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Sprint Nextel Corporation (NYSE:S) will release its financial results for the next quarter later this month. Telecommunications sector giant AT&T Inc. (NYSE:T) will be releasing its earnings on October 24th while Verizon Communications Inc.(NYSE:VZ) will do so on the 18th. Today CapitalCube evaluates Sprint’s Earnings Quality.

Our analysis suggests that while Sprint Nextel’s net margins look relatively weak, it has a reasonable level of accruals relative to peers. Our peers for Sprint Nextel Corporation (NYSE:S) are: AT&T Inc. (NYSE:T), Verizon Communications Inc.(NYSE:VZ), Deutsche Telekom AG (FRA:DTE) (ETR:DTE) (PINK:DTEGY), MetroPCS Communications Inc (NYSE:PCS), United States Cellular Corporation (NYSE:USM), and Clearwire Corporation (NASDAQ:CLWR). For similar Earnings Quality reports on other major players in the telecommunications sector including AT&T Inc.(NYSE:T) and Verizon Communications Inc.(NYSE:VZ) you can log in for a free trial.

Earlier this week we published our Fundamental Analysis for Sprint as well an assessment of potential corporate actions: Sprint Nextel (S): Target for a Merger or an Expensive Acquisition? Sprint did not pay any dividends. This Earnings Quality report wraps up our look at Sprint.

Earnings Quality

Accounting Quality

S-US’s relatively weak net income margins for the last twelve months combined with a level of accruals that is around peer median suggest that its reported net income is supported by a reasonable level of accruals.

Management of Reserves

The company’s accrual levels over the last twelve months are positive but around the peer median suggesting the company is recording a proper level of reserves relative to its peers.

Material Categories

Excluding the effects of change in revenue, the accounting categories causing the most impact on the movement of net income from the prior period to the current period are PP&E, Intangible Assets and SG&A.

Earnings: From Accounting or Cash Flow?

Net Income = Net Operating Cash Flow – “Accruals”

Accruals are estimates by company management of non-cash expenses, assets and liabilities that are recognized before they are paid. They are calculated as net operating cash flow less net income.
The analysis of accruals can help signal possible earnings management of reported net income and EPS results. For example, ‘Over-Accrued’ can signal under reported net income and/or the building of balance sheet reserve accounts, while ‘Under-Accrued’ can signal inflated Net Income results and/or release of balance sheet reserves to aid reported earnings.

Recent trend for S-US’s accruals

The annual trend suggests that S-US’s accruals to revenue ratio is its lowest over the last five years and compares to a high of 96.7% in 2007. Though its accruals to revenue ratio decreased to 19.5% from 25.4% (in 2010), its peer median remained relatively stable during this period at 19.5%. Relative to peers, accruals to revenue ratio fell 5.7 percentage points.
On a quarterly basis, S-US’s accruals to revenue ratio is its highest over the last five quarters and compares to a low of 10.9% in 2011-09-30. Though its accruals to revenue ratio increased to 28.8% from 21.1%, its peer median remained relatively stable during this period at 17.1. Relative to peers, accruals to revenue ratio rose 8.0 percentage points.
Graph of Annual Accruals (TTM) showing Peer Median for Sprint Nextel Corp. (NYSE:S)
Graph of Quarterly Accruals (TTM) showing Peer Median for Sprint Nextel Corp. (NYSE:S)

Accounting Quality

Net income is supported by a reasonable level of accruals.

S-US reported relatively weak net income margins for the last twelve months (-11.1% vs. peer median of 3.3%). However, the company booked a level of accruals that is around peer median (22.2% vs. peer median of 22.2%) for the same period, suggesting that its reported net income is supported by a reasonable level of accruals.
Accounting Quality or Net Margin vs. Accruals charted with respect to Peers for Sprint Nextel Corp. (NYSE:S)

Management of Reserves

S-US’s accounting suggests a proper level of reserves.

S-US’s accruals over the last twelve months are positive suggesting a buildup of reserves. However, this level of accruals is also around the peer median and suggests the company is recording a proper level of reserves compared to its peers.
Management of Reserves, Buildup or Drain? Charted with respect to Peers for Sprint Nextel Corp. (NYSE:S)

Key Items Impacting Cash Flow

PP&E, Accounts Payable and Intangible Assets have the most material impact on the movement of net income.

We assess the impact of various categories on the cash flow of the company by performing a variance analysis. For each category, this variance analysis measures the movement between the current and previous periods, normalized for the size of the company (e.g. days outstanding or percentage of revenues). This normalization eliminates any movement attributable to period-by-period growth and helps isolate the impact of any accounting policy changes the company might have made in recording the values in each category.
The chart on the right shows the impact of the top accounting categories on Sprint Nextel Corp.’s cash flow for the current quarter. We consider both positive and negative impacts on the cash flow since the categories could have either decreased or increased the reported net income.
% Impact on Cash Flow for Sprint Nextel Corp. (NYSE:S)
The table below details the impact of the major accounting categories on Sprint Nextel Corp.’s net operating cash flow for the current quarter. While we have identified the major accrual categories, and conduct several tests on this standardized set, it should be noted that companies can sometimes have a non-standard accrual item that has a higher impact on the difference between net operating cash flow and net income.
Item Latest Quarter Previous Quarter Impact On Cash Flow (mn) Impact On Cash Flow (%)
Accounts Receivable DSO 33.6 34.3 69.1 5.9
Inventory DSO 7.5 8.4 83.5 7.1
Accounts Payable DSO 32.1 27.8 412.7 35.1
PPE DSO 136.2 143.3 695.7 59.1
Intangible Assets DSO 230.8 233.7 285.5 24.3
R&D DSO 0.0 0.0 0.0 0.0
SG&A DSO 24.5 25.4 85.4 7.3
Tax Rate (%) N/A N/A N/A N/A
Restructuring Expense (% Revenue) N/A N/A N/A N/A
Other Income (% Revenue) (8.8) (8.9) (3.5) (0.3)

Supporting Tests and Analytics

For further reference, we provide an extended analysis of the quality of accounting for each accrual category and the company’s results. We judge these results by comparing (i) against the company’s previous accounting policy — to ascertain if the policy has changed or (ii) against the peer group — to check if the company is being more aggressive or conservative than the peers or (iii) the appropriateness of the change and its implication. Log in for detailed report.

Sprint Nextel (S): Target for a Merger or an Expensive Acquisition?

Sprint Nextel Corp. (S) stock suffered yesterday after an analyst downgrade that ended Sprint’s stock rally; the report also noted likely consolidation in the wireless sector. Earlier