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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 September 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 1-6781
The Ohio Bell Telephone Company
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An Ohio Corporation
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45 Erieview Plaza
Cleveland, Ohio 44114
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I.R.S. Employer Identification
Number 34-0436390
Telephone number (800) 257-0902
OHIO 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 October 31, 1998, one common share was outstanding.
TABLE OF CONTENTS
PART I
ITEM Page
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1. Financial Statements
Condensed Statements of Income and Accumulated Deficit
for the three months and nine months ended
September 30, 1998 and 1997 1
Condensed Balance Sheets as of
September 30, 1998 and December 31, 1997 2-3
Condensed Statements of Cash Flows for
the nine months ended September 30, 1998 and 1997 4
Notes to Condensed Financial Statements 5
2. Management's Discussion and Analysis
of Results of Operations 6-17
PART II
6. Exhibits and Reports on Form 8-K 19
Glossary 21-22
Page i
Item 1 - Financial Statements
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CONDENSED STATEMENTS OF INCOME AND ACCUMULATED DEFICIT
(Dollars in Millions)
(Unaudited)
Three Months Ended Nine Months Ended
September 30 September 30
---------------- ----------------
1998 1997 1998 1997
---- ---- ---- ----
Revenues
Local service................. $ 353.3 $ 346.8 $ 1,053.6 $ 1,021.8
Interstate network access..... 129.7 130.9 393.6 390.5
Intrastate network access..... 25.7 30.4 80.6 94.4
Long distance service......... 33.9 33.6 98.2 106.6
Other......................... 52.0 47.3 152.7 134.2
--------- --------- --------- ---------
594.6 589.0 1,778.7 1,747.5
--------- --------- --------- ---------
Operating expenses
Employee-related expenses..... 117.5 117.0 339.8 333.2
Depreciation and amortization. 106.5 103.3 314.1 308.0
Other operating expenses...... 210.7 203.3 599.8 579.5
Taxes other than income taxes. 34.0 48.3 131.1 142.2
--------- --------- --------- ---------
468.7 471.9 1,384.8 1,362.9
--------- --------- --------- ---------
Operating income................ 125.9 117.1 393.9 384.6
Interest expense................ 16.6 16.4 48.0 46.3
Other income, net............... 1.1 1.6 6.2 4.9
--------- --------- --------- ---------
Income before income taxes...... 110.4 102.3 352.1 343.2
Income taxes.................... 41.8 38.8 133.2 120.6
--------- --------- --------- ---------
Net income...................... 68.6 63.5 218.9 222.6
Accumulated deficit,
beginning of period........... (73.6) (84.6) (85.2) (98.1)
Less, dividends declared.... 50.8 68.3 189.5 213.9
--------- --------- --------- ---------
Accumulated deficit,
end of period................. $ (55.8) $ (89.4) $ (55.8) $ (89.4)
========= ========= ========= =========
See Notes to Condensed Financial Statements.
Page 1
CONDENSED BALANCE SHEETS
(Dollars in Millions)
Sept. 30, 1998 Dec. 31, 1997
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(Unaudited) (Derived from
Audited
Financial
Statements)
ASSETS
Current assets
Cash and temporary cash investments......... $ 11.6 $ 1.4
Receivables, net
Customers................................. 456.8 465.9
Ameritech and affiliates.................. 1.2 2.0
Other..................................... 19.1 18.8
Material and supplies....................... 14.6 4.0
Prepaid and other........................... 24.9 18.0
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528.2 510.1
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Property, plant and equipment................ 6,541.8 6,289.2
Less, accumulated depreciation............... 4,175.9 3,939.8
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2,365.9 2,349.4
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Investments, primarily in affiliates......... 74.3 87.2
Other assets and deferred charges............ 257.9 226.2
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Total assets................................. $ 3,226.3 $ 3,172.9
========= =========
See Notes to Condensed Financial Statements.
Page 2
CONDENSED BALANCE SHEETS (continued)
(Dollars in Millions)
Sept. 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................................. $ 194.0 $ 188.3
Other..................................... 0.1 0.1
Accounts payable
Ameritech Services, Inc. (ASI)............ 51.9 38.4
Ameritech and affiliates.................. 43.9 33.2
Other..................................... 136.4 112.1
Other current liabilities.................. 210.3 269.6
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636.6 641.7
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Long-term debt.............................. 835.2 834.9
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Deferred credits and other long-term liabilities
Accumulated deferred income taxes.......... 125.4 116.9
Unamortized investment tax credits......... 26.5 29.8
Postretirement benefits
other than pensions...................... 523.2 529.2
Long-term payable to ASI................... 13.9 15.1
Other...................................... 51.9 56.4
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740.9 747.4
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Shareowner's equity
Common shares - (one share issued
and outstanding without par value)....... 1,069.4 1,034.1
Accumulated deficit........................ (55.8) (85.2)
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1,013.6 948.9
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Total liabilities and shareowner's equity... $ 3,226.3 $ 3,172.9
========= =========
See Notes to Condensed Financial Statements.
Page 3
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Nine Months Ended
September 30
-------------
1998 1997
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CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................... $ 218.9 $ 222.6
Adjustments to net income
Depreciation and amortization............... 314.1 308.0
Deferred income taxes, net.................. (24.2) 3.6
Investment tax credits, net................. (3.3) (4.1)
Capitalized interest........................ (1.5) (2.6)
Change in accounts receivable, net.......... 9.6 (1.2)
Change in material and supplies............. (16.3) (7.6)
Change in certain other current assets...... (6.9) (9.5)
Change in accounts payable.................. 48.5 (59.0)
Change in certain other current
liabilities................................ (26.6) (48.2)
Change in certain other noncurrent
assets and liabilities..................... (9.9) (11.0)
Gain on the sale of
Champaign Telephone Company................ (3.5) --
Other operating activities, net............. 4.4 2.4
-------- --------
Net cash from operating activities............ 503.3 393.4
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.......................... (328.3) (310.2)
Additional investments........................ -- (21.6)
Proceeds from the sale of
Champaign Telephone Company.................. 14.5 8.3
Proceeds from disposals of
property, plant and equipment................ 4.7 0.6
-------- --------
Net cash from investing activities............ (309.1) (322.9)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Intercompany financing, net................... 5.6 143.9
Retirements of long-term debt................. (0.1) (0.6)
Dividend payments............................. (189.5) (213.9)
Other financing activities, net............... -- 0.2
-------- --------
Net cash from financing activities............ (184.0) (70.4)
-------- --------
Net change in cash and
temporary cash investments................... 10.2 0.1
Cash and temporary cash investments,
beginning of period.......................... 1.4 0.1
-------- --------
Cash and temporary cash investments,
end of period................................ $ 11.6 $ 0.2
======== ========
See Notes to Condensed Financial Statements.
Page 4
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in Millions)
SEPTEMBER 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 reports 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 21 and 22.
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. Ameritech shareowners will vote on the
merger proposal at a special meeting of shareowners to be held on
December 11, 1998. SBC has called a special meeting of its
shareowners to consider various matters relating to this transaction
on December 10, 1998.
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 nine months of 1998 as compared with the first nine months of
1997.
RESULTS OF OPERATIONS
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Revenues
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Our revenues in the first nine months of 1998 were $1,778.7 million
and were $1,747.5 million for the same period in 1997, an increase of
$31.2 million. 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 were the primary reasons
for the increase. Net rate reductions and decreased long distance
revenues partially offset these increases, as discussed below.
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Local service
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $1,053.6 $1,021.8 $ 31.8 3.1
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 nine months ended
September 30, 1998 due largely to increased sales of call management
services, resulting from strong growth in both the number of features
in service and services provided on a pay-per-use basis. Access line
growth of 2.3% over the prior year period, as well as rate increases,
also contributed to the increase.
There were 4,069,000 access lines in service as of September 30, 1998
compared with 3,978,000 as of September 30, 1997 (restated to
standardize counting of voice-grade equivalent lines).
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Network access
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Interstate
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Nine Months Ended $ 393.6 $ 390.5 $ 3.1 0.8
Intrastate
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Nine Months Ended $ 80.6 $ 94.4 $ (13.8) (14.6)
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 nine months
ended September 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
certain 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 $15.3
million in the first nine months of 1998 compared with the prior
year. Interstate minutes of use for the nine months ended September
30, 1998 increased by 5.6% over the same period last year.
Intrastate network access revenues decreased for the nine months
ended September 30, 1998 due primarily to rate reductions related to
access charge reform implemented by the FCC in July 1997, and a
similar filing effective July 1, 1998, as well as a change in
reporting classification of certain pay phone revenues received from
network access to other revenues. This change in classification
decreased intrastate network access revenues by approximately $4.5
million in the first nine months of 1998 compared with the prior
year. Volume increases resulting from higher network usage partially
offset these decreases. Intrastate minutes of use for the nine
months ended September 30, 1998 increased 5.9% over the same period
last year.
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Long distance service
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 98.2 $ 106.6 $ (8.4) (7.9)
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 in the first nine months of 1998 due primarily to
a decrease in network usage, partially offset by a slight increase in
rates. In addition, other carriers are moving to retain revenue from
their customers' use of intraLATA toll calling services, where
previously they had allowed us to provide these services in exchange
for access charge payments to them. Although we no longer earn these
revenues, we also no longer incur the related access charge expenses.
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Other
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September 30 Increase Percent
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(dollars in millions) 1998 1997 (Decrease) Change
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Nine Months Ended $ 152.7 $ 134.2 $ 18.5 13.8
Other revenues include revenue derived from directory advertising,
billing and collection services, inside wire installation and
maintenance services and other miscellaneous services. Other
revenues increased for the nine months ended September 30, 1998 due
primarily to a change in reporting classification of certain pay
phone revenues from network access to other revenues, as previously
discussed. Increased revenues from nonregulated services, such as
equipment sales and voice messaging, combined with increases in
revenues from billing and collection services, also contributed to
the increase.
Page 7
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Operating expenses
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Total operating expenses for the nine months ended September 30, 1998
increased by $21.9 million or 1.6 percent to $1,384.8 million.
Higher employee-related expense and other operating expenses resulted
in most of this increase, as discussed below.
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Employee-related expenses
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 339.8 $ 333.2 $ 6.6 2.0
Employee-related expenses increased for the nine months ended
September 30, 1998 due primarily to increased wage rates, combined
with higher employee benefit expenses. Decreases in bonus levels,
overtime expenses and average force levels partially offset these
increases.
In July 1998 the Communications Workers of America (CWA) ratified a
new contract, which was effective August 9, 1998 and expires on March
31, 2001. The contract provides basic wage increases of 11.2%
(compounded) over the contract period and a one-time $500 signing
bonus per employee, and also addresses benefits, pensions, work-rules
and other wage-related items. The CWA represents approximately 90%
of our employees.
We employed 8,081 employees as of September 30, 1998, compared with
8,527 as of September 30, 1997.
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Depreciation and
amortization
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 314.1 $ 308.0 $ 6.1 2.0
Depreciation and amortization expense increased for the nine months
ended September 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.
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Other operating expenses
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 599.8 $ 579.5 $ 20.3 3.5
Other operating expenses increased for the nine months ended
September 30, 1998 due primarily to higher access charge expenses
resulting from state commission rulings regarding calls to the
Internet. 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 $11.3
million in segregated funds pending final resolution of
Page 8
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Other operating expenses (cont'd.)
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these disputes. Increased contract and affiliated services related
to systems programming and network support also contributed to the
increase. A decrease in uncollectibles resulting from improved
credit screening and collection efforts, combined with lower material
costs, partially offset these increases.
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Taxes other than income taxes
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 131.1 $ 142.2 $ (11.1) (7.8)
Taxes other than income taxes consist of property taxes, gross
receipts taxes and other taxes not related to earnings. Taxes other
than income taxes decreased for the nine months ended September 30,
1998 due primarily to lower property tax assessments and rates,
favorable results from property tax reforms and use tax refunds.
Revenue increases and the elimination of certain credits, resulting
in higher accruals for gross receipts taxes, partially offset the
decrease.
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Other income and expenses
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Interest expense
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 48.0 $ 46.3 $ 1.7 3.7
Interest expense increased for the nine months ended September 30,
1998 due primarily to an increase in interest on borrowings from the
Ameritech short-term funding pool, reflecting higher average pool
balances. Higher miscellaneous interest expense also contributed to
the increase.
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Other income, net
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Change
September 30 Income Percent
------------
(dollars in millions) 1998 1997 (Expense) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 6.2 $ 4.9 $ 1.3 26.5
Other income, net includes equity in earnings of affiliates, interest
income and other nonoperating items. Other income increased for the
nine months ended September 30, 1998 due primarily to the gain
realized from the sale of our interest in the Champaign Telephone
Company in January 1998, combined with higher interest income.
Decreased equity earnings from Ameritech Services, Inc. (ASI)
partially offset the increase.
Page 9
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Income taxes
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September 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Nine Months Ended $ 133.2 $ 120.6 $ 12.6 10.4
Income taxes increased for the nine months ended September 30, 1998
due primarily to the tax impacts of the centralization of
administration of benefits for employees. The increase in pretax
earnings discussed above also contributed to the increase.
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Debt Ratings
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Moody's Investors Service advised Ohio Bell in October 1998 that it
lowered the debt rating of our debt from Aaa to Aa1. The change
resulted not from any action taken by Ohio Bell or Ameritech, but
from Moody's efforts to bring the ratings of wholly owned
subsidiaries more in line with parent holding company ratings in the
telecommunications industry. Management believes the impact to Ohio
Bell will not be significant.
Page 10
Management's Discussion and Analysis
of Results of Operations (cont'd.)
OTHER MATTERS
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Regulatory considerations
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The Telecommunications Act of 1996
In general, the Telecommunications Act of 1996 (the "1996 Act")
includes provisions designed to open local exchange markets to
competition and afford the Bell operating companies ("BOCs") or their
affiliates the competitive opportunity to provide interLATA (long
distance) services. Under the 1996 Act, the BOCs' 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 for opening the local market to competition.
In late 1997, 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 BOCs 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 BOCs. On September 4, 1998, the U.S.
Court of Appeals for the Fifth Circuit reversed that decision, and
petitions for certiorari are pending before the U.S. Supreme Court.
In two other cases, similar constitutional challenges 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. The
D.C. Circuit Court heard oral arguments on this case 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 "1996 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 1996 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.
Page 11
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Local interconnection and unbundled access (cont'd.)
The U.S. Supreme Court has agreed to review the Eighth Circuit Court
decision and heard oral arguments on the case in 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. In September 1998, we
filed a petition for reconsideration of this decision by the Eighth
Circuit Court.
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 certain Ameritech subsidiaries 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 is required to make reciprocal
compensation payments in these circumstances under its applicable
interconnection agreements. This order is on appeal to the U.S.
Court of Appeals for the Seventh Circuit. Cases involving appeals by
other Ameritech subsidiaries of adverse regulatory determinations are
pending in U.S. District Courts in Michigan and Wisconsin. Pending
the outcome of such appeals, Ameritech's Illinois, Michigan and
Wisconsin landline communications subsidiaries are currently making
reciprocal compensation payments, under protest, to CLECs pursuant to
existing interconnection agreements. The Public Utilities Commission
of Ohio recently ruled that we are required to make reciprocal
compensation payments, but stayed its order pending rehearing.
On October 30, 1998, the FCC issued a Memorandum Opinion and Order in
which it found that a service offering by another ILEC, permitting
ISPs to furnish their customers with high speed access to the
Internet through a dedicated connection, is an interstate service
that is properly tariffed at the federal level. In so ruling, the
FCC considered the totality of the communication as an end-to-end
transmission between an end user and the Internet website accessed by
the end user,
Page 12
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Reciprocal compensation (cont'd.)
and rejected the argument that such a communication should be
separated into two components (consisting of an ILEC-provided
intrastate telecommunications service that terminated at the ISP's
local server, and an interstate information service provided by the
ISP). The FCC expressly limited its decision only to the high speed,
dedicated access connection between an end user subscriber and an ISP
as described in the proposed tariff, and made no determination
whether ILECs generally should be required to pay reciprocal
compensation when they exchange Internet traffic with CLECs. The FCC
has indicated its intention to provide separate guidance in the near
future on the jurisdictional nature of dial-up access via a LEC's
local switch.
We believe that this recent FCC Order is consistent with our view
that Internet traffic is appropriately classified as interstate and
that reciprocal compensation is not required for dial-up access in
the circumstances described above. We also believe that our view
should ultimately 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 to begin
to make such reciprocal compensation payments under existing
interconnection agreements. We are making periodic accruals of
amounts which may become payable in the event our view is not
ultimately upheld.
Universal service, access charge reform and price caps
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").
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 nine
months of 1998.
Access charge reform - In its May 1997 order on interstate access
charge pricing (the "Access Reform Order"), the FCC restructured
interstate access pricing and adopted changes to its tariff structure
requiring ILECs subject to use rates that reflect the type of costs
incurred. 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. On August 19, 1998,
the Eighth Circuit Court affirmed the FCC's approach in the Access
Reform Order. We are complying with the Access Reform Order and do
not intend to seek any review of the Eight Circuit Court decision.
Price caps - 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
Page 13
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Universal service, access charge reform and price caps (cont'd.)
Price caps (cont'd.) - 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.
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 are completing implementation of long-term number portability by
the end of 1998, in compliance with an FCC-mandated schedule, and
plan to file our number portability surcharge rates and cost support
with the FCC in time to begin to assess the surcharge in February
1999.
Competitive environment
- -----------------------
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 Ohio Bell to offset the
potential revenue decline brought by local service competition. 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.
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
Page 14
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 readiness (cont'd.)
- -----------------------------
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, as of September 30, 1998, the
inventory and assessment phases have been substantially completed and
the remediation and testing phases are in progress.
We expect that most of our mission critical systems, network elements
and products will be remediated and redeployed in January 1999,
subject to additional Year 2000 testing and responsive actions.
Ameritech's ability to meet that target is dependent upon a variety
of factors, including 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 or early 1999; accordingly, Ameritech's testing and
redeployment of affected items may be delayed until later in 1999.
In addition, Ameritech has no method of ensuring 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.
Ameritech and all of its subsidiaries, including Ohio Bell, expect to
incur total expenses of approximately $195 million through 2001 in
connection with anticipated Year 2000 efforts, in addition to
approximately $57 million in total expenses incurred through
September 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, Ameritech 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 to leverage this
experience in the development of plans tailored to meet Year 2000-
related challenges. This work is being performed through centrally-
coordinated, company-wide teams organized by critical business
functions (including ordering,
Page 15
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 readiness (cont'd.)
- -----------------------------
provisioning, maintenance, billing and power). Our contingency and
business continuity 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 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.
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. Ameritech plans to adopt SOP 98-1 in the first quarter of 1999,
and estimates that the impact of adoption will be to decrease
software-related expenses for Ameritech and all of its subsidiaries,
including Ohio Bell, by $200 million to $250 million in the year of
adoption. We have historically expensed most computer software costs
as incurred.
Page 16
Management's Discussion and Analysis
of Results of Operations (cont'd.)
New accounting pronouncements (cont'd.)
- ---------------------------------------
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.
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;
- - the effects of vigorous competition in the local exchange,
intraLATA toll or data markets;
- - federal regulatory developments that impact the telecommunications
industry and pending regulatory issues under state jurisdiction;
- - potential additional costs to comply with the regulatory
requirements of entry into the interLATA long distance market;
- - the timing of, and potential regulatory or other considerations
relating to, the consummation of Ameritech's proposed merger with
SBC;
Page 17
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Private Securities Litigation Reform Act safe harbor statement
(cont'd.)
- ---------------------------------------------------------------------
- ---
- - 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.
The words "expect," "believe," "anticipate," "estimate," "project,"
and "intend" and similar expressions are intended to identify forward-
looking statements. These forward-looking statements are found at
various places throughout the Management's Discussion and Analysis
and elsewhere in this report.
You should not place undue reliance on these forward-looking
statements, which are applicable only as of November 12, 1998. We
have no obligation to revise or update these forward-looking
statements to reflect events or circumstances that arise after
November 12, 1998 or to reflect the occurrence of unanticipated
events.
Page 18
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
--------
27 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
We did not file a Form 8-K during the quarter ended
September 30, 1998.
Page 19
SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, an
authorized company official has signed this report on our behalf.
THE OHIO BELL TELEPHONE COMPANY
------------------------------
(Registrant)
Date: November 12, 1998 /s/ Ronald G. Pippin
----------------------
Ronald G. Pippin
Vice President and Comptroller
(Duly Authorized Signatory and
Principal Accounting Officer)
Page 20
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.
Advanced data services -
- ----------------------
services that use advanced technology to allow faster network access
to the Internet and other multimedia and data services.
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.
Landline communications subsidiaries -
- -----------------------------------
the subsidiaries of Ameritech engaged primarily in providing local
phone service and network access in the states of Illinois, Indiana,
Michigan, Ohio and Wisconsin.
Page 21
GLOSSARY (cont'd.)
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.
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.
Voice-grade equivalent line -
- ---------------------------
a channel or other portion of a high capacity access line that can be
used to transmit voice or data traffic. For example, one DS1 circuit
is capable of handling 24 voice-grade and/or data lines.
Page 22