UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

Commission file number 1-04721

 

SPRINT NEXTEL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Registrant’s telephone number, including area code:

(703) 433-4000

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (check one):

 

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  Yes o     No þ

 

COMMON SHARES OUTSTANDING AT JULY 31, 2007:

 

 

SPRINT NEXTEL CORPORATION

 

TABLE OF CONTENTS

 

 

SPRINT NEXTEL CORPORATION

 

CONSOLIDATED BALANCE SHEETS

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

SPRINT NEXTEL CORPORATION

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

SPRINT NEXTEL CORPORATION

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

SPRINT NEXTEL CORPORATION

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
(Unaudited)
(in millions)

 

 

 

 

See accompanying Notes to Consolidated Financial Statements (Unaudited)

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1.  Basis of Presentation

 

Our unaudited consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission, or SEC, and reflect all adjustments that are necessary for a fair presentation of the results for interim periods. All adjustments made were of a normal recurring nature, except as described in the notes below. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared according to accounting principles generally accepted in the United States have been omitted. As a result, you should read these consolidated financial statements along with the consolidated financial statements and notes contained in our annual report on Form 10-K for the year ended December 31, 2006. Operating results for the interim period should not be viewed as representative of results that may be expected for the year ending December 31, 2007.

 

We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the United States, which require 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Due to the inherent uncertainty involved in making those estimates, actual results could differ from those estimates. Areas in which significant estimates have been made include, but are not limited to, the allowance for doubtful accounts receivable, inventory obsolescence, tax valuation allowances, useful lives for property, plant and equipment and definite lived intangible assets, intangible asset impairment analyses and the evaluation of uncertain tax positions.

 

Certain prior period amounts have been reclassified to conform to the current period presentation.

 

Supplemental Cash Flow Information from Continuing Operations

 

 

Earnings (Loss) per Common Share

 

Basic earnings (loss) per common share is calculated by dividing income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share adjusts basic earnings (loss) per common share for the effects of potentially dilutive common shares. Potentially dilutive common shares include the dilutive effects of shares issuable under our equity plans computed using the treasury stock method, and the dilutive effects of shares issuable upon the conversion of our convertible senior notes computed using the if-converted method.

 

Dilutive shares issuable under our equity plans, used in calculating earnings per common share, were 18 million shares for the second quarter 2007. All 11 million shares issuable upon the assumed conversion of our convertible senior notes could potentially dilute earnings per share in the future; however, they were excluded from the calculation of diluted earnings per common share for the second quarter and the year-to-date period 2007 due to their antidilutive effects. Additionally, about 52 million average shares issuable under the equity plans that could also potentially dilute earnings per share in the future were excluded from the calculation of diluted earnings per common share for the second quarter 2007 as the exercise prices exceeded the average market price during the period. Shares issuable under our equity plans were antidilutive for the year-to-date period 2007 because we incurred a net loss from continuing operations.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Dilutive shares issuable under our equity plans, used in calculating earnings per common share, were 23 million shares for the second quarter 2006 and 25 million shares for the year-to-date period 2006. All 11 million shares issuable upon the assumed conversion of our convertible senior notes could potentially dilute earnings per share in the future; however, they were excluded from the calculation of diluted earnings per common share for the second quarter and year-to-date period 2006 due to their antidilutive effects. Additionally, about 60 million average shares issuable under the equity plans that could also potentially dilute earnings per share in the future were excluded from the calculation of diluted earnings per common share for the second quarter and year-to-date period 2006 as the exercise prices exceeded the average market price during those periods.

 

Dividends

 

On May 8, 2007, our board of directors declared a dividend of $0.025 per share on our common shares, payable to shareholders of record at the close of business on June 8, 2007. The dividend was paid on June 29, 2007. We also paid a dividend of $0.025 per share on our common stock in the first quarter 2007.

 

Share Repurchase Program

 

On July 25, 2006, our board of directors authorized the purchase of up to $6.0 billion of our Series 1 common stock through open market purchases. This authorization will expire upon the earlier of the full repurchase of the authorized shares or during the first quarter 2008. The number of shares purchased and the timing of any purchases will vary throughout the purchase period. In the second quarter 2007, we repurchased about 51 million shares of our Series 1 common stock for about $1.1 billion at an average price of $21.73 per share. In the year-to-date period 2007, we repurchased about 66 million shares of our Series 1 common stock for about $1.4 billion at an average price of $21.24 per share. From the inception of this program through June 30, 2007, we repurchased a total of 164 million shares of our Series 1 common stock for about $3.0 billion at an average price of $18.56 per share.

 

Significant New Accounting Pronouncements

 

In June 2006, the Emerging Issues Task Force, or EITF, reached a consensus on Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). EITF Issue No. 06-3 requires that companies disclose their accounting policy regarding the gross or net presentation of certain taxes. Taxes within the scope of EITF Issue No. 06-3 are any taxes assessed by a governmental authority that are directly imposed on a revenue-producing transaction between a seller and a customer and may include, but are not limited to, sales, use, value added and some excise taxes. We adopted EITF Issue No. 06-3 on January 1, 2007. The adoption did not impact our consolidated financial statements. We account for transaction taxes such as sales, excise and usage taxes on a net basis. Universal Service Fund revenues and costs are recorded gross. Universal Service Fund revenues represented about 2% of net operating revenues for the year-to-date periods 2007 and 2006.

 

In September 2006, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 157, Fair Value Measurements. This statement defines fair value and establishes a framework for measuring fair value. Additionally, this statement expands disclosure requirements for fair value with a particular focus on measurement inputs. SFAS No. 157 is effective for our quarterly reporting period ending March 31, 2008. We are in the process of evaluating the impact of this statement on our consolidated financial statements.

 

In September 2006, the EITF reached a consensus on Issue No. 06-1, Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. EITF Issue No. 06-1 provides guidance regarding whether the consideration given by a service provider to a manufacturer or reseller of specialized equipment should be characterized as a

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

reduction of revenue or as an expense. This issue is effective for our quarterly reporting period ending March 31, 2008. Entities are required to recognize the effects of applying this issue as a change in accounting principle through retrospective application to all prior periods unless it is impracticable to do so. We do not expect this consensus to have a material impact on our consolidated financial statements.

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This statement allows entities to measure assets and liabilities at fair value and report any unrecognized gains or losses in earnings subsequent to adoption. The statement serves to minimize the fluctuations in earnings that occur when assets and liabilities are measured differently without imposing hedge accounting requirements. This statement is effective for our quarterly reporting period ending March 31, 2008 and must be applied in conjunction with SFAS No. 157. We are in the process of evaluating the impact of this statement on our consolidated financial statements.

 

In June 2007, the EITF reached a consensus on Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. EITF Issue No. 06-11 provides guidance regarding how an entity should recognize the tax benefit received as a result of dividends paid to holders of share-based compensation awards and charged to retained earnings according to SFAS No. 123R, Share-Based Payment. This issue is effective for our quarterly reporting period ending March 31, 2008. We are in the process of evaluating the impact of this issue on our consolidated financial statements.

 

 

On May 17, 2006, we completed the spin-off of our local communications business, which is now known as Embarq Corporation. Embarq offers regulated local communications services as an incumbent local exchange carrier and provides a suite of communications services, consisting of local and long distance voice and data services, including high-speed Internet access. As required by SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, and as permitted by SFAS No. 95, Statement of Cash Flows, the results of operations and cash flows from operating activities of this business for 2006 are presented as discontinued operations.

 

In the spin-off, we distributed pro rata to our shareholders one share of Embarq common stock for every 20 shares held of our voting and non-voting common stock, or about 149 million shares of Embarq common stock. Cash was paid for fractional shares. The distribution of Embarq common stock is considered a tax free transaction for us and for our shareholders, except cash payments made in lieu of fractional shares, which are generally taxable.

 

In connection with the spin-off, Embarq transferred to our parent company $2.1 billion in cash and about $4.5 billion of Embarq senior notes in partial consideration for, and as a condition to, our transfer to Embarq of the local communications business. Embarq also retained about $665 million in debt obligations of its subsidiaries. Our parent company transferred the cash and senior notes to our finance subsidiary, Sprint Capital Corporation, in satisfaction of indebtedness owed by our parent company to Sprint Capital. On May 19, 2006, Sprint Capital sold the Embarq senior notes to the public, and received about $4.4 billion in net proceeds.

 

Also, in connection with the spin-off, we entered into a separation and distribution agreement and related agreements with Embarq, which provide that generally each party will be responsible for its respective assets, liabilities and businesses following the spin-off and that we and Embarq will provide each other with certain transition services relating to our respective businesses for specified periods at cost-based prices. The transition services primarily include billing, field support, information technology and real estate services. We also entered into agreements pursuant to which we and Embarq will provide each other with specified services at commercial rates. Further, the agreements provide for a settlement process surrounding the transfer of certain assets and liabilities. It is possible that adjustments will occur in future periods as these matters are settled.

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

At the time of the spin-off, all outstanding options to purchase our common stock held by employees of Embarq were cancelled and replaced with options to purchase Embarq common stock. Outstanding options to purchase our common stock held by our directors and employees who remained with us were adjusted by multiplying the number of shares subject to the options by 1.0955 and dividing the exercise price by the same number in order to account for the impact of the spin-off on the value of our shares at the time the spin-off was completed.

 

Generally, restricted stock units awarded pursuant to our equity incentive plans and held by our employees at the time of the spin-off (including those held by those of our employees who became employees of Embarq) were treated in a manner similar to the treatment of outstanding shares of our common stock in the spin-off. Holders of these restricted stock units received one Embarq restricted stock unit for every 20 restricted stock units held. Outstanding deferred shares granted under the Nextel Incentive Equity Plan, which represent the right to receive shares of our common stock, were adjusted by multiplying the number of deferred shares by 1.0955. Cash was paid to the holders of deferred shares in lieu of fractional shares.

 

The results of operations of the local communications business were as follows:

 

 

 

 

 

We have accounted for our acquisitions in the Wireless segment under the purchase method as required by SFAS No. 141, Business Combinations. SFAS No. 141 requires that the total purchase price of each of the acquired entities be allocated to the assets acquired and liabilities assumed based on their fair values at the respective acquisition dates. The allocation process requires an analysis of intangible assets, such as Federal Communications Commission, or FCC, licenses, customer relationships, trade names, rights under affiliation agreements, acquired contractual rights and assumed contractual commitments and legal contingencies to identify and record all assets acquired and liabilities assumed at their fair value. In valuing acquired assets and assumed liabilities, fair values are based on, but are not limited to: quoted market prices, where available; our intent with respect to whether the assets purchased are to be held, sold or abandoned; expected future cash flows; current replacement cost for similar capacity for certain property, plant and equipment; market rate assumptions for contractual obligations; and appropriate discount rates and growth rates. The results of operations for all acquired companies are included in our consolidated financial statements either from the date of acquisition or from the start of the month closest to the acquisition date.

 

We have relied in part on commercial affiliation arrangements between us and third party affiliates, each referred to as a PCS Affiliate, to offer Sprint-branded digital wireless service in and around certain smaller U.S. metropolitan areas. Until our acquisition of Nextel Partners, Inc., we relied on commercial arrangements between us and Nextel Partners to offer Nextel branded digital wireless service in and around certain smaller U.S. metropolitan areas. During 2006, we acquired several PCS Affiliates, including Enterprise Communications Partnership, Alamosa Holdings, Inc. and UbiquiTel Inc., as well as Velocita Wireless Holdings Corporation and the remaining 72% of Nextel Partners that we did not previously own for an aggregate of $10.5 billion in cash. We paid a premium (i.e., goodwill) over the fair value of the net tangible

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

and identified intangible assets of these entities because we believed the acquisition of the PCS Affiliates and Nextel Partners would give us more control of the distribution of services under the Sprint^® and Nextel^® brands, and would provide us with strategic and financial benefits associated with a larger customer base and expanded network coverage. We acquired Velocita Wireless, primarily to increase our licenses to use spectrum in the 900 megahertz, or MHz, spectrum band. In the second quarter 2007, we sold the operations of this business as discussed in note 6. On August 1, 2007, we acquired Northern PCS Services, LLC, a PCS Affiliate, for about $313 million in cash.

 

Changes to the initial purchase price allocations for these acquisitions have occurred primarily based on further analysis and valuations of certain assets and liabilities, and are summarized in the table below along with the respective total fair value amounts.

 

 

During 2007, a net decrease was made to goodwill in the amount of $321 million, primarily due to adjustments to the fair value of FCC licenses, as well as an adjustment to the net assets of Nextel Partners relating to the dilution of our ownership interest in Nextel Partners prior to our acquisition. We have completed our valuations of our business acquisitions, as well as our plans for rationalizing certain redundant assets and activities associated with these acquisitions. We will continue to execute these plans over the next several quarters. There will be no further purchase accounting adjustments related to our acquisitions, except when required by certain accounting rules. See note 5 for information regarding the useful lives of acquired definite lived intangible assets as well as other information regarding intangible assets. See note 6 for information regarding our exit costs associated with our business combinations.

 

 

Share-Based Payment Plans

 

As of June 30, 2007, we sponsored four equity incentive plans, the 2007 Omnibus Incentive Plan, or 2007 Plan; the 1997 Long-Term Incentive Program, or the 1997 Program; the Nextel Incentive Equity Plan, or the Nextel Plan; and the Management Incentive Stock Option Plan, or MISOP, as well as our Employees Stock Purchase Plan, or ESPP. On May 8, 2007, our shareholders approved the 2007 Plan, under which we may grant stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units and other equity-based and cash awards to our employees, outside directors and certain other service providers. The Human Capital and Compensation Committee, or HC&CC, of our board of directors or one or more executive officers should the HC&CC so authorize, as provided in the 2007 Plan, will

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

determine the terms of each equity-based award. No new grants can be made under the 1997 Program, the Nextel Plan or the MISOP.

 

During the second quarter 2007, the number of shares available under the 2007 Plan increased by about 4 million shares, as the number of shares available under the 2007 Plan is increased by any shares granted under the 1997 Program, the Nextel Plan or the MISOP that are forfeited, expired, settled for cash or otherwise terminated. As of June 30, 2007, under the 2007 Plan, about 203 million common shares were available. As of June 30, 2007, awards to acquire about 84 million common shares were outstanding under the 1997 Program, awards to acquire about 51 million common shares were outstanding under the Nextel Plan, options to buy about 31 million common shares were outstanding under the MISOP, and the ESPP authorized about 21 million shares for future purchases. Currently, we use treasury shares to satisfy share-based awards or new shares if no treasury shares are available. Refer to note 4 of the “Notes to Consolidated Financial Statements” in our annual report on Form 10-K for the year ended December 31, 2006 for additional information regarding our equity incentive plans.

 

Statement of Financial Accounting Standards No. 123R

 

Effective January 1, 2006, we adopted SFAS No. 123R, which supersedes SFAS No. 123, Accounting for Stock-Based Compensation. The adoption of SFAS No. 123R did not have a material effect on our consolidated financial statements as we had previously adopted SFAS No. 123 in 2003.

 

Pre-tax share-based compensation cost charged against net income (loss) for our share-based award plans was $58 million for the second quarter 2007 and $131 million for the year-to-date period 2007. Pre-tax share-based compensation cost charged against net income for our share-based award plans was $85 million for the second quarter 2006 and $206 million for the year-to-date period 2006. Pre-tax share-based compensation cost charged against income from continuing operations for our share-based award plans was $79 million for the second quarter 2006 and $183 million for the year-to-date period 2006.

 

The total income tax benefit recognized and the income tax benefit related to continuing operations recognized in the consolidated financial statements for share-based award compensation was $22 million for the second quarter 2007 and $50 million for the year-to-date period 2007. The total income tax benefit recognized in the statements of operations for share-based award compensation was $32 million for the second quarter 2006 and $77 million for the year-to-date period 2006. The total income tax benefit recognized in the statement of operations related to continuing operations for share-based award compensation was $29 million for the second quarter 2006 and $67 million for the year-to-date period 2006.

 

As of June 30, 2007, there was $372 million of total unrecognized compensation cost related to our share-based award plans that is expected to be recognized over a weighted average period of two years. Cash received from exercise under all share-based payment arrangements was $312 million for the year-to-date period 2007 and $326 million for the year-to-date period 2006. The actual tax benefit realized for the tax deductions from exercise of the share-based payment arrangements totaled $4 million for the year-to-date period 2007 and $5 million for the year-to-date period 2006.

 

Under our share-based payment plans, we had options, restricted stock units and nonvested shares outstanding as of June 30, 2007. Awards with graded vesting are recognized using the straight-line method. Forfeitures were estimated for share-based awards using a 4% weighted average annual rate.

 

Options

 

The fair value of each option award is estimated on the grant date using the Black-Scholes option valuation model. Options outstanding as of June 30, 2007 include options granted under the 1997 Program, the MISOP and the Nextel Plan, as discussed above.

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

No options were granted in the second quarter 2007, and options to purchase about 13 million shares of our common stock were granted in the year-to-date period 2007. The total intrinsic value of options exercised was $137 million during the year-to-date period 2007 and $217 million during the year-to-date period 2006.

 

Restricted Stock Units

 

The fair value of each restricted stock unit award is calculated using the share price at the date of grant. Restricted stock units consist of those units granted under the 2007 Plan and the 1997 Program, as discussed above. About 260,000 restricted stock units were granted in the second quarter 2007, and about 7 million restricted stock units were granted in the year-to-date period 2007.

 

The total fair value of restricted stock units vested was $68 million during the year-to-date period 2007 and $38 million during the year-to-date period 2006. The weighted-average grant date fair value of restricted stock units granted during the year-to-date period 2007 was $18.83 per unit, compared with $24.44 per unit for the same prior year period.

 

Most restricted stock units outstanding as of June 30, 2007 are entitled to dividend equivalents paid in cash, but performance-based restricted stock units are not entitled to dividend equivalent payments until the applicable performance period has been completed. Dividend equivalents paid on restricted stock units are charged to retained earnings when paid.

 

Nonvested Shares

 

Nonvested shares outstanding as of June 30, 2007 consist of restricted shares granted under the 1997 Program and deferred shares granted under the Nextel Plan. The fair value of each nonvested share award is calculated using the share price at the date of grant. All nonvested shares outstanding as of June 30, 2007 will be vested in full by the end of 2008. The total fair value of shares vested was about $738,000 during the year-to-date period 2007 and $18 million during the year-to-date period 2006. No nonvested shares were granted in the second quarter 2007 or in the year-to-date period 2007.

 

 

Indefinite Lived Intangibles

 

 

 

 

We have identified FCC licenses and our Boost Mobile and Sprint trademarks as indefinite lived intangible assets, in addition to our goodwill, after considering the expected use of the assets, the regulatory and economic environment within which they are being used, and the effects of obsolescence on their use. The Boost Mobile and Sprint trademarks are highly respected brands with positive connotations. We have no legal, regulatory or contractual limitations associated with our trademarks. We cultivate and protect the use of our brands.

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

We hold several kinds of FCC licenses to deploy our wireless services: 1.9 gigahertz, or GHz, personal communications services, or PCS, licenses utilized in our code division multiple access, or CDMA, network, 800 MHz and 900 MHz licenses utilized in our integrated Digital Enhanced Network, or iDEN, and 2.5 GHz licenses that we use for first generation wireless Internet access services. We also hold 2.5 GHz, 1.9 GHz and other FCC licenses that we currently do not utilize in our networks or operations. As long as we act within the requirements and constraints of the regulatory authorities, the renewal and extension of our licenses is reasonably certain at minimal cost. FCC licenses authorize wireless carriers to use radio frequency spectrum. That spectrum is a renewable, reusable resource that does not deplete or exhaust over time. We are not aware of any technology being developed that would render spectrum obsolete. Currently, there are no changes in the competitive or legislative environments that would put in question the future need for spectrum licenses.

 

During the fourth quarter 2006, we performed our annual goodwill and other indefinite lived intangible asset impairment analyses. The result of these analyses was that our goodwill and other indefinite lived intangible assets were not impaired. The goodwill analysis estimated the fair value of our wireless reporting unit based on discounted expected future cash flows, supported by the results of various market approach valuation models. We also periodically review our goodwill for indicators of impairment. We perform this review, in part, by deriving the estimated equity value of the wireless reporting unit, which we then compare to the carrying value of the wireless reporting unit. Specifically, we reduce our stock price by the estimated fair value per share of our Wireline segment and then add a control premium, as permitted by FASB guidance, to determine an estimate of the equity value of the wireless reporting unit. As of June 30, 2007, we have not identified any indicators of impairment with respect to our goodwill or other indefinite lived intangible assets. However, if an indicator of impairment exists, such as a significant decline in expected cash flows or if our stock price were to experience a sustained, significant decline, as compared to the stock price as of June 30, 2007, we may be required to perform the second step of the goodwill impairment test, which could cause us to recognize a non-cash impairment charge that could be material to our consolidated financial statements.

 

Definite Lived Intangibles

 

 

 

Definite lived intangible assets consist primarily of customer relationships that are amortized over three to five years using the sum of the years’ digits method, which we believe best reflects the estimated pattern in which the economic benefits will be consumed. Other definite lived intangible assets primarily include certain rights under affiliation agreements that we reacquired in connection with the acquisitions of the PCS Affiliates and Nextel Partners, which are being amortized over the remaining terms of those affiliation agreements on a straight-line basis, and the Nextel and Direct Connect trade names, which are being amortized over ten years

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

from the date of the Sprint-Nextel merger on a straight-line basis. We recorded aggregate amortization expense of $906 million and $1.8 billion for the second quarter 2007 and the year-to-date period 2007 and $958 million and $1.9 billion for the second quarter 2006 and the year-to-date period 2006.

 

We review our long-lived asset groups for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. Our wireless asset group includes definite lived intangible assets. Such indicators include, but are not limited to, a significant decrease in the market price of or the cash flows expected to be derived from the asset groups, or a significant change in the extent or manner in which the assets in the group are utilized. In addition, if we ever were required to determine the implied fair value of our goodwill as part of a second step goodwill impairment test, it would potentially result in our evaluating the recorded value of our long-lived assets for impairment. We also evaluate the remaining useful lives of our definite lived intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining periods of amortization, which would be addressed prospectively.

 

Spectrum Reconfiguration Obligations

 

On February 7, 2005, Nextel accepted the terms and conditions of the Report and Order of the FCC, which implemented a spectrum reconfiguration plan designed to eliminate interference with public safety operators in the 800 MHz band. Under the terms of the Report and Order, Nextel surrendered certain spectrum rights and received certain other spectrum rights, and undertook to pay the costs incurred by Nextel and third parties in connection with the reconfiguration plan, which is required to be completed within a 36-month period, subject to certain exceptions particularly with respect to markets that border Mexico and Canada. We assumed these obligations when we merged with Nextel in August 2005. If, as a result of events within our control, we fail to complete the reconfiguration plan within the 36-month period, the FCC could take actions against us to enforce the Report and Order. These actions could have adverse operating or financial impacts on us, some of which could be material. We believe that, based on our experiences to date, we will not complete this reconfiguration process within the applicable FCC designated time period due primarily to circumstances largely outside of our control. We do not believe at this time that the impact from this delay will be material to our results of operations or financial condition, although there can be no assurances. Recognizing the current limitations in the reconfiguration process, we and the public safety community jointly filed a letter with the FCC on February 15, 2007, requesting that the FCC direct the independent Transition Administrator, or TA, through working closely with the affected parties, to develop a schedule and benchmarks for completing the second phase of the 800 MHz reconfiguration. Although the FCC has not yet taken any formal action with regard to this request, the TA has begun regional planning in order to develop region-by-region schedules.

 

Based on the FCC’s determination of the values of the spectrum rights received and surrendered by Nextel, the minimum obligation to be incurred under the Report and Order is $2.8 billion. The Report and Order provides that qualifying costs we incur as part of the reconfiguration plan, including costs to reconfigure our own infrastructure and spectrum positions, can be used to offset the minimum obligation of $2.8 billion; however, we are obligated to pay the full amount of the costs relating to the reconfiguration plan, even if those costs exceed that amount. In addition, a financial reconciliation is required to be completed at the end of the reconfiguration implementation, at which time we will be required to make a payment to the U.S. Treasury to the extent that the value of the spectrum rights received exceeds the total of (i) the value of the spectrum rights that are surrendered and (ii) the qualifying costs referred to above. As a result of the uncertainty with regard to the calculation of the credit for our internal network costs, as well as the significant number of variables outside of our control, particularly with regard to the 800 MHz reconfiguration licensee costs, we do not believe that we can reasonably estimate what amount, if any, will be paid to the U.S. Treasury. From the inception of the program through June 30, 2007, we estimate that we have incurred $892 million of costs directly attributable to the reconfiguration program. This amount does not include any indirect network costs that we have preliminarily allocated to the reconfiguration program.

 

SPRINT NEXTEL CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

As of June 30, 2007, we had a remaining liability of $97 million associated with the estimated portion of the reconfiguration costs that represents our best estimate of amounts to be paid under the Report and Order that would not benefit our infrastructure or spectrum positions. All other costs incurred pursuant to the Report and Order that relate to the spectrum and infrastructure, when expended, are accounted for either as property, plant and equipment or as additions to the FCC licenses intangible asset, consistent with our accounting policies. The following table represents expenditures incurred directly attributable to our performance under the Report and Order from the inception of the program:

 

 

In addition, not included in the table above are estimated reconfiguration costs incurred to date that are included in property, plant and equipment on our consolidated balance sheet, which are based on allocations between reconfiguration activities and our normal network growth. These estimated allocations may vary depending on key assumptions, including subscribers, call volumes and other factors over the life of the reconfiguration program. As a result, the amount allocated to reconfiguration activity is subject to change based on additional assessments made over the course of the reconfiguration program. Since we, the TA and the FCC have not yet reached an agreement on our methodology for calculating the amount to be submitted for credit, we cannot provide assurance that we will be granted full credit for certain of these allocated network costs.

 

 

For the second quarter 2007 and the year-to-date period 2007, total severance, exit costs and asset impairment costs aggregated $85 million and $259 million compared to $40 million and $78 million in the second quarter 2006 and the year-to-date period 2006. For the second quarter 2007 and year-to-date period 2007, this included a $44 million loss on the sale of Velocita Wireless, excluding the FCC licenses acquired.

 

We had asset impairments of $44 million and $52 million in the second quarter 2007 and the year-to-date period 2007, which related to the sale of Velocita Wireless, the closing of retail stores due to integration activities and the write-off of network assets. For the second quarter 2006 and the year-to-date period 2006, we had asset impairments of $23 million and $41 million primarily related to software asset impairments and abandonment of various assets, including certain cell sites under construction in our Wireless segment.

 

In 2007, we continue to transition to unified customer care, financial systems, device activation, billing and service and technology platforms as a further step to completing our integration initiatives associated with the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions. The resulting efficiencies, along with other business simplification, process improvement initiatives and announced workforce reductions, are expected to enable us to reduce our cost structure. Beginning in the first quarter 2007, we reduced our full-time headcount under this initiative and, in connection with this reduction and expected future reductions, we recorded $164 million related to severance liability with a corresponding charge to severance expense. We had completed the majority of our planned headcount reductions by March 31, 2007, the remainder of which are

 

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expected to occur by year-end. The following table provides an analysis of our severance and exit costs liability that is expected to be paid in cash.

 

 

Exit Costs Associated with Business Combinations

 

In connection with activities related to business combinations, we recorded certain costs associated with dispositions and integration activities in accordance with the requirements of EITF Issue No. 95-3, Recognition of Liabilities in Connection with a Purchase Business Combination. The exit costs are primarily related to termination fees associated with leases and contractual arrangements, as well as severance and related costs associated with work force reductions. These actions have resulted in adjustments to accrued liabilities and goodwill. The activity is presented in the table below:

 

 

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As of June 30, 2007, Sprint Nextel Corporation, our parent corporation, had about $4.1 billion of debt outstanding, including commercial paper. In addition, as of June 30, 2007, about $18.6 billion of long-term debt had been issued by wholly-owned subsidiaries of, and is fully and unconditionally guaranteed by, Sprint Nextel. The indentures and financing arrangements of certain of our subsidiaries contain provisions that limit cash dividend payments on subsidiary common stock held by our parent corporation. The transfer of cash in the form of advances from the subsidiaries to our parent corporation is generally not restricted.

 

We are currently in compliance with all restrictive and financial covenants associated with the borrowings discussed above. There is no provision under any of our indebtedness that requires repayment in the event of a downgrade by any rating agency.

 

Our interest rate swap activity generated a net liability of $30 million as of June 30, 2007 compared to a net liability of $25 million as of December 31, 2006, resulting from changes in the fair value of the interest rate swaps with an offset recorded to the underlying long-term debt.

 

Senior Notes

 

We paid a total of $604 million in cash for early redemptions of senior notes in the year-to-date period 2007, as we redeemed in their entirety $150 million of IWO Holdings, Inc.’s Senior Secured Floating Rate Notes due 2012 in January 2007 for $153 million in cash and $420 million of UbiquiTel Operating Company’s 9.875% Senior Notes due 2011 in March 2007 for $451 million in cash.

 

In June 2007, we completed the sale of $750 million in principal amount of floating rate notes due 2010. Cash interest is payable quarterly in arrears on March 28, June 28, September 28 and December 28 of each year, commencing September 28, 2007, at a rate of three-month London Interbank Offered Rate, or LIBOR, plus 40 basis points. We may not redeem these notes prior to maturity. These notes are senior unsecured obligations and rank equal in right of payment with all our other unsecured senior indebtedness.

 

On May 30, 2007, we announced our intention to redeem our Nextel Partners 8.125% senior notes due 2011, of which $475 million in aggregate principal amount was outstanding as of June 30, 2007, for $494 million in

 

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cash. The redemption occurred on July 2, 2007. On June 28, 2007, we announced our intention to redeem our Alamosa 11.00% senior notes due 2010, of which $251 million in aggregate principal amount was outstanding as of June 30, 2007, for $264 million in cash. The redemption occurred on July 31, 2007. Accordingly, we have reclassified $726 million of aggregate principal amount of long-term debt to current as of June 30, 2007.

 

Credit Facilities

 

Our revolving bank credit facility provides for total unsecured financing capacity of $6.0 billion. As of June 30, 2007, we had $2.6 billion of outstanding letters of credit, including a $2.5 billion letter of credit that is required by the FCC’s Report and Order, and $400 million in commercial paper backed by this facility, resulting in $3.0 billion of available revolving credit. We also had an additional $12 million of outstanding letters of credit as of June 30, 2007 used for various financial obligations that are not backed by our bank credit facility.

 

In March 2007, we entered into a $750 million unsecured loan agreement with Export Development Canada. As of June 30, 2007, we had borrowed all $750 million available under this agreement and this loan will mature in March 2012. The terms of this loan provide for an interest rate equal to LIBOR plus a spread that varies depending on our credit ratings. We may choose to prepay this loan, in whole or in part, at any time.

 

Commercial Paper

 

In April 2006, we commenced a commercial paper program, which has reduced our borrowing costs by allowing us to issue short-term debt at lower rates than those available under our $6.0 billion revolving credit facility. The $2.0 billion program is backed by our revolving credit facility and reduces the amount we can borrow under the facility to the extent of the commercial paper outstanding. As of June 30, 2007, we had $400 million of commercial paper outstanding, included in the current maturities of long-term debt with a weighted average interest rate of 5.61% and a weighted average maturity of 72 days.

 

 

We have a non-contributory defined benefit pension plan and a postretirement benefit plan, which provide benefits to certain employees. We also provide postretirement life insurance to employees who retired before certain dates. Most of our employees who were employed by us prior to the Sprint-Nextel merger are participants in the pension plan. At the time of the Sprint-Nextel merger, we did not extend plan participation to Nextel employees for either the pension plan or retiree medical plan. As of December 31, 2005, the pension plan was amended to freeze benefit accruals for pension plan participants not designated to work for Embarq following the spin-off. The postretirement benefit plan was amended to include only employees designated to work for Embarq following the spin-off and pre-merger Sprint employees born prior to 1956.

 

As of May 17, 2006, in connection with the spin-off of Embarq, accrued pension benefit obligations for participants designated to work for Embarq and related plan assets were transferred to Embarq. Additionally, the accrued postretirement benefit obligation for participants designated to work for Embarq was transferred to Embarq. This event required a remeasurement of benefit obligations associated with both the pension and postretirement benefit plans for the remaining Sprint Nextel employees. As a result of these above actions, the pension and postretirement benefit plan activity for the second quarter 2007 and the year-to-date period 2007 did not have a significant impact on our results of operations.

 

 

FASB Interpretation No. 48

 

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN 48, on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an

 

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enterprise’s financial statements in accordance with SFAS No. 109, Accounting for Income Taxes, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The cumulative effect of adopting FIN 48 generally is recorded directly to retained earnings. However, to the extent the adoption of FIN 48 resulted in a revaluation of uncertain tax positions acquired in any purchase business combination, the cumulative effect is recorded as an adjustment to the goodwill remaining from the corresponding purchase business combination.

 

As a result of the adoption of FIN 48, we recognized a $20 million increase in the liability for unrecognized tax benefits, which was accounted for as a $24 million increase to goodwill and a $4 million increase to retained earnings as of January 1, 2007. The total unrecognized tax benefits attributable to uncertain tax positions as of January 1, 2007 were $606 million. Upon adoption of FIN 48, we reclassified the majority of our liability for unrecognized tax benefits from deferred tax liabilities to other liabilities with the remainder being netted against our deferred tax assets. Upon adoption, the total unrecognized tax benefits included items that would favorably affect the income tax provision by $89 million, if recognized. The total unrecognized tax benefits attributable to uncertain tax positions as of June 30, 2007 were $635 million. We recognize interest related to unrecognized tax benefits in interest expense or interest income. We recognize penalties as additional income tax expense. As of January 1, 2007, the accrued expense for income tax related interest and penalties was not material.

 

We file income tax returns in the U.S. federal jurisdiction and each state jurisdiction which imposes an income tax. We also file income tax returns in a number of foreign jurisdictions. However, our foreign income tax activity has historically been immaterial. The Internal Revenue Service, or IRS, is currently examining our 2005 consolidated federal income tax return and other 2005 returns of certain of our subsidiaries. They have effectively completed the examination of our consolidated returns related to years prior to 2005. We have reached settlement agreements with the Appeals division of the IRS for our examination issues in dispute following the IRS exam for the years 1995-2002. The unresolved disputed issues from the 2003-2004 IRS examination are awaiting consideration by IRS Appeals; however, they are immaterial to our consolidated financial statements. The IRS is also examining the 2001 through pre-merger 2005 consolidated income tax returns of our subsidiary, Nextel Communications, Inc. We are also involved in multiple state income tax examinations related to various years beginning with 1988, which are in various stages of the examination, administrative review or appellate process.

 

Based on our current knowledge of the proposed adjustments from the aforementioned examinations, we do not anticipate the adjustments would result in a material change to our financial position. We also do not believe it is reasonably possible that we will have significant increases or decreases to the liability for unrecognized tax benefits during the next twelve months on our current uncertain tax positions.

 

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Effective Income Tax Rate

 

The differences that caused our effective income tax rates to vary from the 35% federal statutory rate for income taxes related to continuing operations were as follows:

 

 

The cumulative effect of state income tax law changes enacted during the second quarter 2007 in Texas and West Virginia resulted in an income tax benefit of $17 million for the second quarter 2007 and the year-to-date period 2007, and 2006 changes in Ohio and Texas resulted in an income tax benefit of $27 million for the year-to-date period 2006.

 

We maintain a valuation allowance against certain of our deferred tax assets in instances where we determine that it is more likely than not that a tax benefit will not be realized. As of June 30, 2007, we maintained a total valuation allowance of about $833 million related to our deferred tax assets. This amount includes a valuation allowance of $618 million for the total tax benefits related to net operating loss carryforwards subject to utilization restrictions, acquired in connection with certain acquisitions. The remainder of the valuation allowance relates to capital loss, state net operating loss and tax credit carryforwards. Within our total valuation allowance, we had $54 million related to separate company state net operating losses incurred by the PCS Affiliates after we acquired them.

 

 

Litigation, Claims and Assessments

 

In March 2004, eight purported class action lawsuits relating to the recombination of our tracking stocks were filed against us and our directors by holders of PCS common stock. Seven of the lawsuits were consolidated in the District Court of Johnson County, Kansas. The eighth, pending in New York, has been voluntarily stayed. The consolidated lawsuit alleges breach of fiduciary duty in connection with allocations between the wireline operations and the wireless operations before the recombination of the tracking stocks and breach of fiduciary duty in the recombination. The lawsuit seeks to rescind the recombination and monetary damages. In December 2006, the court denied defendants’ motion to dismiss the complaint and for summary judgment, and granted a motion to certify the class. In February 2007, the court, upon reconsideration, dismissed a count of the complaint related to intracompany allocations, which requires dismissal of the complaint against three of our former directors and reconsideration of the class definition. In April 2007, the Kansas Court of Appeals accepted interlocutory appeal of the District Court’s class certification and stayed proceedings in the trial court pending the decision on appeal. In July 2007, the parties accepted a mediator’s proposal that the litigation be settled. The proposed settlement had an immaterial impact on our consolidated financial statements.

 

In September 2004, the U.S. District Court for the District of Kansas denied a motion to dismiss a shareholder lawsuit alleging that our 2001 and 2002 proxy statements were false and misleading in violation of federal

 

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securities laws to the extent they described new employment agreements with certain senior executives without disclosing that, according to the allegations, replacement of those executives was inevitable. These allegations, made in an amended complaint in a lawsuit originally filed in 2003, are asserted against us and certain current and former officers and directors, and seek to recover any decline in the value of our tracking stocks during the class period. The parties have stipulated that the case can proceed as a class action. All defendants have denied plaintiffs’ allegations and intend to defend this matter vigorously. Allegations in the original complaint, which asserted claims against the same defendants and our former independent auditor, were dismissed by the court in April 2004.

 

A number of putative class action cases that allege Sprint Communications Company LP failed to obtain easements from property owners during the installation of its fiber optic network in the 1980’s have been filed in various courts. Several of these cases sought certification of nationwide classes, and in one case, a nationwide class has been certified. In 2002, a nationwide settlement of these claims was approved by the U.S. District Court for the Northern District of Illinois, but objectors appealed the preliminary approval order to the Seventh Circuit Court of Appeals, which overturned the settlement and remanded the case to the trial court for further proceedings. The parties now are proceeding with litigation and/or settlement negotiations on a state by state basis. In 2001, we accrued an expense reflecting the estimated settlement costs of these suits.

 

Various other suits, proceedings and claims, including purported class actions, typical for a large business enterprise, are pending against us or our subsidiaries. While it is not possible to determine the ultimate disposition of each of these proceedings and whether they will be resolved consistent with our beliefs, we expect that the outcome of such proceedings, individually or in the aggregate, will not have a material adverse effect on our financial condition or results of operations.

 

 

We operate, and are managed, as two strategic segments: Wireless and Wireline. These segments are organized by products and services.

 

Our executives use segment earnings as the primary measure to evaluate segment performance and make resource allocation decisions. Segment earnings is defined as wireless or wireline operating income before other segment expenses, such as depreciation, amortization, severance, exit costs, asset impairments and other, and merger and integration expenses solely and directly attributable to the segment. Expenses and income items excluded from segment earnings are managed at the corporate level.

 

Our Wireless segment includes revenue from a wide array of wireless mobile telephone and wireless data transmission services and the sale of wireless equipment. Through our Wireless segment, we, together with the third party PCS Affiliates, offer digital wireless service in all 50 states, Puerto Rico and the U.S. Virgin Islands.

 

Our Wireline segment includes revenue from domestic and international wireline voice and data communication services and services to the cable multiple systems operators that resell our long distance service and/or use our back office systems and network assets in support of their local and long distance telephone services provided over cable facilities.

 

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We generally account for transactions between segments based on fully distributed costs, which we believe approximate fair value. In certain transactions, pricing is set using market rates. Segment financial information is as follows:

 

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Net operating revenues by service and products were as follows: