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U.S. Securities and Exchange Commission
Washington, D.C. 20549
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Form 10-Q
(Mark one)
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[x] Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 1998
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or
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[ ] Transition Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
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Commission File Number 1-3499
Michigan Bell Telephone Company
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A Michigan Corporation
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444 Michigan Avenue
Detroit, Michigan 48226
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I.R.S. Employer Identification
Number 38-0823930
Telephone number (800) 257-0902
MICHIGAN BELL IS A WHOLLY OWNED SUBSIDIARY OF AMERITECH CORPORATION AND
MEETS THE CONDITIONS IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q.
WE ARE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT UNDER GENERAL
INSTRUCTION H(2).
We have 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, and
have been subject to those filing requirements for the past 90 days.
Yes X No
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At July 31, 1998, 120,526,415 common shares were outstanding.
TABLE OF CONTENTS
PART I
ITEM Page
- ---- ----
1. Financial Statements
Condensed Statements of Income and Accumulated Deficit for
the three and six months ended June 30, 1998 and 1997 1
Condensed Balance Sheets as of
June 30, 1998 and December 31, 1997 2-3
Condensed Statements of Cash Flows for
the six months ended June 30, 1998 and 1997 4
Notes to Condensed Financial Statements 5
2. Management's Discussion and Analysis
of Results of Operations 6-18
3. Quantitative and Qualitative
Disclosures about Market Risk 19
PART II
6. Exhibits and Reports on Form 8-K 20
Glossary 22-23
Page i
Item 1 - Financial Statements
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CONDENSED STATEMENTS OF INCOME AND ACCUMULATED DEFICIT
(Dollars in Millions)
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
---------------- ----------------
1998 1997 1998 1997
---- ---- ---- ----
Revenues
Local service................. $ 406.4 $ 381.9 $ 795.9 $ 750.2
Interstate network access..... 164.2 163.4 325.5 320.5
Intrastate network access..... 75.4 52.4 127.1 102.7
Long distance service......... 179.4 180.0 360.6 373.3
Other......................... 70.6 78.7 136.6 152.7
--------- --------- --------- ---------
896.0 856.4 1,745.7 1,699.4
--------- --------- --------- ---------
Operating expenses
Employee-related expenses..... 167.5 166.5 328.9 327.2
Depreciation and amortization. 139.0 127.8 275.3 260.4
Other operating expenses...... 269.9 248.9 530.3 476.8
Taxes other than income taxes. 39.6 37.1 79.2 77.7
--------- --------- --------- ---------
616.0 580.3 1,213.7 1,142.1
--------- --------- --------- ---------
Operating income................ 280.0 276.1 532.0 557.3
Interest expense................ 20.3 20.5 41.1 41.6
Other income, net............... 3.6 1.9 5.8 2.9
--------- --------- --------- ---------
Income before income taxes...... 263.3 257.5 496.7 518.6
Income taxes.................... 96.2 88.8 182.1 179.0
--------- --------- --------- ---------
Net income...................... 167.1 168.7 314.6 339.6
Accumulated deficit,
beginning of period........... (295.0) (356.9) (299.5) (347.2)
Less, dividends declared.... 119.6 131.8 262.6 312.4
--------- --------- --------- ---------
Accumulated deficit,
end of period................. $ (247.5) $ (320.0) $ (247.5) $ (320.0)
========= ========= ========= =========
See Notes to Condensed Financial Statements.
Page 1
CONDENSED BALANCE SHEETS
(Dollars in Millions)
June 30, 1998 Dec. 31, 1997
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(Unaudited) (Derived from
Audited
Financial
Statements)
ASSETS
Current assets
Cash and temporary cash investments......... $ 37.0 $ 12.8
Investment in Ameritech funding pool........ 98.7 --
--------- ---------
135.7 12.8
Receivables, net
Customers................................. 667.3 654.3
Ameritech and affiliates.................. 3.8 4.4
Other..................................... 19.8 21.6
Material and supplies....................... 20.8 6.8
Prepaid and other........................... 20.7 18.2
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868.1 718.1
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Property, plant and equipment................ 8,528.6 8,363.1
Less, accumulated depreciation............... 5,650.7 5,425.9
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2,877.9 2,937.2
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Investments, primarily in affiliates......... 88.6 92.5
Other assets and deferred charges............ 359.9 324.7
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Total assets................................. $ 4,194.5 $ 4,072.5
========= =========
See Notes to Condensed Financial Statements.
Page 2
CONDENSED BALANCE SHEETS (continued)
(Dollars in Millions)
June 30, 1998 Dec. 31, 1997
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(Unaudited) (Derived from
Audited
Financial
Statements)
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities
Debt maturing within one year
Ameritech................................ $ -- $ 50.2
Other.................................... 107.3 101.5
Accounts payable
Ameritech Services, Inc. (ASI)............ 33.4 53.0
Ameritech and affiliates.................. 53.4 41.0
Other..................................... 206.0 157.0
Other current liabilities.................. 333.2 277.0
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733.3 679.7
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Long-term debt.............................. 993.9 993.8
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Deferred credits and other long-term liabilities
Accumulated deferred income taxes.......... 136.9 138.5
Unamortized investment tax credits......... 34.0 37.5
Postretirement benefits
other than pensions...................... 661.4 663.6
Long-term payable to ASI................... 17.2 18.6
Other ..................................... 69.3 70.3
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918.8 928.5
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Shareowner's equity
Common shares - ($14 2/7 par value;
120,810,000 shares authorized;
120,526,415 issued and outstanding)...... 1,721.8 1,721.8
Proceeds in excess of par value............ 74.2 48.2
Accumulated deficit........................ (247.5) (299.5)
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1,548.5 1,470.5
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Total liabilities and shareowner's equity... $ 4,194.5 $ 4,072.5
========= =========
See Notes to Condensed Financial Statements.
Page 3
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Six Months Ended
June 30
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1998 1997
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................... $ 314.6 $ 339.6
Adjustments to net income
Depreciation and amortization............... 275.3 260.4
Deferred income taxes, net.................. (14.3) (3.8)
Investment tax credits, net................. (3.5) (4.3)
Capitalized interest........................ (0.8) (0.7)
Change in accounts receivable, net.......... (10.6) 51.5
Change in material and supplies............. (17.9) (5.9)
Change in certain other current assets...... (3.1) (3.7)
Change in accounts payable.................. 41.8 16.1
Change in certain other current
liabilities................................ 75.8 63.9
Change in certain other noncurrent
assets and liabilities..................... (14.1) (6.5)
Other operating activities, net............. 5.1 6.3
-------- --------
Net cash from operating activities............ 648.3 712.9
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.......................... (212.8) (174.6)
Additional investments........................ -- (23.2)
Proceeds from disposals of
property, plant and equipment................ 1.6 2.8
Other investing activities, net............... -- 0.1
-------- --------
Net cash from investing activities............ (211.2) (194.9)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Intercompany financing, net................... (50.2) (138.3)
Retirements of long-term debt................. (1.4) (0.6)
Dividend payments............................. (262.6) (312.4)
Other investing activities, net............... -- 0.1
-------- --------
Net cash from financing activities............ (314.2) (451.2)
-------- --------
Net change in cash and
temporary cash investments................... 122.9 66.8
Cash and temporary cash investments,
beginning of period.......................... 12.8 0.2
-------- --------
Cash and temporary cash investments,
end of period................................ $ 135.7 $ 67.0
======== ========
See Notes to Condensed Financial Statements.
Page 4
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in Millions)
JUNE 30, 1998
NOTE 1: Preparation of Interim Financial Statements
We have prepared the unaudited condensed financial statements in this
report by following Securities and Exchange Commission rules that
permit reduced disclosure for quarterly period reports. These
financial statements include estimates and assumptions that affect
the reported amounts of assets and liabilities and the amounts of
revenues and expenses. Actual amounts could differ from those
estimates. We believe these statements include all adjustments
necessary for a fair statement of results for each period shown. We
believe our disclosures are adequate to make the presented
information clear. You should read these financial statements in
conjunction with the financial statements and notes included in our
1997 Annual Report on Form 10-K and the quarterly report on Form 10-Q
previously filed in 1998.
When reading these financial statements, you should be familiar with
the terminology unique to our business. We have defined a number of
terms in the glossary on pages 22 and 23.
NOTE 2: Merger Agreement
On May 11, 1998, our parent (Ameritech Corporation) jointly announced
with SBC Communications Inc. (SBC) a definitive agreement to merge an
SBC subsidiary with Ameritech in a transaction in which each share of
Ameritech common stock will be converted into and exchanged for 1.316
shares of SBC common stock. After the merger, Ameritech will be a
wholly owned subsidiary of SBC. The transaction, which was approved
by the Board of Directors of each company, is intended to be
accounted for as a pooling of interests and to be a tax-free
reorganization. The merger is subject to the satisfaction of certain
conditions and regulatory approvals, as well as approval by the
shareowners of each company.
Page 5
Item 2 - Management's Discussion and Analysis
of Results of Operations
The following is a discussion and analysis of the changes in
revenues, operating expenses and other income and expenses for the
first six months of 1998 as compared with the first six months of
1997.
RESULTS OF OPERATIONS
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Revenues
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Our revenues in the first six months of 1998 were $1,745.7 million
and were $1,699.4 million for the same period in 1997, an increase of
46.3 million. A favorable court ruling in Michigan, which increased
revenues by about $20 million in the second quarter of 1998, was the
primary reason for the increase. Growth in sales of call management
services and access lines, as well as increases in switched minutes
of use resulting from higher network usage volumes also contributed
to the increase. Net rate reductions and decreased long distance
revenues partially offset these increases.
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Local service
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June 30 Increase Percent
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(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 795.9 $ 750.2 $ 45.7 6.1
Local service revenues include basic monthly service fees and usage
charges, fees for call management services, installation and
connection charges, certain data services and most public phone
revenues. Local service revenues increased for the six months ended
June 30, 1998 due largely to increased sales of call management
services, resulting from strong growth in both the number of features
in service and usage of services on a pay-per-use basis. Higher
network usage volumes, resulting primarily from access line growth of
3.4% over the prior year period, also contributed to the increase.
There were 5,382,000 access lines in service as of June 30, 1998,
compared with 5,206,000 as of June 30, 1997 (restated to standardize
counting of voice-grade equivalent lines).
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Network access
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June 30 Increase Percent
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(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Interstate
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Six Months Ended $ 325.5 $ 320.5 $ 5.0 1.6
Intrastate
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Six Months Ended $ 127.1 $ 102.7 $ 24.4 23.8
Network access revenues are fees charged to interexchange carriers
that use our local landline communications network to connect
customers to their long distance networks. In addition, end users
pay flat rate access fees to connect to the long distance network.
These revenues result from both interstate and intrastate services.
Page 6
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Network access (cont'd.)
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Interstate network access revenues increased for the six months ended
June 30, 1998 due primarily to an increase in minutes of use,
resulting from overall growth in the volume of calls handled for
interexchange carriers, and greater demand for dedicated services by
Internet service providers and other high-capacity users. Rate
reductions, combined with a change in reporting classification of pay
phone revenues received from network access to other miscellaneous
revenues beginning in the first quarter of 1998, partially offset
these increases. This change in classification decreased interstate
network access revenues by approximately $10.8 million in the first
six months of 1998 compared with the prior year. Interstate minutes
of use for the six months ended June 30, 1998 increased by 4.9% over
the prior year.
Intrastate network access revenues increased for the six months ended
June 30, 1998 largely due to a favorable court ruling in Michigan
which found that interexchange carriers are not entitled to access
charge discounts for intraLATA toll services prior to the time that
Ameritech Michigan is allowed to offer interLATA long distance
service in the state. Intrastate network access revenues increased
by about $20 million in the first six months of 1998 compared with
the prior year period as a result of this ruling. Several
interexchange carriers have challenged the ruling at the Michigan
Supreme court and at the Michigan Public Service Commission (MPSC).
Volume increases, largely resulting from increased network usage by
alternative providers of intraLATA toll service, also contributed to
the increase. Rate decreases, combined with a change in reporting
classification of certain pay phone revenues received from network
access to other revenues partially offset the volume increases. This
change in classification decreased intrastate network access revenues
by approximately $4.5 million in the first six months of 1998
compared with the prior year. Intrastate minutes of use for the six
months ended June 30, 1998 increased by 14.5% over the same period
last year.
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Long distance service
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 360.6 $ 373.3 $ (12.7) (3.4)
Long distance service revenues result from customer calls to
locations outside of their local calling areas, but within the same
Local Access and Transport Area (LATA). Long distance service
revenues decreased for the six months ended June 30, 1998 due
primarily to volume decreases, due primarily to increased competition
from alternative intraLATA toll providers. Rate increases partially
offset these volume decreases.
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Other
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 136.6 $ 152.7 $ (16.1) (10.5)
Other revenues include revenues derived from directory advertising,
billing and collection services, inside wire installation and
maintenance services and other miscellaneous services. Other
revenues decreased for the six months ended June 30, 1998 due
primarily to a decrease in directory advertising revenues, combined
with a decrease in revenues from inside wire installation and
maintenance services.
Page 7
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Other (cont'd.)
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A change in reporting classification of certain pay phone revenues
from network access to other revenues, as previously discussed,
combined with increased sales of equipment and other nonregulated
services, such as voice messaging and billing and collection
services, partially offset the decrease.
We have entered into a new agreement with Ameritech Publishing, Inc.
(API), a wholly owned Ameritech subsidiary, for the publication and
distribution of directories. This agreement, which was effective
July 1, 1997, reduced our revenues from directory services by
approximately $38.6 million in the first half of 1998 compared with
the prior year period.
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Operating expenses
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Total operating expenses for the six months ended June 30, 1998
increased $71.6 million, or 6.3 percent to $1,213.7 million.
Increases in other operating expenses and depreciation and
amortization expenses were the primary reasons for the increase, as
discussed below.
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Employee-related expenses
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 328.9 $ 327.2 $ 1.7 0.5
Employee-related expenses increased for the six months ended June 30,
1998 due primarily to wage rate increases and increased overtime
expenses, partially offset by lower average force levels, and
decreases to bonus expenses and other employee benefit expenses.
In July 1998 the Communications Workers of America (CWA) ratified a
new contract, which is effective August 9, 1998 and expires on March
31, 2001. The contract provides basic wage increases of 11.2%
(compounded), and also addresses benefits, pensions, work-rules and
other wage-related items. The CWA represents approximately 90% of
our employees.
We employed 11,939 employees as of June 30, 1998, compared with
12,274 as of June 30, 1997.
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Depreciation and
amortization
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 275.3 $ 260.4 $ 14.9 5.7
Depreciation and amortization expense increased for the six months
ended June 30, 1998 due primarily to higher property, plant and
equipment balances. Higher depreciation rates on certain asset
categories also contributed to the increases, as we used shorter
depreciable lives for newer technologies.
Page 8
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Other operating expenses
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
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Six Months Ended $ 530.3 $ 476.8 $ 53.5 11.2
Other operating expenses increased for the six months ended June 30,
1998 due primarily to increased contract and affiliated services
related to systems programming and network support. Higher access
charge expenses resulting from state commission rulings regarding
calls to the Internet also contributed to the increase. These
rulings (which we are contesting) require local exchange carriers to
pay reciprocal compensation for calls by their customers to the
Internet via Internet service providers (ISPs) who, in turn, are
customers of competing local exchange carriers. We have accrued all
disputed charges and set aside approximately $36.4 million in
segregated funds pending final resolution of these disputes.
A decrease in uncollectibles resulting from improved credit screening
and collection efforts, combined with lower material costs and right-
to-use fees for switching system software, partially offset these
increases.
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Taxes other than income taxes
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 79.2 $ 77.7 $ 1.5 1.9
Taxes other than income taxes consist of property taxes, gross
receipts taxes and other taxes not directly related to earnings.
Taxes other than income taxes increased in the period ended June 30,
1998 due primarily to increased property taxes, resulting from higher
assessed valuation and property tax rates. Lower sales and use tax
expenses in the first half of 1998 compared with the prior year
period partially offset the decrease.
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Other income and expenses
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Interest expense
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 41.1 $ 41.6 $ (0.5) (1.2)
Interest expense decreased for the six months ended June 30, 1998 due
primarily to a decrease in interest on short-term debt, reflecting
lower average balances in the Ameritech short-term funding pool.
Page 9
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Other income, net
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Change
June 30 Income Percent
------------
(dollars in millions) 1998 1997 (Expense) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 5.8 $ 2.9 $ 2.9 100.0
Other income, net includes equity in earnings of affiliates, interest
income and other nonoperating items. Other income increased for the
six months ended June 30, 1998 due primarily to increased income on
funds deposited in the Ameritech short-term funding pool, partially
offset by decreased equity earnings from Ameritech Services, Inc. (ASI).
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Income taxes
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 182.1 $ 179.0 $ 3.1 1.7
Income taxes increased for the six months ended June 30, 1998 due
primarily to the tax impacts of the centralization of administration
of benefits for employees. A decrease in pretax earnings, as
discussed above, partially offset the increase.
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Ratio of earnings to fixed charges
- ----------------------------------
The ratio of earnings to fixed charges for the six months ended June
30 was 11.91 in 1998 and 12.23 in 1997.
Page 10
Management's Discussion and Analysis
of Results of Operations (cont'd.)
OTHER MATTERS
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Competitive environment
- -----------------------
The Telecommunications Act of 1996 (the "1996 Act") establishes a
national policy that calls for competition and open markets, rather
than regulatory management, as the basic industry business
environment. This public policy change has further opened
opportunities for providers of all forms of communications services
and products, potentially enabling them to become either niche or
full-service providers of voice, video, data, local and long distance
services for their customers.
Technological developments, marketplace demand and legislative,
regulatory and judicial actions have expanded the types of services
and products available from an increasing number of companies,
creating growth opportunities within the global communications
industry. Our competitive strategy includes positioning ourselves to
take advantage of such growth opportunities, by continuing to branch
into new services that are logical extensions of our business.
With the passage of the 1996 Act and other regulatory initiatives,
our local service markets have been more extensively opened to new
competitors, many of which are believed to have initially targeted
high-volume business customers in densely populated areas.
Interconnection agreements with competitive service providers require
us to provide interconnection or access to unbundled network elements
at cost-based rates and telecommunications services at discounted,
wholesale rates. These agreements and applicable tariffs may result
in some downward pressure on local service revenues, as a portion of
our revenue shifts from local service at retail prices to network
access and wholesale services at lower rates. Further, FCC rules
require that interLATA long distance service be offered by a separate
Ameritech subsidiary. As a result, Ameritech's entry into this
market will not generate revenues for Michigan Bell to offset the
potential revenue decline brought by local service competition.
Although we cannot predict with certainty the impact that these and
other developments ultimately may have on our future business,
results of operations or financial condition, especially given the
type of legal and regulatory uncertainties described below, we
believe that over time market competition and regulatory change will
provide opportunities to accelerate growth.
Regulatory considerations
- -------------------------
The Telecommunications Act of 1996
In general, the 1996 Act includes provisions designed to open local
exchange markets to competition and afford the regional Bell
operating companies ("RBOCs") or their affiliates, the competitive
opportunity to provide interLATA (long distance) services. Under the
1996 Act, the RBOCs' ability to provide in-region long distance
services is dependent upon their satisfaction of, among other
conditions, a 14 point "competitive checklist" of specific
requirements, including compliance with interconnection, network
element access and resale service obligations and related pricing
standards and provision of number portability, and their
demonstration that entry into the in-region long distance market
would be in the public interest.
Page 11
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
The Telecommunications Act of 1996 (cont'd.)
A U.S. District Court in Texas ruled that certain line-of-business
restrictions in the 1996 Act, including the requirement in Section
271 that the RBOCs must comply with the competitive checklist before
being permitted to provide long distance services, constitute an
unconstitutional bill of attainder by virtue of their exclusive
applicability to the RBOCs. Appeals of this decision by various
parties are pending before the U.S. Court of Appeals for the Fifth
Circuit, with the lower court decision stayed pending resolution of
such appeals. These appeals were argued before the Fifth Circuit
Court of Appeals on July 9, 1998.
In two other cases, constitutional challenges to some of the
provisions of the 1996 Act governing the RBOCs have been presented to
the U.S. Court of Appeals for the District of Columbia Circuit (the
"D.C. Circuit Court"). In May 1998, the D.C. Circuit Court found
that Section 274 of the 1996 Act, covering electronic publishing
activities, did not constitute an unconstitutional bill of attainder.
The second action pending before the D.C. Circuit Court, in which
Ameritech has intervened, challenges the constitutionality of the
long distance provisions of Section 271 of the 1996 Act. This case
is scheduled for oral argument in September 1998.
Local Interconnection and Unbundled Access
In July 1997, and in an October 1997 rehearing, the U.S. Circuit
Court of Appeals for the Eighth Circuit (the "Eighth Circuit Court")
vacated several provisions of an August 1996 FCC order regarding the
interconnection provisions of the 1996 Act (the "FCC Order"), ruling
that such provisions represented improper preemptions of state
authority or were inconsistent with statutory requirements of the
1996 Act. The Eighth Circuit Court ruled, among other things, that:
the states have exclusive jurisdiction over the pricing for local
interconnection, unbundled network elements and local service resale
involving incumbent local exchange carriers ("ILECs") and competitive
local exchange carriers ("CLECs"); the FCC cannot lawfully allow
CLECs to "pick and choose" among isolated, individual provisions from
other interconnection agreements; and the FCC cannot require ILECs
either to recombine or "rebundle" unbundled network elements for
CLECs or to provide them with a preassembled network platform (or
existing combinations of two or more network elements) at network
element prices. These rulings of the Eighth Circuit Court were
appealed by various parties, including the FCC.
The Eighth Circuit Court upheld certain aspects of the FCC Order.
These included, among other things: the classification of
operational support services, operator services, directory assistance
and vertical services as unbundled network elements; the definition
of "technically feasible" interconnection to exclude economic
considerations; and the ability of CLECs to provide complete
telecommunications services by recombining network elements without
providing any of their own facilities. Ameritech has appealed these
matters, among others.
The U.S. Supreme Court has agreed to review the Eighth Circuit Court
decision. Oral arguments are scheduled for October 1998.
In August 1997, the FCC revised its local competition rules and
required ILECs to make available a new purported network element
known as "shared transport," which would include access to all of an
ILEC's transmission facilities. Ameritech and other ILECs appealed
this matter to the Eighth Circuit Court. On August 10, 1998, the
Eighth Circuit Court upheld the FCC's determination that shared
transport is a network element and that it should be made available
by ILECs to entrants on an unbundled basis. Ameritech intends to
seek judicial review of this decision.
Page 12
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Local Interconnection and Unbundled Access (cont'd.)
At present, local interconnection matters and unbundled network
element pricing continue to be resolved through interconnection
agreement negotiations or state commission arbitration provisions.
We are continuing to negotiate and enter into interconnection
agreements and pursue, through appropriate proceedings, timely
recovery of the costs of providing interconnection services so as to
promote a fair competitive environment, especially as local and long
distance markets are opened to competition at different times. The
outcome of these activities is subject to significant legal and
regulatory uncertainties, as outlined above.
Reciprocal Compensation
A number of CLECs are engaged in regulatory and judicial proceedings
with us and various other ILECs with respect to the payment of
reciprocal compensation to the CLECs for calls originating on the
ILECs' networks for dial-up connections to access the Internet via
ISPs served by the CLECs' networks. The CLECs have asserted that
such reciprocal compensation is provided for by interconnection
agreements between the CLECs and the ILECs. Together with other
ILECs, we have maintained that we are not required to make such
reciprocal compensation payments, because such traffic is interstate
access service, not local, and therefore is not covered by applicable
local interconnection agreements.
A U.S. District Court in Illinois has ruled that Ameritech's Illinois
landline communications subsidiary will be required to make
reciprocal compensation payments in these circumstances under its
applicable interconnection agreements, but has issued a brief stay of
its order to permit an appeal. Cases involving appeals by other
Ameritech subsidiaries of adverse regulatory determinations are
pending in U.S. District Courts in Michigan and Wisconsin. The issue
of whether reciprocal compensation is payable with respect to
Internet traffic also is pending before the FCC, in the context of a
request for expedited clarification of the issue filed in June 1997
by the Association for Local Telecommunications Service. We believe
that reciprocal compensation is not required in such circumstances,
and that such view ultimately will be upheld in pending or future
appellate judicial proceedings or through FCC determination.
However, there can be no assurance as to that outcome or that we will
not be required in the future to begin to make such reciprocal
compensation payments under existing interconnection agreements. We
have made periodic accruals of amounts which may become payable in
the event our view is not ultimately upheld.
Number Portability
On May 5, 1998, the FCC entered an order to allow us and other
telecommunications carriers to recover over a five-year period their
carrier-specific costs of implementing long-term number portability.
Long-term number portability allows customers to retain their local
telephone numbers in the event they change local exchange carriers.
We began implementing long-term number portability on March 31, 1998,
consistent with the FCC implementation schedule. The FCC order
permits such cost recovery to begin no earlier than February 1, 1999,
in the form of a surcharge from customers to whom number portability
is available.
Universal Service, Access Charge Reform and Price Cap Order
In May 1997, the FCC issued three closely-related orders that
established rules to implement the universal service provisions of
the 1996 Act (the "Universal Service Order") and to revise both
interstate access charge pricing (the "Access Reform Order") and the
price cap plan for certain ILECs (the "Price Cap Order").
Page 13
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Universal Service The FCC's Universal Service Order provides that
all interstate telecommunications providers will be required to
contribute to universal service funding, based on retail
telecommunications revenues. The Universal Service Order establishes
a multi-billion dollar interstate universal service fund to help link
eligible schools and libraries and low-income consumers and rural
health care providers to the global telecommunications network
(including the Internet). The FCC directed the phase-in of these
funds during 1998, with a reduced funding rate for the first six
months of 1998.
Access Reform In its Access Reform Order, the FCC restructured
interstate access pricing and adopted changes to its tariff structure
requiring LECs subject to price cap legislation to use rates that
reflect the type of costs incurred. A significant portion of the
services that had been charged using minutes-of-use pricing instead
becomes chargeable using a combination of minutes-of-use rates and
flat-rate charges. The net effect of these changes has been to
decrease minutes-of-use charges and increase per line charges. The
majority of these mandated pricing changes first became effective in
January 1998, with additional changes to be phased in at the
beginning of each subsequent year through 2001. The Access Reform
Order also continued in place existing rules by which ILECs may not
assess interstate access charges on ISPs and purchasers of unbundled
network elements. Together with other ILECs, Ameritech has appealed
certain aspects of the Access Reform Order to the Eighth Circuit
Court, where a decision is pending. In the meantime, we have
implemented state changes that mirror the federal access reform
structure. Various interexchange carriers opposing such changes have
filed complaints before the Illinois and Michigan state commissions.
Price Cap Order Our interstate services are subject to price cap
regulation, which limits prices rather than profits. The Price Cap
Order effectively reduced access charges by increasing the price cap
productivity offset factor to 6.5% from the previous 5.3% and by
applying this factor uniformly to all access providers. The order
also required LECs subject to price cap regulation to set their 1997
price cap index assuming that the 6.5% factor had been in effect
since July 1996. Certain parties have sought judicial review of the
Price Cap Order, and a decision by the D. C. Circuit Court with
respect to these matters is now pending.
We currently cannot predict the precise impact of these regulatory
changes on our business, especially as their nature and timing may
evolve in connection with judicial and FCC consideration of other
provisions of the 1996 Act.
Dial 1+
- --------
In 1996, the MPSC issued two Orders requiring Michigan Bell to
provide statewide dialing parity (the ability to choose an alternate
carrier for intraLATA toll calls by dialing 1 before the phone
number), or to discount intraLATA toll access rates by 55% where
dialing parity was not implemented. In January 1997, the Michigan
Court of Appeals issued a stay of the MPSC Orders pending a
determination of Ameritech Michigan's appeal on the merits.
In May 1998, the Court of Appeals issued a decision which reversed
the 1996 MPSC Orders. The Court concluded that, under the plain
language of the Michigan Telecommunications Act (MTA), Ameritech was
required to provide intraLATA toll dialing parity to no more than ten
percent of its customers on January 1, 1996, until Ameritech obtained
interLATA relief. The Court of Appeals also reversed the imposition
of a 55% discount on access charges.
Page 14
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Dial 1+ (cont'd.)
- --------
AT&T, MCI, the MPSC and the Michigan Attorney General have filed
applications with the Michigan Supreme Court for leave to appeal the
Court of Appeals' May 1998 decision. Ameritech Michigan filed a
response in opposition to the applications. The Supreme Court has
not yet ruled on the applications for leave to appeal, and there is
no specific timetable as to when the Supreme Court must rule.
To date we are continuing to provide Dial 1+ capability in Michigan
to over 70% of our access lines on a voluntary basis.
Year 2000 readiness
- -------------------
The Year 2000 issue exists because many computer systems and
applications, including those embedded in equipment and facilities,
use two digit rather than four digit date fields to designate an
applicable year. As a result, the systems and applications may not
properly recognize the year 2000 or process data which includes it,
potentially causing data miscalculations or inaccuracies or
operational malfunctions or failures.
Ameritech has established a centrally-managed, company-wide
initiative to identify, evaluate and address Year 2000 issues. Begun
in May 1996, Ameritech's Year 2000 effort covers network and
supporting infrastructure for provision of local switched and data
telecommunications services, as well as operational and financial
information technology ("IT") systems and applications, end-user
computing resources and building systems, such as security, elevator
and heating and cooling systems. In addition, the project includes a
review of the Year 2000 compliance efforts of key suppliers and other
principal business partners and, as appropriate, the development of
joint business support and continuity plans for Year 2000 issues.
While this initiative is broad in scope, it has been structured to
identify and prioritize our efforts for mission critical systems,
network elements and products and key business partners.
Work is progressing in the following phases: inventory, assessment,
remediation, testing, deployment and monitoring. Although the pace
of the work varies among Ameritech's business units and the phases
are often conducted in parallel, the inventory and assessment phases
have been substantially completed as of June 30, 1998 and the
remediation phase is in progress. As part of the testing phase,
Ameritech intends to conduct independent verification testing of
selected network component upgrades received from suppliers. In
addition, selected Year 2000 upgrades are slated to undergo testing
in a controlled environment that replicates the current network and
is equipped to simulate the turn of the century and leap year dates.
Under the current Year 2000 plan, Ameritech has established a target
date of January 1, 1999 for remediation of critical systems, network
elements and products, subject to additional Year 2000 testing and
responsive actions. Ameritech's ability to meet that target date is
dependent upon the timely provision of necessary upgrades and
modifications by suppliers and contractors. In some instances, third
party upgrades or modifications are not expected to be available
until late 1998; accordingly, Ameritech's testing and redeployment of
affected items may be delayed into 1999. In addition, Ameritech
cannot guarantee that third parties on whom we depend for essential
services (such as electric utilities, interexchange carriers, etc.)
will convert their critical systems and processes in a timely manner.
Failure or delay by any of these parties could significantly disrupt
our business. However, Ameritech has established a supplier
compliance program, and is working with its key suppliers to minimize
such risks.
Page 15
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 readiness (cont'd.)
- -----------------------------
Ameritech and all of its subsidiaries, including Michigan Bell,
expect to incur total expenses of approximately $210 million through
2001 in connection with anticipated Year 2000 efforts, in addition to
approximately $40 million in total expenses incurred through June 30,
1998 for matters historically identified as Year 2000-related. The
timing of these expenses may vary and is not necessarily indicative
of readiness efforts or progress to date. We anticipate that a
portion of our Year 2000 expenses will not be incremental costs, but
rather will represent the redeployment of existing IT resources.
Ameritech as a whole also expects to incur certain capital
improvement costs (totaling approximately $30 million) to support
this project. Such capital costs are being incurred sooner than
originally planned, but, for the most part, would have been required
in the normal course of business.
As part of its Year 2000 initiative, Michigan is evaluating
scenarios that may occur as a result of the century change and is in
the process of developing contingency and business continuity plans
tailored for Year 2000-related occurrences. Contingency planning to
maintain and restore service in the event of natural disasters,
power failures and software-related problems has been part of our
standard operation for many years, and we are working with Ameritech
to leverage this experience in the development of plans tailored to
meet Year 2000-related challenges. These plans are expected to
assess the potential for business disruption in various scenarios,
and to provide for key operational back-up, recovery and restoration
alternatives.
The above information is based on current best estimates, which were
derived using numerous assumptions of future events, including the
availability and future costs of certain technological and other
resources, third party modification actions and other factors.
Given the complexity of these issues and possible as yet
unidentified risks, actual results may vary materially from those
anticipated and discussed above. Specific factors that might cause
such differences include, among others, the availability and cost of
personnel trained in this area, the ability to locate and correct
all affected computer code, the timing and success of remedial
efforts of our third party suppliers and similar uncertainties.
New accounting pronouncements
- -----------------------------
FAS 131
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (FAS) 131, "Disclosures
about Segments of an Enterprise and Related Information." This
statement supersedes FAS 14, "Financial Reporting of Segments of a
Business Enterprise," by establishing new standards for the way that
a public business enterprise reports operating segment information
in its annual and interim financial statements. In general, FAS 131
requires reporting of financial information as it is used by senior
company management for evaluating performance and deciding how to
allocate resources. The statement is effective in 1998, but need
not be applied to interim financial statements this year.
Comparative information for earlier years must be restated. We will
adopt FAS 131 beginning with our 1998 Annual Report on Form 10-K.
Page 16
Management's Discussion and Analysis
of Results of Operations (cont'd.)
New accounting pronouncements (cont'd.)
- ---------------------------------------
AICPA SOP 98-1
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use."
This SOP provides authoritative guidance for the capitalization of
certain computer software costs developed or obtained for our
internal applications, such as:
- - external direct costs of materials and services, such as
programming costs,
- - payroll costs for employees devoting time to the software project,
and
- - interest costs to be capitalized.
Costs incurred during the preliminary project stage, as well as
training and data conversion costs, are to be expensed as incurred.
The SOP is effective for fiscal years beginning after December 15,
1998, however earlier application is encouraged. We have not yet
quantified the impacts of adopting this SOP on our financial
statements and have not determined the timing of our adoption. We
historically have expensed most computer software costs as incurred.
FAS 133
In June 1998 the FASB issued FAS 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement provides
standardized accounting and disclosure guidance for derivative
instruments and the derivative portion of certain similar contracts.
It amends FAS 52, "Foreign Currency Translation" and FAS 107,
"Disclosures about Fair Values of Financial Instruments," and it
supersedes a number of financial accounting standards previously
issued by the FASB and several interpretations from the Emerging
Issues Task Force.
The statement requires entities that use derivative instruments to
measure these instruments at fair value and record them as assets or
liabilities on the balance sheet. It also requires entities to
reflect the gains or losses associated with changes in the fair value
of these derivatives, either in earnings or as a separate component
of comprehensive income, depending on the nature of the underlying
contract or transaction.
FAS 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999, and is to be adopted as of the
beginning of the fiscal year. At the time of adoption, all
derivative instruments are to be measured at fair value and recorded
on the balance sheet. Any differences between fair value and
carrying amount at that time will be recorded as a cumulative effect
of a change in accounting principle, in either net income or other
comprehensive income, as appropriate. Adoption of this statement may
or may not have a material impact on our results of operations or
financial position in a given year, depending upon the nature and
magnitude of derivative activity that we engage in and the changes in
market conditions with respect to interest rates or other underlying
values. We have not yet quantified the impacts of the initial
adoption of FAS 133 on our results of operations or financial
condition, nor have we determined when we will implement the new
standard.
Page 17
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Private Securities Litigation Reform Act safe harbor statement
- --------------------------------------------------------------
Some of the information presented in, or in connection with, this
report may constitute "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995 that involve
potential risks and uncertainties. Our future results could differ
materially from those discussed here. Some of the factors that could
cause or contribute to such differences include:
- - changes in economic and market conditions that impact the demand
for our products and services;
- - greater than anticipated competition from new entrants into the
local exchange, intraLATA toll or data markets;
- - regulatory developments that impact the telecommunications
industry, as well as pending regulatory issues under state
jurisdiction;
- - potential additional costs to comply with the regulatory
requirements of entry into the interLATA long distance market;
- - the impact of new technologies and the potential effect of delays
in development or deployment of such technologies; and,
- - the potential impact of issues related to year 2000 software
compliance.
You should not place undue reliance on these forward-looking
statements, which are applicable only as of August 13, 1998. We have
no obligation to revise or update these forward-looking statements to
reflect events or circumstances that arise after August 13, 1998 or
to reflect the occurrence of unanticipated events.
Page 18
Item 3 - Quantitative and Qualitative
Disclosures about Market Risk
-----------------------------
We have not included quantitative and qualitative disclosures about
market risk as of June 30, 1998 because Michigan Bell's value at risk
has not changed significantly since December 31, 1997. Quantitative
and qualitative disclosures about market risk were included in our
1997 Annual Report on Form 10-K.
Page 19
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
--------
12 Computation of Ratio of Earnings to Fixed Charges for
the six months ended June 30, 1998 and June 30, 1997.
27 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
We did not file a Form 8-K during the quarter ended June
30, 1998.
Page 20
SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, an
authorized company official has signed this report on our behalf.
MICHIGAN BELL TELEPHONE COMPANY
-------------------------------
(Registrant)
Date: August 13, 1998 /s/ Ronald G. Pippin
----------------------
Ronald G. Pippin
Vice President and Comptroller
(Duly Authorized Signatory and
Principal Accounting Officer)
Page 21
GLOSSARY
Access charges -
- ---------------
fees that local phone companies charge to long distance carriers for
the handling of long distance calls on our local network.
Access line -
- ------------
a telephone line for voice, data or video reaching from a local phone
company to a home or business.
Call management services -
- -------------------------
services that add value and convenience for phone customers, such as
call waiting, call forwarding and Caller ID. These services are sold
to customers individually or in "packages".
Customer premises equipment (CPE) -
- ----------------------------------
communications equipment owned by customers, including telephones,
faxes and switches.
Dial 1+ -
- ---------
a feature that allows local phone customers to designate a carrier
other than the local service provider for toll calls within their
calling area by simply dialing 1 plus the telephone number.
Digital -
- --------
an alternative to traditional analog communications, digital systems
transport information in computer code for improved clarity and
quality.
Federal Communications Commission (FCC) -
- ----------------------------------------
the federal agency responsible for regulating the interstate aspects
of telecommunications activities.
Financial Accounting Standards Board (FASB) -
- --------------------------------------------
the independent body responsible for setting accounting and financial
reporting standards to be followed by U.S. business enterprises.
Gross receipts taxes -
- ---------------------
state and local taxes based upon the gross operating revenues earned
in a particular jurisdiction. These taxes may be imposed on general
businesses or public utilities in lieu of other taxes.
Interconnection -
- ----------------
allowing a competitive local service provider to use the local phone
company's network, or elements of the network, to provide local phone
service to its customers.
Interexchange carriers (IXCs) -
- ------------------------------
those companies primarily involved in providing long distance voice
and data transmission services, such as AT&T, MCI and Sprint.
Internet -
- ---------
the global web of networks that connects computers around the world,
providing rapid access to information from multiple sources.
Internet service providers (ISPs) -
- ----------------------------------
those companies providing access to the Internet and other computer-
based information networks.
Intrastate revenues -
- --------------------
that portion of revenues regulated by state rather than federal
authorities.
Local access and transport area (LATA) -
- ---------------------------------------
the boundary within which a local telephone company may provide phone
service. It is usually centered around a city or other identifiable
community of interest.
Local exchange carriers (LECs) -
- -------------------------------
those companies primarily involved in providing local phone service
and access to the local phone network, including Ameritech's landline
communications subsidiaries in Illinois, Indiana, Michigan, Ohio and
Wisconsin.
Page 22
GLOSSARY (cont'd.)
Operations support systems (OSS) -
- ---------------------------------
the databases and information used to support the provision of
telephone service to end users.
Price caps -
- -----------
a form of regulation that sets maximum limits on the prices that LECs
can charge for access services instead of limits on rate of return or
profits.
Productivity factor -
- --------------------
a portion of the interstate price cap formula that requires LECs to
reduce the price cap based on an assumed increase in productivity.
Securities and Exchange Commission (SEC) -
- -----------------------------------------
the federal agency that regulates the issuance and trading of public
debt and equity securities in the United States and monitors
compliance with these regulations.
Switched Minutes of Use -
- -----------------------
the measure of time used to bill IXC's for access to our public
switched network.
Unbundled network element -
- -------------------------
any feature, function or capability used in the provision of
telecommunications service that is made available by local exchange
carriers to other telecommunications providers separate from other
network elements and for a separate fee.
Universal service -
- ------------------
a concept designed to ensure access to the telecommunications network
in rural and low-income areas at affordable prices. Funding
typically comes from urban telecommunication operators.
Page 23