Exhibit 99(a)
[LOGO][SPRINT]
Supplemental Information -- Annex I
-----------------------------------
Sprint FON Group
Combined Financial Information
The FON Group is an integrated business of Sprint Corporation and does not
constitute a stand-alone entity. The purpose of this combined financial
information is to provide investors additional information to use in analyzing
the results of operations and financial condition of the FON Group, and this
combined financial information should be read in conjunction with the
consolidated financial statements of Sprint Corporation.
MANAGEMENT REPORT
Sprint Corporation's management is responsible for the integrity and objectivity
of the information contained in this annex. Management is responsible for the
consistency of reporting this information and for ensuring that accounting
principles generally accepted in the United States are used.
In discharging this responsibility, management maintains a comprehensive system
of internal controls and supports an extensive program of internal audits, has
made organizational arrangements providing appropriate divisions of
responsibility and has established communication programs aimed at assuring that
its policies, procedures and principles of business conduct are understood and
practiced by its employees.
The combined financial statements included in this annex have been audited by
Ernst & Young LLP, independent auditors. Their audits were conducted using
auditing standards generally accepted in the United States and their report is
included herein.
The Board of Director's responsibility for these combined financial statements
is pursued mainly through its Audit Committee. The Audit Committee, composed
entirely of directors who are not officers or employees of Sprint, meets
periodically with the internal auditors and independent auditors, both with and
without management present, to assure that their respective responsibilities are
being fulfilled. The internal and independent auditors have full access to the
Audit Committee to discuss auditing and financial reporting matters.
/s/ W. T. Esrey
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William T. Esrey
Chairman and Chief Executive Officer
/s/ Arthur B. Krause
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Arthur B. Krause
Executive Vice President and Chief Financial Officer
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REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders Sprint Corporation
We have audited the accompanying combined balance sheets of the Sprint FON Group
(as described in Note 1) as of December 31, 2000 and 1999, and the related
combined statements of operations, comprehensive income and cash flows for each
of the three years in the period ended December 31, 2000. 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 auditing standards generally accepted
in the United States. 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 financial statements referred to above present fairly, in
all material respects, the combined financial position of the Sprint FON Group
at December 31, 2000 and 1999, and the combined results of its operations and
its cash flows for each of the three years in the period ended December 31,
2000, in conformity with accounting principles generally accepted in the United
States.
As discussed in Note 7 to the combined financial statements, in 2000 the Sprint
FON Group changed its accounting for service activation and certain installation
fee revenues.
The Sprint FON Group is a fully integrated business of Sprint. Accordingly,
these combined financial statements have been derived from the consolidated
financial statements and accounting records of Sprint and, as discussed in
Note 1, reflect certain assumptions and allocations. As more fully discussed in
Note 1, the combined financial statements of the Sprint FON Group should be read
together with the audited consolidated financial statements of Sprint.
Ernst & Young LLP
Kansas City, Missouri
February 1, 2001
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COMBINED STATEMENTS OF OPERATIONS Sprint FON Group
(millions) (an integrated business
of Sprint Corporation)
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Years Ended December 31, 2000 1999 1998
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Net Operating Revenues $ 17,688 $ 17,160 $ 15,958
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Operating Expenses
Costs of services and products 8,094 7,481 7,163
Selling, general and administrative 4,493 4,620 4,114
Depreciation 2,199 2,086 1,878
Amortization 68 43 43
Asset write-down and merger related costs 401 - -
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Total operating expenses 15,255 14,230 13,198
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Operating Income 2,433 2,930 2,760
Interest expense (76) (182) (243)
Other income (expense), net (187) 49 153
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Income from continuing operations before income taxes 2,170 2,797 2,670
Income taxes (878) (1,061) (995)
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Income from Continuing Operations 1,292 1,736 1,675
Discontinued operation, net 675 (130) (135)
Extraordinary items, net (1) (39) (5)
Cumulative effect of change in accounting principle, net (2) - -
- -------------------------------------------------------------------------------------------------------------------
Net Income $ 1,964 $ 1,567 $ 1,535
==============================================
See accompanying Notes to Combined Financial Statements.
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COMBINED STATEMENTS OF COMPREHENSIVE INCOME Sprint FON Group
(millions) (an integrated business
of Sprint Corporation)
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Years Ended December 31, 2000 1999 1998
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Net Income $ 1,964 $ 1,567 $ 1,535
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Other Comprehensive Income
Unrealized holding gains (losses) on securities (69) 33 28
Income tax (expense) benefit 25 (12) (10)
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Net unrealized holding gains (losses) on securities
during the period (44) 21 18
Reclassification adjustment for net gains included
in net income (2) (57) -
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Total net unrealized holding gains (losses)
on securities (46) (36) 18
Foreign currency translation adjustments (12) - (2)
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Total other comprehensive income (loss) (58) (36) 16
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Comprehensive Income $ 1,906 $ 1,531 $ 1,551
====================================================
See accompanying Notes to Combined Financial Statements.
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COMBINED BALANCE SHEETS Sprint FON Group
(millions) (an integrated business
of Sprint Corporation)
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December 31, 2000 1999
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Assets
Current assets
Cash and equivalents $ 122 $ 104
Accounts receivable, net of allowance for doubtful accounts
of $293 and $228 3,126 2,836
Inventories 434 441
Prepaid expenses 276 251
Receivables from the PCS Group 361 136
Investments in equity securities - 316
Other 193 198
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Total current assets 4,512 4,282
Investments in securities 66 139
Property, plant and equipment
Global markets division 12,512 10,602
Local division 16,835 15,828
Other 1,651 1,257
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Total property, plant and equipment 30,998 27,687
Accumulated depreciation (15,165) (13,685)
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Net property, plant and equipment 15,833 14,002
Investments in and advances to affiliates 842 883
Intangible assets
Goodwill 877 1,223
Other 384 296
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Total intangible assets 1,261 1,519
Accumulated amortization (57) (140)
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Net intangible assets 1,204 1,379
Net assets of discontinued operation - 394
Other assets 1,192 724
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Total $ 23,649 $ 21,803
===================================
Liabilities and Combined Attributed Net Assets
Current liabilities
Current maturities of long-term debt $ 1,026 $ 902
Accounts payable 1,598 1,012
Accrued interconnection costs 547 683
Accrued taxes 264 162
Advance billings 462 323
Payroll and employee benefits 377 557
Other 730 662
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Total current liabilities 5,004 4,301
Long-term debt and capital lease obligations 3,482 4,531
Deferred credits and other liabilities
Deferred income taxes and investment tax credits 1,276 935
Postretirement and other benefit obligations 1,077 1,064
Other 457 448
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Total deferred credits and other liabilities 2,810 2,447
Redeemable preferred stock 10 10
Combined attributed net assets 12,343 10,514
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Total $ 23,649 $ 21,803
===================================
See accompanying Notes to Combined Financial Statements.
I-4
COMBINED STATEMENTS OF CASH FLOWS Sprint FON Group
(millions) (an integrated business
of Sprint Corporation)
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Years Ended December 31, 2000 1999 1998
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Operating Activities
Net income $ 1,964 $ 1,567 $ 1,535
Adjustments to reconcile net income to net cash provided by
operating activities:
Discontinued operation, net (675) 130 135
Extraordinary items, net 1 39 1
Equity in net losses of affiliates 201 70 52
Depreciation and amortization 2,267 2,129 1,921
Deferred income taxes and investment tax credits 386 220 60
Net gains on sales of assets (83) (158) (104)
Net losses on write-down of assets 365 102 -
Changes in assets and liabilities:
Accounts receivable, net (316) (459) 102
Inventories and other current assets 39 (130) (19)
Accounts payable and other current liabilities 711 152 347
Affiliate receivables and payables, net (422) 88 (84)
Noncurrent assets and liabilities, net (103) (76) (24)
Other, net (12) 39 (7)
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Net cash provided by operating activities 4,323 3,713 3,915
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Investing Activities
Capital expenditures (4,105) (3,534) (3,159)
Repayments from (investments in and loans to) Sprint PCS - 314 (154)
Investments in and loans to other affiliates, net (686) (135) (236)
Net proceeds from sales of assets 51 90 230
Purchase of broadband fixed wireless companies,
net of cash acquired - (618) -
Advances from (to) the PCS Group 17 - (64)
Net assets transferred from the PCS Group - - 340
Other, net (16) (82) (55)
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Net cash used by continuing operations (4,739) (3,965) (3,098)
Proceeds from the sale of Global One 1,403 - -
Net investing activities of discontinued operation - (384) (268)
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Net cash used by investing activities (3,336) (4,349) (3,366)
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Financing Activities
Proceeds from long-term debt 344 1,020 785
Payments on long-term debt (949) (529) (388)
Proceeds from common stock issued 148 52 -
Proceeds from treasury stock issued 12 134 60
Dividends paid (433) (426) (430)
Treasury stock purchased (61) (48) (321)
Other, net (30) 105 75
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Net cash provided (used) by financing activities (969) 308 (219)
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Increase (Decrease) in Cash and Equivalents 18 (328) 330
Cash and Equivalents at Beginning of Year 104 432 102
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Cash and Equivalents at End of Year $ 122 $ 104 $ 432
====================================================
See accompanying Notes to Combined Financial Statements.
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NOTES TO COMBINED FINANCIAL STATEMENTS Sprint FON Group
(an integrated business
of Sprint Corporation)
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1. Summary of Significant Accounting Policies
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Tracking Stock Formation
In November 1998, Sprint's shareholders approved the allocation of all of
Sprint;s assets and liabilities into two groups, the FON Group and the PCS
Group, as well as the creation of the FON stock and the PCS stock. In addition,
Sprint purchased the remaining ownership interests in Sprint Spectrum Holding
Company, L.P. and PhillieCo, L.P. (together, Sprint PCS), other than a minority
interest in Cox Communications PCS, L.P. (Cox PCS). Sprint acquired these
ownership interests from Tele-Communications, Inc., Comcast Corporation and Cox
Communications, Inc. (the Cable Partners). In exchange, Sprint issued the Cable
Partners special low-vote PCS shares and warrants to acquire additional PCS
shares. Sprint also issued the Cable Partners shares of a new class of preferred
stock convertible into PCS shares. The purchase of the Cable Partners' interests
is referred to as the PCS Restructuring. In the 1999 second quarter, Sprint
acquired the remaining minority interest in Cox PCS.
Also in November 1998, Sprint reclassified each of its publicly traded common
shares into one share of FON stock and 1/2 share of PCS stock. This
recapitalization was tax-free to shareholders. Each Class A common share owned
by France Telecom (FT) and Deutsche Telekom AG (DT) entitles FT and DT to one
share of FON stock and 1/2 share of PCS stock. These transactions are referred
to as the Recapitalization.
In connection with the PCS Restructuring, FT and DT purchased 5.1 million
additional PCS shares (pre-split basis) to maintain their voting power in Sprint
(Top-up).
Operating Segments
Sprint's business is divided into four lines of business: the global markets
division, the local division, the product distribution and directory publishing
businesses and the PCS wireless telephony products and services business. The
FON Group includes the global markets division, the local division and the
product distribution and directory publishing businesses, and the PCS Group
includes the PCS wireless telephony products and services business. The PCS
common stock is intended to reflect the financial results and economic value of
the PCS wireless telephony products and services business. The FON common stock
is intended to reflect the financial results and economic value of the global
markets division, the local division and the product distribution and directory
publishing businesses.
Basis of Combination and Presentation
The FON Group is an integrated business of Sprint Corporation and does not
constitute a stand-alone entity. The purpose of this combined financial
information is to provide investors additional information to use in analyzing
the results of operations and financial condition of the FON Group, and this
combined financial information should be read in conjunction with the
consolidated financial statements of Sprint.
Investors in FON stock are shareholders of Sprint and are subject to the risks
related to an equity investment in Sprint and all of Sprint's businesses, assets
and liabilities. The assets and liabilities allocated by Sprint's Board to the
FON Group remain assets and liabilities of Sprint and are therefore subject to
the claims of Sprint's creditors generally. In the event of the liquidation or
winding up of Sprint Corporation, assets of Sprint remaining for distribution to
Sprint's common shareholders will be distributed to holders of FON stock based
on the liquidation value of such shares as provided in Sprint's articles of
incorporation, which may differ from the Board's allocation of assets and
liabilities among the Groups. The Board of Directors of Sprint may, subject to
the restrictions in Sprint's articles of incorporation, change the allocation of
the assets and liabilities that comprise each of the FON Group and the PCS Group
without shareholder approval. Given the Board's discretion in these matters, it
may be difficult to assess the future prospects of each group based on past
performance.
The combined FON Group financial statements, together with the combined PCS
Group financial statements, include all the accounts in Sprint's consolidated
financial statements prior to inter-group eliminations.
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 FON Group entities are commonly controlled companies. Transactions between
the PCS Group and the FON Group have not been eliminated in the combined
financial statements of either group.
I-6
As a result, the FON Group combined financial statements should be read along
with Sprint's consolidated financial statements and the PCS Group combined
financial statements.
The FON Group combined financial statements are prepared using accounting
principles generally accepted in the United States. These principles require
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities, and
the reported amounts of revenues and expenses. Actual results could differ from
those estimates.
Certain prior year amounts have been reclassified to conform to the current year
presentation. These reclassifications had no effect on the results of operations
or combined attributed net assets as previously reported.
Classification of Operations
Global Markets Division
The global markets division provides a broad suite of communications services
targeted to domestic business and residential customers, multinational
corporations and other communications companies. These services include domestic
and international voice; data communications such as Internet and frame relay
access and transport, web hosting, virtual private networks, and managed
security services; and broadband services.
Sprint is deploying integrated communications services, referred to as Sprint
ION(SM). Sprint ION extends Sprint's existing network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for advanced services including integrated voice, data,
Internet and video. It is also expected to be the foundation for Sprint to
provide advanced services in the competitive local service market. Sprint uses
various advanced services last-mile technologies, including dedicated access and
Digital Subscriber Line (xDSL), and expects to use Multipoint Multichannel
Distribution Services (MMDS).
The global markets division also includes the operating results of the cable TV
service operations of the broadband fixed wireless companies after their 1999
acquisition dates. During 2000, Sprint converted several markets served by MMDS
capabilities from cable TV services to high-speed data services. Global markets
division's operating results reflect the development costs and the operating
revenues and expenses of these broadband fixed wireless services. Sprint intends
to provide broadband data and voice services to additional markets served by
these capabilities.
Included in the global markets division are the costs of establishing
international operations beginning in 2000.
This division also includes the FON Group's investments in EarthLink, Inc., an
Internet service provider; Call-Net, a long distance provider in Canada
operating under the Sprint brand name; Intelig, a long distance provider in
Brazil, and certain other telecommunications investments and ventures.
Local Division
The local division consists mainly of regulated local phone companies serving
approximately 8.3 million access lines in 18 states. It provides local services,
access by phone customers and other carriers to its local network, consumer long
distance services to customers within its franchise territories, sales of
telecommunications equipment, and other long distance services within certain
regional calling areas, or LATAs.
Product Distribution and Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
Allocation of Shared Services
Sprint directly assigns, where possible, certain general and administrative
costs to the FON Group and the PCS Group based on their actual use of those
services. Where direct assignment of costs is not possible, or practical, Sprint
uses other indirect methods, including time studies, to estimate the assignment
of costs to each group. Cost allocation methods other than time studies include
factors (general, marketing or headcount) derived from the operating unit's
relative share of the predefined category referenced (e.g. headcount). Sprint
believes that the costs allocated are comparable to the costs that would be
incurred if the groups would have been operating on a stand-alone basis. The
allocation of shared services may change at the discretion of Sprint and does
not require shareholder approval.
Allocation of Federal and State Income Taxes
Sprint files a consolidated federal income tax return and certain state income
tax returns which include FON Group and PCS Group results. In connection
I-7
with the PCS Restructuring, Sprint adopted a tax sharing agreement which
provides for the allocation of income taxes between the two groups. The FON
Group's income taxes are calculated as if it files returns which exclude the PCS
Group. Intergroup tax payments are satisfied on the date Sprint's related tax
payment is due to or the refund is received from the applicable tax authority.
The FON Group accrued income taxes payable to the PCS Group in accordance with
the tax sharing agreement totaling $605 million in 2000, $887 million in 1999
and $190 million in 1998.
The tax sharing agreement applies to tax years ending on or before December 31,
2001. For periods after December 31, 2001, Sprint's board of directors will
adopt a tax sharing arrangement that will be designed to allocate tax benefits
and burdens fairly between the FON Group and the PCS Group.
Allocation of Group Financing
Financing activities for the groups are managed by Sprint on a centralized
basis. Debt incurred by Sprint on behalf of the groups is specifically allocated
to and reflected in the financial statements of the applicable group. Interest
expense is allocated to the PCS Group based on an interest rate that is
substantially equal to the rate it would be able to obtain from third parties as
a direct or indirect wholly owned Sprint subsidiary, but without the benefit of
any guaranty by Sprint or any member of the FON Group. That interest rate is
higher than the rate Sprint obtains on borrowings. The difference between
Sprint's actual interest rate and the rate charged to the PCS Group is reflected
as a reduction in the FON Group's interest expense.
Under Sprint's centralized cash management program, one group may advance funds
to the other group. These advances are accounted for as short-term borrowings
between the groups and bear interest at a market rate that is substantially
equal to the rate that group would be able to obtain from third parties on a
short-term basis.
The allocation of group financing activities may change at the discretion of
Sprint and does not require shareholder approval.
Income Taxes
The FON Group records deferred income taxes based on temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and their tax bases.
Revenue Recognition
The FON Group recognizes operating revenues as services are rendered or as
products are delivered to customers. Service activation and certain installation
fees are deferred and amortized over the average life of the service. Sprint's
directory publishing business recognizes revenues for directory services over
the life of the related directory (amortization method).
Cash and Equivalents
Cash and equivalents generally include highly liquid investments with original
maturities of three months or less. They are stated at cost, which approximates
market value. Sprint uses controlled disbursement banking arrangements as part
of its cash management program. Outstanding checks in excess of cash balances
for the FON Group were included in accounts payable. These amounts totaled $614
million at year-end 2000 and $174 million at year-end 1999. 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 "Combined
attributed net assets," net of related income taxes.
Inventories
Inventories are stated at the lower of cost (principally first-in, first-out
method) or market value.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost. Generally, ordinary asset
retirements and disposals are charged against accumulated depreciation with no
gain or loss recognized. The cost of property, plant and equipment is generally
depreciated on a straight-line basis over estimated economic useful lives.
Repair and maintenance costs are expensed as incurred.
Capitalized Interest
The FON Group capitalized interest costs related to constructing capital assets
of $22 million in 2000, $43 million in 1999 and $42 million in 1998. In
addition, Sprint capitalized interest costs related to the PCS Group's network
buildout. Capitalized interest totaled $61 million for 1998 and was contributed
to, and is being amortized by, the PCS Group.
I-8
Intangible Assets
The FON Group evaluates the recoverability of intangible assets when events or
circumstances indicate that such assets might be impaired. The FON Group
determines impairment by comparing the undiscounted future cash flows estimated
to be generated by these assets to their respective carrying value. In the event
impairment exists, a loss is recognized based on the amount by which the
carrying value exceeds the fair value of the asset.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the
net assets acquired in business combinations accounted for as purchases.
Goodwill is being amortized over five to 40 years using the straight-line
method. Accumulated amortization totaled $28 million at year-end 2000 and $94
million at year-end 1999.
Stock-based Compensation
The FON Group participates in the incentive-based stock option plans and
employee stock purchase plan administered by Sprint for executives and other
employees. Sprint adopted the pro forma disclosure requirements under Statement
of Financial Accounting Standards (SFAS) No. 123, "Stock-based Compensation,"
and continues to apply Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations to its stock option
and employee stock purchase plans. Had the FON Group applied SFAS 123, pro forma
net income would have been $1,668 million for 2000, $1,434 million for 1999 and
$103 million from the Recapitalization date through year-end 1998. See Note 13
of Sprint's Notes to Consolidated Financial Statements for more information
about Sprint's stock-based compensation and the FON Group's pro forma net income
and earnings per share.
In 1997, Sprint granted performance-based stock options to certain key
executives. The FON Group expensed $5 million in 2000, $9 million in 1999 and
$14 million in 1998 related to these performance-based stock options. The 2000
amount reflects expense through the date of the shareholder approval of the
proposed WorldCom merger. At that time, all of these options became vested. An
additional $19 million of expense related to these options was included in
"Asset write-down and merger related costs" in the Combined Statements of
Operations.
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2. Business Combinations
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Broadband Fixed Wireless Companies
In the second half of 1999, Sprint acquired People's Choice TV Corp. (PCTV),
American Telecasting, Inc. (ATI), Videotron USA and the operating subsidiaries
of WBS America, LLC. These companies own broadband fixed wireless licenses in
the Midwest, Southwest, North Central, Western and Southeastern United States.
Sprint paid $618 million for the companies' outstanding stock and assumed $575
million of the companies' debt. These notes were redeemed, prior to scheduled
maturities, in the 1999 fourth quarter (see Note 10).
These acquisitions were accounted for as purchases. As a result, the financial
statements of these companies have been reflected in the FON Group's combined
financial statements after the acquisition dates. The excess of the purchase
price over the net liabilities acquired totaled $835 million and was allocated
to goodwill, which is being amortized on a straight-line basis over 40 years.
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3. Investments
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Investments in Securities
The cost of investments in securities was $13 million at year-end 2000 and $153
million at year-end 1999. Gross unrealized holding gains were $53 million at
year-end 2000 and $302 million at year-end 1999.
In the 2000 fourth quarter, the FON Group recorded a write-down of securities
with a cost basis of $48 million due to a decline in market value that was
considered other than temporary. The $48 million charge was included in "Other
income (expense), net" in the Combined Statements of Operations.
During 2000, Sprint used equity securities with a cost basis of $94 million to
retire debt instruments (see Note 10). The FON Group recorded a $45 million gain
associated with the transaction which was included in "Other income (expense),
net" in the Combined Statements of Operations. At year-end 1999, these equity
securities were classified as current assets at their fair value.
During 1999, the FON Group sold available-for-sale securities with a cost basis
of $14 million for $104 million. The $90 million gain was included in "Other
income (expense), net" in the Combined Statements of Operations.
Investments in and Advances to Other Affiliates
At year-end 2000, investments accounted for using the equity method consisted of
the FON Group's investments in Intelig, EarthLink and certain other strategic
investments. In February 2001, Sprint modified its relationship with EarthLink
which resulted in the FON Group's investment being accounted for as a cost
method investment (see Note 17).
In the 2000 fourth quarter, Sprint completed an analysis of the valuation of its
equity method investments in response to changes in the overall
telecommunications industry. The analysis resulted in an $87 million charge for
the write-down of an equity method investment which was included in "Other
income (expense), net" in the FON Group's Combined Statements of Operations.
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Combined, unaudited, summarized financial information (100% basis) of these
entities and others accounted for using the equity method was as follows:
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2000 1999 1998
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(millions)
Results of operations
Net operating revenues $ 2,091 $ 1,571 $ 1,242
================================
Operating income (loss) $ (649) $ (192) $ 67
================================
Net loss $ (870) $ (329) $ (145)
================================
Financial position
Current assets $ 1,393 $ 1,524 $ 1,038
Noncurrent assets 2,184 2,749 2,401
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Total $ 3,577 $ 4,273 $ 3,439
================================
Current liabilities $ 735 $ 599 $ 538
Noncurrent liabilities 206 1,644 1,004
Owners' equity 2,636 2,030 1,897
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Total $ 3,577 $ 4,273 $ 3,439
================================
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4. Asset Write-down
- --------------------------------------------------------------------------------
In the 2000 fourth quarter, Sprint completed its analysis of the valuation of
various FON Group assets resulting from its reassessment of the FON Group's
business strategies in response to recent changes within the overall
telecommunications industry. This analysis resulted in a $238 million pre-tax
charge, primarily related to the impairment of goodwill associated with the
global markets division's Paranet operations.
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5. Merger Termination
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On July 13, 2000, Sprint and WorldCom, Inc. announced that the boards of
directors of both companies terminated their merger agreement, previously
announced in October 1999, as a result of regulatory opposition to the merger.
In the 2000 second quarter, the FON Group recognized a one-time, pre-tax charge
of $163 million for costs associated with the terminated merger.
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6. Discontinued Operation
- --------------------------------------------------------------------------------
In the 2000 first quarter, Sprint sold its interest in Global One to FT and DT.
Sprint received $1.1 billion in cash and was repaid $276 million for advances
for its entire stake in Global One. As a result of Sprint's sale of its interest
in Global One, Sprint's gain on the sale and equity share of the results of
Global One have been reported as a discontinued operation for all periods
presented.
In 2000, the FON Group recorded an after-tax gain related to the sale of its
interest in Global One of $675 million. The FON Group recorded after-tax losses
related to Global One totaling $130 million in 1999 and $135 million in 1998.
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7. Cumulative Effect of Change in Accounting Principle
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The FON Group implemented SEC Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," during the fourth quarter of 2000,
effective the beginning of the year. This bulletin requires activation and
installation fee revenues that do not represent a separate earnings process to
be deferred and recognized over the estimated service period. Associated
incremental direct costs may also be deferred, but only to the extent of
revenues subject to deferral. The FON Group recorded a $2 million charge for the
cumulative effect of change in accounting principle in 2000. The change had no
material impact on the nine months ended September 30, 2000.
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8. Employee Benefit Plans
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Defined Benefit Pension Plan
Most FON Group employees are covered by a noncontributory defined benefit
pension plan sponsored by Sprint. Benefits for plan participants belonging to
unions are based on negotiated schedules. For non-union participants, pension
benefits are based on years of service and the participants' compensation.
Sprint's policy is to make plan contributions equal to an actuarially determined
amount consistent with federal tax regulations. The funding objective is to
accumulate funds at a relatively stable rate over the participants' working
lives so benefits are fully funded at retirement.
Amounts included in the Combined Balance Sheets for the plan were prepaid
pension costs of $407 million at year-end 2000 and $285 million at year-end
1999.
Net pension costs or credits are determined for the FON Group based on a direct
calculation of service costs and interest on projected benefit obligations and
an appropriate allocation of unrecognized prior service costs, amortization of
unrecognized transition asset, actuarial gains and losses, and expected return
on plan assets. The FON Group recorded net pension credits of $122 million in
2000, $63 million in 1999 and $46 million in 1998.
I-10
Defined Contribution Plans
Sprint sponsors defined contribution employee savings plans covering most FON
Group employees. Participants may contribute portions of their pay to the plans.
For union employees, Sprint matches contributions based on negotiated amounts.
Sprint also matches contributions of non-union employees in FON and PCS stock.
The matching is equal to 50% of participants' contributions up to 6% of their
pay. In addition, Sprint may, at the discretion of the Board of Directors,
provide additional matching contributions based on the performance of FON and
PCS stock compared to other telecommunications companies' stock. The FON Group
recorded expenses of $95 million in 2000, $73 million in 1999 and $54 million in
1998 for Sprint's matching contributions to the Sprint defined contribution
plans. At year-end 2000, Sprint's defined contribution plans held 34 million FON
shares and 31 million PCS shares.
Postretirement Benefits
Sprint provides postretirement benefits (mainly medical and life insurance
benefits) to most FON Group employees. Employees retiring before certain dates
are eligible for benefits at no cost, or at a reduced cost. Employees retiring
after certain dates are eligible for benefits on a shared-cost basis. Sprint
funds the accrued costs as benefits are paid.
Amounts included in the Combined Balance Sheets at year-end were accrued
postretirement benefits costs of $1.1 billion in 2000 and $1.0 billion in 1999.
Net postretirement benefits costs are determined for the FON Group based on a
direct calculation of service costs and interest on accumulated postretirement
benefit obligations and an appropriate allocation of unrecognized prior service
costs and actuarial gains. The FON Group recorded net postretirement benefits
costs of $62 million in 2000, $54 million in 1999 and $51 million in 1998.
- --------------------------------------------------------------------------------
9. Income Taxes
- --------------------------------------------------------------------------------
Income tax expense allocated to continuing operations consisted of the
following:
--------------------------------------------------------------------
2000 1999 1998
--------------------------------------------------------------------
(millions)
Current income tax expense
Federal $ 429 $ 776 $ 861
State 63 65 74
--------------------------------------------------------------------
Total current 492 841 935
--------------------------------------------------------------------
Deferred income tax expense
Federal 338 170 38
State 48 50 22
--------------------------------------------------------------------
Total deferred 386 220 60
--------------------------------------------------------------------
Total $ 878 $ 1,061 $ 995
=================================
I-11
The differences that caused the FON Group's effective income tax rates to vary
from the 35% federal statutory rate for income taxes related to continuing
operations were as follows:
- --------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------
(millions)
Income tax expense at the federal
statutory rate $ 759 $ 979 $ 935
Effect of:
State income taxes, net of
federal income tax effect 72 75 62
Equity in losses of foreign
joint ventures 25 18 6
Write down of equity method
investment 30 - -
Other, net (8) (11) (8)
- --------------------------------------------------------------------
Income tax expense $ 878 $ 1,061 $ 995
================================
Effective income tax rate 40.5% 37.9% 37.3%
================================
Income tax expense (benefit) allocated to other items was as follows:
- ----------------------------------------------------------------------
2000 1999 1998
- ----------------------------------------------------------------------
(millions)
Discontinued operation $ 370 $ (111) $ (62)
Extraordinary items (1) (23) (3)
Unrealized holding gains (losses)
on investments/(1)/ (26) (20) 10
Stock ownership, purchase and
options arrangements/(1)/ (276) (223) (49)
- ----------------------------------------------------------------------
/(1)/ These amounts have been recorded directly to "Combined attributed net
assets."
I-12
The FON Group recognizes deferred income taxes for the temporary differences
between the carrying amounts of its assets and liabilities for financial
statement purposes and their tax bases. The sources of the differences that give
rise to the deferred income tax assets and liabilities at year-end 2000 and
1999, along with the income tax effect of each, were as follows:
- ------------------------------------------------------------------------
2000 Deferred Income Tax
------------------------------
Assets Liabilities
- ------------------------------------------------------------------------
(millions)
Property, plant and equipment $ - $ 1,891
Postretirement and other benefits 428 -
Reserves and allowances 175 -
Unrealized holding gains on investments - 26
Operating loss carryforwards 217 -
Other, net 144 -
- ------------------------------------------------------------------------
964 1,917
Less valuation allowance 273 -
- ------------------------------------------------------------------------
Total $ 691 $ 1,917
==============================
- ------------------------------------------------------------------------
1999 Deferred Income Tax
------------------------------
Assets Liabilities
- ------------------------------------------------------------------------
(millions)
Property, plant and equipment $ - $ 1,555
Postretirement and other benefits 422 -
Reserves and allowances 143 -
Unrealized holding gains on investments - 52
Operating loss carryforwards 197 -
Tax credit carryforwards 22 -
Other, net 161 -
- ------------------------------------------------------------------------
945 1,607
Less valuation allowance 197 -
- ------------------------------------------------------------------------
Total $ 748 $ 1,607
==============================
Management believes it is more likely than not that these deferred income tax
assets, net of the valuation allowance, will be realized based on current income
tax laws and expectations of future taxable income stemming from the reversal of
existing deferred tax liabilities or ordinary operations. Uncertainties
surrounding income tax law changes, shifts in operations between state taxing
jurisdictions, and future operating income levels may, however, affect the
ultimate realization of all or some of these deferred income tax assets.
The valuation allowance related to deferred income tax assets increased $76
million in 2000 and $193 million in 1999.
In 1999, the FON Group acquired approximately $193 million of potential tax
benefits related to net operating loss carryforwards in the acquisitions of the
broadband fixed wireless companies. These benefits are subject to certain
realization restrictions under various tax laws. A valuation allowance was
provided for the total of these benefits. If these benefits are subsequently
recognized, they will reduce goodwill or other noncurrent intangible assets
resulting from the application of the purchase method of accounting for these
transactions.
At year-end 2000, the FON Group had federal operating loss carryforwards of $514
million and state operating loss carryforwards of $923 million. Related to these
loss carryforwards are federal tax benefits of $180 million and state tax
benefits of $56 million which expire in varying amounts through 2020.
I-13
- --------------------------------------------------------------------------------
10. Long-term Debt and Capital Lease Obligations
- --------------------------------------------------------------------------------
Sprint's consolidated long-term debt and capital lease obligations at year-end
was as follows:
- ------------------------------------------------------------------------------------------------------------------------------------
2000 1999
------------------------------------ ------------------------------------
Sprint Sprint Sprint Sprint
FON PCS FON PCS
Maturing Group Group Consolidated Group Group Consolidated
- ------------------------------------------------------------------------------------------------------------------------------------
(millions)
Senior notes
5.7% to 7.6%/(1)/ 2001 to 2028 $ 1,105 $ 9,395 $ 10,500 $ 1,105 $ 8,145 $ 9,250
8.1% to 9.8% 2000 to 2003 382 - 382 632 - 632
11.0% to 12.5%/(2)/ 2001 to 2006 - 776 607 - 734 584
Debentures and notes
5.8% to 9.6% 2000 to 2022 500 - 500 565 - 565
Notes payable and commercial paper - 157 3,797 3,954 294 1,971 2,265
First mortgage bonds
5.9% to 9.9% 2000 to 2025 1,085 - 1,085 1,295 - 1,295
Capital lease obligations
5.2% to 14.0% 2000 to 2008 61 408 469 69 486 555
Revolving credit facilities
Variable rates 2002 900 - 900 900 - 900
Other
2.0% to 10.0% 2000 to 2006 318 4 322 573 153 726
- ------------------------------------------------------------------------------------------------------------------------------------
4,508 14,380 18,719 5,433 11,489 16,772
Less: current maturities/(2)/ 1,026 244 1,205 902 185 1,087
- ------------------------------------------------------------------------------------------------------------------------------------
Long-term debt and capital lease
obligations/(2)/ $ 3,482 $ 14,136 $ 17,514 $ 4,531 $ 11,304 $ 15,685
============================================================================
/(1)/ These borrowings were incurred by Sprint and allocated to the applicable
group. Sprint's weighted average interest rate related to these borrowings
was 6.7% at year-end 2000 and 6.6% at year-end 1999. The weighted average
interest rate related to the borrowings allocated to the PCS Group was
approximately 8.8% at year-end 2000 and 8.7% at year-end 1999. See Note 1
for a more detailed description of how Sprint allocates financing to each
of the groups.
/(2)/ Consolidated debt does not equal the total of PCS Group and FON Group debt
due to intergroup debt eliminated in consolidation. The FON Group had an
investment in the PCS Group's Senior Discount notes totaling $169 million
at year-end 2000, including $65 million classified as current, and $150
million at year-end 1999.
I-14
Scheduled principal payments, excluding reclassified short-term borrowings,
during each of the next five years are as follows:
- ------------------------------------------------------
Sprint Sprint
FON PCS
Group Group Sprint
- ------------------------------------------------------
(millions)
2001/(1)/ $ 1,026 $ 258 $ 1,214
2002 1,339 1,309 2,648
2003 372 1,060 1,432
2004 144 1,062 1,206
2005 122 61 183
- ------------------------------------------------------
/(1)/ The 2001 scheduled principal payments do not equal current maturities as
these amounts reflect the maturity value of the scheduled payment on the
PCS Group's Senior Discount notes.
Included in the above schedule are payments on PCS Group debt that are to be
made in Japanese yen. The yen needed to satisfy the obligations is currently
held on deposit by the PCS Group and included in "Other assets" on the PCS
Group's Combined Balance Sheets. The scheduled yen payments included in the
above schedule are $1 million in 2003, $20 million in 2004 and $43 million in
2005.
Sprint
Short-term Borrowings
Sprint had bank notes payable totaling $676 million at year-end 2000 and $670
million at year-end 1999. In addition, Sprint had commercial paper borrowings
totaling $3.3 billion at year-end 2000 and $1.6 billion at year-end 1999. Though
these borrowings are renewable at various dates throughout the year, they were
classified as long-term debt because of Sprint's intent and ability to refinance
these borrowings on a long-term basis through unused credit facilities and
unissued debt under Sprint's shelf registration.
Sprint currently has revolving credit facilities with syndicates of domestic and
international banks totaling $5 billion; $3 billion of which is a 364 day
facility, renewed in August 2000, expiring in 2001, and $2 billion is a 5 year
facility expiring in 2003. Commercial paper and certain bank notes are supported
by Sprint's revolving credit facilities. Certain other notes payable relate to a
separate revolving credit facility which expires in 2002. At year-end 2000,
Sprint had total unused lines of credit of $1.8 billion.
Bank notes outstanding had weighted average interest rates of 7.1% at year-end
2000 and 6.3% at year-end 1999. The weighted average interest rate of commercial
paper was 7.5% at year-end 2000 and 6.4% at year-end 1999.
Long-term Debt
In June 2000, Sprint issued $1.25 billion of debt securities under its $4
billion shelf registration statement with the SEC. These borrowings mature in
2002 and have interest rates ranging from 6.9% to 7.6%. At year-end 2000, Sprint
had issued a total of $2 billion of debt securities under the shelf. In January
2001, Sprint issued securities using the remaining amount of the shelf (see Note
19 of Notes to Sprint's Consolidated Financial statements).
In June 1999, Sprint entered into a $1 billion financing agreement to sell, on a
continuous basis with recourse, undivided percentage ownership interests in a
designated pool of its accounts receivable. Subsequent collections of
receivables sold to investors are typically reinvested in new receivables. At
year-end 2000, Sprint had borrowed $900 million with a weighted average interest
rate of 6.9% under this agreement. These borrowings mature in 2002.
Sprint FON Group
In 2000, the FON Group received an allocation of $344 million of debt from
Sprint. This debt was mainly used to repay existing debt and to fund new capital
investments. See Note 1 for a more detailed description of how Sprint allocates
debt to the groups.
In the 2000 fourth quarter, Sprint redeemed, prior to scheduled maturities, $25
million of FON Group debt with a weighted average interest rate of 9.6%. This
resulted in a $1 million after-tax extraordinary loss for the FON Group.
In the 2000 first quarter, Sprint exchanged 6.6 million common shares of SBC
Communications, Inc. for certain notes payable of the FON Group. The notes had a
market value of $275 million on the maturity date and $316 million at year-end
1999. The notes had an interest rate of 8.3%.
In the 1999 fourth quarter, Sprint redeemed, prior to scheduled maturities, $575
million of the assumed broadband fixed wireless companies' debt with interest
rates ranging from 13.1% to 14.5%. This resulted in a $39 million after-tax
extraordinary loss for the FON Group.
I-15
In 1998, Sprint redeemed, prior to scheduled maturities, $138 million of FON
Group debt with interest rates ranging from 7.9% to 9.3%. This resulted in a $5
million after-tax extraordinary loss for the FON Group.
FON Group gross property, plant and equipment totaling $16.1 billion was either
pledged as security for first mortgage bonds and certain notes or is restricted
for use as mortgaged property.
Other
Sprint, including the FON Group, had complied with all restrictive or financial
covenants relating to its debt arrangements at year-end 2000.
- ------------------------------------------------------
11. Combined Attributed Net Assets
- ------------------------------------------------------
- ------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------
(millions)
Beginning balance $ 10,514 $ 9,024 $ 7,639
Net income 1,964 1,567 1,535
Dividends (435) (427) (431)
Common stock issued 202 209 164
Treasury stock
purchased (61) (48) (321)
Tax benefit of
stock compensation 276 223 49
Contributions to
the PCS Group - - (146)
Equity transfer
from the PCS Group - - 460
Other comprehensive
income (loss) (58) (36) 16
Other, net (59) 2 59
------------------------------------------------------
Ending balance $ 12,343 $ 10,514 $ 9,024
=================================
- -------------------------------------------------------
12. Commitments and Contingencies
- -------------------------------------------------------
Litigation, Claims and Assessments
FON shareholders are subject to all of the risks related to an investment in
Sprint and the FON Group, including the effects of any legal proceedings and
claims against the PCS Group.
In December 2000, Amalgamated Bank, an institutional shareholder, filed a
derivative action purportedly on behalf of Sprint against certain of its current
and former officers and directors in the Jackson County, Missouri, Circuit
Court. The complaint alleges that the individual defendants breached their
fiduciary duties to Sprint and were unjustly enriched by making undisclosed
amendments to Sprint's stock option plans, by failing to disclose certain
information concerning regulatory approval of the proposed merger of Sprint and
WorldCom, and by overstating Sprint's earnings for the first quarter of 2000.
The plaintiff seeks damages, to be paid to Sprint, in an unspecified amount. Two
additional, substantially identical, derivative actions by other shareholders
have been filed.
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 be material to the FON Group's combined financial
statements.
Operating Leases
The FON Group's minimum rental commitments at year-end 2000 for all
noncancelable operating leases, consisting mainly of leases for data processing
equipment and real estate, are as follows:
- ------------------------------------------------------
(millions)
2001 $ 372
2002 252
2003 175
2004 124
2005 93
Thereafter 301
- ------------------------------------------------------
The FON Group's gross rental expense totaled $643 million in 2000, $575 million
in 1999 and $474 million in 1998. Rental commitments for subleases, contingent
rentals and executory costs were not significant.
- ------------------------------------------------------
13. Financial Instruments
- ------------------------------------------------------
Fair Value of Financial Instruments
Sprint estimates the fair value of the FON Group's financial instruments using
available market information and appropriate valuation methodologies. As a
result, the following estimates do not necessarily represent the values the FON
Group could realize in a current market exchange. Although management is not
aware of any factors that would affect the year-end 2000 estimated fair values,
those amounts have not been comprehensively revalued for purposes of these
financial statements since that date. Therefore, estimates of fair value after
year-end 2000 may differ significantly from the amounts presented below.
I-16
The carrying amounts and estimated fair values of the FON Group's financial
instruments at year-end were as follows:
- ---------------------------------------------------------
2000
------------------------------
Carrying Estimated
Amount Fair Value
- ---------------------------------------------------------
(millions)
Cash and equivalents $ 122 $ 122
Investment in affiliate
debt securities 188 188
Investments in securities 66 66
Long-term debt and capital
lease obligations 4,508 4,539
Redeemable preferred stock 10 9
- ---------------------------------------------------------
- ---------------------------------------------------------
1999
------------------------------
Carrying Estimated
Amount Fair Value
- ---------------------------------------------------------
(millions)
Cash and equivalents $ 104 $ 104
Investment in affiliate
debt securities 169 169
Investments in securities 455 455
Long-term debt and capital
lease obligations 5,433 5,497
Redeemable preferred stock 10 9
- ---------------------------------------------------------
The carrying amounts of the FON Group's cash and equivalents approximate fair
value at year-end 2000 and 1999. The estimated fair value of investments in debt
and equity securities was based on quoted market prices. The estimated fair
value of the FON Group's long-term debt was based on quoted market prices for
publicly traded issues. The estimated fair value of all other issues was based
on either the Black-Scholes pricing model or the present value of estimated
future cash flows using a discount rate based on the risks involved.
Concentrations of Credit Risk
The FON Group's accounts receivable are not subject to any concentration of
credit risk.
I-17
- ---------------------------------------------------------
14. Additional Financial Information
- ---------------------------------------------------------
Segment Information
The FON Group operates in three business segments, based on how Sprint manages
the FON Group's operations and assesses its performance: the global markets
division, the local division, and the product distribution and directory
publishing businesses. Beginning in 2000, the FON Group combined its long
distance operation, Sprint ION and broadband fixed wireless services and certain
other ventures into one division, global markets. Along with creating the global
markets division, the FON Group shifted the recognition of consumer long
distance revenues and expenses associated with customers in its local franchise
territories from the global markets division to the local division. Prior
periods have been restated to reflect these changes.
Sprint generally accounts for transactions between segments based on fully
distributed costs, which Sprint believes approximates fair value.
Segment financial information was as follows:
- --------------------------------------------------------------------------------------------------------------
Product
Global Distribution Corporate Sprint
Markets Local & Directory and FON
Division Division Publishing Eliminations/(1)/ Group
- --------------------------------------------------------------------------------------------------------------
(millions)
2000
Net operating revenues $ 10,528 $ 6,155 $ 1,936 $ (931) $ 17,688
Intercompany revenue 105 137 689 (931) -
Depreciation and amortization 1,121 1,139 16 (9) 2,267
Operating expenses 9,943 4,392 1,652 (732) 15,255
Operating income (loss) 585 1,763 284 (199) 2,433
Operating margin 5.6% 28.6% 14.7% - 13.8%
Capital expenditures 2,294 1,371 8 432 4,105
Total assets 12,042 9,219 845 (1,543) 23,649
1999
Net operating revenues $ 10,308 $ 5,958 $ 1,758 $ (864) $ 17,160
Intercompany revenue 93 133 638 (864) -
Depreciation and amortization 1,045 1,069 17 (2) 2,129
Operating expenses 9,133 4,405 1,516 (824) 14,230
Operating income (loss) 1,175 1,553 242 (40) 2,930
Operating margin 11.4% 26.1% 13.8% - 17.1%
Capital expenditures 1,774 1,354 36 370 3,534
Total assets 10,661 8,641 651 1,850 21,803
1998
Net operating revenues $ 9,541 $ 5,599 $ 1,709 $ (891) $ 15,958
Intercompany revenue 53 130 708 (891) -
Depreciation and amortization 928 984 13 (4) 1,921
Operating expenses 8,351 4,198 1,478 (829) 13,198
Operating income (loss) 1,190 1,401 231 (62) 2,760
Operating margin 12.5% 25.0% 13.5% - 17.3%
Capital expenditures 1,518 1,374 9 258 3,159
Total assets 8,008 8,176 612 2,205 19,001
/(1)/ Significant intercompany eliminations consist of equipment purchases from
the product distribution business, local access charged to the global
markets division and interexchange services provided to the local
division. In 2000, corporate operating loss includes a $163 million
charge for costs associated with the terminated merger between Sprint and
WorldCom, Inc.
More than 95% of the FON Group's revenues are from domestic customers located
within the United States.
I-18
Net operating revenues by product and services were as follows:
- --------------------------------------------------------------------------------------------------------------
Product
Global Distribution Sprint
Markets Local & Directory FON
Division Division Publishing Eliminations/(1)/ Group
- --------------------------------------------------------------------------------------------------------------
(millions)
2000
Voice $ 7,094 $ - $ - $ (105) $ 6,989
Data 1,937 - - - 1,937
Internet 920 - - - 920
Local service - 2,846 - - 2,846
Network access - 1,987 - (133) 1,854
Toll service - 717 - - 717
Product distribution - - 1,468 (689) 779
Directory publishing - - 468 - 468
Other 577 605 - (4) 1,178
- --------------------------------------------------------------------------------------------------------------
Total net operating revenues $ 10,528 $ 6,155 $ 1,936 $ (931) $ 17,688
================================================================================
1999
Voice $ 7,445 $ - $ - $ (93) $ 7,352
Data 1,696 - - - 1,696
Internet 615 - - - 615
Local service - 2,677 - - 2,677
Network access - 1,918 - (130) 1,788
Toll service - 611 - - 611
Product distribution - - 1,350 (638) 712
Directory publishing - - 408 - 408
Other 552 752 - (3) 1,301
- --------------------------------------------------------------------------------------------------------------
Total net operating revenues $ 10,308 $ 5,958 $ 1,758 $ (864) $ 17,160
================================================================================
1998
Voice $ 7,079 $ - $ - $ (53) $ 7,026
Data 1,396 - - - 1,396
Internet 434 - - - 434
Local service - 2,469 - - 2,469
Network access - 1,894 - (127) 1,767
Toll service - 503 - - 503
Product distribution - - 1,315 (708) 607
Directory publishing - - 394 - 394
Other 632 733 - (3) 1,362
- --------------------------------------------------------------------------------------------------------------
Total net operating revenues $ 9,541 $ 5,599 $ 1,709 $ (891) $ 15,958
================================================================================
/(1)/ Significant intercompany eliminations consist of equipment purchases from
the product distribution business, local access charged to the global
markets division and interexchange services provided to the local
division. In 2000, corporate operating loss includes a $163 million charge
for costs associated with the terminated merger between Sprint and
WorldCom, Inc.
I-19
Supplemental Cash Flows Information
The FON Group's cash paid for interest and income taxes was as follows:
- ----------------------------------------------------------
2000 1999 1998
- ----------------------------------------------------------
(millions)
Interest (net of
capitalized interest) $ 113 $ 82 $ 217
================================
Income taxes $ 486 $ 633 $ 327
================================
Noncash activities for the FON Group included the following:
- ------------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------------
(millions)
Tax benefit from
stock options
exercised $ 276 $ 223 $ 49
=================================
Stock received for
stock options
exercised $ 29 $ 78 $ 18
=================================
Noncash
extinguishment of
debt $ 275 $ 78 $ -
=================================
Common stock issued
under employee
benefit stock plans $ 106 $ 95 $ 99
=================================
Capital lease
obligations $ - $ 41 $ -
=================================
Debt assumed in the
broadband fixed
wireless acquisitions $ - $ 575 $ -
=================================
Intergroup Investments and Transactions
Sprint FON Group Investments in the Sprint PCS Group
The following table reflects the FON Group's investments in the PCS Group, which
have been eliminated in Sprint's consolidated financial statements:
- --------------------------------------------------------
2000 1999
- --------------------------------------------------------
(millions)
Common and preferred
intergroup interest $ 260 $ 262
Investment in debt securities/(1)/ 188 169
- --------------------------------------------------------
Total $ 448 $ 431
====================
/(1)/ $65 million is classified as current at year-end 2000 and is included in
"Receivables from the PCS Group" in the FON Group's Combined Balance
Sheets.
Common Intergroup Interest
The FON Group received a 1% intergroup interest in the PCS Group at the time of
the PCS Restructuring and Recapitalization. Subsequently, PCS shares
representing the intergroup interest were issued to FON Group employees,
exhausting the FON Group's interest in the PCS Group in January 2000.
The FON Group's share of the PCS Group's net loss totaled $13 million in 1999
and $6 million from the date of the PCS Restructuring to year-end 1998 and was
included in "Other income, net" in the Sprint FON Group Combined Statements of
Operations. As the intergroup interest was exhausted in 2000, no additional PCS
Group losses were recognized by the FON Group in 2000.
Preferred Intergroup Interest
The FON Group provided Sprint PCS and the PCS Group with interim financing from
the date the PCS Restructuring agreement was signed in May 1998 until it was
completed in November 1998. As part of the PCS Restructuring, Sprint converted
this financing, totaling $279 million, into an intergroup interest representing
0.3 million shares of 10-year PCS preferred stock convertible into a PCS common
intergroup interest. The PCS Group paid the FON Group dividends on the preferred
intergroup interest of $8 million in 2000 and 1999 and $1 million in 1998.
Long-term Loans
Sprint provided Sprint PCS with additional interim financing of $180 million
from May 1998 through November 1998. This loan was repaid in 1999.
Intergroup Interest Income
The difference between Sprint's actual interest costs and the interest costs
charged to the PCS Group on allocated debt totaled $235 million in 2000, $167
million in 1999 and $11 million in 1998. These amounts are reflected as a
reduction to "Interest expense" in the Sprint FON Group Combined Statements of
Operations. See Note 1 for a more detailed description of how Sprint allocates
interest expense to each of the groups.
The FON Group earned intergroup interest income of $19 million in 2000, $20
million in 1999 and $16 million in 1998 primarily related to the FON Group's
investment in PCS Group debt securities. These amounts are included in "Other
income, net" in the Sprint FON Group Combined Statements of Operations.
I-20
Intergroup Transactions
The PCS Group uses the long distance operation as its interexchange carrier and
purchases wholesale long distance for resale to its customers. Additionally, the
FON Group provides the PCS Group with Caller ID services and various other goods
and services. Charges to the PCS Group for these items totaled $381 million in
2000, $264 million in 1999 and $21 million from the PCS Restructuring date to
year-end 1998.
The PCS Group provides the FON Group with access to its network and
telemarketing and various other services. Charges to the FON Group for these
items totaled $35 million in 2000 and $4 million in 1999.
The FON Group provides management, printing, mailing and warehousing services to
the PCS Group. Charges to the PCS Group for these services totaled $150 million
in 2000, $65 million in 1999 and $5 million from the PCS Restructuring date to
year-end 1998.
Related Party Transactions
Sprint PCS
The following discussion reflects related party transactions between Sprint and
Sprint PCS prior to the PCS Restructuring:
Sprint provided Sprint PCS with billing and operator services, and switching
equipment. Sprint PCS also used the long distance operation as its interexchange
carrier. Charges to Sprint PCS for these services totaled $87 million in 1998.
Sprint provided management, printing, mailing and warehousing services to Sprint
PCS. Charges to Sprint PCS for these services totaled $25 million in 1998.
Sprint had a vendor financing loan to Sprint PCS for $300 million at year-end
1997 which was repaid in 1998. Sprint also loaned Sprint PCS $114 million in
1998, which was repaid in the 1999 first quarter.
- --------------------------------------------------------
15. Recently Issued Accounting Pronouncements
- --------------------------------------------------------
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This standard
requires all derivatives to be recorded on the balance sheet as either assets or
liabilities and be measured at fair value. Gains or losses from changes in the
derivative values are to be accounted for based on how the derivative is used
and whether it qualifies for hedge accounting. When this statement was adopted
in January 2001, it had no material impact on the FON Group's combined financial
statements.
In September 2000, the Financial Accounting Standards Board issued SFAS No. 140,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities--a replacement of FASB Statement No. 125." This statement revises
the standards for accounting for securitizations and other transfers of
financial assets and provides consistent standards for distinguishing transfers
from sales and secured borrowings. This statement is effective for transactions
occurring after March 31, 2001 and is not expected to have a material impact on
the FON Group's combined financial statements.
I-21
- --------------------------------------------------------
16. Quarterly Financial Data (Unaudited)
- --------------------------------------------------------
Quarter
----------------------------------------------------------
2000 1/st/ 2/nd/ 3/rd/ 4/th(1)/
- -------------------------------------------------------------------------------------------------------------
(millions, except per share data)
Net operating revenues/(2),(3)/ $ 4,404 $ 4,446 $ 4,444 $ 4,394
Operating income 758 591 724 360
Income from continuing operations 445 365 384 98
Net income/(3)/ 1,118 365 384 97
- -------------------------------------------------------------------------------------------------------------
Quarter
----------------------------------------------------------
1999 1/st/ 2/nd/ 3/rd/ 4/th/
- -------------------------------------------------------------------------------------------------------------
(millions, except per share data)
Net operating revenues/(2)/ $ 4,157 $ 4,254 $ 4,331 $ 4,418
Operating income 737 736 726 731
Income from continuing operations 434 452 419 431
Net income 406 386 359 416
- -------------------------------------------------------------------------------------------------------------
/(1)/ See Notes 3 and 4 of Notes to Combined Financial Statements for
information about nonrecurring charges recorded in the 2000 fourth
quarter.
/(2)/ Certain reclassifications were made between net operating revenues and
operating expenses from amounts reported in the 2000 quarterly reports on
Form 10-Q to conform to industry events or practices. These
reclassifications had no impact on operating income as previously
reported.
/(3)/ In the 2000 fourth quarter, the FON Group adopted SEC Staff Accounting
Bulletin No. 101, "Revenue Recognition in Financial Statements," (SAB
101). As required by SAB 101, 2000 net operating revenues have been
restated from amounts reported in the 2000 quarterly reports on Form 10-Q.
Net operating revenues were reduced by $4 million in the 2000 first
quarter, and increased by $1 million in the 2000 second quarter and $3
million in the 2000 third quarter. The FON Group also restated the 2000
first quarter net income by recording a $2 million loss for the cumulative
effect of change in accounting principle at the effective adoption date of
SAB 101.
- --------------------------------------------------------
17. Subsequent Events (Unaudited)
- --------------------------------------------------------
In February 2001, Sprint agreed to end its exclusive alliance with EarthLink and
relinquished its seats on EarthLink's Board of Directors. As a result of these
changes, Sprint will now treat its investment in EarthLink as a cost method
investment.
In February 2001, Sprint filed a registration statement with the SEC for a
secondary offering of 174.8 million shares of FON stock (including 22.8 million
shares to cover over-allotments) owned by FT and DT, including the FON stock
underlying the Class A common stock. Sprint will not receive any of the proceeds
from the sale of this stock.
In February 2001, Sprint's Board of Directors declared dividends of 12.5 cents
per share on the Sprint FON common stock and Class A common stock. Dividends
will be paid March 30, 2001.
I-22
MANAGEMENT'S DISCUSSION OF Sprint FON Group
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (an integrated business
of Sprint Corporation)
- --------------------------------------------------------
Forward-looking Information
- --------------------------------------------------------
Sprint includes certain estimates, projections and other forward-looking
statements in its reports, in presentations to analysts and others, and in other
publicly available material. Future performance cannot be ensured. Actual
results may differ materially from those in the forward-looking statements. Some
factors that could cause actual results to differ include:
. the effects of vigorous competition in the markets in which Sprint
operates;
. the costs and business risks associated with providing new services
and entering new markets necessary to provide nationwide or global
services;
. the ability of the PCS Group to continue to grow a significant market
presence;
. the effects of mergers and consolidations within the
telecommunications industry;
. the uncertainties related to Sprint's strategic investments;
. the impact of any unusual items resulting from ongoing evaluations of
Sprint's business strategies;
. unexpected results of litigation filed against Sprint;
. 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 including the impact
of the Telecommunications Act of 1996 (Telecom Act), or other external
factors over which Sprint has no control; and
. other risks referenced from time to time in Sprint's filings with the
Securities and Exchange Commission.
The words "estimate," "project," "intend," "expect," "believe" and similar
expressions are intended to identify forward-looking statements. Forward-looking
statements are found throughout MD&A. The reader should not place undue reliance
on forward-looking statements, which speak only as of the date of this report.
Sprint is not obligated to publicly release any revisions to forward-looking
statements to reflect events after the date of this report or unforeseen events.
- --------------------------------------------------------
Sprint FON Group
- --------------------------------------------------------
Operating Segments
Sprint's business is divided into four lines of business: the global markets
division, the local division, the product distribution and directory publishing
businesses and the PCS wireless telephony products and services business. The
FON Group includes the global markets division, the local division and the
product distribution and directory publishing businesses, and the PCS Group
includes the PCS wireless telephony products and services business. The PCS
common stock is intended to reflect the financial results and economic value of
the PCS wireless telephony products and services business. The FON common stock
is intended to reflect the financial results and economic value of the global
markets division, the local division and the product distribution and directory
publishing businesses.
During 2000, Sprint changed FON Group's segment reporting to align financial
reporting with changes in how Sprint manages the FON Group's operations and
assesses its performance. The FON Group operates in three business segments: the
global markets division, the local division and the product distribution and
directory publishing businesses.
Board Discretion Regarding Tracking Stocks
Sprint's Board has the discretion to, among other things, make operating and
financial decisions that could favor one group over the other and, subject to
the restrictions in Sprint's articles of incorporation, to change the allocation
of the assets and liabilities that comprises each of the FON Group and the PCS
Group without shareholder approval. Under the applicable corporate law, Sprint's
Board owes its fiduciary duties to all of Sprint's shareholders and there is no
board of directors that owes separate duties to the holders of either the FON
common stock or the PCS common stock. The Tracking Stock Policies provide that
the Board, in resolving material matters in which the holders of FON common
stock and PCS common stock have potentially divergent interests, will act in the
best interests of Sprint and all of its common shareholders after giving fair
consideration to the potentially divergent interests of the holders of the
separate classes of Sprint common stock. These policies may be changed by the
Board without shareholder
I-23
approval. Given the Board's discretion in these matters, it may be difficult to
assess the future prospects of each group based on past performance.
Global Markets Division
The global markets division provides a broad suite of communications services
targeted to domestic business and residential customers, multinational
corporations and other communications companies. These services include domestic
and international voice; data communications such as Internet and frame relay
access and transport, web hosting, virtual private networks, and managed
security services; and broadband services.
Sprint is deploying integrated communications services, referred to as Sprint
ION(SM). Sprint ION extends Sprint's existing network capabilities to the
customer and enables Sprint to provide the network infrastructure to meet
customers' demands for advanced services including integrated voice, data,
Internet and video. It is also expected to be the foundation for Sprint to
provide advanced services in the competitive local service market. Sprint uses
various advanced services last-mile technologies, including dedicated access and
Digital Subscriber Line (xDSL), and expects to use Multipoint Multichannel
Distribution Services (MMDS).
The global markets division also includes the operating results of the cable TV
service operations of the broadband fixed wireless companies after their 1999
acquisition dates. During 2000, Sprint converted several markets served by MMDS
capabilities from cable TV services to high-speed data services. Global markets
operating results reflect the development costs and the operating revenues and
expenses of these broadband fixed wireless services. Sprint intends to provide
broadband data and voice services to additional markets served by these
capabilities.
Included in the global markets division are the costs of establishing
international operations beginning in 2000.
This division also includes the FON Group's investments in EarthLink, Inc., an
Internet service provider; Call-Net, a long distance provider in Canada
operating under the Sprint brand name; Intelig, a long distance provider in
Brazil; and certain other telecommunications investments and ventures.
Local Division
The local division consists mainly of regulated local phone companies serving
approximately 8.3 million access lines in 18 states. It provides local phone
services, access by phone customers and other carriers to its local network,
consumer long distance services to customers within its franchise territories,
sales of telecommunications equipment, and other long distance services within
certain regional calling areas, or LATAs.
Product Distribution and Directory Publishing Businesses
The product distribution business provides wholesale distribution services of
telecommunications products. The directory publishing business publishes and
markets white and yellow page phone directories.
- ----------------------------------------------------------
Results of Operations
- ----------------------------------------------------------
- ----------------------------------------------------------
2000 1999 1998
- ----------------------------------------------------------
(millions)
Net operating revenues $ 17,688 $ 17,160 $ 15,958
Operating expenses 15,255 14,230 13,198
- ----------------------------------------------------------
Operating income $ 2,433 $ 2,930 $ 2,760
=================================
Income from continuing
operations $ 1,292 $ 1,736 $ 1,675
=================================
Capital expenditures $ 4,105 $ 3,534 $ 3,159
=================================
In the 2000 fourth quarter, Sprint completed an analysis of the valuation of
various FON Group assets resulting from its reassessment of the FON Group's
business strategies in response to changes in the overall telecommunications
industry. As a result of this analysis, operating expenses include a
nonrecurring charge of $238 million primarily related to a write-down of
goodwill associated with the FON Group's Paranet operations, which declined
significantly. In 2000, operating expenses also include a nonrecurring charge of
$163 million for costs associated with the WorldCom merger. These charges
reduced operating income by $401 million and income from continuing operations
by $257 million. In the 2000 fourth quarter, Sprint also completed an analysis
of the valuation of its equity method investments in response to changes in the
overall telecommunications industry. As a result of this analysis, income from
continuing operations includes nonrecurring charges of $87 million for the
write-down of the FON Group's equity method investment in Call-Net, which had an
other than temporary decline in market value, and $22 million for the write-down
of certain FON Group investment securities, which had an other than temporary
decline in market value. Income from continuing operations in 2000 also includes
net nonrecurring gains of $44 million from the sale of an independent directory
publishing operation and from investment activities. In 1999, income from
continuing operations includes net nonrecurring gains of $35 million from
investment activities. In 1998, income from continuing operations includes a
nonrecurring gain of $62 million mainly from the sale of local exchanges.
Excluding nonrecurring items, operating income was $2.8 billion in 2000, $2.9
billion in 1999 and $2.8 billion in 1998; income from continuing operations was
$1.6 billion in 2000, $1.7 billion in 1999 and $1.6 billion in 1998.
- ----------------------------------------------------------
Segmental Results of Operations
- ----------------------------------------------------------
Beginning in 2000, the FON Group combined its long distance operation, Sprint
ION, broadband fixed wireless services and certain other ventures into one
I-24
division, global markets, to align financial reporting with changes in how
Sprint manages operations and assesses performance. The global markets division
now includes four major revenue streams: voice, data, Internet and other. In
connection with the resegmentation, the FON Group shifted the recognition of
consumer long distance revenues and expenses associated with customers in its
local franchise territories from the global markets division to the local
division. Prior periods have been restated to reflect these changes.
Global Markets Division
- -------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------
(millions)
Net operating revenues
Voice $ 7,094 $ 7,445 $ 7,079
Data 1,937 1,696 1,396
Internet 920 615 434
Other 577 552 632
- -------------------------------------------------------------
Total net operating
revenues 10,528 10,308 9,541
- -------------------------------------------------------------
Operating expenses
Costs of services
and products 5,558 4,947 4,784
Selling, general and
administrative 3,026 3,141 2,639
Depreciation and
amortization 1,121 1,045 928
Asset write-down 238 - -
- -------------------------------------------------------------
Total operating
expenses 9,943 9,133 8,351
- -------------------------------------------------------------
Operating income $ 585 $ 1,175 $ 1,190
================================
Operating margin 5.6% 11.4% 12.5%
================================
Capital expenditures $ 2,294 $ 1,774 $ 1,518
================================
Net Operating Revenues
Net operating revenues increased 2% in 2000 and 8% in 1999. The increases mainly
reflect strong data communications services revenue growth. A more competitive
pricing environment and a change in the mix of products sold more than offset
minute growth of 18% in 2000. Strong minute growth of 22% in 1999 was partly
offset by a more competitive pricing environment and a change in the mix of
products sold. The minute growth in 2000 was also offset by a reduction in
access cost pass-throughs resulting from the implementation of the Coalition for
Affordable Local and Long Distance Service proposal (CALLS).
Voice Revenues
Voice revenues decreased 5% in 2000 and increased 5% in 1999. The 2000 decrease
was largely due to a decline in consumer voice revenues as a result of a more
competitive pricing environment, lower calling card usage due to the increased
use of wireless phones, and the implementation of CALLS. The 1999 increase
mainly reflects increased wholesale voice revenues due to strong minute growth
mainly from international calls and increased inbound and outbound toll-free
calls.
I-25
Data Revenues
Data revenues reflect sales of current-generation data services including
asynchronous transfer mode and frame relay services. These revenues increased
14% in 2000 and 21% in 1999 due to increased sales as a result of an increase
emphasis on these services.
Internet Revenues
Internet revenues increased 50% in 2000 and 42% in 1999 due to strong growth in
dial-up Internet service provider-related revenues and dedicated service
revenues. Internet revenues showed strong growth because of continued demand and
increased use of the Internet.
Other Revenues
Other revenues increased 5% in 2000 and decreased 13% in 1999. The 2000 increase
was due to sales of capacity on transoceanic cable and the inclusion of a full
year of revenues from the cable TV service operations of the broadband fixed
wireless companies purchased in 1999 largely offset by a decline in legacy data
services. The 1999 decrease was due to a decline in legacy data services.
Costs of Services and Products
Costs of services and products include interconnection costs paid to local phone
companies, other domestic service providers and foreign phone companies to
complete calls made by the division's domestic customers, costs to operate and
maintain the long distance network, costs of equipment and transmission capacity
sales, and costs related to the development and deployment of Sprint ION. These
costs increased 12% in 2000 and 3% in 1999.
Interconnection costs remained flat in 2000 and increased 3% in 1999. Reductions
in per-minute international access costs as well as domestic access costs offset
the impact of increased calling volumes in 2000. Increased calling volumes in
1999 were partly offset by reductions in per-minute costs for both domestic and
international access. The domestic rate reductions were generally due to the
FCC-mandated access rate reductions that took effect in January and July 1998,
July 1999 and July 2000. The access rate reductions in July 2000 included the
implementation of CALLS.
All other costs of services and products increased 42% in 2000 and 5% in 1999.
The 2000 increase was largely due to the expansion of Sprint ION business
services nationwide and the launch of consumer services in select markets as
well as increased sales of capacity on transoceanic cable. Increased costs of
services and products in both 2000 and 1999 were driven by growth in data
services. The 1999 increase was also impacted by increases in network equipment
operating leases expense.
Total costs of services and products for global markets were 52.8% of net
operating revenues in 2000, 48.0% in 1999 and 50.1% in 1998.
Selling, General and Administrative Expense
Selling, general and administrative (SG&A) expense decreased 4% in 2000 and
increased 19% in 1999. The 2000 decrease is due to a strong emphasis on cost
control. The 1999 increase mainly reflects the overall growth of the business as
well as increased marketing and promotions to support products and services,
including the rollout of an airline alliance program which enabled customers to
earn frequent flyer miles when they used Sprint's services.
SG&A expense includes costs associated with the continued development and
deployment activities for Sprint ION, including costs for systems and operations
development, product development and advertising associated with market
launches. SG&A expense for Sprint ION was $281 million in 2000, $320 million in
1999 and $138 million in 1998.
Total SG&A expense for the global markets division was 28.7% of net operating
revenues in 2000, 30.5% in 1999 and 27.7% in 1998.
Depreciation and Amortization Expense
Depreciation and amortization expense increased 7% in 2000 and 13% in 1999. The
increases mainly reflect a rapidly increasing asset base for Sprint ION as well
as an increased asset base to enhance network reliability, meet increased demand
for voice and data-related services and upgrade capabilities for providing new
products and services. Depreciation and amortization expense was 10.6% of net
operating revenues in 2000, 10.1% in 1999 and 9.7% in 1998.
I-26
Local Division
- ------------------------------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------------------------------
(millions)
Net operating revenues
Local service $ 2,846 $ 2,677 $ 2,469
Network access 1,987 1,918 1,894
Toll service 717 611 503
Other 605 752 733
- ------------------------------------------------------------------------------
Total net operating
revenues 6,155 5,958 5,599
- ------------------------------------------------------------------------------
Operating expenses
Costs of services and
products 1,965 2,016 1,889
Selling, general and
administrative 1,288 1,320 1,325
Depreciation and
amortization 1,139 1,069 984
- ------------------------------------------------------------------------------
Total operating
expenses 4,392 4,405 4,198
- ------------------------------------------------------------------------------
Operating income $ 1,763 $ 1,553 $ 1,401
================================
Operating margin 28.6% 26.1% 25.0%
================================
Capital expenditures $ 1,371 $ 1,354 $ 1,374
================================
Beginning in July 2000, Sprint changed its transfer pricing for certain
transactions between FON Group entities to more accurately reflect market
pricing. The main effect of this change was a reduction in the local division's
"Net Operating Revenues--Other Revenues." In addition, Sprint's local division
transferred a customer service and telemarketing organization to the PCS Group
at the beginning of the 2000 second quarter and sold approximately 81,000 access
lines in Illinois in November 1998. For comparative purposes, the following
discussion of local division results assumes the transfer pricing change, the
transfer of the customer service and the sale of telemarketing organization, and
the sale of exchanges occurred at the beginning of 1998. Adjusting for these
changes, operating margins would have been 28.4% in 2000, 25.7% in 1999 and
24.4% in 1998.
Net Operating Revenues
Net operating revenues increased 5% in 2000 and 7% in 1999. These increases
mainly reflect increased sales of network-based services such as Caller ID and
Call Waiting, increased long distance revenues, and customer access line growth.
Sales of network-based services and long distance services increased due to
strong demand for bundled services which combine local service, network-based
features and long distance calling. Customer access lines increased 4% in 2000
and 5% in 1999. Net operating revenues were $6.1 billion in 2000, $5.8 billion
in 1999 and $5.5 billion in 1998.
Local Service Revenues
Local service revenues, derived from local exchange services, grew 6% in 2000
and 9% in 1999 because of continued demand for network-based services, customer
access line growth and growth in data products. Revenue growth in 1999 also
reflects increased revenues from maintaining customer wiring and equipment.
Network Access Revenues
Network access revenues, derived from long distance phone companies using the
local network to complete calls, increased 4% in 2000 and 2% in 1999. These
revenues reflect increased revenues from special access services and a 2% and 4%
increase in minutes of use in 2000 and 1999, respectively. These increases were
offset by FCC-mandated access rate reductions. Access rate reductions took
effect in January and July 1998, July 1999 and July 2000.
Toll Service Revenues
Toll service revenues are mainly derived from providing consumer long distance
services to customers within Sprint's local franchise territories and other long
distance services within specified regional calling areas, or LATAs, that are
beyond the local calling area. These revenues increased 17% in 2000 and 22% in
1999. These increases reflect the success of bundled services which include
long distance calling.
Other Revenues
Other revenues decreased 11% in 2000 and 1% in 1999. The decrease in 2000 was
mainly due to a decrease in equipment sales as a result of a planned shift in
focus to selling higher margin products.
Costs of Services and Products
Costs of services and products include costs to operate and maintain the local
network and costs of equipment sales. These costs decreased 1% in 2000 and
increased 6% in 1999. The 2000 decrease was due to a decline in equipment sales
and the success of cost control initiatives. The 1999 increase was driven by
customer access line growth, an increased emphasis on service levels and storm
related costs. Costs of services and products were 31.9% of net operating
revenues in 2000, 33.8% in 1999 and 34.1% in 1998.
I-27
Selling, General and Administrative Expense
SG&A expenses decreased 1% in 2000 and remained flat in 1999. The 2000 decrease
was due to a strong emphasis on cost control. In 1999, increased marketing
costs to promote new products and services and increased customer service costs
related to customer access line growth was offset by a strong emphasis on cost
control. SG&A expense was 21.0% of net operating revenues in 2000, 22.3% in
1999 and 23.6% in 1998.
Depreciation and Amortization Expense
Depreciation and amortization expense increased 7% in 2000 and 9% in 1999,
mainly from increased capital expenditures in switching and transport
technologies which have shorter asset lives. Depreciation and amortization
expense was 18.7% of net operating revenues in 2000, 18.2% in 1999 and 17.9% in
1998.
Product Distribution and Directory Publishing Businesses
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
(millions)
Net operating
revenues $ 1,936 $ 1,758 $ 1,709
- --------------------------------------------------------------------------------
Operating expenses
Costs of services
and products 1,460 1,345 1,330
Selling, general and
administrative 176 154 135
Depreciation and
amortization 16 17 13
- --------------------------------------------------------------------------------
Total operating
expenses 1,652 1,516 1,478
- --------------------------------------------------------------------------------
Operating income $ 284 $ 242 $ 231
==================================
Operating margin 14.7% 13.8% 13.5%
==================================
Capital expenditures $ 8 $ 36 $ 9
==================================
Net operating revenues increased 10% in 2000 and 3% in 1999. Nonaffiliated
revenues accounted for over 60% of revenues in 2000 and 1999. These revenues
increased 11% in 2000 and 12% in 1999. The increase in nonaffiliated revenues
in 2000 was mainly due to the consolidation of a directory publishing
partnership. In the second half of 2000, the directory publishing partnership,
previously accounted for as an equity method investment, was fully consolidated
due to a restructuring in the partnership management. Sales to affiliates
increased 8% in 2000 and decreased 10% in 1999 due to changes in the local
division's capital program.
Costs of services and products increased 9% in 2000 and increased 1% in 1999
reflecting increased equipment sales. The 2000 increase was also due to the
consolidation of the directory publishing partnership. SG&A expense increased
14% in 2000 and 1999. The 2000 increase was due to costs related to the
transformation of the product distribution business to a web-enabled business as
well as the consolidation of the directory publishing partnership. The 1999
increase was the result of staffing demands related to nonaffiliated sales
growth.
- --------------------------------------------------------------------------------
Nonoperating Items
- --------------------------------------------------------------------------------
Interest Expense
Effective with the PCS Restructuring, interest expense on borrowings incurred by
Sprint and allocated to the PCS Group is based on the rates the PCS Group could
obtain from third parties. These interest rates are higher than the rates
Sprint obtains on the borrowings. The difference between Sprint's actual
interest rates and the rates charged to the PCS Group is reflected as a
reduction in the FON Group's interest expense as follows:
2000 1999 1998
- --------------------------------------------------------------------------
(millions)
FON Group
Interest costs $ 311 $ 349 $ 254
Credit from the PCS
Group (235) (167) (11)
---------------------------------
Interest expense $ 76 $ 182 $ 243
=================================
See Note 1 of Notes to Combined Financial Statements for a more detailed
description about the allocation of group financing.
The effective interest rates in the following table reflect interest costs on
long-term debt only. Interest costs on short-term borrowings classified as
long-term debt, intergroup borrowings, deferred compensation plans, customer
deposits and the credit from the PCS Group detailed above have been excluded so
as not to distort the effective interest rates on long-term debt.
- --------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------
Effective interest rate
on long-term debt 7.4% 7.8% 7.9%
=================================
The decreases in effective interest rates mainly reflect the retirement of debt
with higher interest rates.
I-28
Other Income (Expense), Net
Other income (expense) consisted of the following:
- ----------------------------------------------------------------------------
2000 1999 1998
- ----------------------------------------------------------------------------
(millions)
Dividend and interest
income $ 48 $ 35 $ 74
Equity in net losses
of affiliates (181) (73) (41)
Gains on sales of
assets 45 77 156
Net losses from
investments (102) (15) -
Other, net 3 25 (36)
- ----------------------------------------------------------------------------
Total $ (187) $ 49 $ 153
=================================
Dividend and interest income for all years reflects dividends earned on cost
method investments and interest earned on temporary investments. For 1998, it
also reflects interest earned on loans to unconsolidated affiliates and interest
earned on short-term investments following Sprint's $5.0 billion debt offering
in late 1998.
Equity in net losses of affiliates mainly includes losses from Intelig, Call-Net
and EarthLink. The 2000 increase is mainly due to increased Intelig losses.
Gains on sales of assets in 2000 reflect the sale of an independent publishing
operation. The 1999 gains mainly include the gain on the sale of an investment
security. The 1998 gains mainly reflect net gains on sales of local exchanges.
In 2000, net losses from investments mainly include the write-downs of certain
equity investments.
Income Taxes
The FON Group's effective tax rates were 40.5% in 2000, 37.9% in 1999 and 37.3%
in 1998. See Note 9 of Notes to Combined Financial Statements for information
about the differences that caused the effective income tax rates to vary from
the statutory federal rate for income taxes related to continuing operations.
Discontinued Operation, Net
In the 2000 first quarter, Sprint sold its interest in Global One to France
Telecom and Deutsche Telekom AG. Sprint received $1.1 billion in cash and was
repaid $276 million for advances for its entire stake in Global One. As a
result of Sprint's sale of its interest in Global One, the FON Group's gain on
sale and its equity share of the results of Global One have
I-29
been reported as a discontinued operation for all periods presented.
In 2000, the FON Group recorded an after-tax gain related to the sale of its
interest in Global One of $675 million. The FON Group recorded after-tax losses
related to Global One of $130 million in 1999 and $135 million in 1998.
Extraordinary Items, Net
In 2000, Sprint redeemed, prior to scheduled maturities, $25 million of the FON
Group's debt with interest rates ranging from 9.6% to 9.7%. This resulted in a
$1 million after-tax extraordinary loss for the FON Group.
In 1999, Sprint redeemed, prior to scheduled maturities, $575 million of the
broadband fixed wireless companies' debt, assumed by the FON Group, with
interest rates ranging from 13.1% to 14.5%. This resulted in a $39 million
after-tax extraordinary loss for the FON Group.
In 1998, Sprint redeemed, prior to scheduled maturities, $138 million of FON
Group debt with interest rates ranging from 7.9% to 9.3%. This resulted in a $5
million after-tax extraordinary loss.
- --------------------------------------------------------------------------------
Financial Condition
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
2000 1999
- --------------------------------------------------------------------------------
(millions)
Combined assets $ 23,649 $ 21,803
=============================
The FON Group's combined assets increased $1.8 billion in 2000. Net property,
plant and equipment increased $1.8 billion reflecting capital expenditures to
support long distance and local network enhancements and Sprint ION development
and hardware deployment, partly offset by depreciation. Investments in
affiliates and other assets increased $475 million mainly reflecting capital
contributions to the FON Group's equity method investees, partly offset by
equity in net losses of those affiliates and the write-down of certain equity
investments. Offsetting decreases in the FON Group's combined assets primarily
reflect the exchange of investments in equity securities for certain notes
payable, the write-down of goodwill and other related assets of the FON Group's
professional services business and the sale of the net assets of the Global One
discontinued operation. See ''Liquidity and Capital Resources'' for more
information about changes in the Combined Balance Sheets.
- --------------------------------------------------------------------------------
Liquidity and Capital Resources
- --------------------------------------------------------------------------------
Sprint's Board exercises discretion regarding the liquidity and capital resource
needs of each group. This includes the ability to prioritize the use of capital
and debt capacity, to determine cash management policies and to make decisions
regarding the timing and amount of capital expenditures. The actions of the
Board of Directors are subject to its fiduciary duties to all shareholders of
Sprint and not just to the holders of a particular class of common stock. Given
the Board's discretion in these matters, it may be difficult to assess each
group's liquidity and capital resource needs and future prospects based on past
performance.
Operating Activities
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
(millions)
Cash flows provided by
operating activities $ 4,323 $ 3,713 $ 3,915
====================================
Operating cash flows increased $610 million in 2000 and decreased $202 million
in 1999. The 2000 increase mainly reflects decreases in working capital
requirements. The 1999 decrease mainly reflects increases in working capital
partly offset by improved operating results.
Investing Activities
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
(millions)
Cash flows used by
investing activities $ (3,336) $ (4,349) $ (3,366)
====================================
Capital expenditures, which are the FON Group's largest investing activity,
totaled $4.1 billion in 2000, $3.5 billion in 1999 and $3.2 billion in 1998.
Global markets division capital expenditures were incurred mainly to enhance
network reliability, meet increased demand for voice and data-related services,
upgrade capabilities for providing new products and services and to continue
development and hardware deployment of Sprint ION. The local division incurred
capital expenditures to accommodate access line growth, provide additional
capacity for increased Internet traffic and expand capabilities for providing
enhanced services. Other FON Group capital expenditures were incurred mainly
for Sprint's World Headquarters Campus.
In 2000, investing activities include $1.4 billion of proceeds from the sale of
the FON Group's interest in Global One. Investing activities also include
proceeds from sales of other assets totaling $51
I-30
million in 2000, $90 million in 1999 and $230 million in 1998. In 1999, Sprint
purchased the net assets of several broadband fixed wireless companies for $618
million, excluding assumed debt.
"Investments in and loans to other affiliates, net" includes the FON Group's
investment in EarthLink, Intelig and other affiliates.
Financing Activities
- --------------------------------------------------------------------------------
2000 1999 1998
- --------------------------------------------------------------------------------
(millions)
Cash flows provided
(used) by financing
activities $ (969) $ 308 $ (219)
============================================
Financing activities mainly reflect net payments on long-term debt of $605
million in 2000, and net proceeds of $491 million in 1999 and $397 million in
1998. The FON Group paid dividends of $433 million in 2000, $426 million in
1999 and $430 million in 1998. The indicated annual dividend rate on FON stock
is $0.50 per share.
Also included in the 2000 financing activities is an $80 million payment to the
PCS Group to compensate for the net amount of PCS stock-based compensation
granted to FON Group employees and FON stock-based compensation granted to PCS
Group employees. In addition, the FON Group received net proceeds from Sprint's
employee stock purchase plan of $50 million in 2000, $136 million in 1999 and
$24 million in 1998.
Capital Requirements
The FON Group's 2001 investing activities, mainly consisting of capital
expenditures and investments in affiliates, are expected to require cash of
$6.0 billion. FON Group capital expenditures are expected to be $5.9 billion in
2001. The global markets division and local division will require the majority
of this total. Investments in affiliates are expected to require cash of
approximately $100 million. Dividend payments are expected to approximate $440
million.
In connection with the PCS Restructuring, Sprint adopted a tax sharing agreement
that provides for the allocation of income taxes between the FON Group and the
PCS Group. Sprint expects the FON Group to continue to make significant
payments to the PCS Group under this agreement because of expected PCS Group
operating losses in the near future and from using the PCS Group's net operating
loss carryforwards. These payments reflect the PCS Group's incremental
cumulative effect on Sprint's consolidated federal and state tax liability and
tax credit position. The PCS Group received payments from the FON Group
totaling $872 million in 2000, $764 million in 1999 and $20 million in 1998.
See Note 1 of Notes to Combined Financial Statements, "Allocation of Federal and
State Income Taxes" for more details.
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Regulatory Developments
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Competitive Local Service
The Telecommunications Act of 1996 (Telecom Act) was designed to promote
competition in all aspects of telecommunications. It eliminated legal and
regulatory barriers to entry into local phone markets. It also required
incumbent local exchange carriers (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. Sprint has obtained interconnection
and collocation agreements with a number of ILECs, and is rolling out Sprint ION
in selected cities across the nation, using collocation and unbundled network
elements obtained from ILECs.
In January 1999, the Supreme Court affirmed the FCC's authority to establish
rules and prices relating to interconnection and unbundling of the ILECs'
networks. The FCC subsequently reaffirmed in large part the list of network
elements ILECs are required to provide on an unbundled basis, and strengthened
collocation requirements. It also took steps to speed the deployment of
advanced technologies such as xDSL.
In July 2000, the U.S. Court of Appeals for the Eighth Circuit invalidated the
pricing standards the FCC had adopted for unbundled network elements and resale
of ILEC services. The court also refused to reconsider, in light of the Supreme
Court decision discussed above, the court's prior holding that ILECs could not
be required to combine unbundled network elements on behalf of other carriers.
In January 2001, the U.S. Supreme Court granted certiorari of three issues from
the Eighth Circuit decision. The Supreme Court will review whether the Telecom
Act forecloses the cost methodology adopted by the FCC for interconnection rates
with the ILECs. A related issue dealing with whether rejection of historical
costs is a taking will also be considered. Finally, the Supreme Court will
consider whether ILECs have a duty under the Telecom Act to combine previously
uncombined network elements when requested and for a fee. If the Supreme Court
affirms the Eighth Circuit's decision, the FCC or the state regulatory
commissions would have to formulate new pricing
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standards for unbundled network elements and interconnection.
Separately, in a March 2000 decision, the U.S. Court of Appeals for the District
of Columbia Circuit remanded to the FCC the issue of what types of equipment
ILECs must allow competitors to collocate in their offices. The FCC has received
comments and reply comments on whether and how to change its collocation rules
in light of the D.C. Circuit's decision.
RBOC Long Distance Entry
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, and obtain an FCC ruling that
the provision of in-region long distance service is in the public interest. The
RBOC's have gained authorization to provide in-region long distance service in
four states. Verizon obtained FCC authorization for New York in December 1999;
SBC obtained FCC authorization to provide in-region services in Texas in June
2000 and in Oklahoma and Kansas in January 2001. RBOCs may gain such
authorization in the near future in other states. The entry of the RBOCs into
the long distance market will impact competition, but the extent of the impact
will depend upon factors such as the RBOCs' competitive ability, the appeal of
the RBOC brand to different market segments, and the response of competitors.
Some of the impact on Sprint may be offset by wholesale revenues from those
RBOCs that choose to resell Sprint services.
Customer Service Slamming
The Telecom Act also established liability for the unauthorized switching of a
consumer's telephone service from one carrier to another (slamming). In late
1998, the FCC adopted new rules intended to prevent slamming and to compensate
victims of slamming. The compensation rules were stayed by the Court of Appeals
for the District of Columbia Circuit. In May 2000, the FCC modified the process
for adjudicating alleged slams. The D.C. Circuit then lifted its stay and the
new rules went into effect on November 28, 2000.
Mergers
A number of mergers received final regulatory approval in 2000 and early 2001.
The Qwest- US West merger was approved by the FCC in March 2000; the Bell
Atlantic-GTE merger was approved by the FCC in June 2000; and the AT&T-MediaOne
merger was approved by the FCC in June 2000. Finally, the AOL-Time Warner
merger received approval from the FCC in January 2001.
Universal Service Requirements
The FCC continues to address issues related to universal service and access
reform. In May 2000, the FCC adopted an access reform plan that substantially
reduced switched access charges paid by long distance carriers to the large
ILECs and created a new universal service fund that offsets a portion of this
reduction in access charges. In connection with its advocacy of this plan,
Sprint committed that it would flow through the reductions in switched access
costs over the five-year life of the plan to both business and residential
customers. Sprint also committed to certain other pricing actions, including
eliminating charges to residential and single-line business customers which had
been used to pass through certain access costs that were eliminated by this
plan, and maintaining, for the duration of the plan, at least one pricing option
that does not include a minimum usage charge. The FCC order adopting this
access reform plan requires Sprint to adhere to these commitments. The FCC's
order has been appealed to the U.S. Court of Appeals for the Fifth Circuit.
The FCC and many states have established "universal service" programs to ensure
affordable, quality local telecommunications services for all Americans. The
FON Group's assessment to fund these programs is typically a percentage of
interstate and international end-user revenues. Currently, management cannot
predict the extent of the FON Group's future federal and state universal service
assessments, or its ability to recover its contributions to the universal
service fund from its customers.
Communications Assistance for Law Enforcement Act
The Communications Assistance for Law Enforcement Act (CALEA) was enacted in
1994 to preserve electronic surveillance capabilities authorized by federal and
state law. CALEA requires telecommunications companies to meet certain
"assistance capability requirements" by the end of June 2000 where circuit-
switching is used and by September 2001 where packet-switching is used. Where
circuit-switched technology was installed before 1995, reimbursement for
hardware and software upgrades to facilitate CALEA compliance was authorized.
The U.S. Department of Justice (DOJ) has published guidelines concerning what is
required for it to support, at the FCC, petitions for extension of the CALEA
enforcement deadlines; however, the FCC did not require carriers to have DOJ
concurrence to seek an extension. LTD uses circuit-switching for the bulk of
its traffic and most LTD switches were installed before 1995 and qualify for
reimbursement if upgrades are required by the DOJ. Sprint ION uses packet
switching for its local operations. In the case of Sprint ION, CALEA compliance
capabilities are not currently available from equipment and software vendors
involved in Sprint ION's deployment. LTD has obtained an extension for CALEA
compliance until June 30, 2001 and has been in discussions with the DOJ which
resulted in an agreement on a deployment schedule for CALEA within LTD. LTD
expects the DOJ to provide a letter of support for use with the FCC in obtaining
a further extension consistent with the agreed upon deployment schedule. Sprint
ION will apply for an extension for the local packet-based services to allow for
development of required hardware and software.
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Recently Issued Accounting Pronouncements
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See Note 15 of Notes to Combined Financial Statements for a discussion of
recently issued accounting pronouncements.
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