Sprint: Is The Turnaround Story Complete?

| About: Sprint Corporation (S)

Thursday morning, Sprint (NYSE:S) reported its fiscal second-quarter earnings report. While revenue was strong and beat analyst estimates, the company reported a much larger loss than expected. Sprint continues to lose money as it shuts down the Nextel network and continues its Network Vision plan. Shares soared early in the day, rallying up to $4.05 in pre-market trading at one point. Let's look at the reported numbers.

Overall Results

The following is a summary of the reported results:

  • Sprint reported revenue of $8.84 billion, greatly ahead of the $8.73 billion analysts were looking for.
  • Average revenue per user of $63.38, with the year-over-year change being the largest in U.S. wireless history.
  • Best ever Sprint quarterly postpaid churn of 1.69%. Postpaid net additions of 442,000.
  • Nearly 1.5 million iPhones sold.
  • Adjusted OIBDA forecast raised to $4.5 to $4.6 billion (from $3.7 billion to $3.9 billion). Revenue forecast maintained at 4% to 6% growth.
  • Net loss of $1.4 billion, or $0.46 per share, missing analyst expectations for a $0.40 loss.

Mixed Messages

There were a lot of good numbers here, but at the same time, some of the "positives" that were reported were actually negatives.

First, Sprint reported that it sold "nearly" 1.5 million iPhones, compared with "more than" 1.5 million iPhones in Q1. That means that iPhone sales did decline over the prior quarter, they were not equal. That was the bad. On the good side, it doesn't appear that Sprint had as much of a decline as we saw with Verizon (NYSE:VZ), AT&T (NYSE:T), or even the overall decline Apple (NASDAQ:AAPL) saw, as seen in the table below (numbers in millions).

iPhones AAPL T VZ S
Q4 37.0 7.6 4.3 1.8
Q1 35.1 4.3 3.2 >1.5
Q2 26.0 3.7 2.7 <1.5

Another negative was that new iPhone customers were only 40%, compared with 44% in the prior quarter. Now onto the average revenue per user, shown in the following table.

ARPU Details Q1 2011 Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012
Postpaid ARPU $58.52 $59.07 $60.20 $61.22 $62.55 $63.38
Q / Q Change $0.99 $0.55 $1.13 $1.02 $1.33 $0.83

As Sprint noted, the year-over-year change in ARPU was the largest in U.S. wireless history. However, Sprint only saw an 83 cent increase in the quarter-over-quarter number, down from the $1 plus in each of the past three quarters. Now, you can see that we saw a similar decline of 44 cents from the 2011 Q1 to Q2 period. I will be looking for a bounce back in Q3. However, one must remember that most analysts are expecting a weak quarter for iPhone sales in anticipation of the iPhone 5 launch, presumably in Sprint's Q4. Should that occur, I would not be surprised if Q3 doesn't show a large ARPU gain, but we could see a huge gain in Q4.

In terms of margins, they are still declining. Yes, Sprint did take a lot of charges due to the network upgrade, but it is still seeing a decrease in gross margins. As it sells more iPhones, gross margins could continue to decline. The following table shows Q2 margins over the past four years. The trend is down.

Q2 Margins 2009 2010 2011 2012
Gross 50.12% 47.29% 44.78% 43.33%
Operating -1.39% -0.79% 0.95% -7.11%
Profit -4.72% -9.47% -10.19% -15.54%

Gross margins did fall another 145 basis points, and are now down almost 7 full percentage points in three years. Yes, as Sprint finishes the network upgrade, operating and profit margins should improve as depreciation and amortization costs subside. However, if gross margins continue to decline, operating and profit margins will not see a full recovery. It's just a matter of simple math.

Sprint was not helped in the quarter by a 7.7% quarterly increase in its interest expense, and those interest costs were up 34.3% over the prior-year period. Sprint also recorded another $204 million, or 7 cent per share pre-tax, impairment charge due to its investment in Clearwire (CLWR). As I recently described, Sprint's fall into earnings had a lot to do with Clearwire plunging. Clearwire shares ended Q2 at $1.12, and have fallen below the $1 mark in recent days, even hitting a low of $0.83. Sprint will continue to record impairment charges if Clearwire's stock continues to drop. Clearwire has dropped because of funding concerns, and we'll get a better idea of how they are doing when Clearwire reports Thursday afternoon.

Balance Sheet Update

I've been a bear on Sprint for quite some time, and one of the main reasons is its poor balance sheet.

Sprint announced that its overall liquidity increased from $8.8 to $9.0 billion in the quarter. However, that includes $1 billion in a secured credit facility contingent on equipment-related purchases from Ericsson for Network Vision. If you take that out, overall liquidity decreased to $8.0 billion in the period.

A number of Sprint's key financial ratios worsened in the period, which I've summarized in the table below.

Financial Ratios 12/31/10 3/31/11 6/30/11 9/30/11 12/31/11 3/31/12 6/30/2012
Current Ratio 1.25 1.02 1.06 1.13 1.59 1.90 1.58
Working Capital $1,989 $175 $551 $968 $3,838 $5,785 $4,241
Debt Ratio 71.84% 71.33% 72.83% 72.84% 76.86% 79.08% 81.18%
Total Debt $20,191 $18,538 $18,534 $18,529 $20,274 $22,268 $21,264
Debt/Liabilities 54.41% 52.69% 51.89% 52.98% 53.41% 55.63% 53.43%
Equity $14,546 $14,140 $13,326 $13,041 $11,427 $10,591 $9,227
Debt/Equity 138.81% 131.10% 139.08% 142.08% 177.42% 210.25% 230.45%

The current ratio fell back to the end of 2011 levels, despite the rise in working capital since that time. The debt (liabilities to assets) ratio increased even more, and is now above 80%. Total debt declined as Sprint paid back $1 billion in debt, but it also hasn't used either of its outstanding credit facilities yet. That also improved the debt as a percentage of total liabilities ratio. Stockholders' equity continued to decline, putting the debt-to-equity ratio at 230%. Sprint now has $4.30 of liabilities for each dollar of equity, up from $2.68 a year ago.


Sprint did report some very good numbers, but there were also some concerning signs as well. Sprint has now lost $14 billion over the past 18 quarters, and a weak Q3 in terms of iPhone sales could set back the company's progress for a few more months. Average revenue per user is rising, but gross margins are declining. The balance sheet also got worse during the quarter. There were a number of "best ever" things in this quarterly report, and I'm not sure if some of those categories can improve at the pace they have been.

By 11:30 AM, Sprint shares were at $3.90, up 15.5% for the day. Now remember, this stock hit a 52-week low of $2.10, so it was 60% off the low going into this report. Like I said in the opening, shares were up to $4.05 in the pre-market, just 15 cents away from doubling off the yearly low.

Sprint's turnaround story is in progress, but the company isn't quite there yet. I stated earlier this year that I believed the company was 12-18 months away from finishing its turnaround, which means we are still 6-12 months away now. I'm a bit skeptical of Thursday's rally, given how much shares were up already. If shares do break the $4 level in the coming days, shorting the name for the probable pull back seems like a decent idea.

Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in S over the next 72 hours. I may also initiate a long position in AAPL over the next 72 hours.