchase of
handsets and other equipment totaling approximately $500 million. During 1997
and 1996, the Company purchased $332.7 million and $85 million under the
agreement, respectively. The total purchase commitment was satisfied during
the second quarter of 1998.
In September, 1996, the Company entered into another three-year purchase and
supply agreement with a second vendor for the purchase of handsets and other
equipment totaling more than $600 million, with purchases that commenced in
April, 1997. During 1997, the Company purchased $147.6 million under the
agreement. The total purchase commitment must be satisfied by April 2000.
SERVICE AGREEMENTS--The Company has entered into an agreement with a vendor
to provide PCS call record and retention services. Monthly rates per
subscriber are variable based on overall subscriber volume. If subscriber fees
are less than specified annual minimum charges, the Company will be obligated
to pay the difference between the amounts paid for processing fees and the
annual minimum. Annual minimums range from $20 million to $60 million through
2001. The agreement extends through December 31, 2001, with two automatic,
two-year renewal periods, unless terminated by the Company. The Company may
terminate the agreement prior to the expiration date, but would be subject to
specified termination penalties.
The Company has also entered into an agreement with a vendor to provide
prepaid calling services. Monthly rates per minute of use are based on overall
call volume. If the average minutes of use are less than monthly specified
minimums, the Company is obligated to pay the difference between the average
minutes used at the applicable rates and the monthly minimum. Monthly minimums
range from $40,000 to $50,000 during the initial term. Certain installation
and setup fees for processing and database centers are also included in the
agreement and are dependent upon a need for such centers. The agreement
extends through July 1999, with successive one-year term renewals, unless
terminated by the Company. The Company may terminate the agreement prior to
the expiration date, but would be subject to specified termination penalties.
In January 1997, the Company entered into a four and one-half year contract
for consulting services. Under the terms of the agreement, consulting services
will be provided at specified hourly rates for a minimum number of hours. The
total commitment is approximately $125 million over the term of the agreement.
LITIGATION--The Company is involved in various 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 Company believes that
the outcome of such proceedings, individually and in the aggregate, will not
have a material adverse effect on the Company's financial condition or results
of operations.
7. EMPLOYEE BENEFITS
Employees performing services for the Company were employed by Sprint
through December 31, 1995. Amounts paid to Sprint relating to pension expense
and employer contributions to the Sprint Corporation 401(k) plan for these
employees approximated $0.3 million in 1995.
The Company maintains short-term and long-term incentive plans. All salaried
employees of Sprint Spectrum L.P. are eligible for the short-term incentive
plan commencing at date of hire. Employees of APC are covered by the APC
plans. Short-term incentive compensation is based on incentive targets
established for each position based on the Company's overall compensation
strategy. Targets contain both an objective Company component and a personal
objective component. Charges to operations for the short-term plan
approximated $20.9 million for the nine months ended September 30, 1998, and
$20.3 million, $12.5 million, and $3.5 million for the years ended December
31, 1997, 1996, and 1995, respectively.
II-65
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
LONG-TERM COMPENSATION OBLIGATION--The Company has two long-term incentive
plans, the 1996 Plan and the 1997 Plan. Employees meeting certain eligibility
requirements are considered to be participants in each plan. Participants in
the 1996 Plan will receive 100% of the pre-established targets for the period
from July 1, 1995 to June 30, 1996 (the "Introductory Term"). Participants in
the 1996 Plan elected either a payout of the amount due or converted 50% or
100% of the award to appreciation units. Unless converted to appreciation
units, payment for the Introductory Term of the 1996 Plan was made in the
third quarter of 1998. Under the 1996 plan, appreciation units vest 25% per
year commencing on the second anniversary of the date of grant and expire
after a term of ten years. The 1997 Plan appreciation units vest 25% per year
commencing on the first anniversary of the date of the grant and also expire
after ten years. For the nine months ended September 30, 1998, approximately
$14.2 million had been expensed under both plans. For the years ended December
31, 1997, 1996, and 1995, $18.3 million, $9.5 million, and $1.9 million,
respectively, has been expensed under both plans. At December 31, 1997 a total
of approximately 103 million units have been authorized for grant for both
plans. The Company has applied APB Opinion No. 25, "Accounting for Stock
Issued to Employees" for 1997 and 1996. No significant difference would have
resulted if SFAS No. 123, "Accounting for Stock-Based Compensation" had been
applied. See Note 10 for further discussion.
SAVINGS PLANS--Effective January, 1996, Holdings established a savings and
retirement program (the "Savings Plan") for certain employees, which qualified
under Section 401(k) of the Internal Revenue Code. Most permanent full-time,
and certain part-time, employees are eligible to become participants in the
plan after one year of service or upon reaching age 35, whichever occurs
first. Participants make contributions to a basic before tax account and
supplemental before tax account. The maximum contribution for any participant
for any year is 16% of such participant's compensation. For each eligible
employee who elects to participate in the Savings Plan and makes a
contribution to the basic before tax account, the Company makes a matching
contribution. The matching contributions equal 50% of the amount of the basic
before tax contribution of each participant up to the first 6% that the
employee elects to contribute. Contributions to the Savings Plan are invested,
at the participant's discretion, in several designated investment funds.
Distributions from the Savings Plan generally will be made only upon
retirement or other termination of employment, unless deferred by the
participant. Expense under the Savings Plan approximated $5.2 million for the
nine months ended September 30, 1998, and $5.0 million and $1.1 million in
1997 and 1996, respectively.
APC also had an employee savings plan that qualifies under Section 401(k) of
the Internal Revenue Code (the "APC Plan"). All APC employees completing one
year of service were eligible and could contribute up to 15% of their pretax
earnings. APC matched 100% of the first 3% of the employee's contribution.
Employees were immediately fully vested in APC's contributions. In addition,
APC could make discretionary contributions on behalf of eligible participants
in the amount of 2% of employee's compensation. Expenses relating to the
employee savings plan were not significant since the date of acquisition.
On June 26, 1998, the Partnership Board of Holdings approved the termination
of the APC Plan. The assets of the APC Plan were liquidated, settled and
transferred to Merrill Lynch Trust Company as trustee of the Plan.
Additionally, APC Plan participants became participants in the Savings Plan.
The Cox PCS Savings and Investment Plan (the "Cox PCS Plan") was established
effective July 1, 1997. Substantially all Cox PCS employees are eligible to
participate in the Cox PCS Plan after completing one year of eligible service
(as defined) and attaining age 21. Employees may make contributions to the Cox
PCS Plan on a pretax basis pursuant to Section 401(k) of the Internal Revenue
Code. Cox PCS makes matching contributions equal to 75% of the employee's
contribution up to a maximum amount equal to 4.5% of the employee's annual
compensation. Employee contributions vest immediately, and Cox PCS' matching
contributions vest over three years of service. Expense under the Cox PCS Plan
approximated $0.9 million for the nine months ended September 30, 1998.
II-66
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
PROFIT SHARING (RETIREMENT) PLAN--Effective January, 1996, the Company
established a profit sharing plan for its employees. Employees are eligible to
participate in the plan after completing one year of service. Profit sharing
contributions are based on the compensation, age, and years of service of the
employee. Profit sharing contributions are deposited into individual accounts
of the Company's retirement plan. Vesting occurs once a participant completes
five years of service. For the years ended December 31, 1997 and 1996, expense
under the profit sharing plan approximated $2.5 million and $0.7 million,
respectively.
DEFERRED COMPENSATION PLAN FOR EXECUTIVES--Effective January, 1997, the
Company established a non-qualified deferred compensation plan which permits
certain eligible executives to defer a portion of their compensation. The plan
allows the participants to defer up to 80% of their base salary and up to 100%
of their annual short-term incentive compensation. The deferred amounts earn
interest at the prime rate. Payments will be made to participants upon
retirement, disability, death or the expiration of the deferral election under
the payment method selected by the participant.
8. RELATED PARTY TRANSACTIONS
BUSINESS SERVICES--The Company reimburses Sprint for certain accounting and
data processing services, for participation in certain advertising contracts,
for certain cash payments made by Sprint on behalf of the Company and other
management services. The Company is allocated the costs of such services based
on direct usage. Allocated expenses of approximately $10.5 million, $11.9
million, and $2.6 million are included in selling, general and administrative
expense in the combined statements of operations for 1997, 1996, and 1995,
respectively. In addition to the miscellaneous services agreement described
above, the Company has entered into agreements with Sprint for invoicing
services, operator services, and switching equipment. The Company is also
using Sprint as its interexchange carrier, with the agreement for such
services covered under the Holdings partnership agreement. Charges are based
on the volume of services provided, and are similar to those that would be
incurred with an unrelated third-party vendor.
APC--Holdings entered into an affiliation agreement with APC in January 1995
which provides for the reimbursement of certain allocable costs and payment of
affiliation fees by APC. For the year ended December 31, 1997, prior to
acquisition, the reimbursement of allocable costs of approximately $14.0
million is included in selling, general and administrative expenses. There
were no reimbursements recognized in 1996 or 1995. Additionally, affiliation
fees are recognized based on a percentage of APC's net revenues.
COX PCS--Concurrent with the execution of the partnership agreement, the
Company entered into an affiliation agreement with Cox PCS which provides for
the reimbursement of certain allocable costs and payment of affiliate fees by
Cox PCS. For the years ended December 31, 1997 and 1996, allocable costs of
approximately $20.0 million and $7.3 million, respectively, are netted against
selling, general and administrative expenses in the accompanying combined
statements of operations. Of these total allocated costs, approximately $1.6
million and $7.3 million were included in receivables from affiliates in the
respective combined balance sheets for December 31, 1997 and 1996,
respectively. In addition, the Company purchases certain equipment, such as
handsets, on behalf of Cox PCS. Receivables from affiliates for handsets and
related equipment were approximately $31.2 million and $6 million at December
31, 1997 and 1996, respectively.
SPRINTCOM, INC.--The Company provides services to SprintCom, Inc.
("SprintCom"), an affiliate of Sprint. The Company is currently building out
the network infrastructure in certain BTA markets where SprintCom was awarded
licenses. Such services include engineering, management, purchasing,
accounting and other related services. For the nine months ended September 30,
1998 and for the year ended December 31, 1997, costs for services provided of
$36.3 million and $29.1 million, respectively were allocated to SprintCom, and
are included as a reduction of selling, general and administrative expenses in
the accompanying combined statements of operations. Of the total allocated
costs, approximately $23.3 million and $14.0 million are included in
receivables from affiliates at September 30, 1998 and December 31, 1997,
respectively. No such costs were incurred in 1996.
II-67
<PAGE>
SPRINT SPECTRUM HOLDING COMPANY COMBINED WITH MINORCO AND PHILLIECO
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(UNAUDITED WITH RESPECT TO SEPTEMBER 30, 1998)
PAGING SERVICES--In 1996, the Company commenced paging services pursuant to
agreements with Paging Network Equipment Company and Sprint Communications
Company L.P. ("Sprint Communications"). For the nine months ended September
30, 1998 and the years ended December 31, 1997 and 1996, Sprint Communications
received agency fees of approximately $6.5 million, $10.6 million and $4.9
million, respectively.
ADVANCES FROM PARTNERS TO HOLDINGS--In December 1996, the Partners advanced
approximately $168 million to the Holdings, which was contributed to Cox PCS
(Note 4). The advances were repaid in February 1997.
ADVANCES FROM PHILLIECO PARTNERS TO PHILLIECO--At December 31, 1997, the
PhillieCo Partners had advanced $45 million to PhillieCo I, for general
operating purposes. The advances accrue interest at prime. Subsequent to
December 31, 1997 and through September 30, 1998, the PhillieCo Partners
advanced an additional $50 million to PhillieCo I. Additionally, during that
same period, Sprint advanced an additional $90 million to PhillieCo I. These
advances accrue interest at rates from prime to prime plus 1 5/8%. All of the
above advances have maturity dates of the earliest of the following events:
(i) the 90th day following the closing date of the restructuring of the
partnership, or (ii) if the restructuring does not occur, the date of the
closing of the buy/sell arrangements that would occur under the partnership
agreement in connection with the deadlock event discussed in Note 1, or (iii)
December 31, 1999.
9. QUARTERLY FINANCIAL DATA (UNAUDITED)
Summarized quarterly financial data for 1997 and 1996 is as follows (in
thousands):
<TABLE>
<CAPTION>
1997 FIRST SECOND THIRD FOURTH
---- -------- -------- -------- --------
<S> <C> <C> <C> <C>
Operating revenues....................... $ 9,487 $ 25,813 $ 75,228 $147,501
Operating expenses....................... 202,011 310,958 466,537 658,197
Net loss................................. 217,069 338,719 465,670 611,195
<CAPTION>
1996
----
<S> <C> <C> <C> <C>
Operating revenues....................... $ -- $ -- $ -- $ 4,175
Operating expenses....................... 31,029 47,208 87,568 195,945
Net loss................................. 67,505 91,205 102,035 183,824
</TABLE>
10. SUBSEQUENT EVENTS
PCS RESTRUCTURING--Sprint has entered into a restructuring agreement with
TCI, Comcast, and Cox to restructure Sprint's PCS operations (the "PCS
Restructuring") subject to Sprint stockholder and FCC approvals. If the PCS
Restructuring occurs as planned, Sprint will acquire the joint venture
interests of TCI, Comcast and Cox in Sprint PCS and the joint venture interest
of TCI and Cox in PhillieCo I and PhillieCo II. In exchange for these joint
venture interests, Sprint will issue to TCI, Comcast, and Cox a newly created
class of Sprint common stock (the "PCS Stock"). The PCS Stock will be intended
to reflect separately the performance of these joint ventures and Sprint's
other PCS interests. The operations will be referred to as the PCS Group.
If the PCS Restructuring occurs as planned, the Partners will convert their
advances to the Company as of December 31, 1997 to equity. As of September 30,
1998 the Partners had loaned $400 million, based on respective ownership
interests, to fund the capital requirements of Holdings from the date of the
signing of the Restructuring Agreement, May 26, 1998. Additionally, as part of
the PCS Restructuring, certain of Sprint's equity-based incentive plans are
intended to replace the Sprint Spectrum Long-Term Incentive Plans.
II-68
<PAGE>
PCS GROUP
UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma condensed combined financial statements
are presented to give effect to (1) the PCS Restructuring, whereby Sprint will
acquire the joint venture interests of the Cable Parents in Sprint Spectrum
Holdings and the joint venture interests of TCI and Cox in PhillieCo, in
exchange for shares of Series 2 PCS Stock, and the exercise of Equity Purchase
Rights by FT and DT in connection with the PCS Restructuring and (2) the tax-
free Recapitalization of Sprint's common stock to be effected by reclassifying
each share of Sprint's Existing Common Stock into 1/2 share of Series 1 PCS
Stock and one share of Series 1 FON Stock and by reclassifying each share of
DT Class A Stock held by DT and each share of Existing Class A Common Stock
held by FT so that each share represents an equity interest in the FON Group
and an equity interest in the PCS Group, together with a right to cause Sprint
to initially issue one share of Series 3 FON Stock and 1/2 share of Series 3
PCS Stock. For purposes of these pro forma financial statements, the proceeds
from the sale of additional shares to FT and DT are assumed to be used for
working capital needs and to fund the buildout of the PCS network. If the debt
issuance discussed below is completed, all or a portion of such proceeds may
instead be used to retire existing indebtedness of the PCS Group. The
acquisitions of the Cable Parents' interests in Sprint Spectrum Holdings and
PhillieCo will be accounted for using the purchase method of accounting. The
pro forma condensed combined financial statements included herein do not give
effect to the proposed initial public offering ("IPO") of the Series 1 PCS
Stock and there can be no assurance that the IPO will occur.
Sprint currently anticipates conducting a debt offering of up to $3 billion
at approximately the same time as the PCS Restructuring. Sprint also intends
that a portion of the proceeds from the proposed debt issuance will be loaned
to the PCS Group at an interest rate substantially equivalent to the rate that
the PCS Group would be able to obtain from third parties as a wholly-owned
subsidiary of Sprint, but without the benefit of any guaranty by Sprint or any
member of the FON Group. Sprint currently expects that the proceeds loaned to
the PCS Group from such issuance will be used to repay indebtedness of the PCS
Group. The pro forma condensed combined financial statements included herein
do not give effect to the proposed debt issuance. There can be no assurance
that such debt issuance will occur.
The unaudited pro forma condensed combined statements of operations include
the historical results of the PCS Group and the historical combined results of
Sprint Spectrum Holdings and PhillieCo for the year ended December 31, 1997
and the nine months ended September 30, 1998, and include the effect of the
PCS Restructuring, Recapitalization and exercise of Equity Purchase Rights by
FT and DT as though such transactions had occurred on January 1, 1997. The
unaudited pro forma condensed combined balance sheet is based upon the
historical balance sheet of the PCS Group and the historical combined balance
sheet of Sprint Spectrum Holdings and PhillieCo as of September 30, 1998. The
historical balance sheet amounts have been adjusted to reflect the PCS
Restructuring, Recapitalization and exercise of Equity Purchase Rights by FT
and DT as though such transactions had occurred on September 30, 1998. The
historical PCS Group amounts include Sprint's investment in Sprint Spectrum
Holdings and its investment in PhillieCo, both of which are reflected on the
equity basis, and SprintCom.
The pro forma condensed combined statements of operations are not
necessarily indicative of what actual results of operations would have been
had the transactions occurred at the beginning of the periods presented nor do
they purport to indicate the results of future operations. The unaudited pro
forma condensed combined financial statements should be read in conjunction
with the historical financial statements of the PCS Group and the historical
combined financial statements of Sprint Spectrum Holdings and PhillieCo
included elsewhere in this Current Report on Form 8-K.
II-69
<PAGE>
PCS GROUP
PRO FORMA CONDENSED COMBINED BALANCE SHEET
SEPTEMBER 30, 1998
(Unaudited, in millions)
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS
-------------------------------
HISTORICAL
COMBINED
SPRINT
SPECTRUM
HISTORICAL HOLDINGS AND PCS
PCS GROUP PHILLIECO RESTRUCTURING RECAPITALIZATION PRO FORMA
---------- ------------ ------------- ---------------- ---------
ASSETS
<S> <C> <C> <C> <C> <C>
Current assets
Cash and equivalents...... $ -- $ 325.3 $ 82.3 D $ 407.6
Accounts receivable, net.. -- 195.3 (47.1) C 148.2
Inventories............... -- 177.8 177.8
Other..................... 32.8 44.1 76.9
-------- -------- -------- ---------
Total current assets...... 32.8 742.5 35.2 810.5
Property, plant and
equipment, net............ 1,327.2 4,531.9 5,859.1
Investments in Sprint
Spectrum Holdings and
PhillieCo ................ 475.4 -- (293.4) B --
(182.0) B
Intangibles, net
PCS licenses.............. 544.5 2,829.1 3,373.6
Customer base............. -- -- 500.0 A 500.0
Goodwill.................. -- -- 3,127.6 A 3,127.6
Other assets............... 114.3 422.9 182.0 B 719.2
-------- -------- -------- ------- ---------
Total...................... $2,494.2 $8,526.4 $3,369.4 $ -- $14,390.0
======== ======== ======== ======= =========
<CAPTION>
LIABILITIES AND
GROUP EQUITY
<S> <C> <C> <C> <C> <C>
Current liabilities
Current maturities of
long-term debt........... $ 42.5 $ 124.5 $ 167.0
Partner advances.......... -- 185.0 185.0
Accounts payable.......... 20.2 287.1 307.3
Advance from the FON
Group.................... 410.0 -- $ (110.6) E 299.4
Payable to Sprint Spectrum
Holdings................. 47.1 -- (47.1) C --
Accrued expenses and other
current liabilities...... 7.3 476.4 483.7
-------- -------- -------- ---------
Total current liabilities. 527.1 1,073.0 (157.7) 1,442.4
Construction obligations... 429.0 575.7 1,004.7
Long-term debt............. 388.2 6,001.2 60.5 A 6,449.9
Deferred income taxes and
other liabilities......... 318.9 84.9 443.0 A 846.8
Limited partner interest in
consolidated subsidiary .. -- 65.8 65.8
Group equity............... 831.0 725.8 3,124.1 A 4,580.4
(293.4) B
82.3 D
510.6 E
(400.0) E
-------- -------- -------- ------- ---------
Total...................... $2,494.2 $8,526.4 $3,369.4 $ -- $14,390.0
======== ======== ======== ======= =========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial
Statements.
II-70
<PAGE>
PCS GROUP
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1998
(Unaudited, in millions, except per share data)
<TABLE>
<CAPTION>
HISTORICAL
COMBINED
SPRINT PRO FORMA ADJUSTMENTS
SPECTRUM ------------------------------
HISTORICAL HOLDINGS AND PCS
PCS GROUP PHILLIECO RESTRUCTURING RECAPITALIZATION PRO FORMA
---------- ------------ ------------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
NET OPERATING REVENUES.. $ -- $ 787.9 $ 787.9
OPERATING EXPENSES
Costs of services and
products............... -- 783.0 783.0
Selling, general and
administrative......... 78.2 931.6 1,009.8
Depreciation and
amortization........... 1.8 529.2 $ 5.2 F 719.8
58.6 G
125.0 H
------- --------- ------- ---------
Total operating ex-
penses................. 80.0 2,243.8 188.8 2,512.6
------- --------- ------- ---------
OPERATING LOSS.......... (80.0) (1,455.9) (188.8) (1,724.7)
Interest expense........ -- (358.3) 60.1 I (293.4)
4.8 J
Equity in loss of Sprint
Spectrum Holdings and
PhillieCo.............. (686.5) -- 681.3 F --
5.2 F
Other income............ -- 23.2 23.2
Minority interest ...... -- 99.0 99.0
------- --------- ------- ---------
Loss before income
taxes.................. (766.5) (1,692.0) 562.6 (1,895.9)
Income tax benefit...... 294.7 -- 399.0 K 717.3
23.6 L
------- --------- ------- ---------
NET LOSS................ (471.8) (1,692.0) 985.2 (1,178.6)
Preferred stock divi-
dends.................. -- -- (11.5)M (11.5)
------- --------- ------- ---------
Loss applicable to com-
mon stock.............. $(471.8) $(1,692.0) $ 973.7 $(1,190.1)
======= ========= ======= =========
BASIC AND DILUTED LOSS
PER
COMMON SHARE........... $ (2.86)
=========
Weighted average common
shares................. 415.4 N
=========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial
Statements.
II-71
<PAGE>
PCS GROUP
PRO FORMA CONDENSED COMBINED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 31, 1997
(Unaudited, in millions, except per share data)
<TABLE>
<CAPTION>
PRO FORMA ADJUSTMENTS
------------------------------
HISTORICAL
COMBINED
SPRINT
SPECTRUM
HISTORICAL HOLDINGS AND PCS
PCS GROUP PHILLIECO RESTRUCTURING RECAPITALIZATION PRO FORMA
---------- ------------ ------------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
NET OPERATING REVENUES.. $ -- $ 258.0 $ 258.0
OPERATING EXPENSES
Costs of services and
products............... -- 574.3 574.3
Selling, general and ad-
ministrative........... 18.5 747.1 765.6
Depreciation and amorti-
zation................. -- 316.3 $ 3.5 F 564.7
78.2 G
166.7 H
------- --------- ------ ---------
Total operating ex-
penses................. 18.5 1,637.7 248.4 1,904.6
------- --------- ------ ---------
OPERATING LOSS.......... (18.5) (1,379.7) (248.4) (1,646.6)
Interest expense........ -- (123.5) 21.0 I (96.1)
6.4 J
Equity in loss of Sprint
Spectrum Holdings and
PhillieCo.............. (659.6) -- 656.1 F --
3.5 F
Equity in loss of
unconsolidated
partnership............ -- (168.9) (168.9)
Other income............ -- 39.4 39.4
------- --------- ------ ---------
Loss before income tax-
es..................... (678.1) (1,632.7) 438.6 (1,872.2)
Income tax benefit...... 259.0 -- 383.1 K 696.8
54.7 L
------- --------- ------ ---------
NET LOSS................ (419.1) (1,632.7) 876.4 (1,175.4)
Preferred stock divi-
dends.................. -- -- (15.3)M (15.3)
------- --------- ------ --- ---------
Loss applicable to com-
mon stock.............. $(419.1) $(1,632.7) $861.1 $(1,190.7)
======= ========= ====== === =========
BASIC AND DILUTED LOSS
PER COMMON SHARE....... $ (2.87)
=========
Weighted average common
shares................. 415.1 N
=========
</TABLE>
See accompanying Notes to Unaudited Pro Forma Condensed Combined Financial
Statements.
II-72
<PAGE>
PCS GROUP
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following adjustments have been made in the preparation of the unaudited
pro forma condensed combined financial statements:
Pro Forma Balance Sheet Adjustments
A To record the purchase of the remaining 60% of Sprint Spectrum Holdings and
52.9% of PhillieCo. The consideration given in connection with the purchase
will be shares of Series 2 PCS Stock and warrants to purchase additional
shares of Series 2 PCS Stock. The preliminary purchase price is based on
the estimated market value of the PCS Group and will be updated at the time
of the PCS Restructuring. The market value of the PCS Group will be
determined based on the market value of the securities issued in the
Recapitalization. The excess of the purchase price over the fair value of
net assets to be acquired has been preliminarily calculated as follows (in
millions):
<TABLE>
<S> <C>
Preliminary purchase price..................................... $3,290.0
Transaction costs.............................................. 26.5
Net assets to be acquired...................................... (192.4)
Customer base.................................................. (500.0)
Step-up in long-term debt to fair value........................ 60.5
Deferred taxes on acquired assets and liabilities.............. 443.0
--------
Goodwill....................................................... $3,127.6
========
</TABLE>
The carrying amounts of the assets to be acquired and liabilities to be
assumed are assumed for purposes of the preliminary purchase price
allocation to approximate fair market value, except for certain long-term
debt of Sprint Spectrum that has been recorded at fair value. A portion of
the purchase price was attributed to the customers acquired in the Sprint
Spectrum Holdings and PhillieCo acquisitions. In addition, deferred taxes
have been recorded for the difference in the book and tax bases of the
assets acquired and liabilities assumed. Cash to fund the transaction costs
will be contributed by the FON Group to the PCS Group. The above
assumptions as to the fair value of the net assets acquired are based upon
information available at the time of the preparation of these pro forma
condensed combined financial statements.
A final allocation of the purchase price to the assets acquired and
liabilities assumed is dependent on a study and analysis of the fair value
of such assets and liabilities, including such items as the PCS licenses
and in-process research and development projects, as well as the size of
the customer base at the closing date. Management expects the only
assumptions that could potentially be subject to material change are those
regarding customer base and in-process research and development. The amount
of the purchase price allocated to the customer base in the pro forma
condensed combined financial statements is based on the size of the
customer base at September 30, 1998. To the extent the customer base at the
closing date exceeds the size of the customer base at September 30, 1998,
the purchase price allocated to the customer base will likely increase
along with a corresponding increase in the amortization of the customer
base. Based on current projections of an increase in the customer base at
November 30, 1998, pro forma net loss for the nine months ended September
30, 1998 and the year ended December 31, 1997 would be $1,190.3 million and
$1,191.1 million, respectively, and the respective loss per share would be
$2.89 and $2.91 for the same periods. Sprint is undertaking an analysis to
determine whether in-process research and development projects acquired in
the PCS Restructuring should be capitalized or expensed. This analysis is
expected to be finalized prior to the completion of the final purchase
price allocation. To the extent that it is determined through this analysis
that some of the in-process research and development projects should be
expensed, a portion of the purchase price will be allocated to these in-
process research and development projects and a nonrecurring, noncash
charge will be recognized in the period in which the charge occurs. Sprint
is unable
II-73
<PAGE>
PCS GROUP
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS--
(CONTINUED)
to determine the potential amount of such a charge at this time. However,
such a charge could be material to the PCS Group's results of operations
for the period in which the charge occurs. Such a write-off would reduce
the amount of purchase price allocated to goodwill, which would result in
lower amortization expense being recognized over the life assigned to the
goodwill. Such a write-off would not impact future cash flows. At the
present time, Sprint anticipates completing its final purchase price
allocation prior to year-end 1998.
B To eliminate the PCS Group's historical investment in Sprint Spectrum
Holdings and PhillieCo, accounted for by the PCS Group on the equity method
of accounting ($293.4 million), and to reclassify interest capitalized as
part of that investment to other assets ($182.0 million).
C To eliminate the PCS Group's payable to Sprint Spectrum Holdings.
D To record the exercise of Equity Purchase Rights by FT and DT. As a result
of the issuance of Series 2 PCS Stock to the Cable Parents in exchange for
their interests in Sprint Spectrum Holdings and PhillieCo, the sale of
these additional shares is required in order for FT and DT to maintain
their combined 20% voting interest in Sprint. For purposes of these pro
forma financial statements, all of the proceeds are assumed to be used for
working capital needs and to fund the buildout of the PCS network. If the
offering of debt securities referred to above is completed, all or a
portion of the proceeds from the sale of additional shares to FT and DT may
be used to reduce long-term debt. If all of the proceeds are used to repay
such debt, the pro forma balance of long-term debt and cash and equivalents
would be $6,367.6 million and $325.3 million, respectively. If long-term
debt is repaid, deferred financing costs associated with such debt would be
written off, resulting in pro forma balances of $717.2 million and $4,578.4
million for other assets and group equity, respectively. Additionally,
interest expense would be reduced, resulting in pro forma interest expense
and income tax benefit of $288.3 million and $715.3 million, respectively,
for the nine months ended September 30, 1998, and $88.6 million and $693.9
million, respectively, for the year ended December 31, 1997.
E To reflect PCS Preferred Stock ($240.0 million) and Preferred Inter-Group
Interest ($270.6 million) issued to the Cable Parents and the FON Group,
respectively, in exchange for funding provided between the date of the
Restructuring Agreement (May 26, 1998) and September 30, 1998. See "The
Tracking Stock Proposal--Funding of the PCS Group Prior to Closing; The PCS
Preferred Stock" in the Proxy Statement.
Pro Forma Statement of Operations Adjustments
F To eliminate Sprint's equity in the losses of Sprint Spectrum Holdings and
PhillieCo, historically accounted for by the PCS Group on the equity method
of accounting ($681.3 million for the nine months ended September 30, 1998
and $656.1 million for the year ended December 31, 1997). The amortization
of interest previously capitalized on the investment in Sprint Spectrum
Holdings and PhillieCo has been reclassified to depreciation and
amortization expense ($5.2 million for the nine months ended September 30,
1998 and $3.5 million for the year ended December 31, 1997).
G To reflect the amortization of the goodwill recorded in connection with the
purchase of the remaining interests in Sprint Spectrum Holdings and
PhillieCo, which is being amortized over 40 years. The goodwill associated
with the acquisition of the remaining interests in Sprint Spectrum Holdings
and PhillieCo is directly related to both the acquisition of the PCS
licenses and the ongoing ability of the businesses to provide wireless
telecommunications services using these licenses. The 40-year life for
goodwill is consistent with the 40-year amortization period being used for
the PCS licenses.
II-74
<PAGE>
PCS GROUP
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS--
(CONTINUED)
H To reflect the amortization of the customer base recorded in connection
with the purchase of the remaining interests in Sprint Spectrum Holdings
and PhillieCo, which is being amortized over three years.
I To reduce interest expense resulting from the tax sharing agreement between
the PCS Group and the FON Group. Under this agreement, the FON Group will
"pay" the PCS Group for the use of its current tax benefits that the FON
Group is able to utilize, thereby providing funds to the PCS Group and
reducing the PCS Group's required borrowings. The computation of the
current tax benefit is performed on a quarterly basis and the resulting
amount is applied to reduce the debt balance and, therefore, interest
expense, from that date forward. Interest expense is computed using the
weighted-average interest rate on the debt assumed to be repaid, or not
incurred, as appropriate. Such debt would have amounted to $1,271.3 million
and $727.3 million as of September 30, 1998 and December 31, 1997,
respectively.
J To reflect the amortization of the purchase price adjustment related to
long-term debt (see Note A).
K To record the income tax benefit, using the statutory income tax rate,
relating to the consolidation of the remaining interests in Sprint Spectrum
Holdings and PhillieCo.
L To record the impact on income taxes of pro forma adjustments H through J
using the statutory income tax rate.
M To reflect dividends at an assumed annual rate of 3% on PCS Preferred Stock
and Preferred Inter-Group Interest issued to the Cable Parents and the FON
Group, respectively. As of September 30, 1998, $510.6 million of funding by
the Cable Parents and the FON Group between the date of the Restructuring
Agreement (May 26, 1998) and September 30, 1998 was assumed to be exchanged
for shares of PCS Preferred Stock or Preferred Inter-Group Interest. For a
discussion of how the actual dividend rate will be determined, see
"Description of Capital Stock--Description of PCS Preferred Stock;
Preferred Inter-Group Interest" in the Proxy Statement.
N The weighted average common shares outstanding reflect (1) the issuance of
Series 2 PCS Stock to the Cable Parents in the PCS Restructuring (195.1
million shares), (2) the Recapitalization of Sprint's Existing Common Stock
into 1/2 share of Series 1 PCS Stock, including the PCS Stock attributes of
the Class A Common Stock (215.4 million shares for the nine months ended
September 30, 1998, and 215.1 million shares for the year ended December
31, 1997), and (3) the exercise of Equity Purchase Rights by FT and DT in
connection with the PCS Restructuring (4.9 million shares).
II-75
<PAGE>
ANNEX III--FON GROUP INFORMATION
BUSINESS
The FON Stock, when issued in the Recapitalization, is intended to track the
performance of the FON Group. The following description should be read in
conjunction with the FON Group Financial Statements and the Notes thereto
provided elsewhere in this Annex III.
GENERAL OVERVIEW OF THE FON GROUP
The principal activities of the FON Group include (i) the FON Group's core
businesses, consisting of its long distance services, local services, product
distribution and directory publishing activities, (ii) the FON Group's
emerging businesses, which consist of the development of new integrated
communications services, Sprint Paranet and Sprint International, (iii)
Sprint's interest in the Global One international strategic alliance and (iv)
other telecommunications investments and alliances.
CORE BUSINESSES--LONG DISTANCE DIVISION
General. The FON Group's long distance division ("LDD") is the nation's
third-largest provider of long distance telephone services. LDD operates a
nationwide, all-digital long distance telecommunications network that uses
state-of-the-art fiber-optic and electronic technology. LDD provides domestic
and international voice, video and data communications services.
The division's financial performance for the fiscal years ended December 31,
1997, 1996 and 1995 is summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Net Operating Revenues(1)...................... $8,954.8 $8,302.1 $7,277.4
Operating Income(2)............................ 1,097.5 924.0 706.8
</TABLE>
- --------
(1) Includes net operating revenues eliminated in consolidation of $3.3
million, $30.9 million, and $38.9 million in 1997, 1996, and 1995,
respectively.
(2) Includes nonrecurring items relating to litigation charges of $20 million
and $60 million for 1997 and 1996, respectively.
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 telephone 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 including: its national brand,
innovative marketing and pricing plans, its reputation for superior customer
service, its state-of-the-art technology, and its partnerships with other FON
Group operating divisions and the PCS Group. LDD will focus on expanding its
leading presence in the high-growth data communications markets for services
such as 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 (including the local
telecommunications division, Sprint Paranet, 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 to create integrated
product offerings for the FON Group's customers.
Marketing and Distribution. The FON Group's long distance services are
marketed to the consumer, business and carrier customer segments under the
Sprint brand name through (i) the Consumer Services Group ("CSG"), (ii) Sprint
Business and (iii) the Wholesale Services Group ("WSG"), respectively.
III-1
<PAGE>
CSG is focused on marketing its products and services primarily to the
residential marketplace. The Sprint Sense(R) dime-a-minute product continues
to be the cornerstone of the CSG marketing effort. Among other channels, CSG's
marketing reach was significantly expanded in the third quarter of 1997 with
the opening of the "store within a store" concept in over 6,000 RadioShack
locations nationwide. CSG also exploits marketing relationships with well-
known consumer franchises such as the NFL and other widely-recognized
organizations or entities. In addition, CSG benefits from Sprint's superior
customer service recognition, having been rated as the number one long
distance provider in 1997 for customer satisfaction by both the Yankee Group,
for the fourth consecutive year, and J.D. Power and Associates, for the fourth
consecutive year.
Sprint Business focuses on marketing and distributing LDD's core products
such as advanced global data, voice and video solutions to business customers.
Sprint Business' ATM, Frame Relay and Internet backbone services experienced
annual revenue growth of 70% in 1997. According to International Data
Corporation, Sprint has the leading market share in combined ATM, Frame Relay
and x.25 data services. In addition to leveraging the FON Group's other
operations, such as the Global One alliance and Sprint Paranet, Sprint
Business has introduced innovative marketing products to business customers
such as the Fridays Free program, which has allowed Sprint Business to grow
the number of its small business accounts by more than 15% over the last two
years.
WSG is organized around three distinct customer segments and their needs
including Reseller Services (selling primarily to other long distance
providers), RBOC Services and Emerging Market Services (focusing on non-
traditional providers such as utilities). Reseller Services has been the
principal driver of WSG's volume and revenue growth. WSG was awarded the right
to provide capacity to two RBOCs as they prepare to enter the long distance
business, and is expected to realize significant volume gains when the RBOCs
are allowed to market long distance services within their regions.
Network Technology. LDD's advanced, nationwide, all-digital network
currently covers approximately 29,000 route miles. LDD is the industry leader
in the deployment of DWDM, ATM and SONET technologies, which provide customers
with unprecedented survivability and bandwidth capacity. As of September 30,
1998, 95% of LDD's long distance traffic was carried on SONET, and by mid year
1999, this number is expected to reach 100%. DWDM can increase the capacity of
a single fiber pair up to 16 times and was utilized on more than 70% of
Sprint's route miles at year-end 1997 with a target of over 95% by year end
1998. LDD is currently deploying DWDM with an even greater capacity
multiplier. As a result of ATM technology deployment, Sprint is transitioning
its network infrastructure to a packet network capable of handling data, video
and voice traffic over common switching and transport electronics. As of the
end of 1997, LDD had deployed 14 ATM core switches on its network backbone
with the throughput capacity of 10 gigabytes per second expandable to 160
gigabytes per second. LDD expects to have deployed in excess of 100 ATM
switches by the end of 1998. In addition to its packet-based technology, LDD
is also developing broadband solutions in select metropolitan areas nationwide
which involve contracting with local exchange carriers to construct high-
speed, SONET-based fiber rings, bringing the advanced technology of LDD's long
distance network to the local market. At the end of 1997, LDD had broadband
metropolitan area networks in 16 of the top 50 MSAs. All of these efforts
combine to provide Sprint's customers with nationwide, end-to-end connectivity
over LDD's state-of-the-art network.
CORE BUSINESSES--LOCAL TELECOMMUNICATIONS DIVISION
General. The local telecommunications division ("LTD") consists primarily of
regulated LECs serving more than 7.5 million access lines in 18 states. LTD
provides local services and access for telephone customers and other carriers
to LTD's local exchange facilities, and sales of telecommunications equipment
and long distance services within specified geographical areas.
III-2
<PAGE>
LTD's financial performance for the years ended December 31, 1997, 1996 and
1995 is summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Net Operating Revenues(1), (3)................... $5,290.2 $5,126.8 $4,690.0
Operating Income(2), (3)......................... 1,394.0 1,337.0 1,040.8
</TABLE>
- --------
(1) Includes net operating revenues eliminated in consolidation of $309.0
million, $410.5 million and $266.4 million in 1997, 1996 and 1995,
respectively.
(2) Includes a nonrecurring charge in 1995 of $88 million related to a
restructuring within the local telecommunications division.
(3) Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between affiliates to more accurately reflect market pricing.
For a further discussion, see "--Management's Discussion and Analysis of
Financial Conditions and Results of Operations."
AT&T is LTD's largest customer for network access services. In 1997 and
1996, services provided by AT&T (mainly network access services) accounted for
13% of the division's net operating revenues compared with 15% in 1995. On a
consolidated basis, revenues from AT&T were 5% of Sprint's revenues in 1997
and 1996 and 6% in 1995. AT&T is a significant customer, but LTD does not
believe that the division's revenues are dependent on AT&T, since any long
distance provider must pay access charges to LTD related to inter-LATA long
distance telephone service.
Strategy. To continue to build on its successful track record, LTD has
embarked on a growth strategy whereby it plans to 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 has reorganized around its principal market segments: (i) Consumer and
Small Business Markets ("CSB"), (ii) Business Markets and (iii) Carrier
Markets. This new structure provides a more efficient and focused approach to
sales and service for these market segments. Along with this market focus, LTD
has centralized the management of support organizations to provide significant
operational efficiencies and to ensure superior support of LTD's end-users.
CSB is focused on increasing voice and data product penetration in the
consumer and small business markets, including small office/home office
customers. Consumer initiatives (including aggressive marketing of advanced
network features such as Caller ID, Caller ID-based telephone sets, and usage-
sensitive features) strongly contributed to growth in 1997. CSB is developing
as a full-service provider and currently sells the Sprint portfolio of
products and services in each state in which LTD operates. Customers who
establish new local service with LTD are offered a "bundle" of products and
services including traditional local service, vertical services, long distance
service, Internet access, paging and wireless service, where available.
Business Markets is focused on selling high-capacity data networking
solutions such as ATM and Frame Relay, and marketing the network's SONET
survivability characteristics. Business Markets is partnering with LDD to
provide end-to-end solutions for medium to large business customers.
Carrier Markets sells and markets LTD's network to emerging resellers of
local telephone services as well as wireless and interexchange carriers.
Efforts are under way to leverage existing strengths, including database,
Signaling System 7 ("SS7"), and billing and collection services, to increase
revenues. Added emphasis is also being placed on growing in the recently
deregulated pay phone business.
Network Technology. LTD will continue to emphasize growth by investing in
advanced network technologies including expanded deployment of SONET ring
technology to enhance network reliability as well as installation of fiber
deeper into the network. Rapidly growing demand for higher-speed data
communications capabilities is being addressed through technologies such as
ADSL and ISDN.
III-3
<PAGE>
CORE BUSINESSES--PRODUCT DISTRIBUTION AND DIRECTORY PUBLISHING
The product distribution and directory publishing businesses consist of
Sprint North Supply Company ("North Supply") and Sprint Publishing and
Advertising ("SPA").
North Supply is one of the nation's largest distributors of
telecommunications equipment to wireline and wireless service companies, cable
TV operators, and system resellers. Available equipment includes a wide array
of products for voice, data and video communications, cable television,
security alarm systems, complementary accessories, tools and supplies. More
than 30,000 different products are stocked from 1,300 manufacturers.
SPA publishes and markets white and yellow page telephone directories in
certain of LTD's local exchange areas, as well as in the greater metropolitan
areas of Milwaukee, Wisconsin and Chicago, Illinois. SPA's revenues are mainly
derived from selling directory advertisement. SPA is currently the nation's
seventh largest Yellow Pages publisher and produces over 320 directories
across 20 states with an annual circulation of more than 20 million.
The financial performance for the product distribution and directory
publishing businesses for the fiscal years ended December 31, 1997, 1996 and
1995 is summarized as follows:
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Net Operating Revenues(1), (2)................... $1,454.3 $1,225.4 $1,147.6
Operating Income(2).............................. 179.9 101.6 86.7
</TABLE>
- --------
(1) Includes net operating revenues eliminated in consolidation of $570.5
million, $325.9 million and $336.8 million in 1997, 1996 and 1995,
respectively. Prior to 1996, revenues resulting from transactions with
regulated affiliates were not eliminated in consolidation.
(2) Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between affiliates to more accurately reflect market pricing.
For a further discussion see "--Management's Discussion and Analysis of
Financial Condition and Results of Operations."
EMERGING BUSINESSES
The FON Group's emerging businesses consist of National Integrated Services
("NIS"), Sprint Paranet and Sprint International.
NIS. The objective of NIS is to enable the FON Group to be a national
provider of fully integrated services across all customer segments. Its
efforts are directed toward the development and deployment of an Integrated
On-demand Network ("ION") which is expected to extend the FON Group's existing
advanced network capabilities to customer premises and enable the FON Group to
meet two critical business needs, namely (i) to provide the network
infrastructure to meet customers' ever-increasing demands for data, Internet,
and video use and (ii) to provide the foundation for the FON Group to provide
competitive local service. NIS believes that this integrated services
capability will generate increased demand for the FON Group's products and
services, while at the same time, reducing the costs to provide such services.
The incremental capital expenditures required to develop this advanced
functionality are projected to approximate $400 million through 1999. Sprint
will be assisted in this development effort by Cisco Systems and Bellcore.
These companies will be contributing their expertise and assisting in the
funding of these efforts. In addition to the capital for development, the
initial deployment of ION is expected to require approximately $400 million
for network upgrades through 1999.
In implementing ION, Sprint intends to rely substantially on the
transmission infrastructure of the long distance division and to a lesser
extent on the transmission infrastructure of the local telecommunications
division. Where existing Sprint facilities do not exist, Sprint will evaluate
whether facilities should be built, leased or acquired for ION. Because a
significant amount of future investment will be associated with specific
customer contracts, Sprint believes it will be able to manage its investment
in ION to be consistent with customer demand.
III-4
<PAGE>
Sprint Paranet. In September 1997, Sprint acquired Paranet, Inc., a leading
provider of integration, management, and support services for distributed
computing environments. The acquisition strengthens Sprint's position as one
of the world's leading data carriers by augmenting the Sprint's wide area
network data products and services with Paranet's expertise in local area
networks and distributed network systems.
Sprint Paranet focuses on integration, management and support of network and
system components, including network hardware from multiple vendors,
collaborative groupware, multiple operating systems, network protocols, client
server infrastructures, network security facilities and "Year 2000" solutions.
Sprint Paranet provides a complete spectrum of custom-designed solutions,
including design, integration, implementation, and day-to-day management for
WANs, LANs, Internet/intranets and desktops. Sprint Paranet offers business
customers the ability to quickly and cost-effectively use network technologies
to increase their competitiveness and business growth.
Sprint International. Sprint International ("SI") was established in 1996 to
enhance Sprint's position as a global communications company by pursuing
carefully selected business opportunities in key countries and markets around
the world outside the scope of Sprint's Global One alliance. Complementing the
strategies of Global One will continue to be an important component in
selecting opportunities.
SI is a 25% owner of Barak, an Israeli joint venture that was awarded a
license for the Israeli international long distance market in 1997 and has
since captured approximately 20% of that market. In China, SI has invested in
Tianjin Global Communications, a fixed wireline network operator, and is
pursuing other potential opportunities. In Europe, SI is concentrating on
developing opportunities with Sprint's Global One partners, FT and DT, in
several markets outside France and Germany.
GLOBAL ONE
Sprint is a partner in Global One, a joint venture with FT and DT, which
provides global telecommunications services to business, consumer and carrier
markets worldwide. Sprint is a one-third 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.
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.
Global One currently has a sales presence in 65 countries; more than 1,400
points of presence (switching centers) outside of Germany, France and the
United States; four network management sites monitoring traffic on the global
backbone networks; 29 customer service centers; and 1997 revenues in excess of
$1.1 billion of which Sprint's proportional share of these revenues was $474
million.
While focusing on the multinational business user, Global One also serves
carriers seeking cost-effective international solutions and the consumer
market. Global One offers products and services through the respective venture
partners in France, Germany and the United States, and through local business
offices, national affiliates, partnerships and distributor agreements in
virtually all other important markets.
OTHER INVESTMENTS AND ALLIANCES
Sprint's other investments and alliances include a 3.7% interest in Iridium
LLC, a satellite-based mobile communications provider. In addition, in August
1993, Sprint acquired a 25% equity interest in Call-Net Enterprises, Inc.
("Call-Net"), a long distance telecommunications company in Canada operating
under the
III-5
<PAGE>
Sprint brand name. At the end of 1997, Call-Net had a 10% share of the long
distance market in Canada. In February 1997, Sprint entered into a 50-50 joint
venture with Telefonos de Mexico (Telmex), the dominant telecommunications
provider in Mexico, to market international long distance services between the
U.S. and Mexico with products and services tailored to the Hispanic community.
Consumer Internet Access Services. In addition, in June 1998, Sprint entered
into a long-term strategic alliance with EarthLink Network, Inc.
("EarthLink"), a leading Internet service provider. As part of this
investment, Sprint purchased an approximate 30% economic interest in EarthLink
and contributed to EarthLink all of Sprint's 130,000 Sprint Internet Passport
customers. EarthLink will manage the operations, customer service, technical
support and product development for the unified Internet service. Leveraging
the brands of both companies, EarthLink and Sprint will work together on
product development, sales and marketing.
REGULATION
The Telecommunications Act of 1996 (the "Telecom Act"), which was signed
into law in February 1996, was designed to promote competition in all aspects
of telecommunications. It eliminated legal and regulatory barriers to entry
into local telephone markets. It also required ILECs, 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 RBOCs to provide in-region long distance service once they obtain state
certification of compliance with a competitive "checklist," have a facilities-
based competitor for both residential and business customers, and obtain a
ruling from the FCC 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.
Sprint has filed for CLEC status in 48 states in anticipation of the local
markets opening to competition; however, currently, Sprint is not actively
marketing CLEC services. See "--Emerging Businesses." In those areas in which
Sprint is the ILEC, local competition is expected to eventually result in some
loss of market share. Because Sprint's ILEC operations are geographically
dispersed and largely in rural markets, local competition is expected to occur
more gradually than in more urban markets.
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 LECs and state public utility commissions appealed these rules to the
U.S. Court of Appeals, which prevented most of the pricing rules from taking
effect, pending a full review by the court. In 1997, the U.S. Court of Appeals
for the Eighth Circuit struck down the FCC's pricing rules. It ruled that the
Telecom Act left jurisdiction over pricing matters to the states. The court
also struck down certain other FCC rules on jurisdictional or substantive
grounds. The U.S. Supreme Court has agreed to review the appeals court
decision.
In 1997, the FCC issued important decisions on the structure and level of
access charges and universal service. These decisions will impact the industry
in several ways, including the following:
. An additional subsidy was created to support telecommunications services
for schools, libraries and rural health care providers. All carriers
providing telecommunications services will be required to fund this
program, which is capped at $2.7 billion per year. However, LECs can
pass their portion of these costs on to long distance carriers.
. Per-minute interstate access rates charged by LECs will decline over
time to become cost-based, beginning in July 1997.
. Certain monthly flat-rate charges paid by some local telephone customers
will increase beginning in 1998.
III-6
<PAGE>
. Certain per-minute access charges paid by long distance companies were
converted to flat monthly charges based on pre-subscribed lines.
. A basis has been established for replacing implicit access subsidies
with an explicit interstate universal service fund beginning in 1999.
A number of LECs, long distance companies and others have appealed some or
all of the FCC's orders. The effectiveness of the orders has not been
suspended, and the appeals are expected to take a year or more to conclude.
The impact of these FCC decisions on Sprint is difficult to determine, but is
not expected to be material to the FON Group.
In 1997, several RBOCs claimed they met the competitive checklist and sought
FCC approval to offer in-region long distance service. These applications were
denied by the FCC.
ENVIRONMENT
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.
PATENTS, TRADEMARKS AND LICENSES
Sprint owns numerous patents, patent applications, service marks and
trademarks in the United States and other countries. Sprint is also licensed
under domestic and foreign patents and trademarks owned by others. In total,
these patents, patent applications, trademarks, service marks and licenses are
of material importance to the FON Group's 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.
EMPLOYEE RELATIONS
As of September 30, 1998, the FON Group had approximately 53,000 employees,
of whom 20.7% are represented by unions. During 1997 and through the nine
months ended September 30, 1998, Sprint had no material work stoppages caused
by labor controversies.
FACILITIES
The FON Group's property, plant and equipment totaled $23.0 billion at year-
end 1997, of which $14.0 billion relates to local communications services and
$8.2 billion relates to long distance communications services. 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.
Property, plant and equipment totaling $12.9 billion is either pledged as
security for first mortgage bonds and certain notes or is restricted for use
as mortgaged property.
III-7
<PAGE>
LEGAL PROCEEDINGS
Sprint is involved in various legal proceedings arising in the ordinary
course of business of the FON Group. While it is not possible to determine the
ultimate disposition of each of these proceedings, Sprint 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.
MANAGEMENT
For information concerning the executive officers and directors of Sprint,
see "Executive Officers and Directors of Sprint" in the Proxy Statement.
III-8
<PAGE>
FON GROUP
SELECTED FINANCIAL DATA
The following unaudited table sets forth Selected Financial Data of the FON
Group. The following should be read in conjunction with the FON Group
Management's Discussion and Analysis of Financial Condition and Results of
Operations, and the FON Group Combined Financial Statements and Notes thereto.
The Selected Financial Data at December 31, 1997 and 1996, and for each of the
three years in the period ended December 31, 1997, have been derived from the
FON Group Combined Financial Statements, which have been audited by Ernst &
Young LLP, independent auditors. The Selected Financial Data at December 31,
1995, 1994 and 1993, at September 30, 1998, for each of the two years in the
period ended December 31, 1994 and for the nine months ended September 30,
1998 and 1997, have been derived from the unaudited FON Group Combined
Financial Statements. The unaudited FON Group Combined Financial Statements
have been prepared on the same basis as the audited FON Group Combined
Financial Statements and, in the opinion of management, contain all
adjustments, consisting of only normal recurring accruals, necessary for a
fair presentation of the financial position and results of operations for
these periods. Results for the nine months ended September 30, 1998 are not
necessarily indicative of the results that may be expected for the entire
year.
<TABLE>
<CAPTION>
AT OR FOR THE
NINE MONTHS AT OR FOR THE
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- --------- --------- --------- --------- --------- ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
RESULTS OF OPERATIONS
DATA
Net operating revenues.. $11,940.3 $11,024.9 $14,873.9 $13,887.5 $12,735.3 $11,964.8 $10,894.9
Operating income(1)..... 2,097.9 1,848.3 2,469.9 2,267.7 1,834.3 1,690.7 1,214.1
Income from continuing
operations(1), (2)..... 1,141.1 1,014.9 1,371.6 1,310.6 966.0 899.2 517.1
CASH FLOW DATA
Net cash from operating
activities--continuing
operations(3).......... $ 2,791.4 $ 2,033.0 $ 2,906.8 $ 2,267.3 $ 2,590.1 $ 2,339.6 $ 2,007.8
Capital expenditures.... 2,320.0 1,835.7 2,708.9 2,433.6 1,857.3 1,751.6 1,429.8
BALANCE SHEET DATA
Total assets............ $18,369.6 $16,491.7 $15,566.6 $14,100.6 $14,374.1 $13,781.8
Property, plant and
equipment, net......... 12,175.0 11,316.8 10,464.1 9,715.8 10,258.8 9,883.1
Total debt (including
short-term borrowings). 4,689.7 3,879.6 3,273.9 5,668.9 4,927.7 5,084.1
Group equity............ 8,471.3 7,639.3 7,332.3 3,676.9 4,473.7 3,918.3
</TABLE>
- -------
(1) During the nine months ended September 30, 1997 and year ended December
31, 1996, the FON Group recorded nonrecurring charges of $20 and $60
million, respectively, related to litigation within the long distance
division. These charges reduced income from continuing operations by $13
million for the nine months ended September 30, 1997 and year ended
December 31, 1997 and $36 million for the year ended December 31, 1996.
During 1995, the FON Group recorded a nonrecurring charge of $88 million
related to a restructuring within the local telecommunications division,
which reduced income from continuing operations by $55 million.
During 1993, the FON Group recorded nonrecurring charges of $293 million
related to (a) transaction costs from the merger with Centel Corporation
and expenses of integrating and restructuring the operations of the two
companies and (b) a realignment and restructuring within the long distance
division. These charges reduced income from continuing operations by $193
million.
(2) During 1997, the FON Group recognized gains of $45 million on sales of
local exchanges and a $26 million gain on the sale of an equity investment
in an equipment provider. These gains increased income from continuing
operations by $27 million and $17 million, respectively.
During 1994, the FON Group recognized a $35 million gain on the sale of
equity securities, which increased income from continuing operations by $22
million.
During 1993, due to the enactment of the Revenue Reconciliation Act of
1993, the FON Group adjusted its deferred income tax assets and liabilities
to reflect the increased tax rate. This adjustment reduced income from
continuing operations by $11 million.
(3) The 1996 amount was reduced by $600 million for cash required to terminate
an accounts receivable sales agreement.
Holders of FON Stock and PCS Stock will be subject to the risks associated
with an investment in a single corporation and all of Sprint's businesses,
assets and liabilities. Events attributable to the FON Group or the PCS Group
that affect Sprint's results of operations or financial condition could affect
the results of operations or financial position of the other group or the
market price of the FON Stock or PCS Stock. Any net losses of the FON Group or
the PCS Group, and dividends or distributions on, or repurchases of, FON
Stock, PCS Stock or preferred stock or other stock or interests will reduce
the funds of Sprint that are legally available for payment of future dividends
on the FON Stock and the PCS Stock.
III-9
<PAGE>
FON GROUP
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Sprint Corporation (and with its subsidiaries "Sprint") has entered into a
restructuring agreement with the Cable Parents to restructure Sprint's
wireless PCS operations. Sprint will acquire the joint venture interests of
the Cable Parents in Sprint Spectrum Holdings and the joint venture interests
of TCI and Cox in PhillieCo. In exchange for these joint venture interests,
Sprint will issue to the Cable Parents a newly created class of Sprint Common
Stock, the PCS Stock. The PCS Stock is intended to reflect separately the
performance of these joint ventures and the domestic PCS operations of
Sprint's wholly owned subsidiary, SprintCom. These operations, which after the
PCS Restructuring will be 100% owned by Sprint (subject to a 40.8% minority
interest in Cox PCS, the entity holding the PCS license for and conducting
operations in the Los Angeles/San Diego/Las Vegas MTA), will be referred to as
the PCS Group.
The FON Stock, which will be created in the Recapitalization, is intended to
reflect the performance of all of Sprint's other operations, including its
long distance, local telecommunications and product distribution and directory
publishing divisions, emerging businesses and its interest in Global One.
These operations will be referred to as the FON Group.
Holders of FON Stock and PCS Stock will be subject to the risks associated
with an investment in a single corporation and all of Sprint's businesses,
assets and liabilities. Events attributable to the FON Group or the PCS Group
that affect Sprint's results of operations or financial condition could affect
the results of operations or financial position of the other group or the
market price of the FON Stock or PCS Stock. Any net losses of the FON Group or
the PCS Group, and dividends or distributions on, or repurchases of, FON
Stock, PCS Stock or preferred stock or other stock or interests will reduce
the funds of Sprint that are legally available for payment of future dividends
on the FON Stock and the PCS Stock.
The Combined Financial Statements of the FON Group include (i) the combined
historical balance sheets, results of operations and cash flows of the
businesses that comprise the FON Group; (ii) corporate assets and liabilities
of Sprint and the related transactions not specifically identified with the
PCS Group; and (iii) all of the allocable corporate expenses not specifically
identified with the PCS Group. These expenses will be allocated to both groups
in accordance with management established policies, see "The Tracking Stock
Proposal--The Tracking Stock Policies" in the Proxy Statement. All significant
intragroup financial transactions have been eliminated; however, transactions
between the FON Group and the PCS Group have not been eliminated.
GENERAL
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. Factors that could cause actual results to differ materially from
estimates or projections contained in the forward-looking statements include
(i) the effects of vigorous competition in the markets in which the FON Group
operates; (ii) the costs and business risks associated with entering new
markets necessary to provide seamless services and to provide new services;
(iii) the uncertainties related to Sprint's investments in Global One and
other joint ventures; (iv) the impact of any unusual items resulting from
ongoing evaluations of the FON Group's business strategies; (v) requirements
imposed on Sprint or latitude allowed its competitors by the FCC or state
regulatory commissions under the Telecommunications Act of 1996; (vi)
unexpected results of litigation filed against Sprint; (vii) the impact of the
Year 2000 issue and any related noncompliance; (viii) 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 or the FON
Group have no control; and (ix) those factors listed under "Risk Factors--The
Tracking Stocks" in the Proxy Statement.
The words "estimate", "project", "intend", "expect", "believe" and similar
expressions are intended to identify forward-looking statements. These
forward-looking statements are found at various places throughout
III-10
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations. Readers are cautioned not to place undue reliance on these
forward-looking statements, which speak only as of the date hereof. Sprint
undertakes no obligation to publicly release any revisions to these forward-
looking statements to reflect events or circumstances after the date hereof or
to reflect the occurrence of unanticipated events. Moreover, Sprint, through
senior management, may from time to time make forward-looking statements about
the matters described herein or other matters concerning Sprint.
CORE BUSINESSES
Long Distance Division
The long distance division is the nation's third-largest long distance
telephone company. It operates a nationwide, all-digital long distance
communications network using state-of-the-art fiber-optic and electronic
technology. The division mainly provides domestic and international voice,
video and data communications services. It offers its services to the public
subject to varying levels of state and federal regulation.
Local Telecommunications Division
The local telecommunications division consists of regulated local exchange
carriers ("LECs") serving more than 7.5 million access lines in 18 states. It
provides local telephone services, access by telephone customers and other
carriers to the FON Group's local network, sales of telecommunications
equipment and long distance services within specified regional calling areas
or local access transport areas (LATAs). In November 1998, Sprint sold its
remaining 80,000 residential and business access lines in Illinois.
Product Distribution and Directory Publishing Division
The product distribution business provides wholesale distribution services
of telecommunications products. The directory publishing business publishes
and markets white and yellow page telephone directories.
EMERGING BUSINESSES
Emerging businesses includes activities to enter new local markets, Sprint
Paranet, SprintCom, and Sprint International. It also included the operating
results of Sprint's consumer Internet access services prior to the closing of
the Earthlink transaction (see "Segmental Results of Operations--Emerging
Businesses" for more information).
STRATEGIC ALLIANCE
Global One
Sprint is a partner in Global One, a joint venture with FT and DT to provide
seamless global telecommunications services to business, residential and
carrier markets worldwide. Sprint is a one-third 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. Global One is accounted for by Sprint in the FON
Group Combined Financial Statements on the equity basis.
FT and DT each own 10% of Sprint's voting equity through Sprint's Class A
common stock. As Class A common stockholders, they have the right in most
cases to proportionate representation on Sprint's Board of Directors.
Following the Recapitalization, the Class A common shares owned by FT and DT
will represent interests in both the FON Group and the PCS Group. FT and DT
each have the right to keep their ownership levels at 10% overall voting power
in Sprint. See "FT and DT Arrangements" in the Proxy Statement.
The FON Group's long distance division contributed certain assets and
related operations of its international business unit to Global One when the
venture was formed in January 1996.
SPINOFF OF CELLULAR DIVISION
In March 1996, Sprint completed the tax-free spinoff of Sprint's cellular
division ("Cellular") to Sprint common stockholders (the "Spinoff"). See
"Liquidity and Capital Resources--Discontinued Operation" for more
information.
III-11
<PAGE>
REGULATION
See "FON Group Information--Business--Regulation" for a complete discussion
of the regulatory developments that could have a future impact on the FON
Group.
RESULTS OF OPERATIONS
COMBINED FON GROUP
Total net operating revenues for the nine months ended September 30, 1998
were $11.9 billion, an 8% increase from $11.0 billion for the same period in
1997. Income from continuing operations was $1.1 billion in the first nine
months of 1998 compared with $1.0 billion for the same period in 1997. Total
net operating revenues for 1997 were $14.9 billion, a 7% increase from $13.9
billion in 1996. Total net operating revenues for 1995 were $12.7 billion.
Income from continuing operations was $1.4 billion in 1997 compared with $1.3
billion in 1996 and $1.0 billion in 1995.
CORE BUSINESSES
Core results exclude the impact from joint ventures and emerging businesses.
The FON Group's core businesses generated improved net operating revenues and
operating income compared with the same 1997 period. For the nine months ended
September 30, 1998, long distance calling volumes increased 13% from the same
1997 period. Access lines served by the local telecommunications division
increased 3.2% during the twelve months ended September 30, 1998. Excluding
sales of exchanges in the 1997 fourth quarter, access line growth would have
been 5.2%.
For 1997, the FON Group's core businesses generated record levels of net
operating revenues and improved operating results. Long distance calling
volumes increased 14% in 1997, and access lines served by the local
telecommunications division grew 5.6%, excluding sales of local exchanges
during 1997. Excluding nonrecurring items, income from core operations was
$1.6 billion in 1997 versus $1.4 billion in 1996 and $1.0 billion in 1995.
NONRECURRING ITEMS
Core income from continuing operations for 1997 includes pretax gains on
sales of local exchanges of $45 million and a pretax gain on the sale of an
equity investment in an equipment provider of $26 million. In addition, 1997
(including the nine months ended September 30, 1997) and 1996 include pretax
litigation charges within the long distance division for $20 million and $60
million, respectively. The 1995 amounts include a pretax charge for
restructuring the local telecommunications division of $88 million.
SEGMENTAL RESULTS OF OPERATIONS
LONG DISTANCE DIVISION
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Net operating revenues.. $ 7,207.7 $ 6,642.7 $8,954.8 $8,302.1 $7,277.4
Operating expenses
Interconnection....... 2,872.4 2,966.8 3,941.1 3,722.7 3,102.7
Operations............ 1,001.8 909.2 1,236.6 1,051.8 1,046.6
Selling, general and
administrative....... 1,684.3 1,464.5 1,962.9 1,970.3 1,839.7
Depreciation and
amortization......... 628.8 520.9 716.7 633.3 581.6
--------- --------- -------- -------- --------
Total operating
expenses............... 6,187.3 5,861.4 7,857.3 7,378.1 6,570.6
--------- --------- -------- -------- --------
Operating income........ $ 1,020.4 $ 781.3(/1/) $1,097.5 $ 924.0 $ 706.8
========= ========= ======== ======== ========
Operating margin........ 14.2% 11.8%(/1/) 12.3% 11.1% 9.7%
========= ========= ======== ======== ========
</TABLE>
- --------
(/1/Excluding)a $20 million charge related to litigation, 1997 operating
income would have been $801 million. The operating margin would have been
12.1%.
III-12
<PAGE>
Nine Months Ended September 30, 1998 and 1997
Net Operating Revenues
For the nine months ended September 30, 1998, net operating revenues
increased 9% from the same 1997 period. All major market segments--business,
residential and wholesale--contributed to this increase. The increase mainly
reflects strong data services revenue growth and minute growth, partly offset
by a more competitive pricing environment and a change in the mix of products
sold.
Business and Data Market--Business market revenues increased 15%. Data
services, which includes sales of capacity on Sprint's network to Internet
service providers, showed strong growth because of continued demand and
expanded service offerings. The increases also reflect strong calling volumes
for WATS and toll-free calls made within the United States. Growth in the
small business market benefited from the Sprint International Business Calling
Plan, which was launched late in the 1998 second quarter. This plan provides
flat international rates, 24 hours a day, seven days a week to more than 200
countries.
Residential Market--Residential market revenues increased 6% in 1998. This
increase reflects strong revenue and volume growth from residential long
distance calls. Growth was also enhanced by the Sprint Sense Anytime "10 by
24" product--dime-a-minute calls, 24 hours a day--which generated increased
sales. Other factors included increased international and prepaid card
revenues as well as calling card calls made by customers of local telephone
companies. Through various agreements Sprint has with local telephone
companies, their customers use the Sprint network when making long distance
calls.
Wholesale Market--Wholesale market revenues increased 4% reflecting strong
minute growth mainly from increased WATS 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 telephone companies,
other domestic service providers, and foreign telephone companies to complete
calls made by the division's domestic customers. These costs decreased 3% from
the same 1997 period reflecting lower unit costs for both domestic and
international access to others' networks, partly offset by strong minute
growth. Domestic unit costs are expected to continue trending downward due to
additional FCC-mandated access rate reductions. Access rates impacting the
periods reported took effect in July 1997 and January and July 1998. Lower
international unit costs reflect continued competition in the market. Sprint
expects government deregulation and competitive pressures to add to the
continued trend of declining unit costs for international interconnection.
Interconnection costs were 39.9% of net operating revenues in the 1998 year-
to-date period versus 44.7% for the same period a year ago.
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 for
the nine months ended September 30, 1998 increased 10% from the same 1997
period. This reflects increased costs related to data services growth as well
as increases in the volume of network equipment operating leases. Operations
expense for 1998 also includes costs related to Sprint's efforts to achieve
year 2000 compliance for its network operating systems. In addition, FCC-
mandated payments to public payphone providers increased in the 1997 second
quarter. As a result, the 1997 year-to-date period reflects six months of this
increase compared with nine months for the same 1998 period. Operations
expense was 13.9% of net operating revenues in the 1998 first nine months and
13.7% for the same period a year ago.
Selling, General and Administrative Expense
For the nine months ended September 30, 1998, selling, general and
administrative ("SG&A") expense increased 15% from the same 1997 period. This
increase reflects the overall growth of the division's operating
III-13
<PAGE>
activities as well as increased marketing activities 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 items such as billing, customer
service and other administrative systems. SG&A expense was 23.3% of net
operating revenues in the first nine months of 1998 and 22.0% for the same
period a year ago.
Depreciation and Amortization Expense
For the first nine months of 1998, depreciation and amortization expense
increased 21% from the same 1997 period generally due to an increased asset
base and shorter average depreciable lives. Capital expenditures in both years
were incurred mainly to enhance network reliability, meet increased demand for
data-related services and upgrade capabilities for providing new products and
services. Depreciation and amortization expense was 8.7% of net operating
revenues in the 1998 first nine months and 7.8% for the same period a year
ago.
Years Ended December 31, 1997, 1996 and 1995
During 1997 and 1996, the long distance division recorded nonrecurring
litigation charges of $20 and $60 million, respectively (see Note 9 of Notes
to FON Group Combined Financial Statements). In January 1996, the division
contributed certain international assets and related operations to Global One.
For comparative purposes, the following discussion of long distance division
operating results excludes the nonrecurring charges and assumes the
contribution occurred at the beginning of 1995. Operating margins would have
been 12.5% in 1997, 12.0% in 1996 and 10.9% in 1995.
Net Operating Revenues
Net operating revenues increased 8% in 1997 and 17% in 1996. All major
market segments--business, residential and wholesale--contributed to these
increases. In general, the increases reflect strong calling volume growth of
14% in 1997 and 20% in 1996 and continued growth in the data services market.
Revenue growth in 1997 was affected by a more competitive pricing environment,
a change in the mix of products sold and an increase in the bad debt
provision. Management continues to monitor Sprint's credit extension policies
to ensure they remain effective. In addition, 1996 includes revenues from
carrying the Internal Revenue Service 800 help line traffic, a service Sprint
no longer provides, while 1997 reflects lower yields on other government
contracts.
Business Market--Business market revenues reflect increased calling volumes
for WATS calls made within the United States. Growth in the small and medium
business market was due to the continuing success of the division's small
business product, Fridays Free. Data services, which includes sales of
capacity on Sprint's network to Internet service providers, showed strong
growth because of continued demand and expanded service offerings.
Residential Market--Residential market revenues reflect the continuing
success of Sprint Sense,(R) a flat-rate calling plan, as well as growth in
1997 from international calls, prepaid phone cards and casual callers
accessing the Sprint network.
Wholesale Market--The wholesale market showed strong growth in both domestic
and international markets. Domestic increases mainly reflect increased WATS
calling volumes, partly offset by a decline in rates due to increased
competition.
Interconnection Costs
Interconnection costs increased 6% in 1997 and 20% in 1996, reflecting
strong growth in calling volumes, partly offset by lower unit costs for both
domestic and international access. The lower domestic rates are generally due
to FCC-mandated access rate reductions that took effect in July 1997--see "FON
Group Information--Business--Regulation" for more information. Interconnection
costs were 44.0% of net operating revenues in 1997, 45.0% in 1996 and 43.9% in
1995.
III-14
<PAGE>
Operations Expense
Operations expense increased 20% in 1997 and 17% in 1996. As a percentage of
net operating revenues, operations expense was 13.8% in 1997, 12.5% in 1996
and 12.4% in 1995. The 1997 increases were mainly due to increased costs
related to FCC-mandated payments to public payphone providers, network
equipment leasing costs, costs related to data services growth and equipment
sales. The 1996 increase in expense reflects overall revenue growth.
Selling, General and Administrative Expense
SG&A expense increased 2% in 1997 and 8% in 1996. These increases reflect
the overall growth of the division's operating activities as well as increases
in marketing and promotions to support products and services. The 1997
increase also reflects increased information technology costs to support
network quality, and customer acquisition and customer management. SG&A
expense was 21.7% of net operating revenues in 1997, 22.9% in 1996 and 24.8%
in 1995. These improvements reflect continued cost control and business
process improvement efforts.
Depreciation and Amortization Expense
Depreciation and amortization expense increased 13% in 1997 and 12% in 1996,
generally because of an increased asset base. Capital expenditures were
incurred mainly to enhance network reliability, meet increased demand for
data-related services and upgrade capabilities for providing new products and
services. Depreciation and amortization expense was 8.0% of net operating
revenues in 1997, 7.6% in 1996 and 8.0% in 1995.
LOCAL TELECOMMUNICATIONS DIVISION
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Net operating revenues..... $ 4,032.3 $ 3,969.7 $5,290.2 $5,126.8 $4,690.0
Operating expenses
Costs of services and
products................ 1,384.0 1,392.0 1,888.1 1,842.5 1,769.5
Selling, general and
administrative.......... 859.4 794.8 1,074.0 1,038.2 956.5
Depreciation and
amortization............ 708.4 697.7 934.1 909.1 835.6
Restructuring costs...... -- -- -- -- 87.6
--------- --------- -------- -------- --------
Total operating expenses... 2,951.8 2,884.5 3,896.2 3,789.8 3,649.2
--------- --------- -------- -------- --------
Operating income........... $ 1,080.5 $ 1,085.2 $1,394.0 $1,337.0 $1,040.8
========= ========= ======== ======== ========
Operating margin........... 26.8% 27.3% 26.4% 26.1% 22.2%
========= ========= ======== ======== ========
</TABLE>
Beginning in July 1997, the FON Group changed its transfer pricing for
certain transactions between affiliates to more accurately reflect market
pricing. The main effect of the pricing change was to reduce "Net Operating
Revenues--Other Revenues." For comparative purposes, the following discussion
of local telecommunications division operating results assumes these pricing
changes occurred at the beginning of 1995. The operating margin for the first
nine months of 1997 would have been 26.3%. Operating margins would have been
25.6% in 1997, 24.5% in 1996 and 22.3% in 1995 (excluding the restructuring
charge).
Nine Months Ended September 30, 1998 and 1997
Net Operating Revenues
Net operating revenues increased 3% in the first nine months of 1998 from
the same 1997 period. This increase mainly reflects customer access line
growth, and increased sales of equipment and network-based services such as
Caller ID and Call Waiting. In November 1997, Sprint sold approximately
139,000 residential
III-15
<PAGE>
and business access lines in a small area of Northwest Chicago and nearby
suburbs. Excluding the sales of these exchanges, net operating revenues would
have increased 5% and access line growth would have been 5.2% during the past
12 months.
Local Service Revenues--Local service revenues, derived from local exchange
services, increased 5% (8% excluding sales of exchanges) in the first nine
months of 1998 from the same 1997 period. Local service revenues increased
because of access line growth and continued demand for network-based services.
These increases also reflect increased sales of private line services and
maintenance of customer wiring and equipment.
Network Access Revenues--Network access revenues, derived from long distance
companies using Sprint's local network to complete calls, increased 1% (3%
excluding sales of exchanges) compared with the same 1997 period. Revenues for
the first nine months of 1998 reflect a 6% (8% excluding sales of exchanges)
increase in minutes of use, partly offset by FCC-mandated access rate
reductions. Access rate reductions impacting these periods 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. Toll service revenues for the
first nine months of 1998 declined 28% compared with the same 1997 period (27%
excluding the sale of exchanges). The decrease reflects extended local calling
area plans and increased competition in the intrastate long distance market.
The losses were, in part, offset by increases in local service revenues since
local calling areas have been expanded and by increases in network access
revenues paid by competitors.
Other Revenues--Other revenues include telecommunications equipment sales,
directory sales and listing services, payphone revenues, billing and
collection services and services to locate underground utility lines. It also
includes commissions income from the sale of long distance services on behalf
of Sprint's long distance division. During the first nine months of 1998 these
revenues increased 17% compared with the same 1997 period mainly due to
increased equipment sales of business systems and data networks, growth in
payphone revenues and revenues from locating underground utility lines, as
well as increased commissions from the sale of Sprint's long distance
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 decreased less than
1% (increased 1% excluding sales of exchanges) in the first nine months of
1998 compared with the same period a year ago. This reflects continued cost
control, while still supporting customer access line growth and increased
equipment sales. Costs of services and products expense 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 34.3% of net operating revenues in the first nine months of 1998
and 35.5% for the same period a year ago.
Selling, General and Administrative Expense
SG&A expense increased 8% (10% excluding sales of exchanges) in the first
nine months of 1998. This increase was mainly due to increased customer
service costs related to access line growth and marketing costs to promote new
products and services. SG&A for 1998 also includes costs related to Sprint's
efforts to achieve year 2000 compliance for items such as billing, customer
service, and other administrative systems. SG&A expense was 21.3% of net
operating revenues in the first nine months of 1998 and 20.3% for the same
period a year ago.
Depreciation and Amortization Expense
Depreciation and amortization expense increased 2% (also 2% excluding sales
of exchanges) in the first nine months of 1998 because of capital
expenditures, offset by lower depreciation rates resulting from longer asset
lives. Depreciation and amortization expense was 17.6% of net operating
revenues in the first nine months of 1998 and 17.9% for the same period a year
ago.
III-16
<PAGE>
Years Ended December 31, 1997, 1996 and 1995
Net Operating Revenues
Net operating revenues increased 4% in 1997 and 9% in 1996 mainly because of
customer access line growth. Excluding sales of local exchanges in 1997,
access line growth was 5.6% in both 1997 and 1996. Net operating revenues were
$5.2 billion in 1997, $5.0 billion in 1996 and $4.6 billion in 1995.
Local Service Revenues--Local service revenues increased 10% in 1997 and 11%
in 1996. These increases reflect strong economic growth in the division's
service areas and increases in second-line service for existing business and
residential customers to meet their lifestyle and data access needs. Local
service revenues also increased because of extended area calling plans and
increased demand for advanced intelligent network services, such as Caller ID
and Call Waiting.
Network Access Revenues--Network access revenues increased 2% in 1997 and
10% in 1996. The increases were largely due to increased calling volumes of 6%
in 1997 and 10% in 1996. The 1997 revenue growth was partly offset by FCC-
mandated access rate reductions effective in July 1997--see "FON Group
Information--Business--Regulation" for more information. In addition, the
FCC's 1995 interim interstate price cap plan increased network access revenues
for 1996 and had a nominal effect on 1995.
Toll Service Revenues--Toll service revenues decreased 19% in 1997 and 13%
in 1996. During 1996 and 1995, the division resold interexchange long distance
services in some of its service areas. This reseller service was phased out
through early 1997, accounting for a large portion of the 1997 decline. Some
of those customers, however, became customers of Sprint's long distance
division, which has reduced the overall impact on Sprint. The decreases in
toll service revenues also reflect extended local area calling plans and
increased competition in the intrastate long distance market since
interexchange long distance carriers now provide intraLATA long distance
services in many states. The declines in toll service revenues were partly
offset by related increases in the division's local and network access
revenues.
Other Revenues--Other revenues increased 10% in 1997 and 24% in 1996, mainly
because of increased equipment sales. A major factor in the 1996 growth was
the introduction of enhanced telephone instruments, such as Caller ID units.
Costs of Services and Products
Costs of services and products consists of costs related to operating and
maintaining the local network and costs of equipment sales. These expenses
increased 3% in 1997 and 4% in 1996 because of customer access line growth and
increased equipment sales. Both years also reflect savings from the division's
restructuring of the network function. Costs of services and products were
36.0% of net operating revenues in 1997, 36.7% in 1996 and 38.5% in 1995. The
improvement in 1996 compared with 1995 reflects the capitalization of switch
software costs beginning in 1996, as discussed in "Depreciation and
Amortization Expense."
Selling, General and Administrative Expense
SG&A expense increased 3% in 1997 and 9% in 1996. These increases were
mainly due to increased customer service costs related to access line growth
and marketing costs to promote new products and services. These increases were
partly offset by savings from the division's restructuring of the finance
function and general cost control measures. SG&A expense was 20.6% of net
operating revenues in 1997, 20.7% in 1996 and 21.0% in 1995.
III-17
<PAGE>
Depreciation and Amortization Expense
Depreciation and amortization expense increased 3% in 1997 and 9% in 1996,
mainly because of plant additions. The 1996 increase also reflects the initial
year of amortizing capitalized switch software costs. At year-end 1995, the
FON Group adopted accounting principles for a competitive marketplace and
discontinued applying Statement of Financial Accounting Standards ("SFAS") No.
71, "Accounting for the Effects of Certain Types of Regulation," to its local
telecommunications division (see Note 12 of Notes to FON Group Combined
Financial Statements). As a result, certain accumulated depreciation balances
were increased; plant asset lives were shortened to reflect their economic
lives; and switch software costs, which were previously expensed as incurred,
are now capitalized and amortized over their estimated economic lives.
Depreciation and amortization expense was 17.8% of net operating revenues in
1997, 18.1% in 1996 and 18.2% in 1995.
Restructuring Costs
In 1995, the FON Group recorded an $88 million charge to restructure the
division (see Note 14 of Notes to FON Group Combined Financial Statements).
PRODUCT DISTRIBUTION AND DIRECTORY PUBLISHING DIVISION
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Net operating revenues..... $ 1,272.5 $ 1,077.8 $1,454.3 $1,225.4 $1,147.6
Operating expenses
Costs of services and
products................ 1,006.5 881.7 1,172.9 1,025.7 965.8
Selling, general and
administrative.......... 81.2 68.8 93.3 90.9 87.7
Depreciation and
amortization............ 8.7 6.0 8.2 7.2 7.4
--------- --------- -------- -------- --------
Total operating expenses... 1,096.4 956.5 1,274.4 1,123.8 1,060.9
--------- --------- -------- -------- --------
Operating income........... $ 176.1 $ 121.3 $ 179.9 $ 101.6 $ 86.7
========= ========= ======== ======== ========
Operating margin........... 13.8% 11.3% 12.4% 8.3% 7.6%
========= ========= ======== ======== ========
</TABLE>
Beginning in July 1997, the FON Group changed its transfer pricing for
certain transactions between affiliates to more accurately reflect market
pricing. For comparative purposes, the following discussion of product
distribution and directory publishing division results assumes these pricing
changes occurred at the beginning of 1995.
Nine Months Ended September 30, 1998 and 1997
Adjusting for the above transfer pricing change, net operating revenues
increased 19% from the first nine months of 1997. Nonaffiliated revenues,
which account for roughly 60% of this segment's revenues, increased 11% from
the 1997 period. Sales to affiliates increased 32% from the same period a year
ago. Costs of services and products increased 22% in the 1998 year-to-date
period from the same 1997 period reflecting increased sales. SG&A expense
increased 18% in the 1998 year-to-date period from the same period a year ago.
This increase reflects Sprint's July 1998 acquisition of a sales force from
another directory publisher. Results for 1998 reflect the amortization of
goodwill and noncompete agreements related to that purchase.
Years Ended December 31, 1997, 1996 and 1995
Adjusting for the transfer pricing change, net operating revenues increased
19% to $1.4 billion in 1997 from $1.2 billion in 1996. Revenues were $1.1
billion in 1995. Sales to non-affiliates in 1997 compared with 1996 remained
relatively flat because of increased competition. Cost of services and
products increased 22% to $1.1 billion in 1997 from $918 million in 1996.
Costs of services and products were $863 million in 1995. Operating
III-18
<PAGE>
margins were 15.8% in 1997, 16.3% in 1996 and 15.8% in 1995. The growth in
revenues and costs of services and products reflects increased sales of
telecommunications equipment and distribution services to the local
telecommunications division.
EMERGING BUSINESSES
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- ---------------
1998 1997 1997 1996
--------- --------- ------- ------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Net operating revenues................... $ 138.0 $ 14.3 $ 57.4 $ 0.5
========= ========= ======= ======
Operating loss........................... $ (228.9) $ (119.1) $(164.5) $(63.8)
========= ========= ======= ======
</TABLE>
Most of emerging businesses' 1998 and year-end 1997 revenues were from
Sprint Paranet's operations. Sprint acquired Houston-based Paranet, Inc., in
September 1997 to allow Sprint to capitalize on the accelerating demand for
network management services.
Costs incurred in the first nine months of 1998 were mainly due to the
development of ION and costs related to the network buildout and market
launches of the SprintCom PCS markets. SprintCom launched service in
Jacksonville and Tallahassee, Florida, in the 1998 third quarter and expects
to expand into several new markets by year-end. Sprint will continue to devote
significant resources through 1999 to develop ION as well as to fund the
network buildout and launch the SprintCom markets.
In June 1998, Sprint completed the strategic alliance to combine Sprint's
Internet business with EarthLink Network Inc. (EarthLink), an internet service
provider. As part of the alliance, EarthLink obtained Sprint's Internet
Passport customers and took over the day-to-day operations of those services.
Beginning with the 1998 third quarter, the emerging businesses segment no
longer includes the operating results of Sprint's Internet business.
NON OPERATING ITEMS
INTEREST EXPENSE
The difference between the interest expense disclosed in the following table
and that disclosed in the Combined Statements of Income relates to interest
expense on items such as deferred compensation, the employee stock purchase
plan and customer deposits--items not related to borrowings. Sprint has
excluded interest expense related to these items from the following table so
as not to distort Sprint's calculation of the effective interest rate on
borrowings. Interest costs on borrowings consist of the following:
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- ----------------------------
1998 1997 1997 1996 1995
--------- --------- -------- -------- --------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Interest expense on
outstanding debt.......... $ 152.2 $ 117.1 $ 183.5 $ 161.2 $ 231.0
Interest expense related to
Cellular (1).............. -- -- -- 21.5 124.0
Capitalized interest costs. 74.7 69.7 69.4 104.0 57.0
--------- --------- -------- -------- --------
Total interest costs on
outstanding debt.......... $ 226.9 $ 186.8 $ 252.9 $ 286.7 $ 412.0
========= ========= ======== ======== ========
Average debt outstanding... $ 4,172.4 $ 3,156.4 $3,251.3 $3,604.9 $5,505.2
========= ========= ======== ======== ========
Effective interest rate.... 7.2% 7.9% 7.8% 8.0% 7.5%
========= ========= ======== ======== ========
</TABLE>
- --------
(1) Interest expense related to Cellular is included in "Discontinued
operation, net" on the FON Group Combined Statements of Income.
III-19
<PAGE>
The FON Group capitalizes interest costs related to constructing capital
assets. Through June 1997, Sprint also capitalized interest costs on
borrowings related to its investments in Sprint Spectrum Holdings and
PhillieCo. Sprint stopped capitalizing interest costs on its investments in
Sprint Spectrum Holdings and PhillieCo in July 1997 because they no longer
qualified as development-stage companies. The capitalized interest on
investments in Sprint Spectrum Holdings and PhillieCo has been contributed to
and is being amortized by the PCS Group.
Average debt outstanding increased approximately $1.3 billion during the
first nine months of 1998 to support various Sprint initiatives and fund
investments in Sprint affiliates. Average debt outstanding decreased $1.9
billion in 1996, generally because of repayments funded by a portion of the
cash received from FT and DT for their equity investments in Sprint and from
Cellular's repayment of intercompany debt in connection with the Spinoff.
Sprint's effective interest rate decreased for the nine months ended
September 30, 1998 because of an increase in short-term borrowings as a
percentage of total debt outstanding, which have lower interest rates. At
September 30, 1998 and December 31, 1997, short-term borrowings have been
classified as long-term debt because of Sprint's intent and ability, through
unused credit facilities, to refinance these borrowings.
GLOBAL ONE
Global One's revenues totaled $801 million for the first nine months of 1998
compared with $810 million for the same period a year ago. Sprint's losses
associated with Global One totaled $120 million in first nine months of 1998
compared with $88 million a year ago. Global One's revenues totaled $1.1
billion in 1997 compared to $800 million in 1996. Sprint's equity in losses
from Global One totaled $162 million in 1997, $82 million in 1996 and $23
million in 1995. In an effort to improve profitability, Global One is
refocusing its effort to place more emphasis on multinational customers. In
addition, it is continuing to review its operations, implement expense
controls and focus on improving the network infrastructure. Global One is in
the process of implementing its plan to address these items, which may result
in one-time charges.
OTHER INCOME (EXPENSE), NET
Other income (expense) consisted of the following:
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
------------------- ----------------------
1998 1997 1997 1996 1995
--------- --------- ------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C>
Dividend and interest income..... $ 49.1 $ 52.8 $ 75.4 $ 99.7 $ 12.6
Net gains on sales of assets..... -- -- 71.5 15.9 --
Loss on sales of accounts
receivable...................... -- -- -- (4.2) (38.6)
Other, net....................... (0.5) (1.0) (6.4) 3.9 (12.9)
--------- --------- ------ ------ ------
Total other income (expense),
net......................... $ 48.6 $ 51.8 $140.5 $115.3 $(38.9)
========= ========= ====== ====== ======
</TABLE>
Dividend and interest income for the nine months ended September 30, 1998
reflects interest earned on loans to unconsolidated affiliates. Dividend and
interest income for the nine months ended September 30, 1997 and the years
ended December 31, 1997 and 1996 reflects income earned on the cash received
from FT and DT for their equity investment in Sprint, as well as Cellular's
repayment of intercompany debt in connection with the Spinoff. Sprint has
since invested these funds in strategic initiatives and has decreased certain
borrowings, reducing the balance held in temporary investments. For the year
ended December 31, 1997, the FON Group recognized pretax gains of $45 million
on sales of local exchanges and sold its equity interest in an equipment
provider, resulting in a $26 million pretax gain.
INCOME TAXES
The FON Group's effective tax rates for the first nine months were 38.0% in
1998 and 39.5% in 1997. The FON Group's effective tax rates for the years
ended December 31 were 39.3% in 1997, 37.7% in 1996 and 36.1% in 1995. See
Note 5 of Notes to FON Group Combined Financial Statements for information
about the differences that caused the effective income tax rates to vary from
the statutory federal rate.
III-20
<PAGE>
DISCONTINUED OPERATION, NET
The FON Group recognized an after-tax loss of $3 million in 1996 and after-
tax income of $15 million in 1995 related to its investment in Cellular.
Cellular was spun off to Sprint common stockholders in March 1996 (see Note 13
of Notes to FON Group Combined Financial Statements).
EXTRAORDINARY ITEMS, NET
In March 1998, the FON Group redeemed, prior to maturity, $115 million of
debt with a 9.25% interest rate. This resulted in a $4 million after-tax loss.
During 1996, the FON Group redeemed, prior to maturity, $190 million of debt
with interest rates ranging from 6.0% to 9.5%. This resulted in a $5 million
after-tax loss.
At year-end 1995, the FON Group adopted accounting principles for a
competitive marketplace and discontinued applying SFAS 71 to its local
telecommunications division (see Note 12 of Notes to FON Group Combined
Financial Statements). This resulted in an after-tax, noncash extraordinary
charge of $565 million in 1995.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
The following discussion of the FON Group's financial condition, liquidity
and capital resources should be read in conjunction with Sprint's discussion
of financial condition, liquidity and capital resources. See "Annex I--
Sprint--Management's Discussion and Analysis of Financial Condition and
Results of Operations."
FINANCIAL CONDITION
The FON Group's combined assets totaled $18.4 billion at September 30, 1998
compared with $16.5 billion at year-end 1997 and $15.6 billion at year-end
1996. Net property, plant and equipment increased $858 million since year-end
1997 and $853 million from 1996 to 1997 mainly because of increased capital
expenditures to support the core long distance and local networks and expanded
product and service offerings. See "Liquidity and Capital Resources" for
additional discussions of changes in the FON Group's Combined Balance Sheets.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Cash flows from continuing operations, which are the FON Group's main source
of liquidity, were $2.8 billion in the first nine months of 1998 versus $2.0
billion in the first nine months of 1997 and were $2.9 billion in 1997, $2.3
billion in 1996 and $2.6 billion in 1995. The growth in operating cash flows
over these periods reflects improved operating results in the FON Group's core
businesses, partly offset by increased losses from its emerging businesses.
During 1996, the FON Group terminated an accounts receivable sales agreement,
which reduced cash flows by $600 million. Excluding this termination, 1996
cash flows increased $277 million, mainly because of improved operating
results in all divisions.
Investing Activities
The FON Group's investing activities from continuing operations used cash of
$3.1 billion in the first nine months of 1998 versus $2.8 billion in the first
nine months of 1997 and used cash of $4.0 billion in 1997, $3.0 billion in
1996 and $2.8 billion in 1995. Capital expenditures, which are the FON Group's
largest investing activity, totaled $2.3 billion in the first nine months of
1998 and $1.8 billion in the first nine months of 1997 and totaled $2.7
billion in 1997, $2.4 billion in 1996 and $1.9 billion in 1995. Within the FON
Group, long distance capital expenditures were incurred mainly to enhance
network reliability, meet increased demand for data-related
III-21
<PAGE>
services and upgrade capabilities for providing new products and services. The
local telecommunications division incurred capital expenditures to accommodate
access line growth and expand capabilities for providing enhanced services.
The FON Group's net investments in and loans to Sprint Spectrum Holdings and
PhillieCo of $114 million for the first nine months of 1998, $155 million for
the first nine months of 1997, $300 million for year-end 1997, and $264
million for year-end 1996 were used to fund capital and operating
requirements. In 1997, Sprint Spectrum Holdings borrowed $300 million from the
FON Group under a vendor financing facility. In 1996, the FON Group purchased
$183 million (face value) of Sprint Spectrum Senior Discount Notes for $100
million which were recorded on the FON Group Combined Balance Sheets.
The FON Group advanced $410 million to the PCS Group in the first nine
months of 1998 to fund SprintCom buildout activities.
Equity transfers to (from) the PCS Group were $(125) million for the first
nine months of 1998, $406 million for the first nine months of 1997 and were
$548 million in 1997, $245 million in 1996, and $891 million in 1995. These
equity transfers to the PCS Group were used to fund the PCS Group's capital
and operating requirements.
Net contributions and advances to Global One of $165 million for the first
nine months of 1998, $200 million for year-end 1997, and $40 million for year-
end 1996 were used mainly to fund operations.
"Investments in and loans to affiliates, net" for the nine-month period
ended September 30, 1998 includes $230 million primarily related to Sprint's
investments in EarthLink and Call-Net enterprises.
In 1997, Sprint purchased the net assets of Paranet, Inc. for $375 million
(see Note 11 of Notes to FON Group Combined Financial Statements).
Financing Activities
The FON Group's financing activities provided cash of $283 million in the
first nine months of 1998, while the first nine months of 1997 activities used
cash of $238 million. Financing activities provided cash of $72 million in
1997, $479 million in 1996 and $423 million in 1995. Financing activities for
the first nine months of 1998 reflect long-term borrowings of $946 million,
partly offset by payments on long-term debt of $239 million. Financing
activities in the first nine months of 1997 reflect long-term borrowings of
$195 million offset by payments of $111 million on long-term debt. In 1997,
Sprint borrowed $867 million, mainly to fund investments in and loans to
affiliates, including the PCS Group. In 1995, Sprint increased its short-term
borrowings by $1.1 billion to fund commitments related to Sprint Spectrum
Holdings and repay long-term debt.
Discontinued Operation
In connection with the March 1996 Spinoff, Cellular repaid $1.4 billion of
intercompany debt owed to Sprint. Prior to the Spinoff, Cellular's investing
activities required net cash of $141 million in 1996 and $325 million in 1996
and 1995, respectively, mainly to fund capital expenditures and acquire
cellular properties.
Capital Requirements
The FON Group's 1998 investing activities, consisting of capital
expenditures and investments in affiliates, are expected to require cash of
$3.6 billion to $3.9 billion. Dividend payments are expected to total $430
million in 1998. These requirements will be funded with cash from operating
activities and external sources. External borrowings are expected to total
$500 million to $700 million in 1998 for FON Group activities.
The FON Group expects to spend $3.3 billion to $3.5 billion on capital
expenditures in 1998. The long distance division and local telecommunications
division will require the majority of this total.
Sprint expects that significant payments pursuant to the Tax Sharing
Agreement will be made from the FON Group to the PCS Group in light of the
substantial operating losses that the PCS Group is expected to incur in
III-22
<PAGE>
the near future. Such payments are intended to reflect the PCS Group's
incremental cumulative effect on Sprint's federal and state tax liability and
tax credit position.
Sprint and the Cable Parents have loaned $400 million, based on respective
ownership interests, to fund the capital requirements of Sprint Spectrum
Holdings from the date of the signing of the PCS Restructuring Agreement, May
26, 1998, through September 30, 1998. The PhillieCo Partners have loaned $50
million to PhillieCo to fund operating and working capital requirements and
capital expenditures through September 30, 1998. Sprint has also loaned $110.6
million to fund SprintCom's capital requirements as part of the Restructuring
Agreement through September 30, 1998. Sprint has been financing SprintCom with
Sprint's cash from operations, commercial paper borrowings and leases on
specific equipment. Sprint intends to continue to fund the buildout of the
SprintCom markets through the closing of the PCS Restructuring. The above
mentioned loans, totaling $510.6 million excluding loans to PhillieCo., will
be converted as of the date of the PCS Restructuring into 10-year preferred
stock of Sprint convertible into PCS Stock or, in the case of Sprint,
Preferred Inter-Group Interest. Such preferred stock may be redeemed with the
proceeds from an anticipated IPO, as further discussed below, but only to the
extent the net proceeds of the IPO exceed $500 million. See "The Tracking
Stock Proposal--Funding of the PCS Group Prior to Closing; The PCS Preferred
Stock" in the Proxy Statement.
Global One is expected to require a total of $300 million to $400 million
from the FON Group to fund operations and ongoing development activities for
1998.
Liquidity
Sprint currently uses the commercial paper market to fund its short-term
working capital needs. Sprint uses four commercial paper dealers to place the
paper at the most favorable rates and maturities. Sprint also uses the medium-
term note and long-term bond markets as well as other debt markets to fund its
needs. Sprint intends to borrow funds through the U.S. and international money
and capital markets and bank credit markets to fund capital expenditures,
operating and working capital requirements and to refinance existing Sprint
PCS debt obligations, after the PCS Restructuring.
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 replace its
previous $1.5 billion revolving credit facility. As of September 30, 1998,
Sprint could borrow $3.6 billion under these new facilities. Sprint also has a
separate five-year revolving credit facility with a bank. The unused capacity
under the committed portion of that facility was $100 million.
In October 1998, Sprint filed a shelf registration statement with the SEC
for $8.0 billion of debt securities. This shelf registration replaced $1.0
billion of Sprint's existing shelf registration statements. Sprint currently
expects to offer up to $3 billion under the new shelf registration at
approximately the same time as the PCS Restructuring. There can be no
assurance that such offering will be consummated. Proceeds from the sale of
securities under this shelf registration statement will be used to repay
short-term borrowings, refinance existing long-term borrowings and provide
funds for working capital and new capital expenditures for both the PCS Group
and the FON Group.
Any borrowings Sprint may incur are ultimately limited by certain debt
covenants. Sprint could borrow up to $13.8 billion at September 30, 1998 under
the most restrictive of its debt covenants. Among other restrictions, Sprint
must maintain certain levels of consolidated net worth.
Subsequent to the PCS Restructuring, financing activities for the Groups
will be managed by Sprint on a centralized basis. Loans from Sprint or any
member of the FON Group to any member of the PCS Group will be made at
interest rates and on other terms and conditions substantially equivalent to
the interest rates and other
III-23
<PAGE>
terms and conditions that the PCS Group would be able to obtain from third
parties (including the public markets) as a direct or indirect wholly-owned
subsidiary of Sprint, but without the benefit of any guaranty by Sprint or any
member of the FON Group. Such policy contemplates that such loans will be made
on the basis set forth above regardless of the interest rates and other terms
and conditions on which Sprint or members of the FON Group may have acquired
the subject funds. Any difference between Sprint's borrowing rate and the rate
charged to the PCS Group, which rates are expected to be higher than the rates
at which Sprint obtained such financing, will be reflected in the FON Group
Combined Financial Statements. This process will be governed by the Tracking
Stock Policies as overseen by the Capital Stock Committee.
FINANCIAL STRATEGIES
For information on general hedging policies, interest rate risk management
and foreign exchange risk management, see Sprint's Management's Discussion and
Analysis of Financial Condition and Results of Operations at Annex I.
YEAR 2000 ISSUE
SPRINT
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 or resellers.
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. Sprint expects to substantially complete the renovation of
these computer systems, software applications and the majority of the network
elements and other business systems by year end 1998. Year 2000 testing
commenced in the third quarter of 1998 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
appropriate warranties and assurances that those third parties are, or will
be, Year 2000 compliant.
Sprint expects to incur approximately $250 million in 1998 and 1999 to
complete its Year 2000 compliance program. If compliance is not achieved in a
timely manner by the FON Group or any significant related third party, the
Year 2000 issue could have a material adverse effect on Sprint'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 and is
addressing the most critical applications first. Although Sprint intends to
develop and implement, if necessary, appropriate contingency plans to mitigate
to the extent possible the effects of any Year 2000 noncompliance, such plans
may not be adequate and the cost of Year 2000 compliance may be higher than
$250 million.
AFFILIATES
Sprint's results of operations and financial condition could also be
materially adversely affected by the failure of its affiliates, including
Global One, to achieve Year 2000 compliance in a timely manner.
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
See Note 15 of Notes to the FON Group Combined Financial Statements for a
discussion of recently issued accounting pronouncements.
III-24
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Sprint Corporation
We have audited the accompanying combined balance sheets of the FON Group
(as described in Note 2) as of December 31, 1997 and 1996, and the related
combined statements of income and cash flows for each of the three years in
the period ended December 31, 1997. These financial statements are the
responsibility of the management of Sprint Corporation ("Sprint"). Our
responsibility is to express an opinion on these financial statements 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 FON
Group at December 31, 1997 and 1996, and the combined results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
As discussed in Note 12 to the combined financial statements, the FON Group
discontinued accounting for the operations of its local telecommunications
division in accordance with Statement of Financial Accounting Standards No.
71, "Accounting for the Effects of Certain Types of Regulation," in 1995.
As more fully discussed in Note 2, the combined financial statements of the
FON Group should be read in connection with the audited consolidated financial
statements of Sprint.
Ernst & Young LLP
Kansas City, Missouri
February 3, 1998, except for Note 1,
as to which the date is May 26, 1998
III-25
<PAGE>
FON GROUP
COMBINED STATEMENTS OF INCOME
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
NET OPERATING REVENUES.. $11,940.3 $11,024.9 $14,873.9 $13,887.5 $12,735.3
OPERATING EXPENSES
Costs of services and
products............. 5,691.3 5,523.7 7,451.0 6,912.9 6,504.9
Selling, general and
administrative....... 2,723.8 2,387.7 3,226.7 3,115.9 2,842.1
Depreciation and
amortization......... 1,427.3 1,265.2 1,726.3 1,591.0 1,466.4
Restructuring costs... -- -- -- -- 87.6
--------- --------- --------- --------- ---------
Total operating
expenses........... 9,842.4 9,176.6 12,404.0 11,619.8 10,901.0
--------- --------- --------- --------- ---------
OPERATING INCOME........ 2,097.9 1,848.3 2,469.9 2,267.7 1,834.3
Interest expense........ (185.6) (133.3) (187.2) (196.7) (260.7)
Equity in loss of Global
One.................... (120.0) (88.3) (162.1) (82.1) (22.9)
Other income (expense),
net.................... 48.6 51.8 140.5 115.3 (38.9)
--------- --------- --------- --------- ---------
Income from continuing
operations before
income
taxes.................. 1,840.9 1,678.5 2,261.1 2,104.2 1,511.8
Income taxes............ (699.8) (663.6) (889.5) (793.6) (545.8)
--------- --------- --------- --------- ---------
INCOME FROM CONTINUING
OPERATIONS............. 1,141.1 1,014.9 1,371.6 1,310.6 966.0
Discontinued operation,
net.................... -- -- -- (2.6) 14.5
Extraordinary items,
net.................... (4.4) -- -- (4.5) (565.3)
--------- --------- --------- --------- ---------
NET INCOME.............. $ 1,136.7 $ 1,014.9 $ 1,371.6 $ 1,303.5 $ 415.2
========= ========= ========= ========= =========
</TABLE>
See accompanying Notes to Combined Financial Statements.
III-26
<PAGE>
FON GROUP
COMBINED BALANCE SHEETS
(IN MILLIONS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
------------- -------------------
1998 1997 1996
------------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets
Cash and equivalents..................... $ 47.7 $ 101.7 $ 1,150.6
Accounts receivable, net of allowance for
doubtful accounts of $166.0 (unaudited),
$146.7 and $117.4....................... 2,515.8 2,495.6 2,343.6
Inventories.............................. 349.9 352.0 305.3
Prepaid expenses......................... 183.5 156.2 150.0
Notes and other receivables.............. 407.8 464.6 101.9
Advance to the PCS Group................. 410.0 -- --
Other.................................... 206.4 199.6 181.5
--------- --------- ---------
Total current assets................... 4,121.1 3,769.7 4,232.9
Investments in equity securities........... 420.2 303.0 254.5
Property, plant and equipment
Long distance communications services.... 9,133.0 8,245.5 7,467.8
Local communications services............ 14,817.2 14,011.5 13,368.7
Other.................................... 980.2 776.6 574.3
--------- --------- ---------
Total property, plant and equipment...... 24,930.4 23,033.6 21,410.8
Less accumulated depreciation............ 12,755.4 11,716.8 10,946.7
--------- --------- ---------
Net property, plant and equipment........ 12,175.0 11,316.8 10,464.1
Investments in and advances to affiliates.. 768.7 459.1 351.3
Other assets............................... 884.6 643.1 263.8
--------- --------- ---------
Total.................................. $18,369.6 $16,491.7 $15,566.6
========= ========= =========
LIABILITIES AND GROUP EQUITY
Current liabilities
Current maturities of long-term debt..... $ 38.1 $ 131.0 $ 99.1
Short-term borrowings.................... -- -- 200.0
Accounts payable......................... 1,078.8 1,082.3 1,026.7
Accrued interconnection costs............ 564.7 672.7 709.0
Accrued taxes............................ 399.2 270.7 189.2
Advance billings......................... 213.3 202.9 199.7
Other.................................... 794.6 659.6 770.6
--------- --------- ---------
Total current liabilities.............. 3,088.7 3,019.2 3,194.3
Long-term debt............................. 4,651.6 3,748.6 2,974.8
Deferred credits and other liabilities
Deferred income taxes and investment tax
credits................................. 724.4 767.2 774.7
Postretirement and other benefit
obligations............................. 1,067.4 947.4 919.7
Other.................................... 366.2 370.0 370.8
--------- --------- ---------
Total deferred credits and other
liabilities............................. 2,158.0 2,084.6 2,065.2
Group equity............................... 8,471.3 7,639.3 7,332.3
--------- --------- ---------
Total.................................. $18,369.6 $16,491.7 $15,566.6
========= ========= =========
</TABLE>
See accompanying Notes to Combined Financial Statements.
III-27
<PAGE>
FON GROUP
COMBINED STATEMENTS OF CASH FLOWS
(IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31,
-------------------- -------------------------------
1998 1997 1997 1996 1995
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income.............. $ 1,136.7 $ 1,014.9 $ 1,371.6 $ 1,303.5 $ 415.2
Adjustments to reconcile
net income to net cash
provided by operating
activities:
Equity in net losses
of affiliates........ 138.4 96.3 184.1 81.9 7.7
Extraordinary items,
net.................. 1.1 -- -- 4.9 565.3
Depreciation and
amortization......... 1,427.3 1,265.2 1,726.3 1,591.0 1,466.4
Deferred income taxes
and investment tax
credits.............. (36.1) 26.0 (10.0) (74.5) (2.2)
Net (gains) losses on
sales of assets...... -- -- (93.2) 7.5 4.2
Changes in assets and
liabilities:
Accounts receivable,
net................ (20.2) (92.9) (127.0) (982.1) (135.4)
Inventories and
other current
assets............. 1.9 (35.0) (91.5) 15.7 (38.6)
Accounts payable and
other current
liabilities........ 107.1 (230.9) (39.6) 362.0 178.1
Noncurrent assets
and liabilities,
net................ 32.9 (14.3) (19.7) (25.5) 123.0
Other, net.......... 2.3 3.7 5.8 (17.1) 6.4
--------- --------- --------- --------- ---------
Net cash provided by
continuing operations.. 2,791.4 2,033.0 2,906.8 2,267.3 2,590.1
Net cash provided (used)
by cellular division... -- -- -- (0.1) 162.5
--------- --------- --------- --------- ---------
Net cash provided by
operating activities... 2,791.4 2,033.0 2,906.8 2,267.2 2,752.6
--------- --------- --------- --------- ---------
INVESTING ACTIVITIES
Capital expenditures.... (2,320.0) (1,835.7) (2,708.9) (2,433.6) (1,857.3)
Investments in and loans
to Sprint Spectrum
Holdings and PhillieCo. (113.6) (154.5) (300.4) (263.5) (43.2)
Advance to the PCS
Group.................. (410.0) -- -- -- --
Equity transfer from
(to) the PCS Group..... 124.6 (406.1) (547.5) (245.2) (891.4)
Investments in and loans
to other affiliates,
net.................... (395.3) (98.5) (385.5) (81.4) (37.8)
Paranet acquisition..... -- (375.0) (375.0) -- --
Proceeds from sales of
assets................. -- -- 292.3 2.1 6.7
Other, net.............. (14.0) 33.8 (2.3) 42.4 (17.1)
--------- --------- --------- --------- ---------
Net cash used by
continuing operations.. (3,128.3) (2,836.0) (4,027.3) (2,979.2) (2,840.1)
Repayment by cellular
division of
intercompany advances.. -- -- -- 1,400.0 --
Net cash used by
cellular division...... -- -- -- (140.7) (324.6)
--------- --------- --------- --------- ---------
Net cash used by
investing activities... (3,128.3) (2,836.0) (4,027.3) (1,719.9) (3,164.7)
--------- --------- --------- --------- ---------
FINANCING ACTIVITIES
Payments on long-term
debt................... (239.3) (110.6) (135.0) (433.1) (630.0)
Proceeds from long-term
debt................... 945.6 194.7 866.5 9.4 260.7
Net change in short-term
borrowings............. -- -- (200.0) (1,986.8) 1,109.5
Dividends............... (291.6) (274.5) (430.0) (419.6) (351.5)
Other net change in
group equity........... (235.4) (128.8) (144.5) 3,254.1 --
Other, net.............. 103.6 81.0 114.6 55.1 33.9
--------- --------- --------- --------- ---------
Net cash provided (used)
by financing
activities............. 282.9 (238.2) 71.6 479.1 422.6
--------- --------- --------- --------- ---------
INCREASE (DECREASE) IN
CASH AND EQUIVALENTS... (54.0) (1,041.2) (1,048.9) 1,026.4 10.5
CASH AND EQUIVALENTS AT
BEGINNING OF PERIOD.... 101.7 1,150.6 1,150.6 124.2 113.7
--------- --------- --------- --------- ---------
CASH AND EQUIVALENTS AT
END OF PERIOD.......... $ 47.7 $ 109.4 $ 101.7 $ 1,150.6 $ 124.2
========= ========= ========= ========= =========
</TABLE>
See accompanying Notes to Combined Financial Statements.
III-28
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS
1. RESTRUCTURING AND RECAPITALIZATION PLANS
Sprint Corporation (and with its subsidiaries "Sprint") has entered into a
restructuring agreement with Tele-Communications, Inc. ("TCI"), Comcast
Corporation ("Comcast") and Cox Communications, Inc. ("Cox," and together with
TCI and Comcast the "Cable Parents") to restructure Sprint's wireless personal
communications services ("PCS") operations (the "PCS Restructuring"). Sprint
will acquire the joint venture interests of TCI, Comcast and Cox in Sprint
Spectrum Holding Company, L.P. and MinorCo, L.P. (together, "Sprint Spectrum
Holdings") and the joint venture interests of TCI and Cox in PhillieCo
Partners I, L.P. and PhillieCo Partners II, L.P. (together, "PhillieCo"). In
exchange for these joint venture interests, Sprint will issue to the Cable
Parents a newly created class of Sprint Common Stock (the "PCS Stock"). The
PCS Stock is intended to reflect separately the performance of these joint
ventures and the domestic PCS operations of Sprint's wholly-owned
subsidiaries, SprintCom, Inc. and SprintCom Equipment Company, L.P. (together,
"SprintCom"). These operations will be referred to as the PCS Group.
The FON Stock, which will be created in the Recapitalization, is intended to
reflect the performance of all of Sprint's other operations, including its
long distance, local telecommunications and product distribution and directory
publishing divisions, emerging businesses and its interest in Global One.
These operations will be referred to as the FON Group.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Combination and Presentation
The Combined Financial Statements of the FON Group together with the
Combined Financial Statements of the PCS Group (the "Groups") comprise all of
the accounts included in the corresponding Consolidated Financial Statements
of Sprint. The entities which comprise the FON Group are commonly controlled
companies. 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). The separate Group financial statements give
effect to the accounting policies that will be applicable upon implementation
of the PCS Restructuring. The separate Groups' Combined Financial Statements
have been prepared on a basis that management believes to be reasonable and
appropriate and include: (i) the combined historical balance sheets, results
of operations and cash flows of the businesses that comprise each of the
Groups with all significant intragroup amounts and transactions eliminated and
(ii) in the case of the FON Group Combined Financial Statements, corporate
assets and liabilities and related transactions of Sprint. Transactions
between the FON Group and the PCS Group have not been eliminated.
The Combined Financial Statements of the FON Group provide holders of FON
Stock with financial information regarding the underlying businesses of the
FON Group. Notwithstanding the allocation of assets and liabilities (including
contingent liabilities) and stockholders' equity between the FON Group and the
PCS Group for the purpose of preparing the respective financial statements of
such Groups, investors in FON Stock and PCS Stock are stockholders of Sprint
and are subject to risks associated with an investment in a single company and
all of Sprint's businesses, assets and liabilities. Sprint retains all
beneficial ownership and control of the assets and operations of the FON Group
and, after the PCS Restructuring, the PCS Group (subject to a minority
interest). Financial effects arising from either Group that affect Sprint's
results of operations or financial condition could affect the results of
operations or financial position of the other Group or market price of the
class of common stock relating to the other Group. Any net losses of the FON
Group or the PCS Group, and dividends or distributions on, or repurchases of,
FON Stock or PCS Stock, will reduce the funds of Sprint legally available for
payment of dividends on both the FON Stock and the PCS Stock. Accordingly, the
FON Group Combined Financial Statements should be read in conjunction with
Sprint's Consolidated Financial Statements and the PCS Group Combined
Financial Statements.
III-29
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The FON Group Combined Financial Statements are prepared according to
generally accepted accounting principles ("GAAP"). 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.
The unaudited interim financial information presented has been prepared
according to GAAP and the rules and regulations of the Securities and Exchange
Commission for interim reporting. In management's opinion, the information
presented reflects all adjustments (consisting only of normal recurring
accruals) necessary to present fairly the interim combined financial position,
results of operations and cash flows of the FON Group.
The FON Group applied Statement of Financial Accounting Standards ("SFAS")
No. 71, "Accounting for the Effects of Certain Types of Regulation," to its
financial statements until December 1995. Under SFAS 71, revenues and related
net income resulting from transactions between the FON Group's nonregulated
operations and its regulated local exchange carriers were not eliminated from
the combined financial statements. Revenues from these intragroup transactions
were $262 million in 1995. All other significant intragroup transactions have
been eliminated.
Classification of Operations
The long distance division provides domestic and international voice, video
and data communications services. The division offers its services to the
public subject to varying levels of state and federal regulation, but rates
are generally not subject to rate-base regulation.
The local telecommunications division consists of regulated telephone
companies. These operations provide local exchange services, access by
telephone customers and other carriers to local exchange facilities, sales of
telecommunications equipment and long distance services within specified
geographical areas.
The product distribution and directory publishing division provides
wholesale distribution services of telecommunications products, and publishes
and markets white and yellow page telephone directories.
Emerging businesses consists of the development of new integrated
communications services, consumer Internet access services, Sprint Paranet and
Sprint International.
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.
Earnings Per Share
Historical earnings per share are omitted from the combined statements of
income because the FON Stock was not part of the capital structure of Sprint
for the periods presented. See the Sprint Consolidated Financial Statements in
Annex I, for information regarding earnings per share based on Sprint's
existing capital structure. Following implementation of the PCS Restructuring
and the Recapitalization, the method of calculating earnings per share for the
FON Group will reflect the terms of the proposed amendments to Sprint's
articles. Earnings per share will be computed by dividing the net income of
the FON Group by the weighted average number of shares of FON Stock and
dilutive securities, such as convertible preferred stock and options,
outstanding during the applicable period.
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
III-30
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
were included in accounts payable, totaled $225 million at December 31, 1997
and $127 million at December 31, 1996. The FON Group had sufficient funds
available to fund these outstanding checks when they were presented for
payment.
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.
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. Repairs and maintenance costs are expensed as
incurred.
Depreciation
The cost of property, plant and equipment is generally depreciated on a
straight-line basis over estimated economic useful lives. Prior to the FON
Group's discontinued use of SFAS 71 at December 31, 1995, the cost of
property, plant and equipment for the local division had been generally
depreciated on a straight-line basis over lives prescribed by regulatory
commissions.
Income Taxes
The operations of the FON Group are included in the consolidated federal
income tax return of Sprint. Federal income tax is calculated by the FON Group
as if it had filed a separate return. The FON Group's state income tax is
computed using methodology consistent with that used to compute federal income
tax.
The FON Group records deferred income taxes based on certain temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and amounts used for tax purposes.
Investment tax credits related to regulated telephone property, plant and
equipment have been deferred and are being amortized over the estimated useful
lives of the related assets.
Capitalized Interest
The FON Group capitalized interest costs related to constructing capital
assets of $23 million for year-end 1997, $8 million for year-end 1996, and $14
million for year-end 1995.
The FON Group also capitalized interest costs related to Sprint's
investments in Sprint Spectrum Holdings and PhillieCo. The FON Group stopped
capitalizing this interest in July 1997 because Sprint Spectrum Holdings and
PhillieCo no longer qualified as development-stage companies. The capitalized
interest on the investments in Sprint Spectrum Holdings and PhillieCo,
totaling $46 million, $96 million and $43 million for the years ended December
31, 1997, 1996 and 1995, respectively, was contributed to and is being
amortized by the PCS Group.
In addition, Sprint capitalized interest costs related to the buildout of
the SprintCom network. This capitalized interest totaled $24 million in 1997
and was contributed to and will be amortized by the PCS Group.
III-31
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
3. INVESTMENTS
INVESTMENTS IN EQUITY SECURITIES
The cost of investments in equity securities was $105 million at year-end
1997 and 1996. Gross unrealized holding gains were $198 million at December
31, 1997 and $149 million at year-end 1996.
INVESTMENTS IN AND ADVANCES TO AFFILIATES
Sprint is a partner in Global One, a joint venture with France Telecom (FT)
and Deutsche Telekom AG (DT) formed to provide seamless global
telecommunications services to business, residential and carrier markets
worldwide. Sprint is a one-third 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. At year-end 1997, Sprint's share of underlying equity in Global
One's net assets exceeded the carrying value of Sprint's investment in Global
One by $158 million. This difference is being amortized through January 2001.
Combined, summarized financial information (100% basis) of Global One and
all other entities accounted for using the equity method by the FON Group is
as follows (in millions):
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER AT OR FOR THE YEAR ENDED
30, DECEMBER 31,
------------------ --------------------------
1998 1997 1997 1996 1995
-------- -------- -------- -------- ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Results of operations
Net operating revenues......... $1,680.6 $1,535.4 $1,937.6 $1,723.7 $779.5
======== ======== ======== ======== ======
Operating loss................. $ (375.9) $ (473.1) $ (782.5) $ (436.4) $ 8.6
======== ======== ======== ======== ======
Net loss....................... $ (495.4) $ (494.4) $ (826.3) $ (399.7) $ 22.1
======== ======== ======== ======== ======
Financial position
Current assets................. $1,913.6 $ 958.9
Noncurrent assets.............. 4,221.0 2,737.5
-------- --------
Total........................ $6,134.6 $3,696.4
======== ========
Current liabilities............ $1,965.7 $ 714.3
Noncurrent liabilities......... 2,105.8 629.6
Owners' equity................. 2,063.1 2,352.5
-------- --------
Total........................ $6,134.6 $3,696.4
======== ========
</TABLE>
The FON Group's investment in Global One, including advances, totaled $93
and $38 million at year-end 1997 and 1996, respectively.
4. EMPLOYEE BENEFIT PLANS
DEFINED BENEFIT PENSION PLAN
Substantially all Sprint employees are covered by a noncontributory defined
benefit pension plan. Benefits for plan participants represented by collective
bargaining units are based on negotiated schedules of defined amounts. For
participants not covered by collective bargaining agreements, the plan
provides pension benefits based on years of service and participants'
compensation.
Sprint's policy is to make annual plan contributions equal to an actuarially
determined amount consistent with applicable 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. At
December 31, 1997, the plan's assets consisted mainly of investments in
corporate equity securities and U.S. government and corporate debt securities.
III-32
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The net pension cost (credit) consists of the following for the FON Group:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C>
Service cost--benefits earned during the period..... $ 61.7 $ 65.4 $ 51.8
Interest cost on projected benefit obligation....... 148.9 138.5 129.7
Actual return on plan assets........................ (448.5) (353.0) (472.1)
Net amortization and deferral....................... 240.0 159.4 287.9
------- ------- -------
Net pension cost (credit)........................... $ 2.1 $ 10.3 $ (2.7)
======= ======= =======
Discount rate....................................... 7.75% 7.25% 8.50%
Expected long-term rate of return on plan assets.... 9.50% 9.50% 9.50%
Anticipated composite rate of future compensation
increases.......................................... 4.75% 4.25% 5.00%
</TABLE>
At December 31, the funded status and amounts recognized in the FON Group
Combined Balance Sheets for the plan were as follows:
<TABLE>
<CAPTION>
1997 1996
--------- ---------
(IN MILLIONS)
<S> <C> <C>
Actuarial present value of benefit obligations
Vested benefit obligation.............................. $(1,966.7) $(1,713.6)
========= =========
Accumulated benefit obligation......................... $(2,129.6) $(1,864.1)
========= =========
Projected benefit obligation............................. $(2,240.9) $(1,967.0)
Plan assets at fair value................................ 2,929.4 2,584.2
--------- ---------
Plan assets in excess of the projected benefit
obligation.............................................. 688.5 617.2
Unrecognized net gains................................... (585.2) (481.8)
Unrecognized prior service cost.......................... 105.4 100.4
Unamortized transition asset............................. (122.1) (147.1)
--------- ---------
Prepaid pension cost..................................... $ 86.6 $ 88.7
========= =========
Discount rate............................................ 7.25% 7.75%
Anticipated composite rate of future compensation
increases............................................... 4.25% 4.75%
</TABLE>
DEFINED CONTRIBUTION PLANS
Sprint sponsors defined contribution employee savings plans covering
substantially all employees. Participants may contribute portions of their pay
to the plans. For employees represented by collective bargaining units, Sprint
matches contributions based on negotiated amounts. Sprint also matches
contributions of employees not covered by collective bargaining agreements.
For those participants, Sprint matches their contributions in Sprint common
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 matching contributions based on the performance of Sprint
common stock compared to other telecommunications companies' stock. The FON
Group's matching contributions were $54 million in 1997, $56 million in 1996
and $51 million in 1995. At December 31, 1997, the plans held 20 million
Sprint common shares.
POSTRETIREMENT BENEFITS
Sprint provides postretirement benefits (principally medical benefits) to
substantially all 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. The FON
Group funds the accrued costs as benefits are paid.
III-33
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The net postretirement benefits cost consists of the following for the FON
Group:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -----
(IN MILLIONS)
<S> <C> <C> <C>
Service cost--benefits earned during the year........... $ 20.8 $ 21.7 $22.2
Interest on accumulated postretirement benefit
obligation............................................. 52.3 49.9 58.7
Net amortization and deferral........................... (19.4) (13.7) (9.4)
------ ------ -----
Net postretirement benefits cost........................ $ 53.7 $ 57.9 $71.5
====== ====== =====
Discount rate........................................... 7.75% 7.25% 8.50%
</TABLE>
For measurement purposes, the assumed 1997 weighted average annual health
care cost trend rate was 9%, gradually decreasing to an ultimate level of 5%
by 2005. A 1% increase in the rate would have increased the 1997 net
postretirement benefits cost by an estimated $12 million.
Amounts included in the FON Group Combined Balance Sheets at year-end are as
follows:
<TABLE>
<CAPTION>
1997 1996
------ ------
(IN MILLIONS)
<S> <C> <C>
Accumulated postretirement benefit obligation
Retirees...................................................... $328.3 $277.9
Active plan participants--
Fully eligible.............................................. 145.2 127.6
Other....................................................... 269.9 320.7
------ ------
743.4 726.2
Unrecognized prior service benefit.............................. 5.4 5.7
Unrecognized net gains.......................................... 190.0 178.7
------ ------
Accrued postretirement benefits cost............................ $938.8 $910.6
====== ======
Discount rate................................................... 7.25% 7.75%
</TABLE>
The assumed 1998 annual health care cost trend rate was 8.5%, gradually
decreasing to an ultimate level of 5% by 2005. A 1% increase in the rate would
have increased the 1997 accumulated postretirement benefit obligation by an
estimated $61 million.
5. INCOME TAXES
Income tax expense allocated to continuing operations consists of the
following:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ ------
(IN MILLIONS)
<S> <C> <C> <C>
Current income tax expense
Federal............................................... $800.0 $778.2 $453.7
State................................................. 99.5 89.9 94.3
------ ------ ------
Total current........................................... 899.5 868.1 548.0
------ ------ ------
Deferred income tax expense (benefit)
Federal............................................... (12.7) (81.6) 40.1
State................................................. 6.5 18.7 (25.8)
Amortization of deferred investment tax credits......... (3.8) (11.6) (16.5)
------ ------ ------
Total deferred.......................................... (10.0) (74.5) (2.2)
------ ------ ------
Total................................................... $889.5 $793.6 $545.8
====== ====== ======
</TABLE>
III-34
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The differences that caused the effective income tax rates to vary from the
statutory federal rate of 35% were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
(IN MILLIONS)
<S> <C> <C> <C>
Income tax expense at the statutory rate............ $ 791.4 $ 736.5 $ 529.1
Less investment tax credits included in income...... 3.8 11.6 16.5
------- ------- -------
Expected federal income tax expense after investment
tax credits........................................ 787.6 724.9 512.6
Effect of
State income taxes, net of federal income tax
effect........................................... 68.9 70.6 44.6
Equity in losses of foreign joint ventures........ 36.4 8.6 --
Other, net........................................ (3.4) (10.5) (11.4)
------- ------- -------
Income tax expense, including investment tax
credits............................................ $ 889.5 $ 793.6 $ 545.8
======= ======= =======
Effective income tax rate........................... 39.3% 37.7% 36.1%
======= ======= =======
</TABLE>
Income tax expense (benefit) allocated to other items was as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------ ------ -------
(IN MILLIONS)
<S> <C> <C> <C>
Discontinued operation.. $ -- $ 7.0 $ 31.2
Extraordinary items..... -- (2.9) (437.4)
Unrealized holding gains
on investments(1)...... 4.4 1.7 30.7
Stock ownership,
purchase and options
arrangements(1)........ (26.2) (14.1) (7.5)
</TABLE>
- --------
(1) These amounts have been recorded directly to "Group equity."
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 December 31,
1997 and 1996, along with the income tax effect of each, were as follows:
<TABLE>
<CAPTION>
1997 DEFERRED 1996 DEFERRED
INCOME TAX INCOME TAX
------------------ ------------------
ASSETS LIABILITIES ASSETS LIABILITIES
------ ----------- ------ -----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Property, plant and equipment............. $ -- $1,278.0 $ -- $1,275.8
Postretirement and other benefits......... 376.1 -- 360.3 --
Reserves and allowances................... 103.1 -- 113.4 --
Unrealized holding gains on investments... -- 61.7 -- 57.3
Other, net................................ 153.8 -- 152.7 --
------ -------- ------ --------
633.0 1,339.7 626.4 1,333.1
Less valuation allowance.................. 11.8 -- 13.7 --
------ -------- ------ --------
Total................................... $621.2 $1,339.7 $612.7 $1,333.1
====== ======== ====== ========
</TABLE>
The valuation allowance related to deferred income tax assets decreased $2
million in 1997 and $4 million in 1996 and 1995.
Management believes it is more likely than not that these deferred income
tax assets, net of the 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
III-35
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
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.
At December 31, 1997, 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 tax
benefits of $12 million related to state operating loss carryforwards. The
loss carryforwards expire in varying amounts per year from 1998 through 2012.
6. BORROWINGS
All of Sprint's borrowings have been allocated to the FON Group and are
reflected on the FON Group Combined Balance Sheets.
LONG-TERM DEBT
Sprint's long-term debt at year-end was as follows:
<TABLE>
<CAPTION>
MATURING 1997 1996
------------ -------- --------
(IN MILLIONS)
<S> <C> <C> <C>
Corporate
Senior notes
8.1% to 9.8%............................... 1998 to 2002 $ 475.3 $ 475.3
9.5%....................................... 2003 to 2007 200.0 200.0
Debentures
9.0% to 9.3%............................... 2019 to 2022 350.0 350.0
Notes payable and commercial paper........... -- 866.5 --
Other
5.4% to 8.9%(1)............................ 1998 to 2006 237.5 194.9
Long Distance Division
Vendor financing agreements
7.4% to 8.9%............................... 1997 to 1999 23.8 44.8
Other
6.2% to 8.4%............................... 1997 to 2007 16.5 23.1
Local Telecommunications Division
First mortgage bonds
2.0% to 7.8%............................... 1997 to 2002 452.3 487.0
4.0% to 7.8%............................... 2003 to 2007 346.0 346.8
6.9% to 9.8%............................... 2008 to 2012 116.7 116.7
6.9% to 8.8%............................... 2013 to 2017 169.6 169.8
8.8% to 9.9%............................... 2018 to 2022 244.9 245.7
7.1% to 8.4%............................... 2023 to 2027 145.0 145.0
Debentures and notes
5.8% to 9.6%............................... 1998 to 2020 237.0 275.3
Other
2.0% to 9.8%............................... 1998 to 2006 4.6 6.2
Unamortized debt discount...................... (6.1) (6.7)
-------- --------
3,879.6 3,073.9
Less current maturities........................ 131.0 99.1
-------- --------
Long-term debt................................. $3,748.6 $2,974.8
======== ========
</TABLE>
- --------
(1) Notes may be exchanged at maturity for Southern New England
Telecommunications Corporation (SNET) common shares owned by Sprint, or
for cash. Based on SNET's closing market price, had the notes matured at
December 31, 1997, they could have been exchanged for 3.8 million SNET
shares. At December 31, 1997, Sprint held 4.2 million SNET shares, which
have been included in "Investments in equity securities" on the FON Group
Combined Balance Sheets.
III-36
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
Sprint's long-term debt maturities, excluding reclassified short-term
borrowings, during each of the next five years are as follows (in millions):
<TABLE>
<S> <C>
1998.............................. $131.0
1999.............................. 33.4
2000.............................. 693.3
2001.............................. 40.8
2002.............................. 354.5
</TABLE>
Property, plant and equipment with a total cost of $12.9 billion is either
pledged as security for first mortgage bonds and certain notes or is
restricted for use as mortgaged property.
During 1996, Sprint redeemed, prior to scheduled maturities, $190 million of
debt with interest rates ranging from 6.0% to 9.5%. This resulted in a $5
million after-tax extraordinary loss that was reflected on the FON Group
Combined Statements of Income.
SHORT-TERM BORROWINGS
At December 31, 1997, Sprint had borrowed $618 million of bank notes payable
and $249 million of commercial paper. Though these borrowings are renewable at
various dates throughout the year, they have been classified as long-term debt
because of Sprint's intent and ability, through unused credit facilities, to
refinance these borrowings. Commercial paper and certain bank notes payable
are supported by Sprint's revolving credit facility with a syndicate of
domestic and international banks. Other notes payable relate to a separate
revolving credit facility that Sprint executed with a bank in 1997. At
December 31, 1997, Sprint's unused lines of credit totaled $1.1 billion.
Sprint's bank notes outstanding at December 31, 1997 and 1996 had weighted
average interest rates of 6.1% and 5.9%, respectively. At December 31, 1997,
the weighted average interest rate of commercial paper was 6.8%.
OTHER
Sprint was in compliance with all restrictive or financial covenants
relating to its debt arrangements at December 31, 1997.
7. FON GROUP EQUITY
Following is a reconciliation of the FON Group's equity (in millions):
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER
30, DECEMBER 31,
------------------ -----------------------------
1998 1997 1997 1996 1995
-------- -------- --------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Balance at beginning of
period..................... $7,639.3 $7,332.3 $ 7,332.3 $3,676.8 $4,473.7
Net income................ 1,136.7 1,014.9 1,371.6 1,303.5 415.2
Dividends................. (323.3) (323.2) (429.5) (421.0) (348.9)
Equity issuances.......... 137.1 49.1 65.0 3,764.0 21.0
Equity repurchases........ (260.2) (128.8) (144.5) (407.2) --
Spinoff of cellular
division (Cellular)...... -- -- -- (260.2) --
Other, net................ 58.6 40.7 61.8 17.9 50.4
Contributions to the PCS
Group.................... (268.5) (804.3) (1,052.1) (478.3) (954.1)
Equity transfer from the
PCS Group................ 351.6 351.9 434.7 136.8 19.5
-------- -------- --------- -------- --------
Balance at end of period.... $8,471.3 $7,532.6 $ 7,639.3 $7,332.3 $3,676.8
======== ======== ========= ======== ========
</TABLE>
III-37
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
8. STOCK-BASED COMPENSATION
Since the FON Stock was not part of the capital structure of Sprint for the
periods presented, there were no stock options outstanding. See the Sprint
Consolidated Financial Statements and Notes thereto set forth in Annex I for
information regarding stock incentive plans.
9. COMMITMENTS AND CONTINGENCIES
LITIGATION, CLAIMS AND ASSESSMENTS
The holders of FON Stock will be shareholders of Sprint and will continue to
be subject to all of the risks associated with an investment in Sprint,
including any legal proceedings and claims affecting the PCS Group.
In December 1996, an arbitration panel entered a $61 million award in favor
of Network 2000 Communications Corporation (Network 2000) on its breach of
contract claim against Sprint. The arbitrators directed Sprint to pay one-half
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.
Sprint filed an action in federal district court seeking to have the
arbitration panel's award struck down, modified, or corrected, and asking the
court to enter an order regarding the distribution of the award. In April
1997, the court denied Sprint's request that the arbitration award be struck
down and granted Network 2000's request that the award be confirmed.
In June 1997, the FON Group recorded an additional $20 million charge in
connection with 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 number
of potential class members have decided not to participate in the settlement
and another group of potential class members have appealed from the order
approving the class action settlement.
Various 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 result in a material effect on the FON Group
Combined Financial Statements.
OPERATING LEASES
Minimum rental commitments at year-end 1997 for all noncancelable operating
leases, consisting mainly of leases for data processing equipment and real
estate, are as follows (in millions):
<TABLE>
<S> <C>
1998.............................. $305.2
1999.............................. 263.1
2000.............................. 160.8
2001.............................. 105.7
2002.............................. 89.1
Thereafter........................ 238.6
</TABLE>
Gross rental expense totaled $406 million in 1997, $401 million in 1996 and
$402 million in 1995. Rental commitments for subleases, contingent rentals and
executory costs were not significant.
10. FINANCIAL INSTRUMENTS
All of Sprint's financial instruments have been allocated to the FON Group,
the carrying amounts of which are reflected on the FON Group Combined Balance
Sheets.
III-38
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
The FON Group 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 the
FON 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 1997, those amounts have not been comprehensively revalued for
purposes of these financial statements since that date. Therefore, estimates
of fair value after year-end 1997 may differ significantly from the amounts
presented below. The carrying amounts and estimated fair values of the FON
Group's financial instruments at December 31 were as follows:
<TABLE>
<CAPTION>
1997 1996
-------------------- --------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
-------- ---------- -------- ----------
(IN MILLIONS)
<S> <C> <C> <C> <C>
Financial assets
Cash and equivalents................ $ 101.7 $ 101.7 $1,150.6 $1,150.6
Investment in affiliate debt
securities......................... 142.4 142.4 122.5 122.5
Investments in equity securities.... 303.0 303.0 254.5 254.5
Financial liabilities
Short-term borrowings............... -- -- 200.0 200.0
Long-term debt
Corporate......................... 2,129.3 2,301.8 1,220.2 1,348.9
Long distance division............ 40.3 41.7 67.9 69.0
Local telecommunications division. 1,710.0 1,812.3 1,785.8 1,846.9
Other financial instruments
Interest rate swap agreements....... -- 0.3 -- 0.2
Foreign currency contracts.......... (0.6) (0.6) (0.5) (0.5)
</TABLE>
The carrying values of the FON Group's cash and equivalents approximate fair
value at year-end 1997 and 1996. The estimated fair value of the FON Group's
investments in debt and equity securities is based on quoted market prices.
The estimated fair value of the FON 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. The estimated fair value of
interest rate swap agreements is the amount the FON Group would receive to
terminate the swap agreements at year-end 1997 and 1996, taking into account
the then-current interest rates. The estimated fair value of foreign currency
contracts is the replacement cost of the contracts at year-end 1997 and 1996,
taking into account the then-current foreign currency exchange rates.
CONCENTRATIONS OF CREDIT RISK
The FON Group's accounts receivable are not subject to any concentration of
credit risk. The FON Group 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, the FON Group'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, the FON Group does not anticipate nonperformance by any of the
counterparties related to these agreements.
INTEREST RATE SWAP AGREEMENTS
The FON Group 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
III-39
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
an adjustment to interest expense. The FON Group had interest rate swap
agreements with notional amounts of $150 and $350 million outstanding at year-
end 1997 and 1996, respectively. Net interest expense (income) related to
interest rate swap agreements included on the FON Group's Combined Statements
of Income was $(200,000) in 1997, $2 million in 1996 and $(400,000) in 1995.
There were no deferred gains or losses related to any terminated interest rate
swap agreements at year-end 1997, 1996 or 1995.
FOREIGN CURRENCY CONTRACTS
As part of its foreign currency exchange risk management program, the FON
Group purchases and sells over-the-counter forward contracts and options in
various foreign currencies. The FON Group had outstanding $29 and $46 million
of open forward contracts to buy various foreign currencies at year-end 1997
and 1996, respectively. The FON Group had $14 and $3 million of outstanding
open purchase option contracts to call various foreign currencies at year-end
1997 and 1996, respectively. The premium paid for an option is expensed as
incurred. The fair value of an option is recorded as an asset at the end of
each period. The forward contracts and options open at year-end 1997 and 1996
all had original maturities of six months or less. The net gain or loss
recorded to reflect the fair value of these contracts is recorded in the
period incurred. Total net losses of $40,000 in 1997, $400,000 in 1996 and $1
million in 1995 related to foreign currency transactions and contracts were
recorded and included on the FON Group Combined Statements of Income.
11. PARANET ACQUISITION
On September 30, 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. Sprint could pay up to an additional
$70 million if Sprint Paranet meets certain financial targets through 1998.
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 will be amortized on a straight-line basis over four to 10 years.
12. ADOPTION OF ACCOUNTING PRINCIPLES FOR A COMPETITIVE MARKETPLACE
At year-end 1995, the FON Group determined that its local telecommunications
division no longer met the criteria necessary for the continued use of SFAS
71. As a result, 1995 operating results included a noncash, extraordinary
charge of $565 million, net of income tax benefits of $437 million. The
decision to discontinue using SFAS 71 was based on changes in the regulatory
framework and the convergence of competition in the telecommunications
industry.
The 1995 extraordinary charge recognized when the FON Group discontinued
using SFAS 71 consisted of the following:
<TABLE>
<CAPTION>
PRETAX AFTER-TAX
-------- ---------
(IN MILLIONS)
<S> <C> <C>
Increase in accumulated depreciation.................. $ 979.1 $607.9
Recognition of switch software asset.................. (99.5) (61.7)
Elimination of other net regulatory asset............. 123.1 76.3
-------- ------
Total............................................... $1,002.7 622.5
========
Tax-related net regulatory liabilities................ (43.9)
Accelerated amortization of investment tax credits.... (13.3)
------
Extraordinary charge................................ $565.3
======
</TABLE>
III-40
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
13. SPINOFF OF CELLULAR DIVISION
In March 1996, Sprint completed the tax-free spinoff of Cellular to Sprint
common stockholders (the "Spinoff"). 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 net operating results, as summarized below, were separately
classified as a discontinued operation in the FON Group 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 and
$13 million in 1995, were reallocated to Sprint's other operating segments.
<TABLE>
<CAPTION>
1996(1) 1995
------- ------
(IN MILLIONS)
<S> <C> <C>
Net operating revenues......................................... $190.2 $834.4
Operating expenses............................................. 156.0 675.6
------ ------
Operating income............................................... 34.2 158.8
Interest expense............................................... (21.5) (124.0)
Other income (expense), net.................................... (8.3) 10.9
------ ------
Income before income taxes..................................... 4.4 45.7
Income taxes................................................... (7.0) (31.2)
------ ------
Income (Loss) from cellular division........................... $ (2.6) $ 14.5
====== ======
</TABLE>
- --------
(1) 1996 reflects Cellular's operating results only through the date of the
Spinoff.
14. ADDITIONAL FINANCIAL INFORMATION
SEGMENT INFORMATION
The FON Group operates in four industry segments: the long distance
division, the local telecommunications division, the product distribution and
directory publishing division and emerging businesses. Sprint's corporate
assets mainly include investments and loans to affiliates, cash and temporary
investments and general corporate assets. In 1995, corporate assets also
included the net assets of the discontinued cellular division. The long
distance division provides domestic and international voice, video and data
communications services. The local telecommunications division provides local
exchange services, access to Sprint's local exchange facilities, sales of
telecommunications equipment and long distance within specified geographical
areas. The product distribution and directory publishing division provides
wholesale distribution services of telecommunications products and publishes
and markets white and yellow page telephone directories. Emerging businesses
consists of the development of new integrated communications services,
consumer Internet access services, Sprint Paranet and Sprint International.
III-41
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
Industry segment financial information follows:
<TABLE>
<CAPTION>
PRODUCT
DISTRIBUTION
LONG LOCAL & DIRECTORY
DISTANCE TELECOMMUNICATIONS PUBLISHING EMERGING INTERSEGMENT TOTAL FON
DIVISION DIVISION DIVISION BUSINESSES CORPORATE ELIMINATIONS GROUP
-------- ------------------ ------------ ---------- --------- ------------ ---------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C> <C>
1997
Net operating
revenues(1)........... $8,954.8 $5,290.2 $1,454.3 $ 57.4 $ -- $(882.8) $14,873.9
Depreciation and
amortization.......... 716.7 934.1 8.2 23.3 44.0 -- 1,726.3
Operating expenses..... 7,857.3 3,896.2 1,274.4 221.9 -- (845.8) 12,404.0
Operating income
(loss)................ 1,097.5 1,394.0 179.9 (164.5) -- (37.0) 2,469.9
Operating margin....... 12.3% 26.4% 12.4% -- -- -- 16.6%
Capital expenditures... 1,218.1 1,258.4 10.5 79.6 142.3 -- 2,708.9
Identifiable assets.... 6,464.6 7,609.7 519.0 585.9 1,312.5 -- 16,491.7
1996
Net operating
revenues(2)........... $8,302.1 $5,126.8 $1,225.4 $ 0.5 $ -- $(767.3) $13,887.5
Depreciation and
amortization.......... 633.3 909.1 7.2 0.5 40.9 -- 1,591.0
Operating expenses..... 7,378.1 3,789.8 1,123.8 63.8 -- (735.7) 11,619.8
Operating income
(loss)................ 924.0 1,337.0 101.6 (63.3) -- (31.6) 2,267.7
Operating margin....... 11.1% 26.1% 8.3% -- -- -- 16.3%
Capital expenditures... 1,133.7 1,142.6 9.4 49.9 98.0 -- 2,433.6
Identifiable assets.... 5,997.7 7,425.4 446.1 54.3 1,643.1 -- 15,566.6
1995
Net operating
revenues(3)........... $7,277.4 $4,690.0 $1,147.6 $ -- -- $(379.7) $12,735.3
Depreciation and
amortization.......... 581.6 835.6 7.4 -- 41.8 -- 1,466.4
Operating expenses..... 6,570.6 3,649.2 1,060.9 -- -- (379.7) 10,901.0
Operating income....... 706.8 1,040.8 86.7 -- -- -- 1,834.3
Operating margin....... 9.7% 22.2% 7.6% -- -- -- 14.4%
Capital expenditures... 861.7 950.8 7.8 -- 37.0 -- 1,857.3
Identifiable assets.... 4,799.0 6,962.0 395.4 -- 1,944.2 -- 14,100.6
</TABLE>
- --------
(1) Includes intercompany revenues eliminated in consolidation in 1997 of $3.3
million, $309.0 million and $570.5 million for the long distance division,
local telecommunications division and product distribution and directory
publishing division, respectively.
(2) Includes intercompany revenues eliminated in consolidation in 1996 of
$30.9 million, $410.5 million and $325.9 million for the long distance
division, local telecommunications division and product distribution and
directory publishing division, respectively.
(3) Includes intercompany revenues eliminated in consolidation in 1995 of
$38.9 million, $266.4 million and $336.8 million for the long distance
division, local telecommunications division and product distribution and
directory publishing division, respectively. Also included in 1995 were
intercompany revenues of $262.4 million not eliminated under SFAS 71.
Operating income (loss) represents sales and other revenues less operating
expenses, and excludes interest expense, equity in losses of unconsolidated
ventures, other income (expense) and income taxes.
Beginning in July 1997, Sprint changed its transfer pricing for certain
transactions between affiliates to more accurately reflect market pricing. The
main effect of the pricing change was to reduce "net operating revenues" of
the local telecommunications division and reduce "operating expenses" of the
product distribution and directory publishing division. Had this change been
effective as of January 1, 1995, the operating income for the local
telecommunications division would have been $1.3 billion, $1.2 billion and
$1.1 billion in 1997, 1996 and 1995, respectively. The operating income for
the product distribution and directory publishing division would have been
$228 million, $198 million and $180 million in 1997, 1996 and 1995,
respectively.
III-42
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
SUPPLEMENTAL CASH FLOWS INFORMATION (IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED DECEMBER
ENDED SEPTEMBER 30, 31,
------------------- --------------------
1998 1997 1997 1996 1995
--------- --------- ------ ------ ------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash paid for:
Interest (net of amounts
capitalized)
Continuing operations............. $ 174.1 $ 133.2 $197.9 $212.1 $263.5
========= ========= ====== ====== ======
Cellular division................. $ -- $ -- $ -- $ 21.5 $124.0
========= ========= ====== ====== ======
Income taxes........................ $ 279.1 $ 288.5 $365.8 $695.3 $532.8
========= ========= ====== ====== ======
Noncash activities:
Capital lease obligations........... $ -- $ 30.1 $ 30.1 $ -- $ --
========= ========= ====== ====== ======
Noncash activity in Group Equity.... $ 111.6 $ 19.5 $ 31.4 $ 79.3 $ 10.5
========= ========= ====== ====== ======
Net book value of assets and
liabilities contributed to
Global One......................... $ -- $ -- $ -- $ 73.3 $ --
========= ========= ====== ====== ======
</TABLE>
During 1996, Sprint completed the Spinoff (see Note 13) which had no
immediate effect on the FON Group's cash flows other than Cellular's repayment
of $1.4 billion in intercompany debt owed to Sprint.
SUPPLEMENTAL RELATED PARTY TRANSACTIONS
The FON Group has a vendor financing loan to Sprint Spectrum Holdings for
$300 million at December 31, 1997 as well as advances to PhillieCo of $67
million at year-end 1996. The FON Group also has advances to PhillieCo for $21
million at year-end 1997. In 1996, Sprint purchased $183 million (face value)
of Sprint Spectrum Senior Discount notes for $100 million. The bonds mature in
2006. At December 31, 1997 and 1996, the accreted cost of the notes was $118
and $104 million and gross unrealized holding gains totaled $24 and $18
million, respectively. This investment has been included in "Current assets--
Other" on the FON Group Combined Balance Sheets.
The FON Group provided various voice, data and administrative services to
Global One totaling $415 million in 1997 and $361 million in 1996. In
addition, Global One provided data and administrative services to the FON
Group totaling $114 million in 1997 and $130 million in 1996. At year-end 1997
and 1996, the FON Group's receivable from Global One was $154 and $163
million, respectively, and the FON Group's payable to Global One was $104 and
$49 million, respectively.
Certain members of the FON Group also provide management, printing/mailing
and warehousing services to the PCS Group. Charges to the PCS Group for such
activities totaled $17 million, $12 million and $3 million for the years ended
December 31, 1997, 1996 and 1995.
RESTRUCTURING CHARGE
In 1995, the FON Group's local telecommunications division recorded an $88
million restructuring charge, which reduced income from continuing operations
by $55 million. The restructuring plan included the planned elimination over
several years of approximately 1,600 positions, mainly in the network and
finance functions. Through 1997, most of the positions have been eliminated
resulting in termination benefit payments of $42 million, with the remainder
to be paid in 1998 and 1999.
III-43
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
15. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1997, the Financial Accounting Standards Board ("FASB") issued SFAS
131, "Disclosures about Segments of an Enterprise and Related Information."
This new standard requires companies to disclose segment data based on how
management makes decisions about allocating resources to segments and how it
measures segment performance. SFAS 131 requires companies to disclose a
measure of segment profit or loss (operating income, for example), segment
assets, and reconciliations to consolidated totals. It also requires entity-
wide disclosures about a company's products and services, its major customers
and the material countries in which it holds assets and reports revenues. The
FON Group will adopt SFAS 131 in its 1998 year-end financial statements. This
statement is not expected to have a significant effect on the FON Group's
reported segments.
In February 1998, the FASB issued SFAS 132, "Employers' Disclosures about
Pensions and Other Postretirement Benefits." SFAS 132 standardizes the
disclosure requirements for pensions and postretirement benefits where
practical. It also eliminates certain disclosures and requires additional
information on changes in benefit obligations and fair values of plan assets.
The FON Group will adopt SFAS 132 in its 1998 year-end financial statements.
SFAS 132 is not expected to have a significant effect on the FON Group's
pension and postretirement benefit plan disclosures.
In June 1998, the FASB issued SFAS 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS 133 requires all derivatives to be
recorded on the balance sheet as either assets or liabilities and measured at
fair value. Gains or losses resulting from changes in the values of the
derivatives would be accounted for depending on the use of the derivative and
whether it qualifies for hedge accounting. Sprint will adopt SFAS 133
beginning January 1, 2000. This statement is not expected to have a material
impact on Sprint.
16. SUBSEQUENT EVENTS (UNAUDITED)
BORROWINGS
During the first nine months of 1998, Sprint increased its short-term
borrowings by $946 million. These borrowings, however, have been classified as
long-term debt because of Sprint's intent and ability, through unused credit
facilities, to refinance them on a long-term basis. The borrowings have
weighted average interest rates of 5.8%.
In August 1998, Sprint entered into new revolving credit facilities with
syndicates of banks totaling $5.0 billion. These facilities support Sprint's
commercial paper operations and replace its previous $1.5 billion revolving
credit facility. At September 30, 1998, $3.6 billion was available under these
facilities.
In October 1998, Sprint filed a shelf registration statement with the SEC
for $8.0 billion of debt securities. This replaced $1.0 billion of Sprint's
previous shelf registration statements totaling $1.1 billion. Sprint currently
expects to offer up to $3 billion under the new shelf at approximately the
same time as the PCS Restructuring.
OTHER
In April 1998, Sprint signed an agreement to sell approximately 80,000
residential and business access lines in rural Illinois. Sprint expects to
complete the sale of these properties, which is subject to regulatory
approval, and record the related gain in November 1998.
In October 1998, Sprint's Board of Directors declared common and Class A
common stock dividends of $0.25 per share payable December 28, 1998.
III-44
<PAGE>
FON GROUP
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
17. COMPREHENSIVE INCOME (UNAUDITED)
In 1998, Sprint adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS
130 establishes standards for the reporting and display of comprehensive
income and its components. Comprehensive income includes all changes in equity
during a period except those due to owner investments and distributions. It
includes items such as foreign currency translation adjustments, and
unrealized gains and losses on available-for-sale securities. This standard
does not change the display or components of present-day net income; rather,
comprehensive income is displayed as a separate statement in the Consolidated
Statements of Comprehensive Income and as an additional component in the
Consolidated Balance Sheets, and the Consolidated Statement of Common Stock
and Other Shareholders' Equity.
Total comprehensive income for the FON Group amounted to $1.1 billion during
the first nine months of 1998 and $1.0 billion during the first nine months of
1997.
III-45
<PAGE>
EXHIBIT 99.2
SPRINT CORPORATION
COMPUTATION OF SUPPLEMENTAL PRO FORMA
RATIOS OF EARNINGS TO FIXED CHARGES
The following schedule computes the ratios of earnings to fixed charges, on
a pro forma basis giving effect to the PCS Restructuring, for purposes of the
Prospectus Supplement filed as part of Registration Statement No. 333-65649.
<TABLE>
<CAPTION>
NINE MONTHS YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
1998 1997
------------------- ------------
(IN MILLIONS)
<S> <C> <C>
Pro forma earnings
Income (loss) from continuing operations
before taxes............................... $ (74.0) $ 388.0
Capitalized interest........................ (125.6) (198.5)
Equity in losses of less than 50 percent
owned entities............................. 81.3 212.8
Minority interest in majority-owned
subsidiaries............................... (99.0) (81.1)
------- -------
Subtotal...................................... (217.3) 321.2
Pro forma fixed charges
Interest charges............................ 612.4 507.0
Interest factor of operating rents.......... 132.8 151.8
Pre-tax cost of preferred stock dividends of
subsidiaries............................... 0.1 0.3
------- -------
Total pro forma fixed charges................. 745.3 659.1
------- -------
Pro forma earnings, as adjusted............... $ 528.0 $ 980.3
======= =======
Pro forma ratio of earnings to fixed charges.. (1) 1.49
======= =======
</TABLE>
(1) Pro forma earnings, as adjusted, were inadequate to cover fixed charges
by $217.3 million for the nine months ended September 30, 1998.
The above ratios were computed by dividing pro forma fixed charges into the
sum of pro forma earnings (after certain adjustments) and pro forma fixed
charges. Pro forma earnings include income from continuing operations before
taxes, plus equity in the net losses of entities that are less than 50% owned
by Sprint, less minority interest and capitalized interest. Pro forma fixed
charges include (1) interest on all debt of continuing operations (including
amortization of debt issuance costs, (2) the interest component of operating
rents, and (3) the pre-tax cost of subsidiary preferred stock dividends.
