UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission file number 1-04721

 

 

 

 

SPRINT NEXTEL CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(703) 433-4000

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

 

 

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

 

Aggregate market value of voting and non-voting common stock equity held by non-affiliates at June 30, 2006 was $59,636,113,799.

 

COMMON SHARES OUTSTANDING AT FEBRUARY 21, 2007:

 

 

Documents incorporated by reference

 

Portions of the registrant’s definitive proxy statement filed under Regulation 14A promulgated by the Securities and Exchange Commission under the Securities Exchange Act of 1934, which definitive proxy statement is to be filed within 120 days after the end of Registrant’s fiscal year ended December 31, 2006, are incorporated by reference in Part III hereof.

 

TABLE OF CONTENTS

 

 

See pages 27 and 28 for “Executive Officers of the Registrant”

SPRINT NEXTEL CORPORATION

SECURITIES AND EXCHANGE COMMISSION

ANNUAL REPORT ON FORM 10-K

 

Part I

 

Item 1.  Business

 

Overview

 

The Corporation

 

Sprint Nextel Corporation, incorporated in 1938 under the laws of Kansas, is mainly a holding company, with its operations primarily conducted by its subsidiaries. Unless the context otherwise requires, references to “Sprint Nextel,” “we,” “us” and “our” mean Sprint Nextel Corporation and its subsidiaries. On May 17, 2006, we spun-off to our shareholders our local communications business, which is now known as Embarq Corporation and is comprised primarily of what was our Local segment prior to the spin-off. The results of Embarq for periods before the spin-off are presented as discontinued operations and we have recast information for our Wireless and Long Distance segments for the periods presented. For information regarding our segments, see note 14 of the Notes to Consolidated Financial Statements at the end of this annual report on Form 10-K. On August 12, 2005, a subsidiary of our company merged with Nextel Communications, Inc. and, as a result, we acquired Nextel.

 

We are a global communications company offering a comprehensive range of wireless and wireline communications products and services that are designed to meet the needs of individual consumers, businesses and government customers. We have organized our operations to meet the needs of our targeted customer groups through focused communications solutions that can incorporate the capabilities of our wireless and wireline services to meet their specific needs. We are one of the three largest wireless companies in the United States based on the number of wireless subscribers. We own extensive wireless networks and a global long distance, Tier 1 Internet backbone.

 

We offer digital wireless service in all 50 states, Puerto Rico and the U.S. Virgin Islands, in part through commercial affiliation arrangements between us and third-party affiliates, each referred to as a PCS Affiliate. We, together with the four remaining PCS Affiliates and resellers of our wholesale wireless services, served about 53.1 million wireless subscribers at the end of 2006.

 

We, together with the PCS Affiliates, provide wireless code division multiple access, or CDMA, based personal communications services, or PCS, under the Sprint^® brand name. The PCS Affiliates offer digital wireless service mainly in and around smaller U.S. metropolitan areas on wireless networks built and operated at their expense, in most instances using spectrum licensed to and controlled by us. We also offer numerous sophisticated data messaging, imaging, entertainment and location-based applications, marketed as Power Vision^SM, that utilize high-speed evolution data optimized, or EV-DO, technology.

 

We also offer digital wireless services under our Nextel^® and Boost Mobile^® brands using integrated Digital Enhanced Network, or iDEN^®, technology. Both brands feature our industry-leading walkie-talkie services, which give subscribers the ability to communicate instantly, as well as a variety of digital wireless mobile telephone and wireless data transmission services.

 

We are one of the nation’s largest providers of long distance services and one of the largest carriers of Internet traffic. We operate an all-digital long distance and Tier 1, Internet Protocol, or IP, network, over which we provide a broad suite of wireline communications services targeted to domestic business customers, multinational corporations and other communications companies. These services include domestic and international data communications using various protocols such as multi-protocol label switching, or MPLS, technologies, IP, asynchronous transfer mode, or ATM, frame relay, managed network services and voice services. We also provide switching and back office services to cable companies, which enable them to provide local and long distance telephone service over their cable facilities.

Our Series 1 voting common stock trades on the New York Stock Exchange, or NYSE, under the symbol “S.”

 

Local Communications Business Spin-off

 

On May 17, 2006, we completed the spin-off of Embarq.  In the spin-off, we distributed pro rata to our shareholders one share of Embarq common stock for every 20 shares of our voting and non-voting common stock, or about 149 million shares of Embarq common stock. Cash was paid for fractional shares. The distribution of Embarq common stock is considered a tax free transaction for us and for our shareholders, except for cash payments made in lieu of fractional shares which are generally taxable.

 

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

 

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

 

Business Combinations

 

On August 12, 2005, a subsidiary of ours merged with Nextel and, as a result, we acquired Nextel. The aggregate consideration paid for the merger was about $37.8 billion, which consisted of $969 million in cash and 1.452 billion shares of Sprint Nextel voting and non-voting common stock, or $0.84629198 in cash and 1.26750218 shares of Sprint Nextel stock in exchange for each then-outstanding share of Nextel stock.

 

We merged with Nextel to secure a number of potential strategic and financial benefits. These benefits include those arising from the combination of our networks, spectrum assets and diverse customer bases and services, the size and scale of the combined company and the opportunity to focus on the fastest growing areas of the communications industry. We also believe that the merger provides significant opportunities to achieve operating efficiencies by realizing revenue, operating cost and capital spending synergies.

 

We have begun to realize cost savings as a result of the merger and, over a number of years, expect to continue to realize significant cost savings and other synergies associated with the merger. However, we believe that our operating results for at least the next several quarters will be impacted negatively by costs that will be incurred to achieve these benefits and other synergies. Such costs generally are not expected to be recurring in nature, and include costs associated with integrating back office systems, severance costs associated with the termination of the employment of certain employees, and lease and other contract termination costs. The ability to achieve these cost savings and other synergies, and the timing in which the benefits can be realized, will depend in large part on the ability to integrate our networks, business operations, back-office functions and other support systems and infrastructure.

 

In 2005 and 2006, we acquired six entities, each of which had been a PCS Affiliate until the time of its acquisition:

 

 

Also, in 2006 we acquired:

 

 

The acquisitions of the PCS Affiliates and Nextel Partners gave us more control of the distribution of services under our Sprint and Nextel brands, and provide us with the strategic and financial benefits associated with a larger customer base and expanded network coverage. We believe that the acquisitions also will facilitate the integration relating to the Sprint-Nextel merger by allowing us to provide consistent service offerings and customer experiences across a wider geographic area. We acquired Velocita Wireless primarily to increase our holdings of licenses in the 900 MHz spectrum band.

 

Access to Public Filings and Board Committee Charters

 

Our website address is www.sprint.com. Information contained on our website is not part of this annual report. We provide public access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed with the Securities and Exchange Commission, or SEC, under the Securities Exchange Act of 1934. These documents may be accessed free of charge on our website at the following address: www.sprint.com/sprint/ir. These documents are provided promptly after filing with the SEC. These documents also may be found at the SEC’s website at www.sec.gov.

 

We also provide public access to our Code of Ethics, entitled the Sprint Nextel Code of Conduct, our Corporate Governance Guidelines and the charters of the following committees of our board of directors: the Audit Committee, the Human Capital and Compensation Committee, the Executive Committee, the Finance Committee, and the Nominating and Corporate Governance Committee. The Code of Conduct, corporate governance guidelines and committee charters may be viewed free of charge on our website at the following address: www.sprint.com/governance. You may obtain copies of any of these documents free of charge by writing to: Sprint Nextel Investor Relations, 2001 Edmund Halley Drive, Reston, Virginia 20191. If a provision of the Code of Conduct required under the NYSE corporate governance standards is materially modified, or if a waiver of the Code of Conduct is granted to a director or executive officer, we will post a notice of such action on our website at the following address: www.sprint.com/governance. Only the Audit Committee may consider a waiver of the Code of Conduct for an executive officer or director.

 

Certifications

 

The certifications of our Chief Executive Officer and Chief Financial Officer pursuant to Sections 302 and 906 of the Sarbanes-Oxley Act of 2002 are attached as Exhibits 31.1, 31.2, 32.1 and 32.2 to this annual report. We also filed with the NYSE in 2006 the required certificate of our Chief Executive Officer certifying that he was not aware of any violation by Sprint Nextel of the NYSE corporate governance listing standards.

Our Business Segments

 

Wireless

 

We offer a wide array of wireless mobile telephone and wireless data transmission services on networks that utilize CDMA and iDEN technologies.

 

 

Our strategy for the Wireless segment is to utilize state-of-the-art technology to provide differentiated wireless services and applications in order to acquire and retain high-quality wireless subscribers. To enable us to offer innovative applications and services, we are deploying high-speed EV-DO technology across our CDMA network. The services supported by this technology, marketed as Power Vision, give our subscribers with EV-DO-capable devices access to the Internet and numerous sophisticated high-speed data messaging, imaging, entertainment and location-based applications. Currently, EV-DO technology covers nearly 209 million people and serves customers in over 219 communities with populations of at least 100,000. We also have begun to incorporate the next version of EV-DO technology into our network, with plans for coverage across the majority of the footprint of our CDMA network by the end of 2007. This version of EV-DO, known as EV-DO Rev. A, is designed to support a variety of IP and video and high performance walkie-talkie applications for our CDMA network.

 

In recent periods, we have experienced declines in the number of new subscribers for our wireless services and increases in our rate of subscriber churn. Customer satisfaction and churn have been adversely impacted by capacity constraints on our iDEN network as a result of a number of factors, including the addition to the network in recent years of many high-call-volume subscribers, limited effectiveness of the 6:1 voice coder upgrade in the iDEN technology that was designed to increase network capacity, and the impact of the reconfiguration process under the Report and Order. In certain of our most capacity constrained markets, we have had to take actions to limit the acquisition of new subscribers of Nextel and Boost Mobile branded services. Also, churn of subscribers of our CDMA services remains high relative to our competitors, in large part due to credit-related deactivations. In 2006, we reorganized our sales and distribution and customer management operations to improve customer satisfaction, adopted a regional sales, service, and distribution structure to streamline operations, increase productivity and move decision-making closer to the customer, and tightened our credit policies for new subscribers of both CDMA and iDEN services. In 2007, we:

 

 

In the future, we plan to utilize QUALCOMM Incorporated’s QChat^®technology, which is designed to provide high performance walkie-talkie services on our CDMA network, and we are designing interfaces to provide for interoperability of walkie-talkie services on our CDMA and iDEN networks.

 

We also plan to deploy a next generation broadband wireless network that will be designed to provide significantly higher data transport speeds using our spectrum holdings in the 2.5 gigahertz, or GHz, band and technology based on the Worldwide Inter-Operability for Microwave Access, or WiMAX, standard. We are designing this network to support a wide range of high-speed IP-based wireless services. Our initial plans contemplate deploying the new network in larger metropolitan areas with a goal of launching the related service offerings in some of those markets beginning in 2008.

 

  Products and Services

 

We offer a wide array of wireless mobile telephone and data transmission services and features in a variety of pricing plans, including prepaid service plans. Our wireless mobile voice communications services include basic local and long distance wireless voice services, as well as voicemail, call waiting, three way calling, caller identification, directory assistance, call forwarding, speakerphone and voice-activated dialing features. Through a variety of roaming arrangements, we provide roaming services to areas in numerous countries outside the United States, including areas of Asia, New Zealand, Canada, Central and South America and most major Caribbean islands.

 

Our data communications services include:

 

 

We offer walkie-talkie services, which give subscribers with iDEN-based devices the ability to communicate instantly across the continental United States and to and from Hawaii. Also, through agreements with third parties, subscribers with iDEN devices can communicate instantly with our walkie-talkie feature to and from selected areas in Canada, Latin America and Mexico. Our walkie-talkie features offer subscribers instant communications in a variety of other ways, including push-to-email applications that allow a user to send a streaming voice message to an email recipient, and off-network walkie-talkie communications available on certain handsets. Our new line of combined CDMA-iDEN devices, marketed as PowerSource, feature voice services over our CDMA network and our walkie-talkie applications over our iDEN network, giving users the benefits of instant communications coupled with high quality voice services. We expect to introduce PowerSource devices that feature our Power Vision data applications over our CDMA network, giving these users access to numerous sophisticated data applications.

 

Our services are provided using a wide variety of handsets and personal computer wireless data cards manufactured by various suppliers for use with our voice and data services. We generally sell these devices at prices below our cost in response to competition, to attract new customers and as retention inducements for existing customers.

 

We sell accessories, such as carrying cases, hands-free devices, batteries, battery chargers and other items to consumers, and we sell handsets and accessories to agents and other third-party distributors for resale.

We offer wholesale services on our CDMA network to resellers, commonly known as mobile virtual network operators, or MVNOs. MVNOs purchase wireless services from us at wholesale rates and resell the services to their customers under their own brand names. Under these MVNO arrangements, the operators bear the costs of acquisition, billing and customer service. We currently provide wholesale services, through multi-year, wholesale agreements, to a number of MVNOs, including Embarq, Movida Communications, Inc., Helio Inc., Qwest Communications International, Inc., The Walt Disney Company and Virgin Mobile USA. Virgin Mobile USA offers prepaid wireless service targeted to the youth and prepaid markets and is a joint venture between us and Virgin Group.

 

We provide wireless services that are marketed and sold by several cable multiple systems operators, or MSOs, in four markets. We entered into an agreement with several cable MSOs to jointly develop converged services designed to combine many of cable’s core products and interactive features with wireless technology to deliver a broad range of services, including video, wireless voice and data services, high speed Internet and cable phone service, to the participating cable MSO’s customers. During 2007, we expect to develop new products and services and introduce service in additional markets.

 

We offer customized design, development, implementation and support services for wireless services provided to large companies and government agencies.

 

 

We focus the marketing and sales of wireless services on targeted groups of customers: individual consumers, businesses and government customers. We offer a variety of pricing options and plans, including plans designed specifically for business customers, individuals and families. We use a variety of sales channels to attract new subscribers of wireless services, including:

 

 

We market our post-paid services under the Sprint and Nextel brands. We offer these services on a contract basis typically for one or two year periods, with services billed on a monthly basis according to the applicable pricing plan. We market our prepaid services under the Boost Mobile brand, as a means to directly target the youth and prepaid wireless service markets.

 

Although we market our services using traditional print and television advertising, we also provide exposure to our brand names and wireless services through various sponsorships. We are the title sponsor of the NASCAR NEXTEL Cup Series^tm, the premier national championship series of the National Association for Stock Car Auto Racing, or NASCAR^®. We are NASCAR’s official telecommunications sponsor, which entitles us to a variety of branding, advertising, merchandising and technology-related opportunities, many of which are exclusive with NASCAR, its drivers and teams, and the racetrack facilities. We also are the official telecommunications service provider of the National Football League, or NFL, and the provider of exclusive and original NFL-related content as part of our Sprint-branded wireless service. The goal of these initiatives, together with our other marketing initiatives, which include affiliations with most major sports leagues, is to increase brand awareness in our targeted customer base and expand the use of our customer-convenient distribution channels: web sales, telesales and retail stores.

Our customer management organization works to improve our customer’s experience, with the goal of retaining subscribers of our wireless services. Call centers, some of which are operated by us and some of which are operated by independent contractors, receive and respond to inquiries from customers. Our goal is to improve the quality of our customer care. We have implemented initiatives that are designed to improve call center processes and procedures, including those related to customer satisfaction ratings with respect to customer care and first call resolution. In 2007, we expect to convert the majority of our post-paid subscriber base to a unified billing platform, which we believe will increase functionality for our customer care representatives and produce more reliable information, which should enhance the customer experience.

 

 

 

We provide our Sprint-branded and wholesale wireless services over our CDMA network, an all-digital wireless network with spectrum licenses that allow us to provide service in all 50 states, Puerto Rico and the U.S. Virgin Islands. The CDMA network uses a single frequency band and a digital spread-spectrum wireless technology that allows a large number of users to access the band by assigning a code to all voice and data bits, sending a scrambled transmission of the encoded bits over the air and reassembling the voice and data into its original format.

 

We, together with the four remaining PCS Affiliates, operate CDMA networks in over 300 metropolitan markets, including 297 of the 300 largest U.S. metropolitan areas, where more than 262 million people live or work. We provide nationwide service through a combination of:

 

 

Under the terms of the commercial arrangements with the PCS Affiliates, our wireless services are offered under the Sprint brand on CDMA networks built and operated at the expense of the PCS Affiliates. In most instances, the PCS Affiliates use spectrum licensed to, and controlled by, us. The PCS Affiliates operate mainly in and around smaller U.S. metropolitan areas.

 

CDMA subscribers can use their phones through roaming agreements in countries other than the United States, including areas of Asia, New Zealand, Canada, Central and South America and most major Caribbean islands. Our digital quad band devices can utilize global system for mobile communications, or GSM, technology, the network technology utilized by many wireless providers throughout Europe and other parts of the world, which enables subscribers to roam in numerous countries outside the U.S., including countries in Europe.

 

We are deploying the high-speed EV-DO technology across our CDMA network. EV-DO increases average mobile-device data speeds up to 10 times faster when compared to the prior generation technology. In addition, this technology delivers applications and services available only on EV-DO-capable handsets and laptops equipped with EV-DO-capable Sprint PCS Connection Cards^tm. The services supported by this technology, marketed as Power Vision, give consumer and business customers access to numerous sophisticated applications using EV-DO-capable devices, including mobile desktop, data messaging, imaging, entertainment and location-based applications. Currently, EV-DO technology covers nearly 209 million people and serves customers in over 219 communities with populations of at least 100,000, and we plan to have coverage across the majority of the footprint of our CDMA network by the end of 2007. EV-DO data roaming is available in selected markets in Canada and Mexico.

 

We also have begun to incorporate EV-DO Rev. A, the next version of EV-DO technology, into our network, with plans for coverage across the majority of the footprint of our CDMA network by the end of 2007.

EV-DO Rev. A is designed to support a variety of IP and video and high performance walkie-talkie applications for our CDMA network.

 

The cell site equipment used in the CDMA network often resides on communications towers. In May 2005, we closed a transaction whereby we provided Global Signal Inc. with the exclusive rights to lease or operate about 6,500 of our communication towers for a negotiated lease term that is the greater of the remaining terms of the underlying ground leases or up to 32 years, assuming successful re-negotiation of the underlying ground leases at the end of their current lease terms. We have committed to sublease space from Global Signal on about 6,400 of these towers for a minimum of ten years. We have built additional sites to enhance and expand the coverage of our CDMA network. The acquisition of Nextel has given us access to cell site communications towers erected for use in connection with the Nextel iDEN network, which in many cases enables us to co-locate CDMA cell site equipment on these towers, instead of requiring us to erect new towers or co-locate the equipment on towers owned by third parties, which we expect will reduce our costs. Similarly, we are able to co-locate iDEN cell site equipment on the CDMA communications towers. We also deploy in-building systems and outdoor distributed antenna systems where cell site solutions are not feasible.

 

     iDEN Network

 

We provide our Nextel-branded post-paid and Boost Mobile-branded prepaid wireless services over our iDEN network. Our iDEN network is an all-digital packet data network based on iDEN wireless technology provided by Motorola, Inc. We are the only national wireless service provider in the United States that utilizes iDEN technology, and, generally, the iDEN handsets that we currently offer are not enabled to roam onto wireless networks that do not utilize iDEN technology. We operate iDEN networks in over 300 metropolitan markets, including 293 of the top 300 U.S. markets, where about 274 million people live or work.

 

We have roaming or interoperability agreements with iDEN-based wireless service providers that operate in selected areas of Canada, Latin America and Mexico, which gives subscribers of iDEN-based services the ability to utilize our walkie-talkie services to communicate to and from these markets. With an i930 or i920 iDEN handset, subscribers are able to roam in numerous countries outside the U.S., including countries in Europe. These handsets utilize GSM technology. In addition, any iDEN subscriber can remove the subscriber identity module card found in each iDEN handset and place it in a Motorola handset that utilizes GSM technology when traveling outside of the U.S.

 

Although the iDEN technology offers a number of advantages over other technology platforms, including the ability to offer our walkie-talkie features, unlike other wireless technologies, it is a proprietary technology that relies principally on our and Motorola’s efforts for further research, and product development and innovation. We rely on Motorola to provide us with technology improvements designed to expand our iDEN-based wireless services, including improvements designed to increase voice capacity and improve our iDEN-based services. Motorola provides substantially all of the iDEN infrastructure equipment used in our iDEN network, and substantially all iDEN handset devices. We have agreements with Motorola that set the prices we must pay to purchase and license this equipment, as well as a structure to develop new features and make long-term improvements to our network. Motorola also provides integration services in connection with the deployment of iDEN network elements. We have also agreed to warranty and maintenance programs and specified indemnity arrangements with Motorola. Motorola is, and is expected to continue to be, our sole source supplier of iDEN infrastructure and iDEN handsets, except primarily for BlackBerry^® devices, which are manufactured by Research In Motion. Further, our ability to timely and efficiently implement the Report and Order of the Federal Communications Commission, or FCC, which implemented a spectrum reconfiguration plan designed to eliminate interference with public safety operators in the 800 MHz band, is dependent, in part, on Motorola. See “Item 1A. — Risk Factors — If Motorola is unable or unwilling to provide us with equipment and handsets in support of our Nextel branded services, as well as anticipated handset and infrastructure improvements for those services, our operations will be adversely affected.”

 

We believe that the market for wireless services has been and will continue to be characterized by intense competition on the basis of price, the types of services offered and quality of service. We compete with a number of wireless carriers, including three other national wireless companies: AT&T (formerly known as Cingular Wireless), Verizon Wireless and T-Mobile. AT&T and Verizon also offer competitively-priced wireless services packaged with local and long distance voice and high-speed Internet services. We also compete with regional providers of mobile wireless services, such as Alltel Corporation. Our Boost Mobile-branded prepaid service competes with a number of regional carriers, including Metro PCS Communications, Inc. and Leap Wireless International, Inc., which offer competitively-priced calling plans that include unlimited local calling. Competition will increase to the extent that new firms enter the market as additional radio spectrum is made available for commercial wireless services. We also expect competition to increase as a result of other technologies and services that are developed and introduced in the future, including potentially those using unlicensed spectrum, including wireless fidelity, or WiFi. The continued addition of MVNOs also contributes to increased competition.

 

Pricing competition has led to declining average voice revenue per subscriber as we and our competitors have offered more competitive service pricing plans, including lower priced plans, plans that allow users to add additional units to their plans at attractive rates, plans with a higher number of bundled minutes included in the fixed monthly charge for the plan, plans that offer the ability to share minutes among a group of related customers, or a combination of these features.

 

In addition to pricing, we believe that our targeted customers are also likely to base their purchase decisions on quality of service and the availability of differentiated features and services that make it easier for them to get things done quickly and efficiently. We believe we compete based on our differentiated service offerings and products, including our Power Vision applications and push-to-talk walkie-talkie feature. Several of our competitors offer high-speed data, imaging, entertainment and location-based services and walkie-talkie-type features that are designed to compete with our differentiated products and services. Other competitors have announced plans to introduce similar services. If our competitors are able to provide applications and features that are comparable to ours, any competitive advantage from the differentiation of our services from those of our competitors would be reduced. To the extent that the competitive environment requires us to decrease prices or increase service and product offerings, our revenue could decline or our costs could increase. Competition in pricing and service and product offerings also may adversely impact customer retention. See “Item 1A. — Risk Factors — We face intense competition that may reduce our market share and harm our financial performance.”

 

Long Distance

 

Through our Long Distance segment, we provide a broad suite of wireline voice and data communications services targeted to domestic business customers, multinational corporations and other communications companies. We are one of the nation’s largest providers of long distance services and operate all-digital long distance and Tier 1 IP networks.

 

 

In an effort to maintain market share in an environment where many long distance communications services, primarily stand-alone voice services, are being marketed and sold as low-cost commodities, our Long Distance segment focuses on expanding its presence in the data communications markets by utilizing our principal strategic assets: our high-capacity national fiber-optic network, our Tier 1 IP network, our base of business customers, our established national brand and offerings available from our Wireless segment. We continue to assess the portfolio of services provided by our Long Distance segment and are focusing our efforts on IP-based services and de-emphasizing stand-alone voice services and non-IP-based data services. For example, in addition to increased emphasis on selling IP services, we are converting many of our existing customers from ATM and frame relay to more advanced IP technologies, in part to support our effort to move to one platform, which will reduce our network cost structure. We also are taking advantage of the growth in voice services

provided by cable MSOs, as consumers increase their use of cable MSOs as alternatives to local and long distance voice communications providers, by providing large cable MSOs with local and long distance voice communications service, which they offer as part of their bundled service offerings.

 

  Products and Services

 

Through our Long Distance segment, we provide a broad suite of wireline voice and data communications services, including domestic and international data communications using various protocols such as MPLS technologies, as well as IP, ATM, frame relay and managed network services and voice services. We also provide services to cable MSOs that resell our long distance service and/or use our back office systems and network assets in support of their telephone service provided over cable facilities primarily to residential end user customers. Although we continue to provide voice services to residential consumers, we no longer actively market those services. Our Long Distance segment markets and sells its services primarily through direct sales representatives. We also provide voice and data services to our Wireless segment.

 

 

Our Long Distance segment competes with AT&T, Verizon Communications, Qwest Communications, Level 3 Communications, Inc., other major local incumbent operating companies, cable operators and other telecommunications providers in all segments of the long distance communications market. Some competitors are targeting the high-end data market and are offering deeply discounted rates in exchange for high-volume traffic as they attempt to utilize excess capacity in their networks. In addition, we face increasing competition from other wireless and IP-based service providers. Many carriers are competing in the residential and small business markets by offering bundled packages of both local and long distance services. Competition in long distance is based on price and pricing plans, the types of services offered, customer service, and communications quality, reliability and availability. Our ability to compete successfully will depend on our ability to anticipate and respond to various competitive factors affecting the industry, including new services that may be introduced, changes in consumer preferences, demographic trends, economic conditions and pricing strategies. See “Item 1A. — Risk Factors — We face intense competition that may reduce our market share and harm our financial performance.”

 

Legislative and Regulatory Developments

 

Overview

 

Communications services are subject to regulation at the federal level by the FCC and in certain states by public utilities commissions, or PUCs. The Communications Act of 1934, or Communications Act, preempts states from regulating the rates of commercial mobile radio service, or CMRS, providers, such as with respect to our Wireless segment, as well as various licensing and technical requirements imposed by the FCC, including provisions related to the acquisition, assignment or transfer of radio licenses. CMRS providers are subject to state regulation of other terms and conditions of service. Our Long Distance segment also is subject to limited federal and state regulation.

 

The following is a summary of the regulatory environment in which we operate and does not describe all present and proposed federal, state and local legislation and regulations affecting the communications industry. Some legislation and regulations are the subject of judicial proceedings, legislative hearings and administrative proceedings that could change the manner in which our industry operates. We cannot predict the outcome of any of these matters or their potential impact on our business. See “Item 1A. Risk Factors — Government regulation could adversely affect our prospects and results of operations; the FCC and state regulatory commissions may adopt new regulations or take other actions that could adversely affect our business prospects or results of operations.” Regulation in the communications industry is subject to change, which could adversely affect us in the future. The following discussion describes some of the major communications-related regulations that affect us, but numerous other substantive areas of regulation not discussed here may also influence our business.

Regulation and Wireless Operations

 

The FCC regulates the licensing, construction, operation, acquisition and sale of our wireless operations and wireless spectrum holdings. FCC requirements impose operating and other restrictions on our wireless operations that increase our costs. The FCC does not currently regulate rates for services offered by CMRS providers, and states are legally preempted from regulating such rates and entry into any market, although states may regulate other terms and conditions. The Communications Act and FCC rules also require the FCC’s prior approval of the assignment or transfer of control of an FCC license, although the FCC’s rules permit spectrum lease arrangements for a range of wireless radio service licenses, including our licenses, with FCC oversight. Approval from the Federal Trade Commission and the Department of Justice, as well as state or local regulatory authorities, also may be required if we sell or acquire spectrum interests. The FCC sets rules, regulations and policies to, among other things:

 

 

We hold several kinds of licenses to deploy our services: 1.9 GHz PCS licenses utilized in our CDMA network, and 800 MHz and 900 MHz licenses utilized in our iDEN network. We also hold 2.1 GHz BRS licenses, 2.5 GHz BRS licenses, and we lease use of 2.5 GHz BRS and EBS licenses held by others, for our first generation fixed wireless Internet access service. We also hold and lease 2.5 GHz, 1.9 GHz and other FCC licenses that we currently do not utilize in our networks or operations, but which we intend to use in the future consistent with customer demand and our obligations as a licensee.

 

 

All PCS licenses are granted for ten-year terms. For purposes of issuing PCS licenses, the FCC utilizes major trading areas, or MTAs, and basic trading areas, or BTAs, with several BTAs making up each MTA. Each license is subject to buildout requirements, and the FCC may revoke a license after a hearing if the buildout or other applicable requirements have not been met. We have met these requirements in all of our MTA and BTA markets.

 

If applicable buildout conditions are met, these licenses may be renewed for additional ten-year terms. Renewal applications are not subject to auctions. If a renewal application is challenged, the FCC grants a preference commonly referred to as a license renewal expectancy to the applicant if the applicant can demonstrate that it has provided “substantial service” during the past license term and has substantially complied with applicable FCC rules and policies and the Communications Act. The licenses for the 10 MHz of spectrum in the 1.9 GHz band that we received as part of the FCC’s Report and Order, described below, have ten-year terms and are not subject to specific buildout conditions, but are subject to renewal requirements that are similar to those for our PCS licenses.

 

We hold licenses for channels in the 800 MHz and 900 MHz bands that are used to deploy our iDEN services. Because spectrum in these bands originally was licensed in small groups of channels, we hold thousands of these licenses, which together allow us to provide coverage across much of the continental United States. Our 800 MHz and 900 MHz licenses are subject to requirements that we meet population coverage benchmarks tied to the initial license grant dates. To date, we have met all of these construction requirements applicable to these licenses, except in the case of licenses that are not material to our business. Our 800 MHz and 900 MHz licenses have ten-year terms, at the end of which each license is subject to renewal requirements that are similar to those for our 1.9 GHz licenses.

 

 

We hold and lease FCC BRS and EBS licenses.  We currently use a portion of this spectrum to provide fixed wireless Internet access services to homes and small businesses using “first generation” line-of-sight technology. This service operates across the country in 14 markets with approximately 16,500 subscribers. We operate our network and a third party provides customer care.

 

In 2004, the FCC ordered that the 2496-2690 MHz band, or the 2.5 GHz band, which is the spectrum for our EBS and BRS licenses, be reconfigured into upper and lower-band segments for low-power operations, and a mid-band segment for high-power operations. Transition to the new band plan has begun. We and other parties are transitioning the 2.5 GHz band to its new configuration market-by-market in a process that may require several years to complete nationally. As of early January 2007, we had served pre-transition data requests to licensees in 115 BTAs, filed initiation plans with the FCC for 57 BTAs and filed notices of completion for transitions in 19 BTAs. When the transition is complete, we believe that the 2.5 GHz band will be more suitable for our WiMAX next generation broadband wireless network. We intend to provide fourth generation Wireless Interactive Multimedia Services, or WIMS, and other services, such as fixed point-to-point communications, using this spectrum.

 

The FCC affirmed its prohibition of commercial ownership on approximately 62% of the total 2.5 GHz spectrum band, which is held primarily by educational institutions; however, these institutions are authorized to lease up to 95% of their licensed spectrum to commercial operators, such as us, subject to certain restrictions. In addition, the FCC adopted a band plan that requires the relocation of licensed BRS operations from the 2150-2162 MHz band, or the 2.1 GHz band, into the 2.5 GHz band. The FCC adopted rules that require new licensees in the 2.1 GHz band to provide incumbent licensees with “comparable facilities,” which will permit incumbents to continue to offer fixed data services to current and future subscribers if they choose to do so.

 

All BRS-EBS licenses are subject to renewal. In January 2007, the FCC Wireless Telecommunications Bureau reinstated more than 50 expired EBS licenses and additional requests for reinstatement of expired EBS licenses remain pending at the FCC. We have and will continue to challenge the validity of these requested or adopted reinstatements, but there can be no assurance that our challenges will be successful. The reinstatement of an expired license may affect our wireless broadband deployment plans in a market in which the reinstated license interferes with one or more of our 2.5 GHz holdings or otherwise requires alteration of our deployment plans.

 

The FCC conditioned its approval of the Sprint-Nextel merger on two deployment milestones in the 2.5 GHz spectrum band. Within four years following the August 8, 2005 effective date of the merger order, we must offer service using the 2.5 GHz band to a population of no less than 15 million people. This deployment must include areas within a minimum of nine of the nation’s most populous 100 BTAs and at least one BTA less populous than the nation’s 200th most populous BTA. In these ten BTAs, the deployment must cover at least one-third of each BTA’s population. In addition, within six years from the effective date of the merger order, we must offer service using the 2.5 GHz band to at least 15 million more people in areas within a minimum of nine additional BTAs in the 100 most populous BTAs, and at least one additional BTA less populous than the nation’s 200th most populous BTA. In these additional ten BTAs, the deployment must also cover at least one-third of each BTA’s population.

 

In recent years, the operations of a number of public safety communications systems in the 800 MHz block of spectrum have experienced interference that is believed to be a result of the operations of CMRS providers operating on adjacent frequencies in the same geographic area.

 

In 2001, Nextel filed a proposal with the FCC that would result in a more efficient use of spectrum through the reconfiguration of spectrum licenses and spectrum allocations in the 700, 800 and 900 MHz bands and, thereby, resolve many of these interference problems. In 2004, following a rulemaking to consider proposals to solve the public safety interference issue, the FCC adopted a Report and Order that included new rules regarding interference in the 800 MHz band and a comprehensive plan to reconfigure the 800 MHz band. In February 2005, Nextel accepted the Report and Order, which was necessary before the order became effective, because the Report and Order required Nextel to undertake a number of obligations and accept modifications to its FCC licenses. We assumed these obligations when we merged with Nextel in August 2005.

 

The Report and Order provides for the exchange of a portion of our FCC spectrum licenses, which the FCC is implementing through modifications to these licenses. Specifically, the Report and Order modified a number of FCC licenses in the 800 MHz band, including many of our licenses, and implemented rules to reconfigure spectrum in the 800 MHz band in a 36-month phased transition process. It also obligated us to surrender all of our holdings in the 700 MHz spectrum band and certain portions of our holdings in the 800 MHz spectrum band, and to fund the cost incurred by public safety systems and other incumbent licensees to reconfigure the 800 MHz spectrum band. Under the Report and Order, we received licenses for 10 MHz of nationwide spectrum in the 1.9 GHz band, but we are required to relocate and reimburse the incumbent licensees in this band for their costs of relocation to another band designated by the FCC.

 

The reconfiguration process is to be completed by geographic region and involves reaching agreement and coordinating numerous processes with the incumbent licensees in that region, as well as vendors and contractors that will be performing much of the reconfiguration. We are permitted to continue to use the spectrum in the 800 MHz band that was surrendered under the Report and Order during the reconfiguration process; however, as part of the reconfiguration process in most regions, we must cease using portions of the surrendered 800 MHz spectrum before we are able to commence use of replacement 800 MHz spectrum, which has contributed to the capacity constraints experienced on our iDEN network, particularly in some of our more capacity constrained markets, and has impacted the performance of our iDEN network in the affected markets.

 

We believe we have substantially met the first progress milestone established by the Report and Order by retuning all incumbent licensees on the first 120 800 MHz channels in at least 26 FCC-defined regions, and by initiating retuning negotiations with all licensees on the last 120 800 MHz channels in those 26 regions, within an 18-month period which began on June 27, 2005. The Report and Order required us to complete these actions in at least 20 of 55 FCC-defined regions within the 18-month period. We have reported our progress to the FCC.

 

The Report and Order requires us to complete the 800 MHz band reconfiguration within a 36-month period, ending in June 2008, subject to certain exceptions particularly with respect to markets that border Mexico and Canada, and to complete the 1.9 GHz band reconfiguration within a 31.5-month period, ending in September 2007. If, as a result of events within our control, we fail to complete our reconfiguration responsibilities within the designated time periods for either the 800 MHz or 1.9 GHz reconfigurations, the FCC could take actions against us to enforce the Report and Order. These actions could have adverse operating or financial impacts on us, some of which could be material. We believe, based on our experiences to date, that neither the 800 MHz reconfiguration nor the 1.9 GHz reconfiguration will be completed within the applicable FCC designated time periods due primarily to circumstances largely outside of our control. We do not believe at this time that the impact from this delay will be material to our results of operations or financial condition, although there can be no assurances. Recognizing the current limitations in the reconfiguration process, both Sprint Nextel and the public safety community jointly filed a letter with the FCC on February 15, 2007, requesting that the FCC direct the independent Transition Administrator, or TA, through working closely with the affected parties, to develop a schedule and benchmarks for completing the second phase of the 800 MHz reconfiguration. See

Part II, Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Forward-Looking Statements.”

 

The Report and Order requires us to make a payment to the U.S. Treasury at the conclusion of the band reconfiguration process to the extent that the value of the 1.9 GHz spectrum we received exceeds the total of the value of licenses for spectrum positions in the 700 MHz and 800 MHz bands that we surrendered under the decision, plus the actual costs that we incur to retune incumbents and our own facilities under the Report and Order. The FCC determined under the Report and Order that, for purposes of calculating that payment amount, the value of the 1.9 GHz spectrum is about $4.9 billion and the aggregate value of the 700 MHz spectrum and the 800 MHz spectrum surrendered, net of 800 MHz spectrum received as part of the exchange, is about $2.1 billion, which, because of the potential payment to the U.S. Treasury, results in minimum cash expenditures of about $2.8 billion by us under the Report and Order. The FCC has designated an independent Transition Administrator to monitor, facilitate and review our expenditures for 800 MHz band reconfiguration. A precise methodology for evaluating and confirming our internal network costs has not yet been established by the TA. Because the TA may not agree that all of the costs we submit as external and internal costs are appropriate or are subject to credit, we may incur certain costs as part of the reconfiguration process for which we will not receive credit against the potential payment to the U.S. Treasury.

 

We are obligated to pay the full amount of the costs relating to the reconfiguration plan, even if those costs exceed $2.8 billion. As of December 31, 2006, we estimate that we had incurred about $721 million of costs directly attributable to the reconfiguration program. This amount does not include any indirect network costs that we have preliminarily allocated to the reconfiguration program.

 

As required under the terms of the Report and Order, we delivered a $2.5 billion letter of credit to provide assurance that funds will be available to pay the relocation costs of the incumbent users of the 800 MHz spectrum. Although the Report and Order provides for the possibility of periodic reductions in the amount of the letter of credit, we have not requested any reductions as of December 31, 2006.

 

In addition, a financial reconciliation is required to be completed at the end of the reconfiguration implementation to determine whether the value of the spectrum rights received exceeds the total of (i) the value of spectrum rights that are surrendered and (ii) the qualifying costs referred to above. If so, we will be required to pay the difference to the U.S. Treasury, as described above. As a result of the uncertainty with regard to the calculation of the credit for our internal network costs, as well as the significant number of variables outside of our control, particularly with regard to the 800 MHz reconfiguration licensee costs, we do not believe that we can reasonably estimate what amount, if any, will be paid to the U.S. Treasury.

 

 

We are a non-voting, minority shareholder in a consortium called SpectrumCo LLC, which was recently awarded numerous advanced wireless services, or AWS, licenses in the 1.7 GHz / 2.1 GHz bands. AWS licensees such as SpectrumCo have no FCC build-out or active spectrum management requirements until they are required to demonstrate “substantial service” at the end of their fifteen-year license terms. Separately, several FCC proceedings and initiatives are underway that may affect the availability of spectrum used or useful in the provision of commercial wireless services, which may allow new competitors to enter the wireless market. For instance, federal law requires the FCC to commence auction of sixty megahertz in the 700 MHz spectrum band for commercial use no later than January 2008. We cannot predict when or whether the FCC will conduct any spectrum auctions or if it will release additional spectrum that might be useful to wireless carriers, including us, in the future.

 

 

Pursuant to FCC rules, CMRS providers, including us, are required to provide enhanced 911, or E911, services in a two-tiered manner. Phase I requires wireless carriers to transmit to a requesting public safety answering point, or PSAP, both (a) the 911 caller’s telephone number and (b) the location of the cell site from which the call is being made. Phase II requires the transmission of more accurate location information using latitude and

longitude, and, with respect to our iDEN and CDMA network services, such information can be determined only if the caller is using a handset with global positioning satellite, or GPS, capability. Implementation of Phase I or Phase II E911 service must be completed within six months of a PSAP request for service in its area, or longer, based on the agreement between the individual PSAP and carrier.

 

We were unable to satisfy the FCC requirement that 95% of our iDEN subscriber base have Assisted-GPS capable handsets by December 31, 2005. The FCC recently denied our request for an extension of this deadline and has referred the matter to the FCC’s Enforcement Bureau for further action. Although we have asked the FCC to reconsider their decision, the FCC may impose fines, set new deadlines for compliance or seek to require us to take actions to encourage our customers to upgrade their handsets so we can fulfill the 95% requirement.

 

 

The FCC’s Truth in Billing rules generally require CMRS licensees, such as us, to provide full and fair disclosure of all charges on their wireless bills, including brief, clear, and non-misleading plain language descriptions of the services provided. In response to a petition from the National Association of State Utility Consumer Advocates, the FCC found that state regulation of CMRS rates, including line items on consumer bills, is preempted by federal statute. This decision was overturned by the 11th Circuit Court of Appeals, however, and many states continue to attempt to impose various regulations on the billing practices of wireless carriers. The FCC is continuing to look at issues of consumer protection and the appropriate state and federal roles. If states gain such authority, or there are other changes in the Truth in Billing rules, our billing and customer service costs could increase.

 

 

Homeland security issues are receiving attention at the FCC, from the states and in Congress. The FCC chairman has created a new FCC bureau devoted to this area. We expect that increased scrutiny of wireless carriers’ networks and several new initiatives could lead to new regulatory requirements regarding disaster preparedness, network reliability, and communications among first responders. In October 2006, Congress passed the Warning, Alert and Response Network Act, or WARN Act, which created a new voluntary wireless emergency alert program. As a result of the WARN Act, the FCC created the Commercial Mobile Service Alert Advisory Committee to recommend standards and protocols for delivery of emergency alerts to wireless customers. We are unable to predict the impact of these initiatives on our business.

 

 

Wireless systems must comply with various federal, state and local regulations that govern the siting, lighting and construction of transmitter towers and antennas, including requirements imposed by the FCC and the Federal Aviation Administration. FCC rules subject certain cell site locations to extensive zoning, environmental and historic preservation requirements and mandate consultation with various parties, including Native Americans. The FCC adopted significant changes to its rules governing historic preservation review of projects, which makes it more difficult and expensive to deploy antenna facilities. The FCC is also considering changes to its rules regarding environmental protection as related to tower constructions, which, if adopted, could make it more difficult to deploy facilities. To the extent governmental agencies impose additional requirements on the tower siting process, the time and cost to construct cell towers could be negatively impacted.

 

 

While the Communications Act generally preempts state and local governments from regulating entry of, or the rates charged by, wireless carriers, certain State PUCs and local governments regulate customer billing, termination of service arrangements, advertising, certification of operation, use of handsets when driving, service quality, sales practices, management of customer call records and protected information and many other areas. Also, some state attorneys general have become more active in enforcing state consumer

protection laws against sales practices and services of wireless carriers. States also may impose their own universal service support requirements on wireless and other communications carriers, similar to the contribution requirements that have been established by the FCC. We anticipate that these trends will continue. It will require us to devote legal and other resources to working with the states to respond to their concerns while minimizing, if not preventing, any new regulation and enforcement actions that could increase our costs of doing business.

 

Regulation and Wireline Operations

 

 

The Telecommunications Act of 1996, or Telecom Act, the first comprehensive update of the Communications Act, was designed to promote competition, and it eliminated legal and regulatory barriers for entry into local and long distance communications markets. It also required ILECs to allow resale of specified local services at wholesale rates, negotiate interconnection agreements, provide nondiscriminatory access to unbundled network elements, or UNEs, and allow co-location of interconnection equipment by competitors. The rules implementing the Telecom Act remain subject to legal challenges. Thus, the scope of future local competition remains uncertain. These local competition rules impact us because we provide wholesale services to cable television companies that wish to compete in the local voice telephony market.

 

We provide cable companies with communications and back-office services to enable the cable companies to provide competitive local and long distance telephony services primarily in a voice over IP, or VoIP, format to their end-user customers. We are now providing these cable services in a number of states while working to gain regulatory approvals and obtain interconnection agreements to enter additional markets. Certain ILECs continue to take steps to impede our ability to provide services to the cable companies in an efficient manner. However, regulatory decisions in several states may speed our market entry in those states.

 

 

With the increasing availability of VoIP services, the FCC continues to consider the regulatory status of various forms of VoIP. In 2004, the FCC issued an order finding that one form of VoIP, involving a specific form of computer-to-computer services for which no charge is assessed and conventional telephone numbers are not used, is an unregulated “information service,” rather than a telecommunications service, and preempted state regulation of this service. The FCC also ruled that long distance offerings in which calls begin and end on the ordinary public switched telephone network, but are transmitted in part through the use of IP, are “telecommunications services,” thereby rendering the services subject to all the regulatory obligations imposed on ordinary long distance services, including payment of access charges and contributions to the universal service funds or USF. In addition, the FCC preempted states from exercising entry and related economic regulation of interconnected VolP services that originate through the use of broadband connections and specialized customer premises equipment. However, this ruling did not address specifically whether this form of VoIP is an “information service” or a “telecommunications service,” or what regulatory obligations, such as intercarrier compensation, should apply. Nevertheless, the FCC requires interconnected VoIP providers to contribute to the federal USF. The FCC also requires interconnected VoIP providers to offer E911 emergency calling capabilities to their subscribers.

 

 

Following a June 2005 U.S. Supreme Court decision affirming the FCC’s classification of cable modem Internet access service as an “information service” and declining to impose mandatory common carrier regulation on cable providers, the FCC issued an order in September 2005 declaring the wireline high-speed Internet access services, which are provided by ILECs, are “information services” rather than “telecommunications services.” As a result, over time ILECs have been relieved of certain obligations regarding the provision of the underlying broadband transmission services. The FCC is considering similar deregulation of wireless high-speed Internet access services. Such deregulation could result in less regulation of some of our EV-DO and WiMAX products and services. Deregulation of broadband services has sparked a debate over

“net neutrality.” Proponents of “net neutrality” assert that operators of broadband transmission facilities should not be permitted to make distinctions among content providers for priority access to the underlying facilities. A net neutrality mandate could adversely affect the operation of our networks that utilize EV-DO and WiMAX technologies by constraining our ability to control the network and enter into innovative business arrangements with third-party content providers. Additionally, the FCC has a pending proceeding to consider whether all high-speed Internet access services, regardless of the technology used, are subject to various FCC consumer protection regulations. The imposition of any such obligations could result in significant costs to us.

 

Other Regulations

 

 

Incumbent local exchange carriers, or ILECs, and other carriers impose access charges for the origination and termination of long distance calls upon wireless and long distance carriers, including our Wireless and Long Distance segments. Also, interconnected local carriers, including our Wireless segment, pay to each other reciprocal compensation fees for terminating interconnected local calls. In addition, ILECs impose special access charges for their provision of dedicated facilities to other carriers, including both our Long Distance and Wireless segments. These fees and charges are a significant cost for our Wireless and Long Distance segments. There are ongoing proceedings at the FCC related to access charges and special access rates, which could impact our costs for these services.

 

Communications carriers also pay fees into and receive revenues from the USF, established by the FCC and many states. The federal USF program funds services provided in high-cost areas, reduced-rate services to low-income consumers, and discounted communications and Internet services for schools, libraries and rural health care facilities. The USF is funded from assessments on communications providers, including our Wireless and Long Distance segments, who must make contributions into the fund. Our contributions to the federal USF are based on separate FCC-prescribed percentages of our interstate and international end-user revenues from telecommunications services for our Wireless and Long Distance segments. The FCC is considering changing the interstate revenue-based assessment with an assessment based on telephone numbers or connections to the public network, which could impact the amount of our assessments. As permitted, we assess customers for these USF charges. The FCC is considering changing the way it distributes federal USF support to carriers. In particular, FCC or state actions could make it more difficult for our Wireless segment, which currently receives support in 24 states as an Eligible Telecommunications Carrier, or ETC, to qualify for and to receive support. Further restrictions on our ETC status at the federal and state levels could result in the rescission of our ETC status.

 

 

The Communications Assistance for Law Enforcement Act, or CALEA, requires telecommunications carriers, including us, to modify equipment, facilities and services to allow for authorized electronic surveillance based on either industry or FCC standards. Our CALEA obligations have been extended to data and VoIP networks, with which we are required to be compliant by May 2007.

 

 

We comply with FCC-mandated rules that limit how carriers may use customer proprietary network information, or CPNI, for marketing purposes, and specify what carriers must do to safeguard CPNI held by third parties. It has recently been reported that the call detail records of both wireline and wireless telephone customers are available from certain Internet-based vendors. Congress has enacted, and state legislatures are considering, legislation to criminalize the sale of call detail records and to further restrict the manner in which carriers make such information available. The FCC is investigating these practices and is examining whether existing regulations with respect to CPNI require revision or expansion, which could result in additional costs to us, including administrative or operational burdens on our customer care, sales, marketing and IT systems.

Environmental Compliance

 

Our environmental compliance and remediation obligations relate primarily to the operation of standby power generators, batteries and fuel storage for our telecommunications equipment. These obligations require compliance with storage and related standards, obtaining of permits and occasional remediation. Although we cannot assess with certainty the impact of any future compliance and remediation obligations, we do not believe that any such expenditures will have a material adverse effect on our financial condition or results of operations.

 

We have identified seven former manufactured gas plant sites in Nebraska, not currently owned or operated by us, that may have been owned or operated by entities acquired by Centel Corporation, formerly a subsidiary of ours and now a subsidiary of Embarq. We and Embarq have agreed to share the environmental liabilities arising from these former manufactured gas plant sites. Three of the sites are part of ongoing settlement negotiations and administrative consent orders with the Environmental Protection Agency, or EPA. Two of the sites have had initial site assessments conducted by the Nebraska Department of Environmental Quality, or NDEQ, but no regulatory actions have followed. The two remaining sites have had no regulatory action by the EPA or the NDEQ. Centel has entered into agreements with other potentially responsible parties to share costs in connection with five of the seven sites. We are working to assess the scope and nature of these sites and our potential responsibility, which is not expected to be material.

 

Patents, Trademarks and Licenses

 

We own numerous patents, patent applications, service marks and trademarks in the United States and other countries. We have a program to file applications for trademarks, service marks and patents where we believe this protection is appropriate. “Sprint,” “Power Vision,” “Sprint PCS,” “Nextel” and “Boost Mobile” are among our trademarks. Our services often use the intellectual property of others, such as licensed software, and we often license copyrights, patents and trademarks of others. In total, these licenses and our copyrights, patents, trademarks and service marks are of material importance to the business. Generally, our trademarks and service marks endure and are enforceable so long as they continue to be used. Our patents and licensed patents have remaining terms generally ranging from one to 19 years.

 

We occasionally license our intellectual property to others, including licenses to others to use the trademarks “Sprint” and “Nextel.”

 

We have received claims in the past, and may in the future receive claims, that we, or third parties from whom we license intellectual property, have infringed on the intellectual property of others. These claims can be time-consuming and costly to defend, and divert management resources. If these claims are successful, we could be forced to pay significant damages or stop selling certain products or services, or the third parties from whom we license intellectual property could be forced to pay significant damages, which could increase the cost of these products and services or force the third parties to stop providing certain products or services to us. We also could enter into licenses with unfavorable terms, including royalty payments, which could adversely affect our business.

 

Employee Relations

 

As of December 31, 2006, we had about 64,600 employees, representing a reduction of about 15,000 employees since December 31, 2005, due primarily to the spin-off of Embarq.

 

In connection with the ongoing merger and integration cost rationalization projects, which began in the second half of 2005, we continue to align our internal resources to achieve synergies from the Sprint-Nextel merger and the acquisitions of the PCS Affiliates and Nextel Partners. In January 2007, we announced that we would be reducing our workforce. We expect to complete the majority of the reductions in the first quarter 2007.

 

Management

 

For information concerning our executive officers, see “Executive Officers of the Registrant” in this document.

Information as to Business Segments

 

For information regarding our business segments, see “Part II, Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations” and also refer to note 14 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K.

 

Item 1A.  Risk Factors

 

In addition to the other information contained in this Form 10-K, the following risk factors should be considered carefully in evaluating us. Our business, financial condition, liquidity or results of operations could be materially adversely affected by any of these risks.

 

Risks Related to the Sprint-Nextel Merger and the Spin-off of Embarq

 

We may not be able to successfully integrate the businesses of Nextel, the acquired PCS Affiliates or Nextel Partners with ours and realize the anticipated benefits of the merger and acquisitions.

 

We continue to devote significant management attention and resources to integrating the Nextel wireless network and other wireless technologies with ours, as well as the business practices, operations and support functions of the two companies. The challenges we are facing and/or may face in the future in connection with these integration efforts include the following:

 

 

The process of integrating Nextel’s operations with ours has caused, and may in the future cause, interruptions of, or loss of momentum in, our business and financial performance. The diversion of management’s attention and any delays or difficulties encountered in connection with the integration of the two companies’ operations has had, and could continue to have, an adverse effect on our business, financial condition or results of operations. We may also incur additional and unforeseen expenses in connection with the integration efforts. There can be no assurance that the expense savings and synergies that we anticipate from the merger will be realized fully or within our expected timeframe.

 

During 2005 and 2006, we also acquired six PCS Affiliates and Nextel Partners. The process of integrating the business practices, operations and support functions of these companies involves challenges similar to those identified above and could add to those challenges by placing a greater strain on our management and employees.

 

We are subject to exclusivity provisions and other restrictions under our arrangements with the remaining independent PCS Affiliates. Continued compliance with those restrictions may limit our ability to achieve synergies and fully integrate the operations of Nextel and Nextel Partners in the geographic areas served by those PCS Affiliates, and we could incur significant costs to resolve issues related to the merger under these arrangements.

 

The arrangements with the four independent PCS Affiliates restrict our and their ability to own, operate, build or manage specified wireless communication networks or to sell certain wireless services within specified

geographic areas. Two of these PCS Affiliates have litigation pending against us asserting that actions that we have taken or may take in the future in connection with our integration efforts are inconsistent with our obligations under our agreements with them, particularly with respect to the restrictions noted above. Continued compliance with those restrictions may limit our ability to achieve synergies and fully integrate the operations of Nextel and Nextel Partners in the areas served by those PCS Affiliates. We could incur significant costs to resolve these issues.

 

We are subject to restrictions on acquisitions involving our stock and other stock issuances and possibly other corporate opportunities in order to enable the spin-off of Embarq to qualify for tax-free treatment.

 

The spin-off of Embarq cannot qualify for tax-free treatment if 50% or more (by vote or value) of our stock, or the stock of Embarq, is acquired or issued as part of a plan, or series of related transactions, that includes the spin-off. Because the Sprint-Nextel merger generally is treated as involving the acquisition of 49.9% of our stock (and the stock of Embarq) for purposes of this analysis, we are subject to restrictions on certain acquisitions using our stock and other issuances of our stock in order to enable the spin-off to qualify for tax-free treatment. These restrictions apply to transactions occurring subsequent to the spin-off that are deemed to be part of a plan or series of transactions related to the Sprint-Nextel merger and the Embarq spin- off. Under applicable tax law, transactions occurring within two years of the spin-off are presumed to be pursuant to such a plan unless we can establish the contrary. At this time, it is not possible to determine how long these restrictions will apply, or whether they will have a material impact on us.

 

If the spin-off of Embarq does not qualify as a tax-free transaction, tax could be imposed on both our shareholders and us.

 

We received a private letter ruling from the Internal Revenue Service, or IRS, that the spin-off of Embarq qualifies for tax-free treatment under Code Sections 355 and 361. In addition, we obtained opinions of counsel from each of Cravath, Swaine & Moore LLP and Paul, Weiss, Rifkind, Wharton & Garrison LLP that the spin-off so qualifies. The IRS ruling and the opinions rely on certain representations, assumptions and undertakings, including those relating to the past and future conduct of Embarq’s and our business. The IRS private letter ruling does not address all the issues that are relevant to determining whether the distribution qualifies for tax-free treatment. The IRS could determine that the distribution should be treated as a taxable transaction if it determines that any of the representations, assumptions or undertakings that were included in the request for the private letter ruling are false or have been violated, or if it disagrees with the conclusions in the opinions that are not covered by the IRS private letter ruling. If the distribution fails to qualify for tax-free treatment, it will be treated as a taxable distribution to our shareholders in an amount equal to the fair market value of Embarq’s equity securities (i.e., Embarq’s common stock issued to our common shareholders) received by them. In addition, we would be required to recognize gain in an amount up to the fair market value of the Embarq equity securities that we distributed on the distribution date plus the fair market value of the senior notes of Embarq received by us.

 

Furthermore, subsequent events, some of which are not in our control, could cause us to recognize gain on the distribution. For example, even minimal acquisitions of our equity securities or Embarq’s equity securities that are deemed to be part of a plan or a series of related transactions that include the distribution and the Sprint-Nextel merger could cause us to recognize gain on the distribution.

 

Risks Related to our Business and Operations

 

We face intense competition that may reduce our market share and harm our financial performance.

 

Our operating segments face intense competition.  Our ability to compete effectively depends on, among other things, the factors discussed below.

 

If we are not able to attract and retain customers, our financial performance could be impaired.

 

Our ability to compete successfully for new customers and to retain our existing customers will depend on:

 

 

A key element in the economic success of communications carriers is the ability to retain customers as measured by the rate of subscriber churn. Our ability to retain customers and reduce our rate of churn is affected by a number of factors including, with respect to our wireless business, the actual or perceived quality and coverage of our network and the attractiveness of our service offerings. For example, peak usage in certain metropolitan markets is being impacted by capacity constraints of the iDEN network, which in turn adversely affects customer satisfaction and churn. Our ability to retain customers also is affected by competitive pricing pressures and the quality of our customer service. Our efforts to reduce churn may not be successful. A high rate of churn could impair our ability to increase the revenues of, or cause a deterioration in the operating margins of, our wireless operations or our operations as a whole.

 

 

We increasingly must attract a greater proportion of our new customers from our competitors’ existing customer bases rather than from first time purchasers of wireless services. The higher market penetration also means that customers purchasing wireless services for the first time, on average, have a lower credit rating than existing wireless users, which generally results in a higher rate of involuntary churn and increased bad debt expense.

 

  Competition and technological changes in the market for wireless services could negatively affect our average revenue per user, subscriber churn, our ability to attract new subscribers and operating costs, which would adversely affect our revenues, growth and profitability.

 

We compete with several other wireless service providers in each of the markets in which we provide wireless services. As competition among wireless communications providers has increased, we have created pricing plans that have resulted in declining average revenue per minute of use for voice services, a trend which we expect will continue. Competition in pricing and service and product offerings may also adversely impact customer retention, which would adversely affect our results of operations.

 

The wireless communications industry is experiencing significant technological change, including improvements in the capacity and quality of digital technology and the deployment of unlicensed spectrum devices. This change causes uncertainty about future subscriber demand for our wireless services and the prices that we will be able to charge for these services. Rapid change in technology may lead to the development of wireless communications technologies or alternative services that are superior to our technologies or services or that consumers prefer over ours. If we are unable to meet future advances in competing technologies on a timely basis, or at an acceptable cost, we may not be able to compete effectively and could lose customers to our competitors.

 

Mergers or other business combinations involving our competitors and new entrants, including MVNOs, beginning to offer wireless services may also continue to increase competition. These wireless operators may be able to offer subscribers network features or products and services not offered by us, coverage in areas not served by either of our wireless networks or pricing plans that are lower than those offered by us, all of which would negatively affect our average revenue per user, subscriber churn, ability to attract new subscribers, and operating costs. For example, AT&T and Verizon now offer competitively-priced wireless services packaged with local and long distance voice and high-speed Internet services, and our Boost Mobile-branded prepaid service competes with a number of regional carriers, including Metro PCS and Leap Wireless, which offer competitively-priced calling plans that include unlimited local calling.

One of the primary differentiating features of our Nextel-branded service is the two-way walkie-talkie service available on our iDEN network. A number of wireless equipment vendors, including Motorola, which supplies equipment for our Nextel-branded service, have begun to offer wireless equipment that is capable of providing walkie-talkie services that are designed to compete with our walkie-talkie services. Several of our competitors have introduced handsets that are capable of providing walkie-talkie services. If these competitors’ services are perceived to be or become, or if any such services introduced in the future are, comparable to our Nextel-branded walkie-talkie services, a key competitive advantage of our Nextel service would be reduced, which in turn could adversely affect our business.

 

  Failure to improve wireless subscriber service and failure to continue to enhance the quality and features of our wireless networks and meet capacity requirements of our subscriber growth could impair our financial performance and adversely affect our results of operations.

 

We must continually make investments and incur costs in order to improve our wireless subscriber service and remain competitive. In connection with our continuing enhancement of the quality of our wireless networks and related services, we must:

 

 

Network enhancements may not occur as scheduled or at the cost that we have estimated. Delays or failure to add network capacity, or increased costs of adding capacity, could limit our ability to satisfy our wireless subscribers, resulting in decreased revenues. Even if we continuously upgrade our wireless networks, there can be no assurance that existing subscribers will not prefer features of our competitors and switch wireless providers.

 

  Consolidation and competition in the wholesale market for wireline services could adversely affect our revenues and profitability.

 

Our Long Distance segment competes with AT&T, Verizon, Qwest Communications, Level 3 Communications, and cable operators, as well as a host of smaller competitors, in the provision of wireline services. Some of these companies have built high-capacity, IP-based fiber-optic networks capable of supporting large amounts of voice and data traffic. These companies claim certain cost structure advantages which, among other factors, may allow them to maintain profitability while offering services at a price below that which we can offer profitably. Increased competition and the significant increase in capacity resulting from new technologies and networks may drive already low prices down further. AT&T and Verizon, as a result of their acquisitions, continue to be our two largest competitors in the domestic long distance communications market. We and other long distance carriers depend heavily on local access facilities obtained from ILECs to serve our long distance customers, and payments to ILECs for these facilities are a significant cost of service for our Long Distance segment. The long distance operations of AT&T and Verizon have cost and operational advantages with respect to these access facilities because those carriers serve significant geographic areas, including many large urban areas, as the incumbent local carrier.

 

  Failure to complete development, testing and deployment of new technology that supports new services could affect our ability to compete in the industry. In addition, the technology we use may place us at a competitive disadvantage.

 

We develop, test and deploy various new technologies and support systems intended to enhance our competitiveness by both supporting new services and features and reducing the costs associated with providing those services. Successful development and implementation of technology upgrades depend, in part, on the

willingness of third parties to develop new applications in a timely manner. We may not successfully complete the development and rollout of new technology and related features or services in a timely manner, and they may not be widely accepted by our customers or may not be profitable, in which case we could not recover our investment in the technology. Deployment of technology supporting new service offerings may also adversely affect the performance or reliability of our networks with respect to both the new and existing services. Any resulting customer dissatisfaction could affect our ability to retain customers and have an adverse effect on our results of operations and growth prospects.

 

Our wireless networks provide services utilizing CDMA and iDEN technologies. Wireless subscribers served by these two technologies represent a smaller portion of global wireless subscribers than the subscribers served by wireless networks that utilize GSM technology. As a result, our costs with respect to both CDMA and iDEN network equipment and handsets may continue to be higher than the comparable costs incurred by our competitors who use GSM technology, which places us at a competitive disadvantage.

 

  The blurring of the traditional dividing lines between long distance, local, wireless, video and Internet services contribute to increased competition.

 

The traditional dividing lines between long distance, local, wireless, video and Internet services are increasingly becoming blurred. Through mergers, joint ventures and various service expansion strategies, major providers are striving to provide integrated services in many of the markets we serve. This trend is also reflected in changes in the regulatory environment that have encouraged competition and the offering of integrated services.

 

We expect competition to intensify across all of our business segments as a result of the entrance of new competitors or the expansion of services offered by existing competitors, and the rapid development of new technologies, products and services. We cannot predict which of many possible future technologies, products, or services will be important to maintain our competitive position or what expenditures we will be required to make in order to develop and provide these technologies, products or services. To the extent we do not keep pace with technological advances or fail to timely respond to changes in the competitive environment affecting our industry, we could lose market share or experience a decline in revenue, cash flows and net income. As a result of the financial strength and benefits of scale enjoyed by some of our competitors, they may be able to offer services at lower prices than we can, thereby adversely affecting our revenues, growth and profitability.

 

If we are unable to meet our future capital needs relating to investment in our networks and other obligations, it may be necessary for us to curtail, delay or abandon our business growth plans. If we incur significant additional indebtedness to fund our plans, it could cause a decline in our credit rating and could increase our borrowing costs or limit our ability to raise additional capital.

 

We likely will require additional capital to make the capital expenditures necessary to implement our business plans and support future growth of our wireless business and satisfy our debt service requirements. In addition, we may incur additional debt in the future for a variety of reasons, including future acquisitions. We may not be able to arrange additional financing to fund our requirements on terms acceptable to us. Our ability to arrange additional financing will depend on, among other factors, our credit rating, financial performance, general economic conditions and prevailing market conditions. Some of these factors are beyond our control. Failure to obtain suitable financing when needed could, among other things, result in our inability to continue to expand our businesses and meet competitive challenges. If we incur significant additional indebtedness, or if we do not continue to generate sufficient cash from our operations, our credit rating could be adversely affected, which would likely increase our future borrowing costs and could affect our ability to access capital.

 

We have entered into outsourcing agreements related to certain business operations. Any difficulties experienced in these arrangements could result in additional expense, loss of customers and revenue, interruption of our services or a delay in the roll-out of new technology.

 

We have entered into outsourcing agreements for the development and maintenance of certain software systems necessary for the operation of our business. We have also entered into agreements with third parties to provide customer service and related support to our wireless subscribers and outsourced many aspects of our

customer care and billing functions to third parties. We also have entered into an agreement whereby a third party has leased or operates a significant number of our communications towers, and we sublease space on these towers. As a result, we must rely on third parties to perform certain of our operations and, in certain circumstances, interface with our customers. If these third parties are unable to perform to our requirements, we would have to pursue alternative strategies to provide these services and that could result in delays, interruptions, additional expenses and loss of customers.

 

The intellectual property rights utilized by us and our suppliers and service providers may infringe on intellectual property rights owned by others.

 

Some of our products and services use intellectual property that we own. We also purchase products from suppliers, including handset device suppliers, and outsource services to service providers, including billing and customer care functions, that incorporate or utilize intellectual property. We and some of our suppliers and service providers have received, and may receive in the future, assertions and claims from third parties that the products or software utilized by us or our suppliers and service providers infringe on the patents or other intellectual property rights of these third parties. These claims could require us or an infringing supplier or service provider to cease certain activities or to cease selling the relevant products and services. Such claims and assertions also could subject us to costly litigation and significant liabilities for damages or royalty payments, or require us to cease certain activities or to cease selling certain products and services.

 

If Motorola is unable or unwilling to provide us with equipment and handsets in support of our iDEN based services, as well as anticipated handset and infrastructure improvements for those services, our operations will be adversely affected.

 

Motorola is our sole source for most of the equipment that supports the iDEN network and for all of the handsets we offer under the Nextel brand except primarily for BlackBerry devices. Although our handset supply agreement with Motorola is structured to provide competitively priced handsets, the cost of iDEN handsets is generally higher than handsets that do not incorporate a similar multi-function capability. This difference may make it more difficult or costly for us to offer handsets at prices that are attractive to potential customers. In addition, the higher cost of iDEN handsets requires us to absorb a larger part of the cost of offering handsets to new and existing customers. These increased costs and handset subsidy expenses may reduce our growth and profitability. Also, we must rely on Motorola to develop handsets and equipment capable of supporting the features and services we plan to offer to subscribers of services on our iDEN network, including a dual-mode handset. A decision by Motorola to discontinue manufacturing, supporting or enhancing our iDEN-based infrastructure and handsets would have a material adverse effect on us. In addition, because iDEN technology is not as widely adopted and has fewer subscribers than other wireless technologies and because we expect that over time more of our customers will utilize service offered on our CDMA network, it is less likely that manufacturers other than Motorola will be willing to make the significant financial commitment required to license, develop and manufacture iDEN infrastructure equipment and handsets. Further, our ability to timely and efficiently implement the spectrum reconfiguration plan in connection with the FCC’s Report and Order is dependent, in part, on Motorola.

 

The reconfiguration process contemplated by the FCC’s Report and Order may adversely affect our business and operations, which could adversely affect our future growth and operating results.

 

In order to accomplish the reconfiguration of the 800 MHz spectrum band that is contemplated by the Report and Order, in most cases we will need to cease our use of a portion of the 800 MHz spectrum on our iDEN network in a particular market before we are able to commence use of replacement 800 MHz spectrum in that market. To mitigate the temporary loss of the use of this spectrum, in many markets we will need to construct additional transmitter and receiver sites or acquire additional spectrum in the 800 MHz or 900 MHz bands. This spectrum may not be available to us on acceptable terms. In markets where we are unable to construct additional sites or acquire additional spectrum as needed, the decrease in capacity may adversely affect the performance of our iDEN network, require us to curtail subscriber additions in those markets until the capacity limitation can be corrected, or a combination of the two. Degradation in network performance in any market could result in higher subscriber churn in that market, the effect of which could be exacerbated if we are forced to curtail subscriber additions in that market. A resulting loss of a significant number of subscribers

could adversely affect our results of operations. We believe that the reconfiguration process has contributed adversely to the capacity and performance of our iDEN network, particularly in some of our more capacity constrained markets. In addition, the Report and Order gives the FCC the authority to suspend our use of the 1.9 GHz spectrum that we received under the Report and Order if we do not comply with our obligations under the Report and Order.

 

Government regulation could adversely affect our prospects and results of operations; the FCC and state regulatory commissions may adopt new regulations or take other actions that could adversely affect our business prospects or results of operations.

 

The FCC and other federal, state and local governmental authorities have jurisdiction over our business and could adopt regulations or take other actions that would adversely affect our business prospects or results of operations.

 

The licensing, construction, operation, sale and interconnection arrangements of wireless telecommunications systems are regulated by the FCC and, depending on the jurisdiction, state and local regulatory agencies. In particular, the FCC imposes significant regulation on licensees of wireless spectrum with respect to:

 

 

Various states are considering regulations over terms and conditions of service, including such things as certain billing practices and consumer-related issues, that may not be preempted by federal law. If imposed, these regulations could increase the costs of our wireless operations.

 

The FCC grants wireless licenses for terms of generally ten years that are subject to renewal and revocation. There is no guarantee that our licenses will be renewed. Failure to comply with FCC requirements in a given license area could result in revocation of the license for that license area.

 

The FCC has initiated a number of proceedings to evaluate its rules and policies regarding spectrum licensing and usage. It is considering new “harmful interference” concepts that might permit unlicensed users to “share” licensed spectrum. These new uses could adversely impact our utilization of our licensed spectrum, and our operational costs.

 

CMRS providers must implement E911 capabilities in accordance with FCC rules. We were unable to satisfy the requirement that 95% of our iDEN subscriber base have Assisted-GPS capable handsets by December 31, 2005. The matter has been referred to the FCC’s Enforcement Bureau for further action, which could result in fines, new deadlines for compliance or further actions by us to encourage our customers to upgrade their handsets so we can fulfill the 95% requirement.

 

Depending upon their outcome, the FCC’s proceedings regarding regulation of special access rates could affect the rates paid by our Long Distance and Wireless segments for special access services in the future. Similarly, depending on their outcome, the FCC’s proceedings on the regulatory classification of VoIP services could affect the intercarrier compensation rates and the level of USF contributions paid by us.

 

Concerns about health risks associated with wireless equipment may reduce the demand for our services.

 

Portable communications devices have been alleged to pose health risks, including cancer, due to radio frequency emissions from these devices. Purported class actions and other lawsuits have been filed against numerous wireless carriers, including us, seeking not only damages but also remedies that could increase our cost of doing business. We cannot be sure of the outcome of those cases or that our business and financial condition will not be adversely affected by litigation of this nature or public perception about health risks. The actual or perceived risk of mobile communications devices could adversely affect us through a reduction in subscribers, reduced network usage per subscriber or reduced financing available to the mobile

communications industry. Further research and studies are ongoing, and we cannot be sure that additional studies will not demonstrate a link between radio frequency emissions and health concerns.

 

Item 1B.  Unresolved Staff Comments

 

Not applicable.

 

Item 2.  Properties

 

We currently lease our corporate headquarters offices in Reston, Virginia. These facilities total about 801,000 square feet and the related operating leases have initial terms expiring in 2009, 2010 and 2014. Such facilities have renewal options, which we may, or may not, exercise. Our operational headquarters campus is located in Overland Park, Kansas and consists of about 4 million square feet.

 

Our gross property, plant and equipment at December 31, 2006 totaled $42.4 billion, distributed among the business segments as follows:

 

 

Properties utilized by our Wireless segment consist of base transceiver stations, switching equipment and towers, as well as leased and owned general office facilities and retail stores. We lease space for base station towers and switch sites for our wireless network. At December 31, 2006, we had 61,000 cell sites on air.

 

In May 2005, we closed a transaction with Global Signal under which Global Signal has exclusive rights to lease or operate about 6,500 communication towers owned by us for a negotiated lease term which is the greater of the remaining terms of the underlying ground leases or up to 32 years, assuming successful re-negotiation of the underlying ground leases at the end of their current lease terms. We have committed to sublease space on about 6,400 of the towers from Global Signal. We will maintain ownership of the towers and will continue to reflect the towers on our consolidated balance sheet.

 

Properties utilized by our Long Distance segment generally consist of land, buildings, switching equipment, digital fiber-optic network and other transport facilities. We have been granted easements, rights-of-way and rights-of-occupancy by railroads and other private landowners for our fiber-optic network.

 

As of December 31, 2006, about $621 million of outstanding debt, comprised of certain secured notes, capital lease obligations and mortgages, is secured by $1.9 billion of gross property, plant and equipment, and other assets.

 

Additional information regarding our commitments related to operating leases can be found in note 13 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K.

 

Item 3.  Legal Proceedings

 

In March 2004, eight purported class action lawsuits relating to the recombination of our tracking stocks were filed against us and our directors by holders of PCS common stock. Seven of the lawsuits were consolidated in the District Court of Johnson County, Kansas. The eighth, pending in New York, has been voluntarily stayed. The consolidated lawsuit alleges breach of fiduciary duty in connection with allocations between the wireline operations and the wireless operations before the recombination of the tracking stocks and breach of fiduciary duty in the recombination. The lawsuit seeks to rescind the recombination and monetary damages. In December 2006, the court denied defendants’ motions to dismiss the complaint and for summary judgment, and granted a motion to certify the class. In February 2007, the court upon reconsideration dismissed a count of the complaint related to intracompany allocations, which requires dismissal of the complaint against three

of our former directors and reconsideration of the class definition. The court has asked the parties for further briefing on the class certification issue and the plaintiffs’ request for a jury trial. Trial is scheduled for September 2007. All defendants have denied plaintiffs’ allegations and intend to defend this matter vigorously.

 

In September 2004, the U.S. District Court for the District of Kansas denied a motion to dismiss a shareholder lawsuit alleging that our 2001 and 2002 proxy statements were false and misleading in violation of federal securities laws to the extent they described new employment agreements with certain senior executives without disclosing that, according to the allegations, replacement of those executives was inevitable. These allegations, made in an amended complaint in a lawsuit originally filed in 2003, are asserted against us and certain of our current and former officers and directors, and seek to recover any decline in the value of our tracking stocks during the class period. The parties have stipulated that the case can proceed as a class action. All defendants have denied plaintiffs’ allegations and intend to defend this matter vigorously. Allegations in the original complaint, which asserted claims against the same defendants and our former independent auditor, were dismissed by the court in April 2004.

 

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

 

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

 

Item 4.  Submission of Matters to a Vote of Security Holders

 

No matter was submitted to a vote of security holders during the fourth quarter 2006.

 

Executive Officers of the Registrant

 

The following people are serving as our executive officers as of February 28, 2007. These executive officers were elected to serve until their successors have been elected. There is no familial relationship between any of our executive officers and directors.

 

 

 

 

Part II

 

 

Common Share Data

 

The principal trading market for our common stock, Series 1 is the New York Stock Exchange, or NYSE. Our common stock, Series 2 is not publicly traded.

 

 

 

 

 

Number of Shareholders of Record

 

As of February 21, 2007, we had about 56,000 common stock, Series 1 record holders, 12 common stock, Series 2 record holders, and no non-voting common stock record holders.

 

Dividends

 

We paid a dividend of $0.025 per outstanding share on our common stock on a quarterly basis in 2006 and in the third and fourth quarters 2005. We paid a dividend of $0.125 per outstanding share on our common stock, Series 1 and the common stock, Series 2 in each of the first two quarters of 2005.

 

Sale of Unregistered Equity Securities

 

In December 2006, we issued to certain of our directors and executive officers an aggregate of 995 restricted stock units relating to our common shares. These restricted stock units were the result of dividend equivalent rights attached to restricted stock units granted to these individuals in 2003. Each restricted stock unit represents the right to one common share once the unit vests. Some of these restricted stock units vested in 2006, but the holder of these restricted stock units elected to delay delivery of the underlying shares. The other restricted stock units vest in 2007. Neither these restricted stock units, nor the common stock issuable once the units vest, were registered under the Securities Act of 1933, or Securities Act. The restricted stock units were issued in reliance on the exemption from registration provided by Section 4(2) of the Securities Act because the restricted stock units were issued in transactions not involving a public offering.

In connection with our Employees Stock Purchase Plan, or ESPP, the number of shares deposited in the accounts of certain participants was greater than the number of shares purchased based on their fourth quarter payroll deductions. When the error was discovered in January 2007, we took steps to remove the excess shares from the accounts of these participants. However, about 300 participants already had sold an aggregate of about 2,500 excess shares into the public market. Steps have been taken to recover the proceeds that the participants received from the sale of the excess shares. The excess shares were not registered under the Securities Act of 1933, as amended. No exemption from registration is available.

 

Issuer Purchases of Equity Securities

 

 

 

 

No options may be granted pursuant to the Management Incentive Stock Option Plan after April 18, 2005; no awards may be granted pursuant to the 1997 Long-Term Stock Incentive Program after April 15, 2007; and no awards may be granted pursuant to the Nextel Incentive Equity Plan after July 13, 2015. Options, restricted share awards and restricted stock unit awards outstanding on those dates may continue to be outstanding after those dates. We cannot estimate how many shares will be acquired in the manner described in footnote (1) to the table above pursuant to the terms of these plans.

Performance Graph

 

The graph below compares the yearly percentage change in the cumulative total shareholder return for our Series 1 common stock with the S&P^® 500 Stock Index and the Dow Jones U.S. Telecommunications Index for the five-year period from December 31, 2001 to December 31, 2006. The cumulative total shareholder return for our Series 1 common stock has been adjusted for the periods shown for the recombination of our FON common stock and PCS common stock that was effected on April 23, 2004. The graph assumes an initial investment of $100 in our common stock on December 31, 2001 and reinvestment of all dividends.

 

The Dow Jones U.S. Telecommunications Index is currently composed of the following companies: Alltel Corp., AT&T Inc., CenturyTel Inc., Cincinnati Bell Inc., Citizens Communications Co., Dobson Communications Corp., Embarq, IDT Corp., Leap Wireless International Inc., Leucadia National Corp., Level 3 Communications Inc., NII Holdings Inc., Qwest Communications International Inc., RCN Corp., Sprint Nextel, Telephone & Data Systems Inc., Time Warner Telecom, Inc., U.S. Cellular Corp., Verizon Communications Inc., Virgin Media Inc. and Windstream Corp.

 

5-Year Total Return

 

 

Value of $100 Invested on December 31, 2001

 

Item 6.  Selected Financial Data

 

The 2006 and 2005 data presented below is not comparable to that of the prior periods as a result of the Sprint-Nextel merger and the Nextel Partners and the PCS Affiliate acquisitions during 2006 and 2005. The acquired companies’ financial results subsequent to their acquisition dates are included in our consolidated financial statements. The spin-off of Embarq in 2006 and our directory publishing business in 2003 are shown as discontinued operations for all periods presented.

 

 

The tables above set forth selected consolidated financial data for the periods or as of the dates indicated and should be read in conjunction with the consolidated financial statements, related notes and other financial information appearing at the end of this annual report on Form 10-K. Highlighted below are certain transactions and factors that may be significant to an understanding of the comparability of our results of operations and our financial condition.

 

 

 

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

We include certain estimates, projections and other forward-looking statements in our annual, quarterly and current reports, and in other publicly available material. Statements regarding expectations, including performance assumptions and estimates relating to capital requirements, as well as other statements that are not historical facts, are forward-looking statements.

 

These statements reflect management’s judgments based on currently available information and involve a number of risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. With respect to these forward-looking statements, management has made assumptions regarding, among other things, customer and network usage, customer growth and retention, pricing, operating costs, the timing of various events and the economic environment.

 

Future performance cannot be assured. Actual results may differ materially from those in the forward-looking statements. Some factors that could cause actual results to differ include:

 

 

 

The words “may,” “could,” “estimate,” “project,” “forecast,” “intend,” “expect,” “believe,” “target,” “providing guidance” and similar expressions are intended to identify forward-looking statements. Forward-looking statements are found throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, and elsewhere in this report. The reader should not place undue reliance on forward-looking statements, which speak only as of the date of this report. We are not obligated to publicly release any revisions to forward-looking statements to reflect events after the date of this report, including unforeseen events.

Overview

 

We are a global communications company offering a comprehensive range of wireless and wireline communications products and services that are designed to meet the needs of individual consumers, businesses and government customers. We have organized our operations to meet the needs of our targeted customer groups through focused communications solutions that incorporate the capabilities of our wireless and wireline services to meet their specific needs. We are one of the three largest wireless companies in the United States based on the number of wireless subscribers. We own extensive wireless networks and a global long distance, Tier 1 Internet backbone.

 

Nextel Merger and Local Communications Business Spin-off

 

On August 12, 2005, a subsidiary of our company merged with Nextel Communications, Inc. and, as a result, we acquired Nextel. We merged with Nextel to secure a number of potential strategic and financial benefits, including those arising from the combination of our networks, spectrum assets, and diverse customer bases and services, the size and scale of the combined company and the opportunity to focus on the fastest growing areas of the communications industry. We also believe that the merger provides significant opportunities to achieve operating efficiencies by realizing revenue, operating cost and capital spending synergies.

 

We have begun to realize cost savings and other synergies as a result of the merger and over a number of years expect to continue to realize significant cost savings and other synergies associated with the merger. However, we believe that our operating results for at least the next several quarters will be impacted negatively by costs that will be incurred to achieve these benefits and other synergies. Such costs are generally not expected to be recurring in nature, and include costs associated with integrating back office systems, severance costs associated with the termination of the employment of certain employees, and lease and other contract termination costs. The merger and integration costs that we incur will be dependent on a number of business or strategic decisions whose timing cannot be predicted with certainty, which could cause merger and integration costs, and our realization of benefits from the merger and integration efforts, to vary from period to period. The ability to achieve these cost savings and other synergies and the timing in which the benefits can be realized will depend in large part on the ability to integrate our networks, business operations, back-office functions and other support systems and infrastructure.

 

At the time that we announced the merger, we also announced our plans to spin-off to our shareholders our local communications business, which is now known as Embarq Corporation and is comprised primarily of what was our Local segment prior to the spin-off. We completed the spin-off on May 17, 2006. In the spin-off, we distributed pro rata to our shareholders one Embarq common share for every 20 shares of our voting and non-voting common stock, or about 149 million shares of Embarq common stock, and received net cash consideration and net proceeds from the sale of Embarq senior notes totaling about $6.3 billion. Cash was paid for fractional shares. As a result of the spin-off, we no longer own any shares of Embarq. The results of Embarq for periods prior to the spin-off are presented as discontinued operations.

 

We received a ruling from the Internal Revenue Service that, based on certain facts, assumptions, representations and undertakings set forth in the ruling, for U.S. federal income tax purposes, the distribution of Embarq common shares is not taxable to us or U.S. holders of our common shares, except cash payments made in lieu of fractional shares, which generally are taxable.

 

Business

 

We offer a comprehensive range of wireless and wireline communications products and services that are designed to meet the needs of individual consumers, businesses and government customers. We conduct our operations through two segments referred to as Wireless and Long Distance.

 

We, together with the PCS Affiliates, offer digital wireless services in all 50 states, Puerto Rico and the U.S. Virgin Islands under the Sprint brand name utilizing wireless code division multiple access, or CDMA, technology. The PCS Affiliates, through commercial arrangements with us, provide wireless services mainly in and around smaller U.S. metropolitan areas on wireless networks built and operated at their expense, in most

instances using spectrum licensed to and controlled by us. During 2005, we acquired three PCS Affiliates and in 2006 we acquired three additional PCS Affiliates. We also offer digital wireless services under the Nextel and Boost brand names using iDEN technology. During 2006, we acquired Nextel Partners which provides digital wireless communications services under the Nextel brand name in certain mid-sized and tertiary U.S. markets. The acquisitions of these PCS Affiliates and Nextel Partners gave us more control of the distribution of services under our Sprint and Nextel brands, and provide us with the strategic and financial benefits associated with a larger customer base and expanded network coverage. We also are one of the largest providers of long distance services and one of the largest carriers of Internet traffic in the nation.

 

We believe the communications industry has been and will continue to be highly competitive on the basis of price, the types of services offered and quality of service. Although we believe that many of our targeted customers base their purchase decisions on quality of service and the availability of differentiated features and services, competitive pricing, both in terms of the monthly recurring charges and the number of minutes or other features available under a particular rate plan, and handset offerings are often important factors in potential customers’ purchase decisions.

 

Our industry has been and continues to be subject to consolidation and dynamic change as well as intense competition. To maintain our operating margins in a price-competitive environment, we continually seek ways to create or improve capital and operating efficiencies in our business. Consequently, we routinely reassess our business strategies and their implications on our operations, and these assessments may continue to impact the future valuation of our long-lived assets. As part of our overall business strategy, we regularly evaluate opportunities to expand and complement our business and may at any time be discussing or negotiating a transaction that, if consummated, could have a material effect on our business, financial condition, liquidity or results of operations.

 

The FCC regulates the licensing, operation, acquisition and sale of the licensed radio spectrum that is essential to our business. The FCC and state Public Utilities Commissions, or PUCs, also regulate the provision of communications services. Future changes in regulations or legislation related to spectrum licensing or other matters related to our business could impose significant additional costs on us either in the form of direct out-of-pocket costs or additional compliance obligations.

 

Management Overview

 

Wireless

 

We offer a wide array of wireless mobile telephone and wireless data transmission services on networks that utilize CDMA and iDEN technologies to meet the needs of individual consumers, businesses and government customers. Through our Wireless segment, we, together with the four remaining PCS Affiliates, offer digital wireless service in all 50 states, Puerto Rico and the U.S. Virgin Islands, and provide wireless coverage in over 300 metropolitan markets, including 297 of the 300 largest U.S. metropolitan areas, where more than 280 million people live or work. We offer wireless international voice roaming for subscribers of both CDMA and iDEN-based services in numerous countries. We, together with the PCS Affiliates and resellers of our wholesale wireless services, served about 53.1 million wireless subscribers at the end of 2006.

 

We offer wireless mobile telephone and data transmission services and features in a variety of pricing plans, including prepaid service plans. We offer these services, other than those offered under prepaid service plans, typically on a contract basis, for one or two year periods, with services billed on a monthly basis according to the applicable pricing plan. We market our prepaid services under the Boost Mobile brand, as a means to directly target the youth and prepaid wireless service markets. We also offer wholesale wireless services to resellers, commonly known as mobile virtual network operators, or MVNOs, such as Embarq, Modiva Communications, Inc., Helio Inc., Qwest Communications International, Inc., The Walt Disney Company and Virgin Mobile USA, which purchase wireless services from us at wholesale rates and resell the services to their customers under their own brand names. Under these MVNO arrangements, the operators bear the costs of acquisition, billing and customer service.

We also provide wireless services that are marketed and sold by several cable multiple systems operators, or MSOs, in four markets. We also have entered into an agreement with several cable MSOs to jointly develop converged services designed to combine many of cable’s core products and interactive features with wireless technology to deliver a broad range of services, including video, wireless voice and data services, high speed Internet and cable phone service, to the participating cable MSO’s customers. During 2007, we expect to develop new products and services and introduce service in additional markets.

 

Our strategy is to utilize state-of-the-art technology to provide differentiated wireless services and applications in order to acquire and retain high-quality wireless subscribers. We offer numerous sophisticated data messaging, imaging, entertainment and location-based applications, marketed as Power Vision^SM, across our CDMA network that utilize high-speed evolution data optimized, or EV-DO, technology. Currently EV-DO technology covers nearly 209 million people and serves customers in over 219 communities with populations of at least 100,000. EV-DO data roaming is available in selected markets in Canada and Mexico. We also have begun to incorporate EV-DO Rev. A, the next version of EV-DO technology, into our network, with plans for coverage across the majority of the footprint of our CDMA network by the end of 2007. EV-DO Rev. A is designed to support a variety of Internet Protocol, or IP, and video and high performance walkie-talkie applications for our CDMA network.

 

On our iDEN network, we continue to support features and services that are designed to meet the needs of our customers. Both the Nextel and Boost Mobile brands feature our industry-leading walkie-talkie services, which give subscribers the ability to communicate instantly across the continental United States and to and from Hawaii and, through agreements with other iDEN providers, to and from selected markets in Canada, Latin America and Mexico, as well as a variety of digital wireless mobile telephone and wireless data transmission services.

 

In recent periods, we have experienced declines in the number of new subscribers for our wireless services and increases in our rate of subscriber churn. Customer satisfaction and churn have been adversely impacted by capacity constraints on our iDEN network as a result of a number of factors, including the addition to the network in recent years of many high-call-volume subscribers, limited effectiveness of the 6:1 voice coder upgrade in the iDEN technology that was designed to increase network capacity, and the impact of the reconfiguration process under the Report and Order. In certain of our most capacity constrained markets, we have had to take actions to limit the acquisition of new subscribers of Nextel and Boost Mobile branded services. Also, churn of subscribers of our CDMA services remains high relative to our competitors, in large part due to credit-related deactivations. In 2006, we reorganized our sales and distribution and customer management operations to improve customer satisfaction, adopted a regional sales, service, and distribution structure to streamline operations, increase productivity and move decision-making closer to the customer, and tightened our credit policies for new subscribers of both CDMA and iDEN services. In 2007, we:

 

 

 

In the future, we also plan to utilize QUALCOMM Incorporated’s QChat^® technology, which is designed to provide high performance walkie-talkie services on our CDMA network, and we are designing interfaces to provide for interoperability of walkie-talkie services on our CDMA and iDEN networks.

 

We also plan to deploy a next generation broadband wireless network that will be designed to provide significantly higher data transport speeds using our spectrum holdings in the 2.5 gigahertz, or GHz, band and technology based on the Worldwide Inter-Operability for Microwave Access, or WiMAX, standard. We are designing this network to support a wide range of high-speed IP-based wireless services. Our initial plans contemplate deploying the new network in larger metropolitan areas with a goal of launching the related service offerings in some of those markets beginning in 2008.

 

Our Wireless segment generates revenues from the provision of wireless services, the sale of wireless equipment and the provision of wholesale and other services. The ability of our Wireless segment to generate service revenues is primarily a function of:

 

 

We believe that wireless carriers increasingly must attract a greater proportion of new customers from the existing customer bases of competitors rather than from first time purchasers of wireless services. For example, we are experiencing increased competition in our prepaid and youth markets from new entrants that are targeting these subscribers. Certain of our competitors continue to increase their focus on customer retention efforts and have reported improvements in their customer retention rates, which may make it harder for us to acquire new customers from these competitors. In addition, the higher market penetration of wireless services in our markets may suggest that customers purchasing wireless services for the first time may, on average, have a lower credit rating than existing wireless users, which generally results in both a higher churn rate due to involuntary churn and in higher bad debt expense. This has intensified the competition among wireless carriers to attract higher quality customers with stronger credit standing, resulting in aggressive pricing strategies for both voice services and other features that are designed to attract those customers.

 

We have also experienced declines in the average voice revenue per subscriber due to our offering more competitive service pricing plans, including lower priced plans, such as “business essentials” and plans that allow users to add additional units to their plans at attractive rates. We are developing and implementing service plans that are designed to offset these declines in voice revenue by expanding and enhancing our value-added array of imaging, high-speed data messaging, entertainment and location-based applications. Recently, the growth in revenue per subscriber generated by these data services, while significant, has not kept pace with the decline in voice revenue, resulting in a decline in our overall monthly average revenue per subscriber.

 

The ability of our Wireless segment to generate equipment revenues is primarily a function of the number of new and existing subscribers who purchase handsets and other accessories. The ability of our Wireless segment to generate wholesale revenues is primarily a function of the number and type of MVNOs that resell our wireless service and the rates that we charge MVNOs for utilization of our network.

 

Although many of the costs relating to the operation of our wireless networks are fixed in the short-term, other costs, such as interconnection fees, fluctuate based on the utilization of the networks. Sales and marketing

expenses are dependent on the number of subscriber additions and the nature and extent of our marketing and promotional activities. Customer care costs are dependent on the number of subscribers that we serve and the nature of programs designed to serve and retain subscribers. General and administrative expenses consist of fees paid for billing, customer care and information technology operations, bad debt expense, customer retention and back office support activities, including collections, legal, finance, human resources, strategic planning and technology and product development, along with the related payroll and facilities costs. Although our goal is to improve operating margins through cost savings initiatives and benefits of scale, costs that fluctuate based on network utilization and the number of subscribers that we serve and costs associated with enhancing and expanding the coverage of our network generally will increase in absolute terms over time. We also seek to realize operating efficiencies in our business from merger-related cost savings and other synergies.

 

In February 2005, Nextel accepted the terms and conditions of the Report and Order, which implemented a spectrum reconfiguration plan designed to eliminate interference with public safety operators in the 800 MHz band. Under the terms of the Report and Order, Nextel surrendered certain spectrum rights and received certain other spectrum rights, and undertook to pay the costs incurred by Nextel and third parties in connection with the reconfiguration plan, which is required to be completed within a 36-month period, subject to certain exceptions particularly with respect to markets that border Mexico and Canada. We assumed these obligations when we merged with Nextel in August 2005. If, as a result of events within our control, we fail to complete the reconfiguration plan within the 36-month period, the FCC could take actions against us to enforce the Report and Order. These actions could have adverse operating or financial impacts on us, some of which could be material. We believe that, based on our experiences to date, we will not complete the reconfiguration process within the 36-month period due to events largely outside of our control. We do not believe at this time that the impact from this delay will be material to our results of operation or financial condition, although there can be no assurance. Recognizing the current limitations in the reconfiguration process, both Sprint Nextel and the public safety community jointly filed a letter with the FCC on February 15, 2007 requesting that the FCC direct the Transition Administrator, through working closely with the affected parties, to develop a schedule and benchmarks for completing the second phase of the 800 MHz reconfiguration. See “— Forward-Looking Statements.”

 

As part of the reconfiguration process in most markets, we must cease using portions of the surrendered 800 MHz spectrum before we are able to commence use of replacement 800 MHz spectrum, which has contributed to the capacity constraints experienced on our iDEN network, particularly in some of our more capacity constrained markets, and has impacted performance of our iDEN network in the affected markets.

 

Based on the FCC’s determination of the values of the spectrum rights received and surrendered by Nextel, the minimum obligation to be incurred under the Report and Order is $2.8 billion. The Report and Order also provides that qualifying costs we incur as part of the reconfiguration plan, including costs to reconfigure our own infrastructure and spectrum positions, can be used to offset the minimum obligation of $2.8 billion; however, we are obligated to pay the full amount of the costs relating to the reconfiguration plan, even if those costs exceed that amount.

 

In addition, a financial reconciliation is required to be completed at the end of the reconfiguration implementation, at which time we will be required to make a payment to the U.S. Treasury to the extent that the value of the spectrum rights received exceeds the total of (i) the value of spectrum rights that are surrendered and (ii) the qualifying costs referred to above. As a result of the uncertainty with regard to the calculation of the credit for our internal network costs, as well as the significant number of variables outside of our control, particularly with regard to the 800 MHz reconfiguration licensee costs, we do not believe that we can reasonably estimate what amount, if any, will be paid to the U.S. Treasury.

 

As required under the terms of the Report and Order, we delivered a $2.5 billion letter of credit to provide assurance that funds will be available to pay the relocation costs of the incumbent users of the 800 MHz spectrum. Although the Report and Order provides for the possibility of periodic reductions in the amount of the letter of credit, no reductions have been made as of December 31, 2006.

Long Distance

 

Through our Long Distance segment, we provide a broad suite of wireline voice and data communications services targeted to domestic business customers, multinational corporations and other communications companies. These services include domestic and international data communications using various protocols, such as multi-protocol label switching, or MPLS, technologies, Internet Protocol, or IP, asynchronous transfer mode, or ATM, frame relay, managed network services and voice services. We also provide services to the cable MSOs that resell our long distance service and/or use our back office systems and network assets in support of their telephone service provided over cable facilities primarily to residential end-user customers. We are one of the nation’s largest providers of long distance services and operate all-digital long distance and Tier 1 IP networks.

 

For several years, our long distance voice services have experienced an industry-wide trend of lower revenue from lower prices and competition from other wireline and wireless communications companies, as well as cable MSOs and Internet service providers. Growth in voice services provided by cable MSOs is accelerating as consumers use cable MSOs as alternatives to local and long distance voice communications providers. We continue to assess the portfolio of services provided by our Long Distance segment and are focusing our efforts on IP-based services and de-emphasizing stand-alone voice services and non-IP-based data services. For example, in addition to increased emphasis on selling IP services, we are converting many of our existing customers from ATM and frame relay to more advanced IP technologies, in part to support our effort to move to one platform, which will reduce our cost structure. Over time, this conversion is expected to result in decreases in revenue from frame relay and ATM service offset by increases in IP and MPLS services. We also are taking advantage of the growth in voice services provided by cable MSOs, by providing large cable MSOs with long distance voice communications service, which they offer as part of their bundled service offerings.

 

Critical Accounting Policies and Estimates

 

We consider the following accounting policies and estimates to be the most important to our financial position and results of operations, either because of the significance of the financial statement item or because they require the exercise of significant judgment and/or use of significant estimates. While management believes that the estimates used are reasonable, actual results could differ from those estimates.

 

Revenue Recognition and Allowance for Doubtful Accounts Policies

 

Operating revenues primarily consist of wireless service revenues, revenues generated from handset and accessory sales and revenues from wholesale operators and PCS Affiliates, as well as long distance voice, data and Internet revenues. Service revenues consist of fixed monthly recurring charges, variable usage charges and miscellaneous fees, such as activation fees, directory assistance, operator-assisted calling, equipment protection, late payment charges and certain regulatory related fees. We recognize service revenues as services are rendered and equipment revenue when title passes to the dealer or end-user customer, in accordance with SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, and Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. We recognize revenue for access charges and other services charged at fixed amounts ratably over the service period, net of credits and adjustments for service discounts, billing disputes and fraud or unauthorized usage. We recognize excess wireless usage and long distance revenue at contractual rates per minute as minutes are used. Additionally, we recognize excess wireless data usage based on kilobytes and one-time use charges, such as for the use of premium services, as incurred. As a result of the cutoff times of our multiple billing cycles each month, we are required to estimate the amount of subscriber revenues earned but not billed from the end of each billing cycle to the end of each reporting period. These estimates are based primarily on rate plans in effect and our historical usage and billing patterns and represented about 13% of our accounts receivable balance as of December 31, 2006.

 

Certain of our bundled products and services, primarily in our Wireless segment, are considered to be revenue arrangements with multiple deliverables. Total consideration received in these arrangements is allocated and measured using units of accounting within the arrangement (i.e., service and handset contracts) based on relative fair values. The activation fee revenue associated with these arrangements in our direct sales channels

is recognized as equipment sales at the time the related handset is sold. For our indirect sales channels, the activation fee is solely linked to the service contract with the subscriber. Accordingly, the activation fee revenue is deferred and amortized over the estimated average service life of the end user customer, and is classified as service revenue.

 

We establish an allowance for doubtful accounts receivable sufficient to cover probable and reasonably estimable losses. Because of the number of accounts that we have, it is not practical to review the collectibility of each of those accounts individually when we determine the amount of our allowance for doubtful accounts each period, although we do perform some account level analysis with respect to long distance customers. Our estimate of the allowance for doubtful accounts considers a number of factors, including collection experience, current economic trends, estimates of forecasted write-offs, aging of the accounts receivable portfolios, industry norms, regulatory decisions and other factors. If our allowance for doubtful accounts estimate at December 31, 2006 were to change by 10%, it would represent a change in bad debt expense of $39 million for the Wireless segment and $3 million for the Long Distance segment.

 

The accounting estimates related to the recognition of revenue in the results of operations require us to make assumptions about future billing adjustments for disputes with customers, unauthorized usage and future returns on handset sales.

 

The allowance amounts recorded, in each instance, represent our best estimate of future outcomes, but the actual outcomes could differ from the estimate selected, and the impact that changes in our actual performance versus these amounts recorded would have on the accounts receivable reported on our balance sheet and our results of operations could be material to our financial condition.

 

Inventories

 

Inventories of handsets and accessories in the Wireless segment and inventories in the Long Distance segment are stated at the lower of cost or market. We determine cost by the first-in, first-out, or FIFO, method. Handset costs in excess of the revenues generated from handset sales, or handset subsidies, are expensed at the time of sale. We do not recognize the expected handset subsidies prior to the time of sale because the promotional discount decision is made at the point of sale and/or because we expect to recover the handset subsidies through service revenues.

 

As of December 31, 2006, we held about $1.2 billion of inventory. We analyze the realizable value of our handset and other inventory on a quarterly basis. This analysis includes assessing obsolescence, sales forecasts, product life cycle, marketplace and other considerations. If our assessments regarding the above factors change, we may be required to sell handsets at a higher subsidy or potentially record expense in future periods prior to the point of sale to the extent that we expect that we will be unable to sell handsets with a service contract.

 

Valuation and Recoverability of Long-lived Assets Including Definite Lived Intangible Assets

 

A significant portion of our total assets are long-lived assets, consisting primarily of property, plant and equipment and definite lived intangible assets. Changes in technology or in our intended use of these assets, as well as changes in economic or industry factors or in our business or prospects, may cause the estimated period of use or the value of these assets to change.

 

Long-lived assets consisting of property, plant and equipment represented $25.9 billion of our $97.2 billion in total assets as of December 31, 2006. We generally calculate depreciation on these assets using the straight-line method based on estimated economic useful lives as follows:

 

Since changes in technology or in our intended use of these assets, as well as changes in broad economic or industry factors, may cause the estimated period of use of these assets to change, we perform annual internal studies to confirm the appropriateness of depreciable lives for most categories of property, plant and equipment. These studies utilize models, which take into account actual usage, physical wear and tear, replacement history, and assumptions about technology evolution, to calculate the remaining life of our asset base. When these factors indicate that an asset’s useful life is different from the original assessment, we depreciate the remaining book values prospectively over the adjusted estimated useful life. If our studies had resulted in a depreciable rate that was 5% higher or lower than those used in the preparation of our consolidated financial statements for the year ended December 31, 2006, recorded depreciation expense would have been impacted by about $300 million. In addition to performing our annual studies, we also continue to assess the estimated useful life of the iDEN network assets, which had a net carrying value of $7.4 billion as of December 31, 2006, and our future strategic plans for this network, as a larger portion of our subscriber base is served by our CDMA network. A reduction in our estimate of the useful life of the iDEN network assets would cause increased depreciation charges in future periods that could be material.

 

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. A significant amount of judgment is involved in determining the occurrence of an indicator of impairment that requires an evaluation of the recoverability of our long-lived assets. If the total of the expected undiscounted future cash flows is less than the carrying amount of our assets, a loss, if any, is recognized for the difference between the fair value and carrying value of the assets. Impairment analyses, when performed, are based on our current business and technology strategy, our views of growth rates for our business, anticipated future economic and regulatory conditions and expected technological availability. For software projects that are under development, we periodically assess the probability of deployment into the business to determine if an impairment charge is required.

 

For the year ended December 31, 2006, we recorded $69 million in asset impairment charges primarily related to software asset impairments and abandonments of various assets, including certain cell sites under construction. For the year ended December 31, 2005, we recorded $44 million in asset impairment charges primarily related to the write-down of various software applications. In 2004, we determined that business conditions and events impacting our Long Distance operations constituted an indicator of possible impairment requiring an evaluation of the recoverability of the Long Distance long-lived assets, which resulted in a non-cash asset impairment charge of $3.5 billion, reducing the net carrying value of Long Distance property, plant and equipment by about 60% to $2.3 billion at September 30, 2004. Additionally, we recognized a non-cash charge of $21 million in 2004 to adjust the carrying value of our wholesale Dial IP assets to fair value. These impairments represented 54% of Long Distance’s property, plant and equipment, net and 13% of the consolidated property, plant and equipment, net at December 31, 2003.

 

Intangible assets with definite useful lives represented $9.2 billion of our $97.2 billion in total assets as of December 31, 2006. Definite lived intangible assets consist primarily of customer relationships that are amortized over three to five years using the sum of the years’ digits method, which we believe best reflects the estimated pattern in which the economic benefits will be consumed. Other definite lived intangible assets primarily include certain rights under affiliation agreements that we reacquired in connection with the acquisitions of the PCS Affiliates and Nextel Partners, which are being amortized over the remaining terms of those affiliation agreements on a straight-line basis, and the Nextel and Direct ConnectSM trade names, which are being amortized over 10 years from the date of the Sprint-Nextel merger on a straight-line basis.

 

We continually assess whether any indicators of impairment exist that would trigger a test of any of these definite lived intangible assets, including, but not limited to, a significant decrease in the market price of the asset, cash flows or a significant change in the extent or manner in which the asset is used. In addition, if we ever were required to determine the implied fair value of our goodwill as part of a second step goodwill impairment test, it would result in our evaluating the recorded value of our definite lived intangible assets for impairment. We also evaluate the remaining useful lives of our definite lived intangible assets each reporting period to determine whether events and circumstances warrant a revision to the remaining periods of amortization, which would be addressed prospectively. For example, we review certain trends such as customer churn, average revenue per user, revenue, our future plans regarding the iDEN network and changes in

marketing strategies, among others. Significant changes in certain trends may cause us to adjust, on a prospective basis, the remaining estimated life of certain of our definite lived intangible assets.

 

Valuation and Recoverability of Goodwill and Indefinite Lived Intangible Assets

 

Intangible assets with indefinite useful lives represented $50.8 billion of our $97.2 billion in total assets as of December 31, 2006. We have identified FCC licenses and our Sprint and Boost Mobile trademarks as indefinite lived intangible assets, in addition to our goodwill, after considering the expected use of the assets, the regulatory and economic environment within which they are being used, and the effects of obsolescence on their use. We review our goodwill, which relates solely to our wireless reporting unit, and other indefinite lived intangibles annually on October 1 for impairment, or more frequently if indicators of impairment exist. We continually assess whether any indicators of impairment exist. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include, a sustained, significant decline in our share price and market capitalization, changes in our expected future cash flows, a significant adverse change in legal factors or in the business climate, unanticipated competition, the testing for recoverability of a significant asset group within a reporting unit, and/or slower growth rates, among others.

 

When required, we first test goodwill for impairment by comparing the fair value of our wireless reporting unit with its carrying amount. If the fair value of the wireless reporting unit exceeds its carrying amount, goodwill is not deemed to be impaired, and no further testing would be necessary. If the carrying amount of our wireless reporting unit were to exceed its fair value, we would perform a second test to measure the amount of impairment loss, if any. To measure the amount of any impairment loss, we would determine the implied fair value of goodwill in the same manner as if our wireless reporting unit were being acquired in a business combination. Specifically, we would allocate the fair value of the wireless reporting unit to all of the assets and liabilities of that unit, including any unrecognized intangible assets, in a hypothetical calculation that would yield the implied fair value of goodwill. If the implied fair value of goodwill is less than the recorded goodwill, we would record an impairment charge for the difference.

 

When required, we test other indefinite lived intangibles for impairment by comparing the asset’s respective carrying value to estimates of fair value, determined using the direct value method. Our FCC licenses are combined as a single unit of accounting following the unit of accounting guidance as prescribed by EITF Issue No. 02-7, Unit of Accounting for Testing Impairment of Indefinite-Lived Intangible Assets, except for our FCC licenses in the 2.5 GHz band, which are tested separately.

 

The accounting estimates related to our goodwill and other indefinite lived intangible assets require us to make significant assumptions about fair values. Our assumptions regarding fair values require significant judgment about economic factors, industry factors and technology considerations, as well as our views regarding the prospects of our business. Changes in these judgments may have a significant effect on the estimated fair values.

 

During the fourth quarter 2006, we performed our annual goodwill and other indefinite lived intangible asset analyses as described above. The result of these analyses was that our indefinite lived intangible assets were not impaired. As permitted by Financial Accounting Standards Board, or FASB, guidance, our goodwill analysis included an estimate of a control premium with respect to the minority interest traded value of our common shares and an estimate of the value of our long distance business, as well as other assumptions. As of December 31, 2006, we have not identified any indicators of impairment with respect to our goodwill and other indefinite lived intangible assets. However, if our share price were to experience a sustained, significant decline as compared to the share price as of December 31, 2006, or if any other indicator of impairment exists, such as a decline in expected cash flows, we may be required to perform the second step of the goodwill impairment test, which could cause us to recognize a non-cash impairment charge that could be material to our consolidated financial statements.

 

Tax Valuation Allowances

 

We are required to estimate the amount of taxes payable or refundable for the current year and the deferred income tax liabilities and assets for the future tax consequences of events that have been reflected in our

consolidated financial statements or tax returns for each taxing jurisdiction in which we operate. This process requires our management to make assessments regarding the timing and probability of the ultimate tax impact. We record valuation allowances on deferred tax assets if we determine it is more likely than not that the asset will not be realized. Additionally, we establish reserves for uncertain tax positions based upon our judgment regarding potential future challenges to those positions. Actual income taxes could vary from these estimates due to future changes in income tax law, significant changes in the jurisdictions in which we operate, our inability to generate sufficient future taxable income or unpredicted results from the final determination of each year’s liability by taxing authorities. These changes could have a significant impact on our financial position.

 

The accounting estimate related to the tax valuation allowance requires us to make assumptions regarding the timing of future events, including the probability of expected future taxable income and available tax planning opportunities. These assumptions require significant judgment because actual performance has fluctuated in the past and may do so in the future. The impact that changes in actual performance versus these estimates could have on the realization of tax benefits as reported in our results of operations could be material.

 

We carried an income tax valuation allowance of $953 million as of December 31, 2006. This amount includes a valuation allowance of $743 million for the total tax benefits related to net operating loss carryforwards, subject to utilization restrictions, acquired in connection with certain acquisitions. The remainder of the valuation allowance relates to capital loss, state net operating loss and tax credit carryforwards. Within our total valuation allowance we had $54 million related to separate company state net operating losses incurred by the PCS entities while owned by us. The valuation allowance was provided on these separate company state net operating loss benefits since these entities had no history of taxable income. Current trends indicate that the valuation allowance continues to be appropriate and we do not anticipate adjusting this amount in the near term. We continue to monitor these trends, and in the future it is possible that our cumulative historical test will ultimately yield sufficient positive evidence that it is more likely than not that we will realize the tax benefit of some of the separate company state net operating losses for which the valuation allowance has been provided. Should that occur, subject to review of other qualitative factors and uncertainties at that time, we would expect to start reversing some of the valuation allowance. For the valuation allowance related to the acquired tax benefits described above, we would first reduce goodwill or intangible assets resulting from the acquisitions, or reduce income tax expense if these intangible assets have been reduced to zero. For the remainder of our valuation allowance, we would reduce income tax expense. Assumption changes that result in a change of expected benefits from realization of capital loss, state net operating loss and tax credit carryforwards by 10% would result in a decrease or increase in our valuation allowance by $38 million, which would be reflected in the statement of operations.

 

Significant New Accounting Pronouncements

 

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

 

In September 2006, the EITF reached a consensus on Issue No. 06-1, Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. EITF Issue No. 06-1 provides guidance regarding whether the consideration given by a service provider to a manufacturer or reseller of specialized equipment should be characterized as a reduction of revenue or an expense. This issue is effective for our quarterly reporting period ending March 31, 2008. Entities are required to recognize the effects of applying this issue as a change in accounting principle through retrospective application to all prior periods unless it is impracticable to do so. We are in the process of evaluating the impact of this issue on our consolidated financial statements.

 

In June 2006, the EITF reached a consensus on Issue No. 06-3, How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net

Presentation). EITF Issue No. 06-3 requires that companies disclose their accounting policy regarding the gross or net presentation of certain taxes. Taxes within the scope of EITF Issue No. 06-3 are any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, sales, use, value added and some excise taxes. EITF Issue No. 06-3 is effective for our quarterly reporting period ending March 31, 2007. We are in the process of evaluating the impact of this issue on our consolidated financial statements.

 

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, or FIN 48, an interpretation of SFAS No. 109, Accounting for Income Taxes. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for our quarterly reporting period ending March 31, 2007. The cumulative effect of adopting FIN 48 generally will be recorded directly to retained earnings. However, to the extent the adoption of FIN 48 results in a revaluation of uncertain tax positions acquired in purchase business combinations, the cumulative effect will be recorded as an adjustment to any goodwill remaining from the corresponding business combination. We do not believe the adoption of FIN 48 will have a material impact on our consolidated financial statements.

 

Results of Operations

 

We present consolidated information as well as separate supplemental financial information for our two reportable segments, Wireless and Long Distance. The disaggregated financial results for our two segments have been prepared in a manner that is consistent with the basis and manner in which our executives evaluate segment performance and make resource allocation decisions. Consequently, we define segment earnings as operating income before depreciation, amortization, severance, lease exit costs, asset impairments and other expenses. See note 14 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K for additional information on our segments. For reconciliations of segment earnings to the closest generally accepted accounting principles measure, operating income, see tables set forth in “— Wireless” and “— Long Distance” below. We generally account for transactions between segments based on fully distributed costs, which we believe approximate fair value. In certain transactions, pricing is set using market rates.

 

Consolidated

 

Our operating results for 2006 include the results of Nextel Partners from July 1 through the end of the year and the PCS Affiliates that we acquired in 2006, either from the date of acquisition or from the start of the month closest to the acquisition date through the end of the year. Our operating results for 2005 include the results of Nextel from August 12 through the end of the year and the PCS Affiliates that we acquired in 2005, from the date of acquisition through the end of the year. For further information on business combinations, see note 3 of the Notes to the Consolidated Financial Statements appearing at the end of this annual report on Form 10-K. These transactions affect the comparability of our reported operating results with other periods.

 

 

Net operating revenues increased 43% in 2006 as compared to 2005 and 33% in 2005 as compared to 2004, reflecting growth in revenues of our Wireless segment, resulting primarily from the business combinations discussed above, partially offset by declining revenues of our Long Distance segment. For additional information, see “— Segment Results of Operations” below.

Income (loss) from continuing operations increased 21% in 2006 as compared to 2005 and improved from a loss to income in 2005 as compared to 2004, primarily due to a decrease in impairment charges. In 2004, we recorded a $3.5 billion asset impairment charge related to our long distance network. In addition, income (loss) from continuing operations increased due to revenue growth as a result of the business combinations discussed above, partially offset by increases to cost of service primarily due to higher volume in roaming and interconnection expenses. For additional information, see “— Segment Results of Operations” and “— Consolidated Information” below.

 

Net income (loss) decreased 26% in 2006 as compared to 2005 primarily as a result of the Embarq spin-off. Net income improved in 2005 from a net loss in 2004 primarily as a result of the $3.5 billion asset impairment charge in 2004 related to our long distance network. For additional information, see “— Segment Results of Operations” and “— Consolidated Information” below.

 

Presented below are results of operations for our Wireless and Long Distance segments, followed by a discussion of results of operations on a consolidated basis.

 

Segment Results of Operations

 

Wireless

 

Our Wireless segment results of operations for the year ended December 31, 2006 include the results of acquired companies from either the date of the acquisition or the start of the month closest to the acquisition date. As such, the results of acquired companies are included as of the following dates: Enterprise Communications Partnership and Alamosa Holdings, Inc. from February 1, 2006, Velocita Wireless Holding Corporation from March 1, 2006 and Nextel Partners and UbiquiTel Inc. from July 1, 2006. The year ended December 31, 2005 results include the results of operations of Nextel and US Unwired, Inc. from August 12, 2005, Gulf Coast Wireless from October 1, 2005 and IWO Holdings from November 1, 2005.

 

 

 

NM — Not Meaningful

 

  Selected Financial and Operating Data

 

The following is a summary of our subscriber activity and related subscriber metrics. The number of subscribers impacts service revenues, cost of service and bad debt expense as well as support costs, such as customer care, which are recorded in general and administrative expenses.

 

 

 

N/A — Not Applicable

 

 

  Service Revenue

 

Service revenues consist of fixed monthly recurring charges, variable usage charges and miscellaneous fees such as activation fees, directory assistance, operator-assisted calling, equipment protection, late payment charges and certain regulatory related fees. Service revenues increased 61% in 2006 as compared to 2005 primarily due to the Sprint-Nextel merger and other acquisitions and the increase in the number of our direct subscribers, partially offset by a decrease in our weighted average monthly service revenue per user to $59 in 2006 as compared to $62 in 2005. Service revenues increased 54% in 2005 as compared to 2004 primarily due to the merger with Nextel and the increase in the number of our direct subscribers, while our weighted average monthly service revenue per user remained flat year over year. In 2006, we ended the year with about 45.8 million direct subscribers and during the year had about 1.7 million net direct subscriber additions, excluding the Nextel Partners and PCS Affiliate subscribers of about 4.1 million that were acquired with these companies. In comparison, we ended 2005 with about 39.7 million direct subscribers and during the year had about 3.0 million net direct subscriber additions excluding the Nextel and PCS Affiliate subscribers of about 18.9 million that were acquired with the merger or acquisition of these companies. In 2004, we ended the year with about 17.8 million direct subscribers and had about 1.9 million net direct subscriber additions. We believe that the growth in direct subscribers, separate from the growth attributable to subscribers gained as part of the

Sprint-Nextel merger and PCS Affiliate and Nextel Partners acquisitions, is primarily due to the following factors:

 

 

Our weighted average monthly service revenue per user decreased to $59 in 2006 from $62 in both 2005 and 2004, primarily due to the following factors:

 

 

We have limited distribution of our prepaid services, which may adversely impact our ability to add users of prepaid services in the affected markets. We also are adjusting our credit policies in certain markets, which may adversely impact our ability to add lower credit quality subscribers in markets with relatively tight credit policies. We expect our weighted average monthly service revenue per user to continue to decline as a result of decreases in pricing due to competitive market pricing, incremental customer acquisitions at lower average revenues and existing customer migrations to lower priced plans, partially offset by expected growth in demand for our data services. See “— Forward-Looking Statements.”

 

  Wholesale, Affiliate and Other Revenue

 

Wholesale, affiliate and other revenues consist primarily of net revenues retained from wireless subscribers residing in PCS Affiliate territories and revenues from the sale of wireless services to companies that resell those services to their subscribers. Wholesale, affiliate and other revenues decreased 4% in 2006 primarily due to the PCS Affiliate acquisitions, partially offset by wholesale operator additions of 1.2 million subscribers in 2006. Wholesale, affiliate and other revenues increased 47% in 2005 reflecting the growth in the wholesale operator subscriber base of 1.5 million additions, as well as the 450,000 and 374,000 net subscriber additions in 2005 and 2004 in the PCS Affiliate base.

 

  Cost of Services

 

Cost of services consists primarily of:

 

 

 

Cost of services increased 47% in 2006 compared to 2005 and 45% in 2005 compared to 2004, primarily due to increased costs relating to the expansion of our network and increased minutes of use on our networks due to our acquisitions. Specifically, we experienced:

 

 

We expect the aggregate amount of cost of service to increase as customer usage of our networks increases and we add more sites and other equipment to expand the coverage and capacity of our CDMA and iDEN networks. See “ — Forward-Looking Statements”, “ — Liquidity and Capital Resources” and “— Capital Requirements.”

 

Service gross margin increased 62% in 2006 compared to a 57% increase in 2005 because total service revenues grew at a faster rate than cost of services. As a percentage of total service revenue, service gross margin increased slightly to 75% in 2006 from 73% in 2005 and 72% in 2004.

 

  Equipment Revenue

 

We recognize equipment revenues when title to the handset or accessory passes to the dealer or end-user customer. Revenues from sales of handsets and accessories increased 49% in 2006 as compared to 2005, and increased 42% in 2005 as compared to 2004. The number of handset units sold increased by 39% in 2006 as compared to 2005, and 53% in 2005 as compared to 2004. These increases were primarily due to the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions. The average sales price per handset increased 7% in 2006 compared to 2005, primarily due to higher priced handsets being sold, including those that are Power Vision enabled. The average sales price per unit decreased 7% in 2005 compared to 2004, because we lowered our handset retail prices as the cost of handsets declined, we changed our third-party compensation plan in 2005, and we continued to offer rebates on existing handsets as new promotional programs were rolled out.

 

  Cost of Products

 

We recognize the cost of handsets and accessories, including handset costs in excess of the revenues generated from handset sales (or subsidy), when title to the handset or accessory passes to the dealer or end-user customer. Cost of handset and accessories also includes order fulfillment related expenses and write-downs of handset and related accessory inventory for shrinkage and obsolescence. The cost of handsets is reduced by any rebates that we earned from the supplier. Handset and accessory costs increased 50% in 2006 as compared to 2005 and increased 37% in 2005 as compared to 2004 primarily due to the Sprint-Nextel merger and the PCS Affiliate and the Nextel Partners acquisitions. There was also a 8% increase in the average cost per handset sold in 2006 as compared to 2005, as opposed to a 10% decrease in 2005 as compared to 2004. Equipment net subsidy as a percentage of equipment revenues increased to 54% in 2006 from 52% in 2005 and declined in 2005 from 58% in 2004.

 

Our marketing plans assume that handsets typically will be sold at prices below our cost, which is consistent with industry practice. Our subscriber retention efforts often include providing incentives to customers such as offering new handsets at discounted prices. We expect to increase handset subsidies to acquire new subscribers or to retain existing subscribers. For example, we have introduced a new line of hybrid CDMA-iDEN devices, marketed as PowerSource, and may offer these devices at a discount in an effort to retain our iDEN

subscribers, which may result in an increase in handset subsidies in future periods. See “ — Forward-Looking Statements.”

 

  Selling, General and Administrative Expense

 

Sales and marketing costs primarily consist of customer acquisition costs, including commissions paid to our indirect dealers, third-party distributors and direct sales force for new handset activations, upgrades, residual payments to our indirect dealers, payroll and facilities costs associated with our direct sales force, retail stores and marketing employees, advertising, media programs and sponsorships, including costs related to branding. General and administrative costs primarily consist of fees paid for billing, customer care and information technology operations, bad debt expense and back office support activities, including collections, legal, finance, human resources, strategic planning and technology and product development, along with the related payroll and facilities costs.

 

Sales and marketing expense increased 52% in 2006 from 2005 as compared to an increase of 55% in 2005 from 2004, primarily due to the launch of new branding initiatives and advertising campaigns in connection with the Sprint-Nextel merger and increased sales and distribution costs to support a larger subscriber base primarily due to the Sprint-Nextel merger and PCS Affiliate and Nextel Partners acquisitions. Additionally, we increased the compensation of our post-paid third-party dealers in the fourth quarter 2006 for both new subscriber additions and upgrades.

 

General and administrative costs increased 62% in 2006 from 2005 as compared to an increase of 49% in 2005 from 2004, primarily due to the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions, as well as:

 

 

We expect certain selling, general and administrative expenses to continue to increase primarily as a result of increased costs associated with customer acquisition and retention, including increased costs related to strengthening third party distribution channels, and additional marketing, advertising and brand awareness initiatives and customer care and information technology and billing activities. See “ — Forward-Looking Statements.”

 

  Wireless Segment Earnings

 

Wireless segment earnings increased 68% in 2006 from 2005 as compared to an increase of 69% in 2005 from 2004, primarily due to increased revenue resulting from the additional subscribers as a result of the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions.

Long Distance

 

 

 

 

Total Net Services Revenues

 

Total net services revenues decreased 4% in 2006 as compared to 2005 and decreased 7% in 2005 as compared to 2004 as a result of a lower priced product mix, the exiting of our unbundled network element platform, or UNE-P, business in the first quarter 2006 and our conferencing business in the third quarter 2005, and migration from legacy data products, partially offset by a higher volume of minutes in our wholesale and affiliate business and increases in our IP revenues. Additionally, the termination of a large Dial IP contract during 2004 and the sale of our wholesale Dial IP business in 2004 further contributed to the decreased revenues from 2004 to 2005. These decreases were partially offset by reduced billing adjustments achieved through improved billing processes and dispute resolution.

 

In 2007, we expect to see continued revenue growth in IP services, offset by declines in voice revenues due to lower pricing on commercial contracts and continued pressures in the long distance market. Increased competition and the excess capacity resulting from new technologies and networks may drive already low prices down further. See “— Forward-Looking Statements.”

 

Voice Revenues

 

Voice revenues decreased 6% in 2006 as compared to 2005 and decreased 8% in 2005 as compared to 2004, primarily as a result of competition from major local exchange carriers and cable MSOs for our consumer and small business customers, as well as wireless, e-mail and instant messaging substitution. Additionally, the 2006 decrease reflects the sale of our UNE-P customers in the first quarter 2006.

 

Our retail business experienced a 23% decrease in voice revenues from 2005 to 2006 as competition resulted in lower prices per minute notwithstanding increased minute volumes. Market trends indicate a shift away from the retail business and towards the wholesale business.

 

Voice revenues related to our wholesale business increased about 25% from 2005 to 2006. Minute volume increases drove about 86% of this increase, primarily as a result of our relationship with Embarq and several large cable MSOs, to which we provide local and long distance communications services that they offer to their customers as part of their bundled service offerings.

 

Voice revenues generated from the provision of services to Wireless subscribers represented 17% of total voice revenues in 2006 compared to 14% in 2005.

 

Data Revenues

 

Data revenues reflect sales of legacy data services, including ATM, frame relay and managed network services. Data revenues decreased 12% in 2006 as compared to 2005 and decreased 5% in 2005 as compared to 2004, primarily related to declines in frame relay and ATM services as customers migrated to IP-based technologies. These declines were partially offset by growth in managed network services.

 

Internet Revenues

 

Internet revenues reflect sales of IP-based data services, including MPLS. Internet revenues increased 27% in 2006 as compared to 2005 and decreased 7% in 2005 as compared to 2004. The 2006 increase was due to higher dedicated IP revenues as business customers increasingly migrate to MPLS services. The 2005 decline was primarily due to the loss of the Dial IP revenues due to the sale of our Dial IP business in October 2004.

 

Other Revenues

 

Other revenues decreased 13% in 2006 as compared to 2005 and 2004 as a result of fewer customer premises equipment, or CPE, projects in 2006 compared to prior years.

 

Costs of Services and Products

 

Costs of services and products include access costs paid to local phone companies, other domestic service providers and foreign phone companies to complete calls made by our domestic customers, costs to operate and maintain our networks and costs of equipment. Costs of services and products increased 1% in 2006 and 3% in 2005. The increases relate primarily to network costs to support growth in our cable initiatives in addition to increased domestic access volume, partially offset by fewer CPE projects in 2006, the loss of UNE-P customers in the first quarter 2006 and renegotiated access rate agreements and initiatives to reduce access circuit costs. The 2005 increase was driven by access volume and international access costs, somewhat offset by renegotiated access rate agreements and initiatives to reduce access circuit costs.

 

Service gross margin decreased from 42% in 2004 to 36% in 2005 to 33% in 2006 primarily as a result of declining net services revenues and a lower margin product mix.

 

Selling, General and Administrative Expense

 

Selling, general and administrative expense decreased 18% in 2006 as compared to 2005 and decreased 27% in 2005 as compared to 2004. The 2006 decline was due primarily to decreased marketing and advertising as a result of a change in the mix of marketing strategies and other cost savings that resulted in lower general and administrative and information technology expenses. The 2005 decline was due primarily to continued restructuring efforts, headcount reductions, aggressive cost savings initiatives, reduced rent costs and lower bad debt expense.

 

Selling, general and administrative expense includes charges for estimated bad debt expense. Every quarter we reassess our allowance for doubtful accounts, based on customer-specific indicators, as well as historical trends and industry data, to ensure we are adequately reserved. Bad debt expense for 2006 decreased to $11 million from $30 million in 2005, which was a decrease from $142 million in 2004. The improvement in bad debt expense reflects improved trends in collections and agings. The allowance for doubtful accounts as a percentage of outstanding accounts receivable was 4% in 2006 and 8% in 2005.

 

Total selling, general and administrative expense as a percentage of net services revenues was 18% in 2006, 21% in 2005, and 27% in 2004.

 

Long Distance Segment Earnings

 

Long Distance segment earnings decreased 5% in 2006 from 2005 as compared to a decrease of 8% in 2005 from 2004, primarily due to voice revenue declines related to customer migrations to alternate sources such as cable and wireless.

 

Consolidated Information

 

 

 

NM — Not Meaningful

 

Selling, General and Administrative Expense

 

Selling, general and administrative expenses are primarily allocated at the segment level and are discussed in the segment earnings discussions above. The selling, general and administrative expenses related to Wireless were $10.6 billion in 2006, $6.7 billion in 2005 and $4.4 billion in 2004. The selling, general and administrative expenses related to Long Distance were $1.2 billion in 2006, $1.4 billion in 2005 and $2.0 billion in 2004.

 

In addition to the selling, general and administrative expenses discussed in the segment earnings discussions, we incurred corporate selling, general and administrative expenses, including merger and integration costs of $413 million in 2006 and $580 million in 2005. Merger and integration costs are generally non-recurring in nature and primarily include charges for costs to adopt and launch a new branding strategy and logos, including costs to re-brand company-owned stores and facilities, costs to train customer-facing employees and prepare systems for the launch of the common customer interfacing systems, processes and other integration planning and execution costs, and costs related to employee retention. These merger and integration costs primarily relate to the Sprint-Nextel merger and have been included with unallocated corporate selling, general and administrative expenses, and thus excluded from segment results.

 

Severance, Lease Exit Costs and Asset Impairments

 

We recorded $128 million in 2006 related to the separation of employees and lease exit costs as part of the Sprint-Nextel merger and integration initiatives, and in 2004 we recorded $151 million in severance and lease exit costs related to organizational realignment and other activities. We recorded asset impairment charges of $69 million in 2006 and $44 million in 2005 primarily related to the write-off of various software applications and $3.5 billion in 2004 related to the impairment of our Long Distance property, plant and equipment. We incurred $10 million in facility lease termination costs due to subtenant lease terminations in 2006, $9 million in 2005 and $65 million in 2004.

 

Depreciation and Amortization Expense

 

Depreciation expense increased 48% in 2006 from 2005 and increased 6% in 2005 from 2004, primarily due to the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions. Excluding the impact of

these business combinations, depreciation expense increased 10% as a result of an increase in cell sites in service and the capitalized costs incurred to modify existing switches and cell sites to enhance the capacity of our networks, partially offset by the reduction in value of assets associated with the impairment of our property, plant and equipment in 2004.

 

Amortization expense increased $2.5 billion in 2006 from 2005 and increased $1.3 billion in 2005 from 2004, primarily due to the amortization of the value of customer relationships and other definite lived intangible assets acquired in connection with the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions. See note 7 to the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K for additional information regarding our definite lived intangible assets.

 

Interest Expense

 

Interest expense in 2006 increased $239 million as compared to 2005 due to the additional indebtedness assumed in connection with the Sprint-Nextel merger and the PCS Affiliate and Nextel Partners acquisitions. The effective interest rate on our average long-term debt balance of $23.3 billion in 2006 was 6.9%. The effective interest rate on our average long-term debt balance of $19.7 billion in 2005 was 6.7%. This increase is primarily related to debt assumed as part of the acquisitions in 2006 with, on average, higher interest rates relative to our existing debt. The effective interest rate on our average long-term debt balance of $17.4 billion in 2004 was 7.1%. The decrease in our effective interest rate between 2005 and 2004 primarily relates to lower effective interest rates on the assumed Nextel long-term debt. The effective interest rate includes the effect of interest rate swap agreements that are discussed in note 10 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K. As of December 31, 2006, the average floating rate of interest on the interest rate swaps was 8.3%, while the weighted average coupon on the underlying debt was 7.2%. See “— Liquidity and Capital Resources” for more information on our financing activities.

 

Interest Income

 

Interest income includes dividends received from certain investments in equity securities and interest earned on marketable debt securities and cash equivalents. In 2006, interest income increased 28% as compared to 2005 primarily due to the higher interest rates on the cash equivalents balances as well as interest income recognized in relation to a favorable tax audit settlement for the years 1995 to 2002. This increase was partially offset by the decrease in cash investment balances due to debt retirements, purchases of common stock and acquisitions. In 2005, interest income increased as compared to 2004 primarily due to the increase in the average cash and cash equivalents balances due to the Sprint-Nextel merger. Interest income also benefited from a 200 basis point increase in the Federal funds rates during 2005.

 

Equity in (Losses) Earnings of Unconsolidated Investees, net

 

Under the equity method of accounting, we record our proportional share of the earnings or losses of the companies in which we have invested and have the ability to exercise significant influence over, up to the amount of our investment in the case of losses. We recorded $6 million of equity method losses during 2006, primarily due to our ownership interests in E-wireless. We recorded $107 million of equity method earnings in 2005 primarily related to Nextel Partners. Our $41 million of equity method losses in 2004 primarily related to our investment in Virgin Mobile USA.

 

Realized Gain on Sale or Exchange of Investments

 

During 2006, we recognized a gain from the sale of investments of $205 million, primarily due to $433 million of gains on the sales of our investment in NII Holdings, Inc., partially offset by a loss of $274 million from the change in fair value of an option contract associated with our investment in NII Holdings, as described in note 10 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K.

 

We recognized a gain of $62 million from the sale of our equity method and other investments in 2005, which primarily consisted of gains related to our investments in Call-Net Enterprises, Inc., NII Holdings and

Earthlink, Inc. In 2004, we recognized a gain of $15 million from the sale of investments, primarily attributable to our investment in Earthlink.

 

Income Tax (Expense) Benefit

 

Our consolidated effective tax rates were 32.9% in 2006, 36.4% in 2005 and 38.2% in 2004. The 2006 effective tax rate was impacted by a $42 million benefit related to tax audit settlements for the years 1995 to 2002 and a $27 million benefit related to state income tax law changes. Information regarding the items that caused the effective income tax rates to vary from the statutory federal rate for income taxes related to continuing operations can be found in note 12 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K.

 

Discontinued Operations, net

 

Discontinued operations reflect the results of our Local segment for the full years 2004 and 2005 and the year-to-date period through May 17, 2006, the date of the Embarq spin-off. Additional information regarding our discontinued operations can be found in note 2 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K. Income from discontinued operations related to the spin-off of Embarq remained relatively stable in 2005 and 2004.

 

Financial Condition

 

Our consolidated assets were $97.2 billion as of December 31, 2006, which included $60.1 billion of intangible assets, and $102.8 billion as of December 31, 2005, which included $49.3 billion of intangible assets. The decrease in our consolidated assets was due primarily to the spin-off of Embarq, payments and retirements of debt, purchases of shares of our common stock and the retirement of our Seventh series redeemable preferred shares, partially offset by an increase due to assets acquired in connection with several business combinations, net of cash used to purchase the acquired entities. Additional information regarding the impact of the spin-off and the business combinations on consolidated assets can be found in notes 2 and 3 of the Notes to Consolidated Financial Statements at the end of this annual report on Form 10-K. See “Liquidity and Capital Resources” for additional information on the change in cash and cash equivalents.

 

Liquidity and Capital Resources

 

Management exercises discretion regarding the liquidity and capital resource needs of our business segments. This responsibility 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.

 

Discontinued Operations

 

On May 17, 2006, we completed the spin-off of Embarq. The separation of Embarq from us resulted in two separate companies each of which can focus on maximizing opportunities for its distinct business. We believe this separation presents the opportunity for enhanced performance of each of the two companies, including: allowing each company separately to pursue the business and regulatory strategies that best suit its long-term interests and, by doing so, addressing the growing strategic divergence between Embarq’s local wireline-centric focus and our increasingly national wireless-centric focus; creating separate companies that have different financial characteristics, which may appeal to different investor bases; creating opportunities to more efficiently develop and finance expansion plans; and creating effective management incentives tied to the relevant company’s performance.

 

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

 

In connection with the spin-off, Embarq transferred to our parent company $2.1 billion in cash and about $4.5 billion of Embarq senior notes in partial consideration for, and as a condition to, our transfer to Embarq of the local communications business. Embarq also retained about $665 million in debt obligations of its subsidiaries. The cash and senior notes were transferred by our parent company to our finance subsidiary,

Sprint Capital Corporation, in satisfaction of indebtedness owed by our parent company to Sprint Capital. On May 19, 2006, Sprint Capital sold the Embarq senior notes to the public, and received about $4.4 billion in net proceeds.

 

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

 

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

 

Generally, restricted stock units awarded pursuant to our equity incentive plans and held by our employees at the time of the spin-off (including those held by those of our employees who became employees of Embarq) were treated in a manner similar to the treatment of outstanding shares of our common stock in the spin-off. Holders of these restricted stock units received one Embarq restricted stock unit for every twenty restricted stock units held. Outstanding deferred shares granted under the Nextel Incentive Equity Plan, which represent the right to receive shares of our common stock, were adjusted by multiplying the number of deferred shares by 1.0955. Cash was paid to the holders of deferred shares in lieu of fractional shares. If the spin-off of Embarq does not qualify as a tax-free transaction, tax could be imposed on both our shareholders and us.

 

We believe that our cash and liquidity requirements will be met without the net cash provided by Embarq.

 

Cash Flows

 

 

 

NM — Not Meaningful

 

Operating Activities

 

Net cash provided by operating activities of $11.0 billion in 2006 increased $279 million from 2005 primarily due to a $12.0 billion increase in cash received from our customers as a result of the Sprint-Nextel merger in the third quarter 2005, the PCS Affiliate acquisitions in 2005 and 2006 and the Nextel Partners acquisition in the second quarter 2006, as well as continued growth in the Wireless customer base. This increase was partially offset by an $8.5 billion increase in cash paid to suppliers and employees, $1.2 billion of proceeds received in 2005 from the communications towers lease transaction and a decrease in cash provided from discontinued operations of $1.1 billion.

 

Investing Activities

 

Net cash used in investing activities for 2006 increased by $6.7 billion from 2005 due primarily to:

 

 

 

Capital expenditures increased due to higher spending in our Wireless segment, in part related to spending on our iDEN network acquired in the Sprint-Nextel merger. We invested in our Wireless segment primarily to enhance network reliability, meet capacity demands and upgrade capabilities for providing new products and services, including the deployment of EV-DO technology, as well as to improve iDEN network reliability to meet capacity demands and fulfill our obligations under the Report and Order. We invested in our Long Distance segment to maintain network reliability, upgrade capabilities for providing new products and services and meet capacity demands.

 

Financing Activities

 

Net cash used in financing activities of $6.4 billion during 2006 consisted primarily of:

 

 

We paid cash dividends of $296 million in 2006 compared to $525 million in 2005. The decrease in cash dividends paid is due to a decrease in the dividend rate from $0.125 per common share per quarter in the first two quarters of 2005 to $0.025 per common share per quarter beginning in the third quarter 2005. This dividend rate decrease was partially offset by an increase in the average number of common shares outstanding in the year ended December 31, 2006 compared to the year ended December 31, 2005, primarily as a result of the Sprint-Nextel merger.

 

Capital Requirements

 

We currently anticipate that future funding needs in the near term will principally relate to:

 

 

 

Liquidity

 

As of December 31, 2006, our cash and cash equivalents and marketable securities totaled $2.1 billion.

 

We have a $6.0 billion revolving credit facility, which represents our total committed financing capacity under this facility. This credit facility, which expires in December 2010, provides for interest rates equal to the London Interbank Offered Rate, or LIBOR, or Prime Rate plus a spread that varies depending on the parent company’s credit ratings. There is no rating trigger that would allow the lenders involved to terminate this facility in the event of a credit rating downgrade.

 

In April 2006, we commenced a commercial paper program, which reduced our borrowing costs by allowing us to issue short-term debt at lower rates than those available under our $6.0 billion revolving credit facility. The $2.0 billion program is backed by our revolving credit facility and reduces the amount we can borrow under the facility to the extent of the commercial paper outstanding. As of December 31, 2006, we had $514 million of commercial paper outstanding, net of discounts. Although our credit rating remains investment grade, recent downgrades to our credit rating by major credit rating agencies have impacted, and may continue to impact, our ability to place the paper with investors, as well as the duration and interest rates of commercial paper issued since the ratings downgrade.

 

As of December 31, 2006, we had $2.6 billion in letters of credit, including a $2.5 billion letter of credit required by the Report and Order, outstanding under our $6.0 billion revolving credit facility. These letters of credit reduce the availability under the revolving credit facility by an equivalent amount. As a result of the letters of credit and outstanding commercial paper, we had about $2.9 billion of borrowing capacity available under our revolving credit facility. In addition, we had $16 million of general letters of credit outstanding.

 

As of December 31, 2006, we were in compliance with all debt covenants, including all financial ratio tests, associated with our borrowings.

 

Our ability to fund our capital needs from outside sources is ultimately impacted by the overall capacity and terms of the banking and securities markets. Given the volatility in these markets, we continue to monitor them closely and to take steps to maintain financial flexibility and a reasonable capital cost structure.

 

As of December 31, 2006, we had working capital of $506 million compared to working capital of $5.0 billion as of December 31, 2005. The decrease in working capital is primarily due to the utilization of cash to fund our 2006 acquisitions, the impact of the spin-off of Embarq, debt payments and retirements, the purchase of common shares and the retirement of our Seventh series redeemable preferred shares. In addition to cash, cash equivalents and marketable securities, our working capital consists of accounts receivable, handset and accessory inventory, prepaid expenses, deferred tax assets and other current assets, net of accounts payable, accrued expenses and the current portion of long-term debt and capital lease obligations.

 

Future Contractual Obligations

 

The following table sets forth our best estimates as to the amounts and timing of contractual payments for our most significant contractual obligations as of December 31, 2006. The information in the table reflects future unconditional payments and is based upon, among other things, the terms of the relevant agreements, appropriate classification of items under GAAP currently in effect and certain assumptions, such as future

interest rates. Future events, including additional purchases of our securities and refinancing of those securities, could cause actual payments to differ significantly from these amounts. See “— Forward-Looking Statements.”

 

 

 

 

The table above does not include remaining costs to be paid in connection with the fulfillment of our obligation under the Report and Order. The total minimum cash obligation for the Report and Order is $2.8 billion. Costs incurred under the Report and Order associated with the reconfiguration of the 800 MHz band may be applied against the $2.8 billion obligation, subject to approval by the Transition Administrator under the Report and Order. In addition, costs associated with the reconfiguration of the 1.9 GHz spectrum are not fully approved for credit until the completion of the entire reconfiguration process. Because the final reconciliation and audit of the entire reconfiguration obligation outlined in the Report and Order will not take place until after the completion of all aspects of the reconfiguration process, there can be no assurance that we will be given full credit for the expenditures that we have incurred under the Report and Order. Additionally, since we, the Transition Administrator and the FCC have not yet reached an agreement on the methodology for calculating certain amounts of property, plant and equipment to be submitted for credit associated with reconfiguration activity with our own network, we cannot provide assurance that we will be granted full credit for certain of these network costs. As a result of the uncertainty with regard to the calculation of the credit for our internal network costs, as well as the significant number of variables outside of our control, particularly with regard to the 800 MHz reconfiguration licensee costs, we do not believe that we can reasonably estimate what amount, if any, will be paid to the U.S. Treasury. Since the inception of the program through December 31, 2006, we estimate that we have incurred $721 million of costs directly attributable to the reconfiguration program. This amount does not include any indirect network costs that we have preliminarily allocated to the reconfiguration program.

 

“Purchase orders and other commitments” include minimum purchases we commit to purchase from suppliers over time and/or the unconditional purchase obligations where we guarantee to make a minimum payment to suppliers for goods and services regardless of whether suppliers fully deliver them. They include agreements for communications and customer billing services, advertising services and contracts related to information technology and customer care outsourcing arrangements. Amounts actually paid under some of these “other” agreements will likely be higher due to variable components of these agreements. The more significant variable components that determine the ultimate obligation owed include hours contracted, subscribers and other factors. In addition, we are party to various arrangements that are conditional in nature and create an obligation to make payments only upon the occurrence of certain events, such as the delivery of functioning software or products. Because it is not possible to predict the timing or amounts that may be due under these conditional arrangements, no such amounts have been included in the table above. The table above also excludes about $3.6 billion of blanket purchase order amounts since their agreement terms are not specified.

No time frame is set for these purchase orders and they are not legally binding. As a result, they are not firm commitments.

 

Off-Balance Sheet Financing

 

We do not participate in, or secure, financings for any unconsolidated, special purpose entities.

 

Future Outlook

 

We expect to be able to meet our currently identified funding needs for at least the next 12 months by using:

 

 

In making this assessment, we have considered:

 

 

If there are material changes in our business plans, or currently prevailing or anticipated economic conditions in any of our markets or competitive practices in the mobile wireless communications industry, or if other presently unexpected circumstances arise that have a material effect on our cash flow or profitability, anticipated cash needs could change significantly.

 

The conclusion that we expect to meet our funding needs for at least the next 12 months as described above does not take into account:

 

 

Any of these events or circumstances could involve significant additional funding needs in excess of anticipated cash flows from operating activities and the identified currently available funding sources, including existing cash on hand, borrowings available under our existing credit facility and our commercial paper program. If existing capital resources are not sufficient to meet these funding needs, it would be necessary to raise additional capital to meet those needs. Our ability to raise additional capital, if necessary, is subject to a variety of additional factors that cannot currently be predicted with certainty, including:

 

 

We have in the past and may in the future have discussions with third parties regarding potential sources of new capital to satisfy actual or anticipated financing needs. At present, other than the existing arrangements that have been described in this report, we have no legally binding commitments or understandings with any third parties to obtain any material amount of additional capital.

 

The above discussion is subject to the risks and other cautionary and qualifying factors set forth under “— Forward-Looking Statements” and in Part  I, Item 1A “Risk Factors.”

 

Financial Strategies

 

General Risk Management Policies

 

We primarily use derivative instruments for hedging and risk management purposes. Hedging activities may be done for various purposes, including, but not limited to, mitigating the risks associated with an asset, liability, committed transaction or probable forecasted transaction. We seek to minimize counterparty credit risk through stringent credit approval and review processes, credit support agreements, continual review and monitoring of all counterparties, and thorough legal review of contracts. We also control exposure to market risk by regularly monitoring changes in hedge positions under normal and stress conditions to ensure they do not exceed established limits.

 

Our board of directors has adopted a financial risk management policy that authorizes us to enter into derivative transactions, and all transactions comply with the policy. We do not purchase or hold any derivative financial instruments for speculative purposes with the exception of equity rights obtained in connection with commercial agreements or strategic investments, usually in the form of warrants to purchase common shares.

 

 

We are primarily exposed to the market risk associated with unfavorable movements in interest rates, foreign currencies and equity prices. The risk inherent in our market risk sensitive instruments and positions is the potential loss arising from adverse changes in those factors.

 

Interest Rate Risk

 

The communications industry is a capital intensive, technology driven business. We are subject to interest rate risk primarily associated with our borrowings. Interest rate risk is the risk that changes in interest rates could adversely affect earnings and cash flows. Specific interest rate risk include: the risk of increasing interest rates on short-term debt; the risk of increasing interest rates for planned new fixed rate long-term financings; and the risk of increasing interest rates for planned refinancing using long-term fixed rate debt.

 

Cash Flow Hedges

 

We enter into interest rate swap agreements designated as cash flow hedges to reduce the impact of interest rate movements on future interest expense by effectively converting a portion of our floating-rate debt to a fixed-rate. As of December 31, 2006, we had no outstanding interest rate cash flow hedges.

 

Fair Value Hedges

 

We enter into interest rate swap agreements to manage exposure to interest rate movements and achieve an optimal mixture of floating and fixed-rate debt while minimizing liquidity risk. The interest rate swap agreements designated as fair value hedges effectively convert our fixed-rate debt to a floating-rate by receiving fixed rate amounts in exchange for floating rate interest payments over the life of the agreement without an exchange of the underlying principal amount. As of December 31, 2006, we had outstanding interest rate swap agreements that were designated as fair value hedges.

 

About 95% of our debt as of December 31, 2006 was fixed-rate debt excluding interest rate swaps. While changes in interest rates impact the fair value of this debt, there is no impact to earnings and cash flows because we intend to hold these obligations to maturity unless market and other conditions are favorable.

 

As of December 31, 2006, we held fair value interest rate swaps with a notional value of $1.0 billion. These swaps were entered into as hedges of the fair value of a portion of our senior notes. These interest rate swaps have maturities ranging from 2008 to 2012. On a semiannual basis, we pay a floating rate of interest equal to the six-month LIBOR plus a fixed spread and receive an average interest rate equal to the coupon rates stated on the underlying senior notes. On December 31, 2006, the rate we would pay averaged 8.3% and the rate we would receive was 7.2%. Assuming a one percentage point increase in the prevailing forward yield curve, the fair value of the interest rate swaps and the underlying senior notes would change by $28 million. These interest rate swaps met all the requirements for perfect effectiveness under derivative accounting rules as all of

the critical terms of the swaps perfectly matched the corresponding terms of the hedged debt; therefore, there is no net effect to earnings and cash flows for any fair value fluctuations.

 

We perform interest rate sensitivity analyses on our variable rate debt including interest rate swaps. These analyses indicate that a one percentage point change in interest rates would have an annual pre-tax impact of $20 million on our statements of operations and cash flows as of December 31, 2006. While our variable-rate debt may impact earnings and cash flows as interest rates change, it is not subject to changes in fair values.

 

We also perform a sensitivity analysis on the fair market value of our outstanding debt. A 10% decline in market interest rates would cause a $976 million increase in the fair market value of our debt to $24.3 billion. This analysis includes the hedged debt.

 

In 2005, we entered into a series of interest rate collars associated with the issuance of debt by Embarq at the time of its spin-off on May 17, 2006. These collars were designated as cash flow hedges in Embarq’s consolidated financial statements against the variability in interest payments that would result from a change in interest rates before the debt was issued at the time of the spin-off. However, because the forecasted interest payments of debt started after the spin-off, the derivative instruments did not qualify for hedge accounting treatment in our consolidated financial statements. As such, included in discontinued operations in 2006 is $43 million in gains, after tax, realized from the change in fair value of these interest rate collars.

 

Foreign Currency Risk

 

We also enter into forward contracts and options in foreign currencies to reduce the impact of changes in foreign exchange rates. Our foreign exchange risk management program focuses on reducing transaction exposure to optimize consolidated cash flow. We use foreign currency derivatives to hedge our foreign currency exposure related to settlement of international telecommunications access charges and the operation of our international subsidiaries. The dollar equivalent of our net foreign currency payables from international settlements was $20 million and net foreign currency receivables from international operations was $20 million as of December 31, 2006. The potential immediate pre-tax loss to us that would result from a hypothetical 10% change in foreign currency exchange rates based on these positions would be insignificant.

 

Equity Risk

 

We are exposed to market risk as it relates to changes in the market value of our investments. We invest in equity instruments of public and private companies for operational and strategic business purposes. These securities are subject to significant fluctuations in fair market value due to volatility of the stock market and industries in which the companies operate. These securities, which are classified in investments and marketable securities on the consolidated balance sheets, include equity method investments, investments in private securities, available-for-sale securities and equity derivative instruments.

 

We entered into a series of option contracts associated with our investment in NII Holdings in order to hedge the price risk associated with this security. The first of these contracts did not qualify for hedge accounting and the changes in fair value of that contract were recognized in earnings during the period of change. The remainder of these equity derivative instruments were settled in December 2006. Additional information regarding our derivative instruments can be found in note 10 of the Notes to Consolidated Financial Statements appearing at the end of this annual report on Form 10-K.

 

In certain business transactions, we are granted warrants to purchase the securities of other companies at fixed rates. These warrants are supplemental to the terms of the business transaction and are not designated as hedging instruments.

 

During 2002 and 2003, we entered into variable prepaid forward contracts to monetize equity securities held as available for sale. The derivatives were designated as cash flow hedges to reduce the variability in expected cash flows related to the forecasted sale of the underlying equity securities. These prepaid contracts were settled between the fourth quarter 2004 and fourth quarter 2005.

 

 

The consolidated financial statements required by this item begin on page F-1 of this annual report on Form 10-K and are incorporated herein by reference. The financial statement schedule required under

Regulation S-X is filed pursuant to Item 15 of this annual report on Form 10-K and is incorporated herein by reference.

 

 

Not applicable.

 

Item 9A.  Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures

 

Disclosure controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports under the Securities Exchange Act of 1934, such as this Form 10-K, is reported in accordance with the SEC’s rules. Disclosure controls are also designed with the objective of ensuring that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

In connection with the preparation of this Form 10-K as of December 31, 2006, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer each concluded that the design and operation of the disclosure controls and procedures were effective as of December 31, 2006 in providing reasonable assurance that information required to be disclosed in reports we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and in providing reasonable assurance that the information is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

We continue to update our internal control over financial reporting as necessary to accommodate any modifications to our business processes or accounting procedures. During the quarter ended December 31, 2006, we completed various phases of our systems and processes consolidation plan. These included migrating certain operating leases on to a single accounting system, migrating certain customers onto a single billing platform, transitioning part of our call traffic to a new call processing system and standardizing the majority of our stores onto one point of sale system. There have been no other changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Management’s Report on Internal Control over Financial Reporting

 

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the reliability of financial reporting and the preparation of financial statements for external purposes.

 

Our management conducted an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006. This assessment was based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, in Internal Control — Integrated Framework. Based on this assessment, management believes that, as of December 31, 2006, our internal control over financial reporting was effective.

 

Our independent registered public accounting firm has issued a report on management’s assessment of our internal control over financial reporting. This report appears on page F-4.

 

As discussed in note 3 to the consolidated financial statements, we completed the acquisition of Nextel Partners, Inc. in June 2006. We have excluded Nextel Partners from our assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006. The accounts of Nextel Partners represent about 2% of our $97.2 billion in total assets and 2% of our $41.0 billion in net operating revenues included in our consolidated financial statements as of and for the year ended December 31, 2006.

 

 

Not applicable.

 

Part III

 

 

The information required by this item regarding our directors is incorporated by reference to the information set forth under the captions “Election of Directors — Nominees for Director,” “— Board Committees and Director Meetings — The Audit Committee” and “— Board Committees and Director Meetings — The Nominating and Corporate Governance Committee” in our proxy statement relating to our 2007 annual meeting of shareholders, which will be filed with the SEC, and with respect to family relationships, to Part I of this report under “Executive Officers of the Registrant.” The information required by this item regarding our executive officers is incorporated by reference to Part I of this report under the caption “Executive Officers of the Registrant.” The information required by this item regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 by our directors, executive officers and holders of ten percent of a registered class of our equity securities is incorporated by reference to the information set forth under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” in our proxy statement relating to our 2007 annual meeting of shareholders, which will be filed with the SEC.

 

We have adopted the Sprint Nextel Code of Conduct, which applies to all of our directors, officers and employees. The Code of Conduct is publicly available on our website at http://www.sprint.com/governance. If we make any amendment to our Code of Conduct, other than a technical, administrative or non-substantive amendment, or we grant any waiver, including any implicit waiver, from a provision of the Code of Conduct, that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, we will disclose the nature of the amendment or waiver on our website at the same location. Also, we may elect to disclose the amendment or waiver in a current report on Form 8-K filed with the SEC.