Sprint - Nextel 2006 Annual Report Download - page 51

providers for calls terminating on their networks, which fluctuates in relation to the level and duration
of those terminating calls; and
• costs to service and repair handsets, activate service for new subscribers and roaming fees paid to other
carriers.
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:
• an increase in cell site and switch related operational costs, including increases in fixed and variable
interconnection costs, due to the increase in usage, cell sites and related equipment in service;
• an increase in backhaul costs driven by the increased capacity required to support our EV-DO service,
as well as our PCS Affiliate and Nextel Partners acquisitions; and
• an increase in costs for premium data services resulting from increased subscriber data usage; partially
offset by
• the decrease in roaming expenses due to the acquisition of Nextel Partners and the PCS Affiliates.
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
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