- ---------------------------------------------------------------------
U.S. Securities and Exchange Commission
Washington, D.C. 20549
- -------------------------------------------
Form 10-K
- -------------------------------------------
Annual Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1998
- -------------------------------------------
Commission File Number 1-6781
The Ohio Bell Telephone Company
-----------------------------
An Ohio Corporation
-----------------------------
45 Erieview Plaza
Cleveland, Ohio 44114
-----------------------------
I.R.S. Employer Identification
Number 34-0436390
Telephone number (800) 257-0902
Securities registered under Section 12(b) of the Act:
None
WE ARE A WHOLLY OWNED SUBSIDIARY OF AMERITECH CORPORATION AND MEET THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(A) AND (B) OF FORM 10-K.
THEREFORE, WE ARE FILING THIS FORM WITH THE REDUCED DISCLOSURE FORMAT
PERMITTED BY GENERAL INSTRUCTION I(2).
We have no securities registered under Section 12(g) of the Act. We are
and during the past 90 days have been subject to certain filing
requirements under Sections 13 and 15 (d) of the Securities Exchange Act of
1934 and have filed all the required reports during the preceding 12
months.
At February 28, 1999, one common share was outstanding.
TABLE OF CONTENTS
PART I
Item Page
---- ----
1. Business
(Abbreviated pursuant to
General Instruction I(2))....................... 1
2. Properties
(Abbreviated pursuant to
General Instruction I(2))....................... 8
3. Legal Proceedings................................ 8
4. Submission of Matters to a Vote of Security
Holders.......................................... 8
PART II
5. Market for Registrant's Common Equity and
Related Stockholder Matters..................... 8
6. Selected Financial Data.......................... 9
7. Management's Discussion and Analysis of Results of
Operations (Abbreviated pursuant to
General Instruction I(2))....................... 10
7A. Quantitative and Qualitative Disclosures about
Market Risk .................................. 16
8. Financial Statements and Supplementary Data...... 17
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.......... 29
PART III
10. Directors and Executive Officers
of the Registrant................................ 30
11. Executive Compensation........................... 30
12. Security Ownership of Certain Beneficial Owners
and Management.................................. 30
13. Certain Relationships and Related Transactions... 30
PART IV
14. Exhibits, Financial Statement Schedules
and Reports on Form 8-K......................... 31
Glossary......................................... 33
Schedule II - Valuation and Qualifying Accounts.. F-1
i
When reading this annual report, you should be familiar with the
terminology unique to our business. We have defined a number of
terms in the Glossary beginning on page 33.
PART I
Item 1. Business.
The Company
The Ohio Bell Telephone Company, incorporated under the laws of
the State of Ohio, has its principal office at 45 Erieview Plaza,
Cleveland, Ohio 44114 (telephone number 1-800-257-0902). We are
one of the five wholly owned landline communications subsidiaries
of Ameritech Corporation, incorporated in 1983 under the laws of
the State of Delaware. Ameritech is the parent company of numerous
other communications businesses with principal executive offices at
30 South Wacker Drive, Chicago, Illinois 60606 (telephone number 1-
800-257-0902). We are a statutory close corporation managed by our
sole shareowner rather than a board of directors as permitted by
Ohio law.
Ameritech is a global diversified, full-service communications
company which provides local and long-distance telephone and
cellular service, paging, security, cable TV, Internet access and
directory publishing services. Ameritech's 1998 revenues were
$17.2 billion. Ameritech has organized its operations using
customer-focused business units, which aggregate into three
reportable segments: communications; information and entertainment;
and international. The operations of Ohio Bell are included in the
results of several business units, and accordingly, Ohio Bell is
not managed as a separate entity. All of the business units that
include the results of Ohio Bell are reflected in Ameritech's
communications segment. The products and services of the Ameritech
companies are marketed under the "Ameritech" brand identity, in all
50 states and 40 countries. Ohio Bell is regionally identified and
does business as "Ameritech Ohio," selling principally landline
local telephone service as described below.
Proposed Merger with SBC Communications Inc.
On May 11, 1998, Ameritech and SBC Communications Inc. (SBC)
jointly announced their signing of a definitive merger agreement
(Merger Agreement). The Merger Agreement provides that a wholly
owned subsidiary of SBC will be merged into Ameritech (the Merger)
and Ameritech will become a wholly owned subsidiary of SBC. The
Merger is intended to be accounted for as a pooling of interests
and to be a tax-free reorganization. In the Merger, each share of
Ameritech common stock (other than shares owned by Ameritech, SBC
or their respective subsidiaries) will be converted into and
exchanged for 1.316 shares of SBC common stock.
The Merger has been approved by the Board of Directors and the
shareowners of each company, but remains subject to various
regulatory approvals, principally by the Federal Communications
Commission (FCC), the Illinois Commerce Commission (ICC) and the
Public Utility Commission of Ohio (PUCO).
On March 23, 1999, the Department of Justice entered into a
consent decree with Ameritech and SBC that would provide a basis
for Department of Justice clearance of both the SBC-Ameritech
merger and SBC's proposed acquisition of Comcast Cellular
Corporation. The consent decree requires the parties to divest
certain "overlapping" cellular properties in 17 markets in
Illinois, Indiana and Missouri, including, as previously undertaken
by Ameritech and SBC, those in Chicago and St. Louis. Under the
proposed consent decree, Ameritech is obligated to divest its
cellular telephone interests in St. Louis and other markets in
Missouri, as well as its interests in three other markets in
Illinois where there is an overlap with Comcast. In the remaining
markets in Illinois (including Chicago) and Indiana where SBC and
Ameritech have overlapping cellular properties, the proposed
consent decree allows Ameritech and SBC to choose which of their
two cellular properties to divest. If Ameritech and SBC consummate
their merger before they have completed these divestitures, the
remaining properties to be divested will be transferred to and
controlled by a trustee appointed by the Department of Justice.
The divestitures, whether made by SBC, Ameritech or the trustee,
must be completed within 180 days from the earlier of the time of
consummation of the merger or the time the parties receive the
final approvals needed for the merger from the FCC. After a
required 60-day comment period on the proposed consent decree
(which is expected to begin shortly), the Department of Justice is
expected to reply to any public comments and seek final approval
and entry of the decree by the U.S. District Court in Washington,
D.C.
PAGE 1
On March 29, 1999, the hearing examiners of the ICC issued their
proposed order approving the Merger subject to certain conditions.
The more significant conditions are to return to customers 100% of
the net Merger-related savings, which may be reduced to 50% if
certain performance requirements are met. Further, SBC must ensure
certain employment levels will not be reduced due to
the Merger, and that capital investments and charitable
contributions in Illinois are continued generally at historical
levels. The proposed order is subject to normal due process
proceedings before it goes to the commissioners of the ICC for a
vote. Under Illinois law, such vote must occur on or before June
24, 1999.
In February 1999, the PUCO staff, Ameritech, SBC, the Ohio
Consumers' Counsel and certain consumer groups and new competitors
of Ameritech in Ohio signed a proposed merger settlement agreement.
The proposed settlement, which requires formal PUCO approval, among
other things would guarantee Ameritech Ohio workforce levels for
two years, extend the Advantage Ohio price cap plan for basic
residential phone rates, provide for certain discounts for resold
local residential service and residential unbundled local loops to
foster facilities-based residential competition, set various
competitive and service quality benchmarks and establish monetary
penalties if those benchmarks are not met, and provide financing
for consumer education and community technology funds.
More detailed information relating to the terms and conditions
of the Merger is contained in the Joint Proxy Statement/Prospectus
of Ameritech and SBC dated October 15, 1998.
Ohio Bell's Full Service Communications Business
Ohio Bell is responsible within its service areas for providing
telephone and other communications services, subject to regulation
by the FCC and the state regulatory commission, the PUCO. We
furnish a wide variety of advanced communications services,
including local exchange and toll service and network access, and
communications products to business, residential and communications
company customers in an operating area comprised of five Local
Access and Transport Areas (LATAs) in Ohio. These LATAs are
generally centered on a city or other identifiable community of
interest, and each LATA marks the boundary within which we may
provide telephone service. We provide two basic types of
communications services:
- - We transport communications traffic between a customer's
equipment and the telephone exchange offices located within the
same LATA (intraLATA service). These services include local
exchange, private line and intraLATA toll services (including
800 and special services for data, radio and video transport).
- - In addition, we provide exchange access service, which links a
subscriber's telephone or other equipment to the transmission
facilities of long-distance carriers, which in turn provide
communications service between LATAs (interLATA, or long-
distance, service).
We serve about 60% of the population and 25% of the geographic
area of Ohio. The remainder of the state is served by
nonaffiliated telephone companies.
In addition, we provide public telephone and local and toll
operator services (including collect calls, third number billing,
person-to-person and calling card calls). A national directory
assistance service is offered by us in parts of Ohio and by other
Ameritech subsidiaries in the other four states in the Ameritech
region. We offer call management services (including voice mail,
Caller ID, call waiting and call forwarding), as well as digital
network services (such as online database access and fax messaging,
document sharing functions and video conferencing for desktop
computers). We provide billing and collection services for several
companies, including billing for long-distance services offered by
certain long-distance carriers. We currently offer a single
monthly statement for phone service and a variety of other
Ameritech services as well as around-the-clock customer service,
for all residential, small business and home office customers.
We market our local phone services on a wholesale basis to
certain other companies that resell our network services. Our
customers are other network and information providers, including
cellular and personal communications services and competing local
service companies, who buy our services to use in their product
offerings.
In 1998, we added 92,000 customer access lines, primarily as a
result of second line additions and increased business usage. We
now serve 4,094,000 lines in Ohio, a 2.3% increase over lines
served in 1997. Demand for speed and access drove record
PAGE 2
growth in our data services, reflecting, among other things, strong
increases in sales of high-speed lines and high-capacity circuits.
Demand for call management services also grew, as customers sought
greater convenience and control over their telephone
communications.
Under our agreement with Ameritech Publishing, Inc., an
Ameritech subsidiary doing business as Ameritech Advertising
Services, we furnish to Ameritech Publishing certain services and
data to be used by them in publishing and distributing classified
and alphabetical directories. In exchange, we receive compensation
for our services and data.
Ameritech Services, Inc. (ASI), a company we own jointly with
the other four Ameritech landline communications subsidiaries,
provides us with technical services, procurement, marketing, human
resources management and regulatory planning, as well as labor
contract bargaining oversight and coordination. ASI is a shared
resource, providing operational support for the five Ameritech
landline communications subsidiaries and integrated communications
and information systems for all Ameritech companies.
In 1998, about 91% of our total operating revenues were from
communications services and the remainder were principally from
billing and collection services, rents, directory advertising and
other miscellaneous nonregulated operations. About 69% of the
revenues from communications services were attributable to
intrastate operations.
Regulatory Environment - Federal
Among other things, the FCC develops and implements policies
concerning interstate communications by wire. In addition to
developing regulations to carry out the intent of the
Telecommunications Act of 1996 (the 1996 Act), the FCC prescribes
for certain communications companies a uniform system of accounts
and rules for apportioning costs between regulated and nonregulated
services. The FCC, in consultation with representatives of state
regulatory commissions, is also responsible for the principles and
standard procedures used to separate regulated property, plant and
equipment costs, revenues, expenses, taxes and reserves between
those applicable to interstate services under FCC jurisdiction and
those applicable to intrastate services under the jurisdiction of
the applicable state regulatory commission.
The Telecommunications Act of 1996
In general, the 1996 Act includes provisions designed to open
local exchange markets to competition and to afford the Bell
operating companies (RHCs) and their affiliates the competitive
opportunity to provide interLATA (long-distance) services. Under
the 1996 Act, the RHCs 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 RHCs must comply with the
competitive checklist before being permitted to provide long-
distance services to local phone customers, constituted an
unconstitutional bill of attainder by virtue of their exclusive
applicability to the RHCs. The U.S. Court of Appeals for the Fifth
Circuit reversed that decision in September 1998, and in January
1999 the U.S. Supreme Court declined to hear an appeal of the
appellate court decision.
In two other cases, similar constitutional challenges were
rejected by 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, which covers
electronic publishing activities, did not constitute an
unconstitutional bill of attainder. A petition for certiorari,
seeking review of that decision, is pending before the U.S. Supreme
Court. In December 1998, the D.C. Circuit Court ruled against
another bill of attainder constitutional challenge to the long-
distance provisions of Section 271 of the 1996 Act.
Local Interconnection and Unbundled Access
In January 1999, the U.S. Supreme Court issued its opinion on
various cross-appeals of the 1997 decision of the U.S. Circuit
Court of Appeals for the Eighth Circuit (the Eighth Circuit Court)
relating to the FCC's 1996 order on the local interconnection
provisions of the 1996 Act (the Interconnection Order).
PAGE 3
The Supreme Court reversed portions of the Eighth Circuit
Court's earlier decision that had vacated several provisions of the
Interconnection Order. The Court decided that the FCC has
rulemaking authority to implement the local competition provisions
of the 1996 Act, including pricing methodology. This overturned
the Eighth Circuit Court's ruling that the states were vested with
exclusive jurisdiction over the pricing for local interconnection,
unbundled network elements and local service resale provided by
incumbent local exchange carriers (ILECs) to competitive local
exchange carriers (CLECs). The Supreme Court also reinstated the
FCC's "pick and choose" rules allowing CLECs to select among
individual provisions from other existing interconnection
agreements.
The Supreme Court upheld the FCC's determination that the
definition of a network element could include items beyond physical
facilities and equipment, such as operational support systems,
operator services, directory assistance and vertical services such
as call forwarding and caller identification. It further ruled
that the FCC could bar ILECs from separating already combined
network elements. However, the Supreme Court overturned the FCC's
rule identifying and requiring ILECs to offer specific network
elements, finding that the FCC had not adequately considered, as
required by the 1996 Act, whether those specific unbundled network
elements were "necessary" or whether the failure to provide access
to them might "impair" the ability of CLECs to provide competitive
services. We believe that this ruling supports our view that the
objectives of the 1996 Act, including development and deployment of
advanced technologies desired by customers, will best be served by
encouraging infrastructure investments, rather than through
unlimited blanket access to all ILEC network elements.
Since the Eighth Circuit Court's 1997 opinion, local
interconnection matters and unbundled network element pricing have
been resolved primarily through negotiated interconnection
agreements or state commission arbitration proceedings. The
substantive validity of the FCC's pricing rules, including its
total element long-run incremental cost (TELRIC) pricing
methodology, was not before the Supreme Court, and will be
addressed by the Eighth Circuit Court on remand. Pending judicial
resolution of the appropriate pricing methodologies and a
determination by the FCC of which unbundled network elements are
must be made available, we expect to continue to negotiate and
enter into interconnection agreements and pursue, through
appropriate state or federal proceedings, timely recovery of our
costs.
In February 1999, Ameritech sought review by the U.S. Supreme
Court of the separate Eighth Circuit Court decision last year
regarding shared transport. In 1998, the Eighth Circuit Court
upheld the FCC's determination that "shared transport," which would
include access to all of an ILEC's transport facilities, is a
network element that should be made available to competitors on an
unbundled basis.
The outcome of future regulatory and judicial developments in
this area is subject to continuing uncertainty. We believe that
the pricing rules and methodologies generally adopted by our state
commission with respect to our existing interconnection agreements
should not differ materially from those that may be applied under
proposed FCC pricing methodologies. We further expect that future
judicial or regulatory decisions will define reasonable limiting
standards, consistent with the purposes of the 1996 Act, as to
which of our existing network elements must be made available to
competitors. We can give no assurance, however, that future
regulatory and judicial determinations may not have a material
adverse effect on our future revenues and operating margins.
Reciprocal Compensation
A number of CLECs are engaged in regulatory and judicial
proceedings with various ILECs, including Ohio Bell, 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 Internet service providers (ISPs) served by
the CLECs' networks. The CLECs have asserted that reciprocal
compensation for such calls is provided for by interconnection
agreements between the CLECs and the ILECs. Together with other
ILECs, Ameritech has maintained that we are not required to make
such reciprocal compensation payments pursuant to those agreements
because such traffic is interstate access service, not local.
On February 26, 1999, the FCC ruled that a substantial portion
of Internet traffic is interstate and therefore under federal law
it is not subject to reciprocal compensation obligations. As a
result, the FCC issued a notice of proposed rulemaking to develop a
federal inter-carrier compensation rule for Internet traffic.
During the interim, the FCC concluded that state commissions may
determine in arbitrations whether reciprocal compensation should be
paid for this traffic. In finding that dial-up calls to ISPs are
largely interstate, the FCC concluded that dial-up traffic to the
Internet does not terminate at the ISP's local server, but
continues to the ultimate Internet website, which is often in
another state. This echoed an earlier FCC opinion and order in
response to a federal tariff
PAGE 4
application for a high-speed dedicated Internet connection. The
FCC noted, however, that carriers remain bound by their existing
interconnection agreements, and thus may be subject to reciprocal
compensation obligations to the extent provided by such
interconnection agreements. A number of CLECs have filed petitions
seeking federal appellate court review of the FCC's ruling on the
interstate nature of dial-up calls to ISPs. Various ILECs have
challenged the FCC's order with respect to the ability of state
commissions to impose reciprocal compensation on Internet traffic.
Ameritech believes that this FCC ruling confirms its view that
Internet traffic is appropriately classified as interstate and that
reciprocal compensation is not payable in connection with dial-up
access to the Internet via ISPs. Ameritech therefore intends to
continue to pursue judicial appeals of the contrary state
commission determinations that preceded this FCC ruling. Cases
that involve appeals by Ameritech's landline communications
subsidiaries of adverse decisions are currently pending before the
U.S. Court of Appeals for the Seventh Circuit and U.S. District
Courts in Michigan and Wisconsin.
Ameritech believes that its view, that reciprocal compensation
is not payable in these circumstances, ultimately should be upheld.
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. Pending the
outcome of current judicial appeals, Ameritech's Illinois, Michigan
and Wisconsin landline communications subsidiaries are making
reciprocal compensation payments, under protest, pursuant to
existing interconnection agreements with CLECs providing services
to ISPs. In addition to such payments, we are making periodic
accruals of amounts which may become payable in Ohio 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 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
through 1999.
Access Charge Reform
In its Access Reform Order, the FCC restructured interstate
access pricing and adopted changes to its tariff structure that
require ILECs to use rates that reflect the type of costs incurred.
In addition to the changes introduced in connection with the
Access Reform Order, we have implemented state changes that mirror
the federal access reform structure. Various interexchange
carriers opposing such changes have filed complaints before the
Illinois, Michigan and Wisconsin state commissions seeking lower
access charges. The state commissions in Illinois (the Illinois
Commerce Commission) and Michigan (the Michigan Public Service
Commission or MPSC), in response to such a complaint, have ordered
Ameritech to split the intrastate primary interexchange carrier
charge (PICC) into two separate per-line components, with one-half
of the total charge payable by the intraLATA toll carrier and the
other half by the interLATA toll carrier. A similar split of the
intrastate PICC was ordered by the Indiana Utility Regulatory
Commission in its ongoing investigation of universal service and
access reform. Accordingly, the revenues these subsidiaries
receive from this charge will decrease to the extent that Ameritech
is the intraLATA toll carrier. In addition, the MPSC required that
these changes be made retroactive to January 1, 1998, when the
initial tariffs for this charge were filed. Ameritech has appealed
the MPSC's order.
Price Caps
Our interstate access 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 ILECs subject to price cap regulation to set
their 1997
PAGE 5
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 currently is 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
telecommunications carriers, such as Ohio Bell, 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 in compliance with an FCC-mandated
schedule. Our number portability surcharge became effective
February 1, 1999, subject to a designation order, which could
result in a reduced surcharge and a partial refund.
Pay Phone Per Call Compensation
In February 1999, the FCC ruled on remand from the D.C. Circuit
Court that the rate interexchange carriers are to pay us for their
customers' "dial-around" access or toll-free calls originating on
our pay phones be decreased from $0.284 per call to $0.24 per call
commencing upon the April 1999 effective date of the order. The
FCC also directed that a reduced rate of $0.238 per call be applied
retroactively for the period from October 7, 1997 through the
effective date of the FCC order. Based on the February 1999 FCC
ruling, which we may appeal, our previously reported pay phone
revenues will be reduced by approximately $5.6 million, with such
reduction to be reflected in the first quarter of 1999.
Audit Report on Continuing Property Records
On March 12, 1999, the FCC released the result of a staff-level
audit of the property records of certain central office equipment
maintained by Ameritech's landline communications subsidiaries,
including Ohio Bell, and the other RHCs. Based solely on a
physical verification audit, this report alleged an overstatement,
and consequently recommended a write-off, of approximately $567
million of Ameritech's central office equipment; however no
allocation of the write-off among Ameritech's five landline
communication subsidiaries was reflected in the audit. In
releasing this audit report, the FCC stated that it did not pass
judgment on its accuracy or the reasonableness of its conclusions
or recommendations.
Ameritech has issued a response to the audit that, among other
things, disputes the validity of its auditing and statistical
sampling methods. We also dispute the practical consequences of
the FCC's property audit while under a price cap regulatory plan.
Further, in the event the FCC required us to write central office
equipment off our books, we believe there would be no accounting
impact on net plant because we follow the group method of
depreciation. Under this method plant retirements are charged
against the accumulated depreciation balance.
The FCC has announced plans to seek public comment on issues
raised by the audit results.
Regulatory Environment - State
We are also subject to regulation by the PUCO with respect to
certain intrastate rates and services. In January 1995, we
implemented the Advantage Ohio price regulation plan, following
approval by the PUCO. Under the plan, overall rate changes are
subject to price caps. During the first year of the plan, rates
for all services were frozen. For the remaining five years of the
plan, rates for basic access lines and usage were capped. The plan
provides for the ability to flexibly price competitive and
discretionary services. A series of annual rate reductions
totaling $84 million are phasing in over a six-year period
including reductions in the rates for residential local usage and
access lines, reductions in carrier access charges and the
deaveraging of access line rates. We have committed to meeting
certain benchmarks for the deployment of advanced technology to
schools, hospitals and libraries, funding of community computer
centers, a discounted Lifeline telephone service for low-income
customers and $21 million in grants for new technology in public
schools and for economic development.
In 1998, we reduced rates by over $10 million on the third
anniversary of the plan and by $4 million annually as a result of
the change in the price cap index which was effective July 1, 1998.
PAGE 6
Long-distance Services
InterLATA long-distance is a $1.9 billion market in our local
service area. Under the 1996 Act, Ameritech and the other RHCs
must open their respective local markets to competition by
implementing a 14-point checklist before they can offer interLATA
long-distance services to their local landline customers. In
considering an application to offer interLATA long-distance
service, the FCC must determine whether or not an RHC has satisfied
the statutory criteria, including the competitive checklist and
various structural and accounting rules, and whether its entry into
long-distance is consistent with the public interest. An RHC is
restricted from providing interLATA long-distance service until the
FCC determines that these criteria have been met. The FCC gives
substantial weight to Department of Justice recommendations in
reviewing RHC applications to enter the market. In preparation, we
have negotiated or arbitrated numerous agreements with competitors
to allow interconnection access to our network elements at cost-
based rates and purchase of our local services at wholesale rates
for resale to the public.
FCC rules require that interLATA long-distance service be
offered by Ameritech's long-distance subsidiary, Ameritech
Communications Inc., which is certified to provide long-distance
service in all states outside the Ameritech five-state region.
Accordingly, Ameritech's entry into this market will not generate
long-distance revenues for Ohio Bell.
Evolution of the Industry
Growing customer need for new services, new technologies,
regulatory reform and corporate alliances are accelerating the pace
of change and creating intense competition in the communications
industry. We believe that more competition in our industry is
inevitable.
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 our 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 and as some competitors provide
services using their own networks, in whole or in part. 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.
Patents, Trademarks and Other Intellectual Property
Ohio Bell, through its parent, Ameritech, has rights to use
various patents, copyrights, trademarks and other intellectual
property necessary to conduct its business. We do not believe that
the expiration of any of our intellectual property, or the
nonrenewal of rights to use it, would have a material adverse
affect on our business.
Ohio Bell's Human Resources
We employed 7,971 people as of December 31, 1998, compared with
8,419 as of December 31, 1997. The Communications Workers of
America (CWA), which is affiliated with the AFL-CIO, represents
about 90% of our employees.
In July 1998, the 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.
Environmental Matters
Ohio Bell is subject to a number of environmental matters,
primarily as a result of contractual sharing arrangements among
Ameritech and the other RHCs that continue in effect and relate to
predivestiture contingent liabilities of AT&T Corp. Our financial
statements reflect a recorded liability for our estimated share of
such contingent liabilities in accordance with generally accepted
accounting principles.
PAGE 7
Item 2. Properties.
General
The large number and widespread locations of Ohio Bell's
properties make it difficult to provide detailed descriptions of
the physical characteristics of the individual components. In
general, however, we can categorize our investment in property,
plant and equipment at year-end 1998 as follows:
- - "Land and Buildings," consisting of land we own including
improvements (namely central and administrative offices),
represents 8% of our total investment;
- - "Central office equipment," including switching and transmission
equipment and related facilities, represents 43%;
- - "Cable, wiring and conduit (or outside plant)," including aerial
cable, poles, underground cable, conduit and wiring, represents
43%;
- - "Other," including motor vehicles, computers and other support
assets, represents 5%; and,
- - "Plant under construction" represents 1%.
Virtually all of our plant investment is attributable to the
communications segment.
Capital Expenditures
Our total investment in property, plant and equipment increased
from about $5.6 billion at year-end 1993 to $6.6 billion at year-
end 1998, after giving effect to retirements but before deducting
accumulated depreciation at either date. Growth in capital
expenditures was driven by demand in our business and regulatory
requirements, such as those related to the 1996 Act. Capital
expenditures, the single largest use of our funds, were $474
million in 1998, $430 million in 1997 and $426 million in 1996.
Our capital spending is based on customer needs and Ameritech's
overall business plans. Investments in technologies that will
enable us to provide customers with new products and services
represent a high priority. We continued to modernize our network
throughout 1998. By investing in our telecommunications
infrastructure, we can anticipate and meet the demands on the
network by customers seeking Internet access, high speed data
transmission, information management and other communications
services.
Under the Advantage Ohio plan, we have committed to meeting
certain benchmarks for the deployment of advanced technology to
schools, hospitals and libraries, funding of community computer
centers, a discounted Lifeline telephone service for low-income
customers and $21 million in grants for new technology in public
schools and for economic development.
The FCC recently issued a staff-level audit report concerning
certain of our property records. Refer to Item 1 for a discussion
of this audit report.
Item 3. Legal Proceedings.
We are a party to various legal and regulatory proceedings
arising in the ordinary course of business. While there can be no
assurance as to the ultimate outcome of any pending proceedings, as
of the date of this report, Ameritech does not believe that any
pending legal proceedings to which Ohio Bell or its properties are
subject are required to be disclosed as material legal proceedings
pursuant to this item.
In November 1997, we reached an agreement in principle to settle
class action lawsuits regarding our inside wire maintenance and
LINE-BACKERr services. Those customers who subscribe to these
services pay a monthly fee to cover repairs to inside telephone
wiring and jacks. They thereby avoid charges for labor and
material at the time of repair. The lawsuits charged unfair sales
practices and violations of the antitrust laws allegedly arising
from our sales and marketing practices. The settlement consists
of, among other things, free calling cards and pay-per-use services
over specified time periods, as well as billing credits.
Item 4. Submission of Matters to a Vote of Security Holders.
Omitted pursuant to General Instruction I(2).
Item 5. Market for Registrant's Common Equity and
Related Stockholder Matters
We are a wholly owned subsidiary of Ameritech Corporation.
Accordingly, our common stock is not publicly traded. Management
declares quarterly dividends at its discretion, typically in an
amount equal to a substantial portion of estimated net income for
the quarter.
PAGE 8
PART II
Item 6. Selected Financial Data.
THE OHIO BELL TELEPHONE COMPANY
SELECTED FINANCIAL DATA
(Dollars in Millions)
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
Revenues
Local service........... $1,408.9 $1,369.4 $1,311.8 $1,241.2 $1,204.2
Interstate
network access......... 533.1 519.8 480.9 449.2 446.0
Intrastate
network access......... 107.0 121.3 140.4 125.0 136.8
Long-distance........... 130.3 141.3 161.6 166.6 182.4
Other................... 210.0 188.1 166.0 231.3 209.2
-------- -------- -------- -------- --------
Total revenues........... 2,389.3 2,339.9 2,260.7 2,213.3 2,178.6
Operating expenses* ..... 1,864.8 1,840.0 1,766.3 1,671.1 1,919.2
-------- -------- -------- -------- --------
Operating income......... 524.5 499.9 494.4 542.2 259.4
Interest expense......... 64.0 62.5 57.4 58.4 59.5
Other (income) expense,
net..................... 1.2 (11.2) (9.4) (5.3) (10.6)
Income taxes............. 170.7 157.3 147.1 163.3 58.7
-------- -------- -------- -------- --------
Income before
extraordinary item...... 288.6 291.3 299.3 325.8 151.8
Extraordinary item **.... - - - - (445.2)
-------- -------- -------- -------- --------
Net income (loss)........ $ 288.6 $ 291.3 $ 299.3 $ 325.8 $ (293.4)
-------- -------- -------- -------- --------
Total assets............. $3,306.5 $3,172.9 $3,086.6 $3,130.7 $3,051.5
Property, plant
and equipment, net...... $2,404.4 $2,349.4 $2,330.2 $2,293.5 $2,358.7
Capital expenditures,
net..................... $ 473.7 $ 429.6 $ 425.5 $ 315.7 $ 286.0
Long-term debt........... $ 483.9 $ 834.9 $ 834.9 $ 834.7 $ 834.9
Debt ratio............... 51.0 % 51.9 % 49.9 % 49.0 % 52.2 %
Return on average
equity.................. 28.6% 30.7 % 32.8 % 38.2 % (25.4)%
Return on average
total capital........... 17.5% 18.2 % 19.4 % 21.8 % (10.7)%
Pretax interest
coverage................ 9.2 8.2 8.9 9.6 4.6
Customer lines,
end of year (000s)...... 4,094 4,002 3,884 3,754 3,609
Customer lines served by -
Digital electronic
offices................ 95.4% 92.9 % 86.6 % 80.1 % 78.9 %
Analog electronic
offices................ 4.6% 7.1 % 13.4 % 19.9 % 21.1 %
Customer lines
per employee............ 514 475 453 449 397
Employees, end of year... 7,971 8,419 8,579 8,360 9,084
- -------------------
* Operating expenses in 1995 include a net work force
restructuring credit of $42.7 million, while 1994 operating
expenses include a nonmanagement work force restructuring
charge of $173.2 million.
** We had a noncash after-tax extraordinary charge in 1994 of
$445.2 million as a result of the discontinuance of the
application of FAS 71 (accounting in a regulatory
environment).
PAGE 9
Item 7. Management's Discussion and Analysis of Results of
Operations.
(Dollars in Millions)
Following is a discussion and analysis of the results of
operations of Ohio Bell for the year ended December 31, 1998 and
for the year ended December 31, 1997, which is based on the
Statements of Income and Accumulated Deficit. Other pertinent data
is also set forth in Selected Financial Data.
Results of Operations
Revenues
Total operating revenues were $2,389.3 million for 1998 and
$2,339.9 million for 1997. The increase of $49.4 million or 2.1%
consisted of the following:
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Local service......... $1,408.9 $1,369.4 $ 39.5 2.9
Local service revenues include basic monthly service fees and
usage charges, fees for call management services, installation and
connection charges and public phone revenues. Local service
revenues increased in 1998 due primarily to volume increases,
reflecting strong growth in the demand for data services. Growth
in ISDN lines and high-capacity circuits, resulting from the
proliferation of fax machines, Internet usage and computer
communications, drove the volume increases. Sales of call
management services, such as call waiting and Caller ID, also
increased, as did the usage of these services on a pay-per-use
basis. Access lines in service increased 2.3% to 4,094,000 as of
December 31, 1998 compared with 4,002,000 as of December 31, 1997
(restated to standardize counting of voice-grade equivalent lines).
Rate decreases partially offset these increases.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Network access
Interstate........... $ 533.1 $ 519.8 $ 13.3 2.6
Intrastate........... 107.0 121.3 (14.3) (11.8)
Network access revenues are fees charged to interexchange
carriers that use our local landline communications network to
connect customers to their long-distance network. In addition, end
users pay flat rate access fees to connect to the long-distance
networks. These revenues result from both interstate and
intrastate services. Interstate network access revenues increased
in 1998 due primarily to an increase in network minutes of use,
resulting from overall growth in the volume of calls handled for
interexchange carriers. Beginning in 1998, as a result of a change
in the FCC's mechanism for funding universal service, we accounted
for expenses related to universal service funding as a component of
other operating expenses, rather than a revenue offset. This
resulted in a revenue increase of approximately $9.9 million
compared with the prior year. Net rate reductions resulting from
access charge reform effective July 1, 1997, and additional
reductions that took effect July 1, 1998, partially offset the
increase. In addition, a change in reporting classification of
certain pay phone revenues from interexchange carriers for their
customers' use of our pay phones reduced interstate network access
revenues and increased miscellaneous revenues by approximately
$17.4 million in 1998. Minutes of use related to interstate calls
increased by 4.7% in 1998 compared with the prior year.
Intrastate network access revenues decreased in 1998 due
primarily to rate reductions resulting from access charge reform,
combined with a change in reporting classification of certain pay
phone revenues as discussed above. This change in classification
reduced intrastate network access revenues and increased
miscellaneous revenues by approximately $5.2 million in 1998.
Volume increases, resulting primarily from increased demand for
network access by alternative providers of intraLATA toll service,
partially offset the decrease. Minutes of use related to
intrastate calls increased by 6.6% compared with the prior year.
PAGE 10
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Long-distance......... $ 130.3 $ 141.3 $ (11.0) (7.8)
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 1998 due primarily to a decrease in network
usage, combined with a decrease in rates.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Other................. $ 210.0 $ 188.1 $ 21.9 11.6
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 in 1998 due primarily to a
change in classification of certain pay phone revenues from
interexchange carriers, as discussed above. Growth in equipment
sales and other nonregulated services, such as voice mail, also
contributed to the increase. A decrease in revenues from other
nonregulated services, such as voice mail, partially offset the
increase.
Operating Expenses
Total operating expenses in 1998 increased by $24.8 million or
1.3% to $1,864.8 million. The increase resulted primarily from
higher other operating expenses and depreciation and amortization,
offset by decreases in employee-related expenses and taxes other
than income taxes.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Employee-related
expenses............. $ 435.0 $ 442.1 $ (7.1) (1.6)
Employee-related expenses decreased in 1998 due primarily to
lower average force levels and decreases in overtime expenses and
other employee benefits expenses. Higher wage rates and increased
employee incentives partially offset the decrease.
Most of our nonmanagement work force (about 90% of total
employees) is represented by the CWA. In July 1998, the 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.
There were 7,971 employees as of December 31, 1998, compared
with 8,419 as of December 31, 1997.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Depreciation and
amortization......... $ 421.5 $ 413.2 $ 8.3 2.0
Depreciation and amortization expense increased in 1998 due
primarily to higher average property, plant and equipment balances
resulting from continued network expansion. Higher depreciation
rates, resulting from increasing investments in newer technologies
that have shorter depreciable lives, also contributed to the
increase.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Other operating
expenses............. $ 830.0 $ 795.8 $ 34.2 4.3
Other operating expenses increased in 1998 due primarily to
higher access charge expenses resulting from state commission
rulings (which we are contesting) that 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.
Higher contract and affiliated services expenses, related primarily
to systems programming and network support, also contributed to the
increase.
PAGE 11
Lower use fees for switching system software, combined with lower
cost of sales and material costs, partially offset the increase. A
decrease in advertising expenses, resulting primarily from the
timing of promotions and other marketing campaigns, also partially
offset the increase.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Taxes other than
income taxes......... $ 178.3 $ 188.9 $ (10.6) (5.6)
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 decreased in 1998 due primarily to
lower property taxes resulting from favorable tax reform
legislation, partially offset by an increase in gross receipts
taxes resulting from higher revenues.
Other Income and Expenses
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Interest expense...... $ 64.0 $ 62.5 $ 1.5 2.4
Interest expense increased in 1998 due primarily to interest
included on reciprocal compensation amounts accrued in 1998. Lower
interest on long-term debt, resulting from the retirement in
December 1998 of $355 million of long-term debt, partially offset
this increase.
Change
Income Percent
1998 1997 (Expense) Change
---- ---- -------- ------
Other (income)
expense, net......... $ 1.2 $ (11.2) $ (12.4) (110.7)
Other (income) expense, net includes equity earnings of
affiliates, interest income and other nonoperating items. Other
income decreased in 1998 due primarily to the costs associated with
the early redemption of $355 million of long-term debt in December
1998. A decrease in equity earnings from Ameritech Services, Inc.
(ASI), largely resulting from the impact of ASI's gain on the sale
of its investment in Bellcore in November 1997, also contributed to
the decrease. Increased interest income, resulting primarily from
a higher average investment in the Ameritech short-term funding
pool, partially offset the decrease. A one-time pretax gain of
$3.5 million in 1998 related to the sale of our interest in
Champaign Telephone Company also offset the decrease.
Increase Percent
1998 1997 (Decrease) Change
---- ---- -------- ------
Income taxes.......... $ 170.7 $ 157.3 $ 13.4 8.5
Income taxes increased in 1998 due primarily to the tax impacts
resulting from the centralization of the administration of benefits
for employees as further discussed in Note B, as well as the
increase in pretax earnings discussed above.
PAGE 12
Other Matters
Refer to Item 1 for a discussion of Federal and State regulatory
matters and competition.
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 that include it,
potentially causing data miscalculations or inaccuracies or
operational malfunctions or failures.
Ameritech has established a centrally managed, companywide
(rather than by subsidiary) initiative to identify, evaluate and
address Year 2000 issues. Begun in May 1996, Ameritech's Year 2000
effort covers network and supporting infrastructure for the
provision of local switched and data telecommunications services.
Also within the scope of this initiative are 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
Ameritech's 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 is 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 often are conducted in parallel, as of
December 31, 1998, Ameritech had substantially completed the
inventory and assessment phases; the remediation phase was nearing
completion; and the testing and deployment phases were well under
way.
As of December 31, 1998, the majority of network elements
requiring corrective activity, including substantially all of the
core network switches and other network components that we regard
as mission-critical, have been made Year 2000 ready and deployed
back into production. As of December 31, 1998, more than 90% of
Ameritech's total identified IT applications, including
substantially all determined to be mission-critical, have been
remediated, and a majority of all corrected applications have
completed certification testing and been deployed back into
production. Ameritech has also made substantial progress in Year
2000 readiness preparations for its remaining infrastructure
components (buildings and physical facilities, internal voice
telephone systems, and desktop PCs), and these efforts are
scheduled to be completed in mid-1999. Final integration testing
for certain critical systems and processes is scheduled to be
completed by the end of the third quarter of 1999.
With the majority of our various systems remediated and a
substantial portion of those already tested and deployed back into
production, Ameritech believes we are well positioned to complete
the remediation and deployment of our remaining systems, any
additional testing that may be necessary, and the development of
our business contingency and continuity plans in advance of the
Year 2000 transition. However, our ability to meet that goal
remains dependent upon a variety of factors, including the timely
provision of necessary upgrades and modifications by our suppliers
and contractors. In some instances, upgrades or modifications are
not expected to be available until mid- or late-1999.
Ameritech has sought Year 2000 readiness information from
various third-party suppliers on whom we depend for certain
products or essential services (such as electric utilities,
interexchange carriers, etc.), but Ameritech has no method of
ensuring that these suppliers will convert their critical systems
and processes in a timely manner. Ameritech is developing business
contingency and continuity plans (see discussion below), and is
continuing to work with key suppliers as part of a supplier
compliance program to seek to minimize such risks.
As is the case for other communications services providers,
there exists a worst case scenario possibility that a failure to
correct a Year 2000 program in one or more of our mission-critical
network elements or IT applications could cause a significant
disruption or interruption in certain of our normal business
functions. Based on Ameritech's assessments and work to date,
Ameritech believes that any such material disruption to our
operations due to failure of an internal system is unlikely.
However, due to the uncertainty inherent
PAGE 13
in Year 2000 issues generally and those that are beyond our control
in particular (e.g. the final Year 2000 readiness of our suppliers,
customers, utilities, and interconnecting carriers), there can be
no assurance that one or more such failures would not have a
material impact on our results of operations, liquidity or
financial condition.
There may also be Year 2000 issues in customer premises
equipment (CPE), including CPE that we have sold or maintained and
CPE that is used in connection with 911 services. Although the
customer generally is responsible for CPE, customers could
attribute a Year 2000 disruption in their CPE to a malfunction of
our network service. Ameritech has taken steps to encourage many
of our customers potentially at risk to undertake the necessary
assessment and remedial activities to avoid a Year 2000 problem
with their equipment and systems.
Ameritech currently estimates that it and all of its
subsidiaries combined, including Ohio Bell, will incur expenses of
approximately $250 million through 2001 in connection with their
anticipated Year 2000 efforts, of which approximately $108 million
had been incurred through December 31, 1998. The timing of our
expenses may vary and is not necessarily indicative of readiness
efforts or progress to date. Ameritech anticipates that a portion
of its Year 2000 expenses will not be incremental costs, but rather
will represent the redeployment of existing IT resources.
Ameritech also expects to incur certain capital improvement costs
(totaling approximately $30 million) to support this project. Such
capital costs ($12 million as of December 31, 1998) 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 contingency and
continuity plans tailored to meet Year 2000-related challenges.
This work is being performed through centrally managed, companywide
teams organized by critical business functions (including ordering,
provisioning, maintenance, billing and power). Ameritech's
contingency and business continuity plans are expected to assess
the potential for business disruption in various scenarios, and to
provide for key operation back-up, recovery and restoration
alternatives.
The above information is based on Ameritech's 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 Year 2000 remedial efforts of our customers
and suppliers, and similar uncertainties.
New accounting pronouncements
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 costs related to
computer software 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. We will adopt SOP 98-1 in the first quarter of 1999 and
estimate that the impact 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
and will be required to continue to expense all Year 2000
modification costs as incurred.
PAGE 14
In June 1998 the Financial Accounting Standards Board (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 other
financial accounting standards.
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 on 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, any
section of this Annual Report on Form 10-K 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 effects of growing demand for wireless technology which may
reduce or replace landline services provided by Ohio Bell;
- - The timing of, and potential regulatory or other considerations
relating to, the consummation of Ameritech's proposed merger
with SBC;
- - 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 the date hereof. We
have no obligation to revise or update these forward-looking
statements to reflect events or circumstances that arise after the
date hereof or to reflect the occurrence of unanticipated events.
PAGE 15
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk
We are exposed to market risks primarily from changes in
interest rates. To manage our exposure to these fluctuations,
Ameritech occasionally enters into various hedging transactions
that have been authorized according to documented policies and
procedures. Ameritech does not use derivatives for trading
purposes, to generate income or to engage in speculative activity,
and Ameritech never uses leveraged derivatives.
Our exposure to interest rate fluctuations results primarily
from our borrowings from the Ameritech short-term funding pool,
which Ameritech funds using commercial paper borrowings, and from
potential changes in the fair value of our fixed rate notes and
debentures. As of December 31, 1998, Ameritech estimated the
potential loss that it could incur from adverse changes in interest
rates using the value-at-risk estimation model. The value-at-risk
model uses historical interest rates to estimate the volatility and
correlation of these rates in future periods. It estimates a
potential loss in fair market value using the variance/co-variance
statistical modeling technique.
Using a confidence level of 95%, Ameritech estimated that, for a
given one-day period, we could incur potential fair value losses
related to long-term debt of $2.8 million as of December 31, 1998
and $3.9 million as of December 31, 1997. The decrease in 1998 in
the amount of fair value at risk was due primarily to a decrease in
long-term debt balances following our redemption of $355 million of
long-term debt in December 1998. This decrease was partially
offset by an increase in the volatility of interest rates, mostly
resulting from market activity in the third and fourth quarters of
1998. These estimated fair value losses would have no impact on
our results of operations or financial condition. Ameritech did
not estimate our potential losses related to the short-term funding
pool because their commercial paper borrowings are not readily
attributable to individual subsidiaries.
The value-at-risk model assumes that all movements in these
rates will be adverse and disregards the possibility that interest
rates could move in our favor. Actual experience has shown that
gains and losses tend to offset each other over time, and we
believe it is unlikely that we could experience losses such as
these over an extended period of time. These amounts should not be
considered estimates of future losses, since actual results may
differ significantly depending upon activity in the financial
markets.
PAGE 16
Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareowner of The Ohio Bell Telephone Company
We have audited the accompanying balance sheets of The Ohio Bell
Telephone Company (an Ohio Corporation) as of December 31, 1998 and
1997, and the related statements of income and accumulated deficit
and cash flows for each of the three years in the period ended
December 31, 1998. These financial statements and the schedule
referred to below are the responsibility of the company's
management. Our responsibility is to express an opinion on these
financial statements and this schedule based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial position of
The Ohio Bell Telephone Company as of December 31, 1998 and 1997,
and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles.
Our audits are made for the purpose of forming an opinion on the
basic financial statements taken as a whole. The financial
statement schedule included in Item 14(a)(2) is presented for
purposes of complying with the Securities and Exchange Commission's
rules and is not a required part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial
statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 21, 1999
PAGE 17
THE OHIO BELL TELEPHONE COMPANY
STATEMENTS OF INCOME AND ACCUMULATED DEFICIT
(Dollars in Millions)
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Revenues
Local service................... $ 1,408.9 $ 1,369.4 $ 1,311.8
Interstate network access....... 533.1 519.8 480.9
Intrastate network access....... 107.0 121.3 140.4
Long-distance................... 130.3 141.3 161.6
Other........................... 210.0 188.1 166.0
--------- --------- ---------
2,389.3 2,339.9 2,260.7
--------- --------- ---------
Operating expenses
Employee-related expenses....... 435.0 442.1 426.7
Depreciation and amortization... 421.5 413.2 389.2
Other operating expenses........ 830.0 795.8 753.0
Taxes other than income taxes... 178.3 188.9 197.4
--------- --------- ---------
1,864.8 1,840.0 1,766.3
--------- --------- ---------
Operating income.................. 524.5 499.9 494.4
Interest expense.................. 64.0 62.5 57.4
Other (income) expense, net....... 1.2 (11.2) (9.4)
--------- --------- ---------
Income before income taxes........ 459.3 448.6 446.4
Income taxes...................... 170.7 157.3 147.1
--------- --------- ---------
Net income........................ 288.6 291.3 299.3
Accumulated deficit,
beginning of year................ (85.2) (98.1) (122.8)
Less, dividends................... 277.7 278.4 274.6
--------- --------- ---------
Accumulated deficit,
end of year...................... $ (74.3) $ (85.2) $ (98.1)
========= ========= =========
The accompanying notes are an integral part of the financial statements.
PAGE 18
THE OHIO BELL TELEPHONE COMPANY
BALANCE SHEETS
(Dollars in Millions)
As of December 31,
-------------------
1998 1997
---- ----
Assets
Current assets
Cash and temporary
cash investments..................... $ 20.7 $ 1.4
Receivables, net
Customers and agents
(less allowance for
uncollectibles of $54.4 in 1998
and $50.9 in 1997).................. 458.4 465.9
Ameritech and affiliates............. - 2.0
Other................................ 23.9 18.8
Material and supplies................. 14.4 4.0
Prepaid and other..................... 25.3 18.0
--------- ---------
542.7 510.1
--------- ---------
Property, plant and equipment
In service............................ 6,584.8 6,230.0
Under construction.................... 53.9 59.2
--------- ---------
6,638.7 6,289.2
Less, accumulated depreciation........ 4,234.3 3,939.8
--------- ---------
2,404.4 2,349.4
--------- ---------
Investments, principally
in affiliates.......................... 76.9 87.2
Other assets and deferred charges....... 282.5 226.2
--------- ---------
Total assets............................. $ 3,306.5 $ 3,172.9
========= =========
Liabilities and shareowner's equity
Current liabilities
Debt maturing within one year
Ameritech............................ $ 568.0 $ 188.3
Other................................ 0.1 0.1
Accounts payable
Ameritech Services, Inc. (ASI)....... 48.6 38.4
Ameritech and affiliates............. 43.8 33.2
Other................................ 160.4 112.1
Other current liabilities............. 248.5 269.6
--------- ---------
1,069.4 641.7
--------- ---------
Long-term debt.......................... 483.9 834.9
--------- ---------
Deferred credits and other long-term liabilities
Accumulated deferred
income taxes......................... 136.3 116.9
Unamortized investment
tax credits.......................... 25.2 29.8
Postretirement benefits
other than pensions.................. 512.6 529.2
Long-term payable to ASI.............. 13.9 15.1
Other................................. 55.4 56.4
--------- ---------
743.4 747.4
--------- ---------
Shareowner's equity
Common stock (no par value;
one share authorized,
issued and outstanding).............. 1,084.1 1,034.1
Accumulated deficit................... (74.3) (85.2)
--------- ---------
1,009.8 948.9
--------- ---------
Total liabilities and
shareowner's equity..................... $ 3,306.5 $ 3,172.9
========= =========
The accompanying notes are an integral part of the financial statements.
PAGE 19
THE OHIO BELL TELEPHONE COMPANY
STATEMENTS OF CASH FLOWS
(Dollars in Millions)
Year Ended December 31,
-----------------------
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net income........................ $ 288.6 $ 291.3 $ 299.3
Adjustments to net income:
Depreciation and amortization... 421.5 413.2 389.2
Deferred income taxes, net...... (0.1) 9.9 (0.4)
Investment tax credits, net..... (4.6) (5.3) (8.0)
Capitalized interest............ (2.0) (3.2) (4.0)
Change in accounts receivable... 4.4 (3.6) (41.2)
Change in material and supplies. (18.7) (9.1) (6.9)
Change in certain other
current assets................. (7.3) (9.1) 15.3
Change in accounts payable...... 69.1 (65.0) (82.2)
Change in certain other
current liabilities............ (1.6) 4.2 25.0
Change in certain noncurrent
assets and liabilities......... (27.7) (25.5) (29.2)
Gain from sale of
Champaign Telephone Company.... (3.5) - -
Other operating activities, net. 12.4 (0.1) (8.8)
--------- --------- ---------
Net cash from operating
activities....................... 730.5 597.7 548.1
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures, net......... (472.0) (426.8) (421.5)
Additional investments............ - (21.2) -
Proceeds from
disposals of property,
plant and equipment, net........ 5.5 9.4 6.3
Proceeds from sale of
Champaign Telephone Company.... 14.5 - -
Other investing activities, net... - 0.8 0.2
--------- --------- ---------
Net cash from investing
activities....................... (452.0) (437.8) (415.0)
--------- --------- ---------
Cash flows from financing activities:
Intercompany financing, net....... 379.7 120.1 68.5
Retirements of long-term debt..... (355.2) (0.6) (0.3)
Dividend payments................. (277.7) (278.4) (335.7)
Costs of refinancing
long-term debt.................. (6.0) - -
Other financing activities, net... - 0.3 -
--------- --------- ---------
Net cash from financing
activities....................... (259.2) (158.6) (267.5)
--------- --------- ---------
Net increase (decrease) in cash and
temporary cash investments........ 19.3 1.3 (134.4)
Cash and temporary cash
investments, beginning of year... 1.4 0.1 134.5
--------- --------- ---------
Cash and temporary cash
investments, end of year......... $ 20.7 $ 1.4 $ 0.1
========= ========= =========
The accompanying notes are an integral part of the financial statements.
PAGE 20
THE OHIO BELL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS
(Dollars in Millions)
A. Significant Accounting Policies
Nature of Operations - The Ohio Bell Telephone Company is a
wholly owned subsidiary of Ameritech Corporation (Ameritech).
Ameritech is also the parent of Illinois Bell Telephone Company;
Indiana Bell Telephone Company, Incorporated; Michigan Bell
Telephone Company; and Wisconsin Bell, Inc. (referred to with Ohio
Bell collectively as the "Ameritech landline communications
subsidiaries"). We provide a wide variety of advanced
communications services, including local exchange and toll service,
network access and telecommunications products in Ohio and are an
integral part of Ameritech's communications segment.
See discussion of Competition and Regulatory developments in
Part I, Item 1 - Business.
Basis of Accounting - We have prepared the financial statements
in accordance with generally accepted accounting principles (GAAP)
based on the books and records of Ohio Bell.
Use of Estimates - The preparation of financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities as of the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Transactions with Affiliates - We have various agreements with
affiliated companies. Below is a description of the significant
arrangements followed by a table of the amounts involved.
1. Ameritech Services, Inc. (ASI) - ASI, an Ameritech-
controlled affiliate in which we have 21% ownership, provides
planning, development, management, procurement and support services
to all of the Ameritech landline communications subsidiaries. We
also provide certain services and facilities to ASI.
1998 1997 1996
---- ---- ----
Purchases of
materials and charges
for services from ASI..... $ 573.3 $ 525.6 $ 549.5
Recovery of
costs for services
provided to ASI........... 8.4 10.0 10.0
2. Ameritech (our parent) - Ameritech provides various
administrative, planning, financial and other services to us, which
are billed at cost.
1998 1997 1996
---- ---- ----
Charges incurred.......... $ 44.3 $ 29.7 $ 28.3
3. Ameritech Publishing, Inc. (API), a wholly owned subsidiary
of Ameritech doing business as Ameritech Advertising Services - We
have an agreement with API under which we furnish to API certain
services and data to be used by API in publishing and distributing
classified and alphabetical directories. In exchange, we receive
compensation for the services and data.
1998 1997 1996
---- ---- ----
Fees paid to Ohio Bell
by API.................... $ 3.1 $ 3.5 $ 3.6
Fees paid by Ohio Bell
to API.................... 0.6 0.5 5.5
PAGE 21
4. Ameritech Information Systems, Inc. (AIS), a wholly owned
subsidiary of Ameritech - We reimburse AIS for costs incurred by
AIS in connection with the sale of network services by AIS
employees.
1998 1997 1996
---- ---- ----
Charges incurred........... $ 25.0 $ 33.5 $ 23.1
5. Bell Communications Research, Inc. (Bellcore) - Bellcore
provides research and technical support to the landline
communications subsidiaries. Prior to November 1997, ASI had a one-
seventh ownership interest in Bellcore and billed us for costs. In
November 1997, ASI sold its interest in Bellcore. The amount for
1997 below includes charges incurred through the date Bellcore was
sold.
1998 1997 1996
---- ---- ----
Charges incurred........... $ - $ 20.3 $ 17.5
Property, Plant and Equipment - We state property, plant and
equipment at original cost. The provision for depreciation is
based principally on the straight-line remaining life and the
straight-line equal life group methods of depreciation applied to
individual categories of property, plant and equipment with similar
characteristics.
We use average plant lives, generally ranging from three to 30
years depending upon the type of asset. In general, the lives used
for certain communications assets and office equipment have
shortened due to the use of newer technologies.
Generally, when depreciable plant is retired, the amount at
which such plant has been carried in property, plant and equipment
in service is charged to accumulated depreciation. The cost of
maintenance and repairs of plant is charged to expense.
Investments - We reflect our investment in ASI (21% ownership)
in the financial statements using the equity method of accounting.
Our investment in ASI was $52.3 million as of December 31, 1998 and
$54.0 million as of December 31, 1997. In January 1998, we sold
our investment in Champaign Telephone Company for approximately
$15.1 million, realizing proceeds of approximately $14.5 million.
We recognized a pretax gain of $3.5 million on the sale. We carry
all other investments at cost. Derivative transactions, if any,
are executed by Ameritech. We had no derivative transactions in
1998, 1997 or 1996.
Material and Supplies - We state inventories of new and reusable
material and supplies at the lower of cost or market with cost
generally determined on an average-cost basis.
Income Taxes - Ameritech includes Ohio Bell in the federal
income tax return filed by Ameritech and its subsidiaries. We
determine our provision for income taxes on a separate company
basis.
We determine deferred tax assets and liabilities at the end of
each period based on differences between the financial statement
bases of assets and liabilities and the tax bases of those same
assets and liabilities, using the currently enacted statutory tax
rates. We measure deferred income tax expense as the change in the
net deferred income tax asset or liability during the year.
We use the deferral method of accounting for investment tax
credits by amortizing realized credits as reductions to tax expense
over the life of the plant that gave rise to the credits.
Temporary Cash Investments - We state temporary cash investments
at cost which approximates market value. We consider all highly
liquid, short-term investments with an original maturity of three
months or less to be cash equivalents.
Advertising Costs - We charge advertising costs to operations as
incurred.
Software Costs - We have historically expensed most software and
related license fees as incurred. Beginning in 1999, we are
required, because of a change in GAAP, to capitalize a significant
portion of software developed or obtained for our internal use.
See our discussion of new accounting pronouncements in Other
Matters in Management's Discussion and Analysis of Results of
Operations.
PAGE 22
Revenue Recognition - We generally recognize revenues as
services are provided or products are delivered to customers. We
bill certain local telephone revenues in advance, resulting in
deferred revenues.
Short-Term Financing Arrangement - Ameritech provides short-term
financing and cash management services to its subsidiaries,
including Ohio Bell. Ameritech issues commercial paper and notes
and secures bank loans to fund the working capital requirements of
its subsidiaries and invests short-term excess funds on their
behalf. (See Note F).
The results were as follows:
1998 1997 1996
---- ---- ----
Interest charged to
Ohio Bell
by Ameritech
for financing............. $ 6.4 $ 6.5 $ 1.7
Cash management interest
income earned
by Ohio Bell.............. - - 1.4
Reclassifications - We made certain reclassifications to the
December 31, 1997 balances to correspond to the presentation as of
December 31, 1998.
B. Investment in Preferred Stock
In June 1997, Ameritech centralized the administration of
benefits for employees who had retired from Ohio Bell and other
subsidiaries as of December 31, 1996. In connection therewith, we
hold approximately $21.6 million in preferred stock issued by the
Ameritech subsidiary responsible for administration of these
benefits. This subsidiary began paying benefits on our behalf in
July 1997. We account for these benefit payments made on our
behalf as a capital contribution in the shareowner's equity section
of the balance sheets, with a corresponding reduction in the
postretirement benefit obligation. These contributions were $50.0
million in 1998 and $23.8 million in 1997.
C. Income Taxes
The components of income tax expense were as follows:
1998 1997 1996
---- ---- ----
Federal
Current........................ $ 175.4 $ 152.7 $ 155.5
Deferred, net................... (0.1) 9.9 (0.4)
Investment tax credits, net..... (4.6) (5.3) (8.0)
--------- --------- ---------
Total............................ $ 170.7 $ 157.3 $ 147.1
========= ========= =========
Total income taxes paid were $176.0 million in 1998, $177.8
million in 1997, and $141.9 million in 1996.
The following is a reconciliation of the statutory federal
income tax rate for each of the past three years to our effective
tax rate (computed by dividing total income tax expense by income
before income taxes):
1998 1997 1996
---- ---- ----
Statutory federal income
tax rate......................... 35.0% 35.0% 35.0%
Reduction in tax expense due to
amortization of investment tax
credits........................ (0.7) (0.8) (1.2)
Tax impact of centralization
of administration of
certain benefits (Note B)....... 3.3 1.8 -
Other............................ (0.4) (0.9) (0.8)
-------- -------- --------
Effective income tax rate......... 37.2% 35.1% 33.0%
======== ======== ========
PAGE 23
As of December 31, 1998 and 1997 the components of long-term
accumulated deferred income taxes were as follows:
1998 1997
---- ----
Deferred tax assets
Postretirement and
postemployment benefits....... $ 171.0 $ 189.9
Other.......................... 16.6 4.1
--------- ---------
187.6 194.0
--------- ---------
Deferred tax liabilities
Accelerated depreciation....... 244.3 239.8
Prepaid pension cost........... 69.3 62.7
Other.......................... 10.3 8.4
--------- ---------
323.9 310.9
--------- ---------
Net deferred tax liability...... $ 136.3 $ 116.9
========= =========
Deferred income taxes in current assets and liabilities relate
primarily to temporary differences resulting from vacation pay and
uncollectibles, and amounts in 1998 and 1997 were not material. We
had valuation allowances against certain deferred tax assets
aggregating $2.5 million as of December 31, 1998 and 1997.
D. Property, Plant and Equipment
The components of property, plant and equipment are as follows:
1998 1997
---- ----
Land............................ $ 16.3 $ 16.4
Buildings....................... 557.9 541.6
Central office equipment........ 2,851.8 2,581.3
Cable, wiring and conduit....... 2,848.7 2,729.6
Other........................... 310.1 361.1
--------- ---------
6,584.8 6,230.0
Under construction.............. 53.9 59.2
--------- ---------
6,638.7 6,289.2
Less, accumulated depreciation.. 4,234.3 3,939.8
--------- ---------
$ 2,404.4 $ 2,349.4
========= =========
Depreciation expense on property, plant and equipment was $421.1
million in 1998, $413.2 million in 1997 and $389.2 million in 1996.
E. Employee Benefit Plans
Pension Plans - Ameritech maintains noncontributory defined
benefit pension plans for substantially all of our employees, as
well as postretirement healthcare and life insurance plans for
substantially all retirees and their dependents.
The following table provides information on our pension credits
and postretirement benefit costs for the Ameritech plans:
1998 1997 1996
---- ---- ----
Pension credits............. $ (18.8) $ (14.5) $ (22.2)
Postretirement
benefit costs............. 49.0 51.7 56.1
Ameritech allocates pension credits to us based upon the
percentage of compensation for the management plan and based on
number of employees for the nonmanagement plan. They allocate
retiree health care cost to us on a per participant basis, whereas
group life insurance is allocated based on compensation levels.
For the pension plans, the fair value of plan assets available for
plan
PAGE 24
benefits as of December 31, 1998 exceeded the projected benefit
obligations. For the postretirement health care and life insurance
plans, the postretirement benefit obligation as of December 31,
1998 exceeded the fair value of plan assets available for plan
benefits.
Certain disclosures are required to be made under FAS 132,
"Employers' Disclosures about Pensions and Other Postretirement
Benefits," of the components of pension credits, postretirement
benefit costs and the funded status of the plans, including the
actuarial present value of accumulated plan benefits, accumulated
or projected benefit obligation and the fair value of plan assets.
We do not present such disclosures because the structure of the
Ameritech plans does not permit the plans' data to be readily
disaggregated.
Ameritech has advised us of the following assumptions used to
calculate pension credits, postretirement benefit costs and the
funded status of the plans:
Pension Benefits Retiree Health and Life
---------------- ----------------------
1998 1997 1998 1997
---- ---- ---- ----
Discount rate................ 6.75% 7.0 % 6.75% 7.0 %
Expected return.............. 8.4 % 8.4 % 8.4 % 8.4 %
Compensation increase rate... 4.1 % 4.1 % 4.1 % 4.1 %
The assumed health care cost trend rate for 1998 was 7.6% and
8.0% in 1997 and is assumed to decrease by 0.4% per year to 4.0% in
2007 and remain at that level. A one percentage-point increase in
the assumed health care cost trend rate would have increased the
1998 annual expense by approximately 14.4%, while a one percentage-
point decrease in the assumed health care cost trend rate would
have decreased 1998 annual expense by approximately 11.5%.
Management Work Force Reductions - Effective January 1, 1995,
management employees who are asked to leave Ohio Bell will receive
a severance payment under the Management Separation Benefit Program
(MSBP). We account for this benefit in accordance with FAS 112,
"Employers' Accounting for Postemployment Benefits," accruing the
separation cost when incurred. The number of employees leaving
Ohio Bell under the MSBP and the predecessor plan was 6 in 1998, 9
in 1997, and 48 in 1996.
Settlement gains result from the payment of lump-sum
distributions from the pension plans to former employees and are
recorded as a credit to other operating expense. Settlement gains,
net of termination costs, under the plans were $1.2 million in
1998, $1.2 million in 1997 and $4.0 million in 1996. The
involuntary plans are funded from our operations and required cash
payments of $0.1 million in 1998, $1.2 million in 1997 and $1.1
million in 1996.
F. Debt Maturing Within One Year
We include debt maturing within one year as debt in the
computation of debt ratios. Debt maturing within one year
consisted of the following as of December 31:
1998 1997
---- ----
Notes payable - Ameritech....... $ 568.0 $ 188.3
Long-term debt maturing
within one year................ 0.1 0.1
--------- ---------
Total........................... $ 568.1 $ 188.4
========= =========
Weighted average interest
rate of notes payable,
year-end....................... 5.4% 5.8%
========= =========
PAGE 25
G. Long-Term Debt
Long-term debt consists principally of debentures and notes
issued by us.
The following table sets forth interest rates, scheduled
maturities and other information on long-term debt outstanding as
of December 31:
1998 1997
---- ----
Forty year 5 % debentures,
due February 1, 2006 ................... $ 60.0 $ 60.0
Forty year 5 3/8 % debentures,
due March 1, 2007........................ 75.0 75.0
Forty year 6 3/4 % debentures,
due July 1, 2008......................... - 55.0
Forty year 7 1/2 % debentures,
due October 1, 2011...................... - 100.0
Forty year 7 7/8 % debentures,
due October 1, 2013...................... - 200.0
Thirty year 7.85 % debentures,
due December 15, 2022.................... 100.0 100.0
Ten year 6 1/8 % notes,
due May 15, 2003......................... 150.0 150.0
Seven year 5 3/4 % notes,
due May 1, 2000.......................... 100.0 100.0
--------- ---------
485.0 840.0
Capital lease obligations ................. 1.0 1.1
Unamortized discount, net ................. (2.1) (6.2)
--------- ---------
Total ..................................... $ 483.9 $ 834.9
========= =========
In December 1998, we redeemed $355 million of long-term debt.
We called this debt in anticipation of refinancing at more
favorable interest rates in 1999, however this new debt may be
issued by Ameritech's wholly owned financing subsidiary, Ameritech
Capital Funding Corporation, not by Ohio Bell. We called the
following debt issues and recognized a pretax charge of $9.7
million for the costs of early redemption:
Face Amount
of Debt Called
--------------
Forty year 6 3/4 % debentures,
due July 1, 2008...................... $ 55.0
Forty year 7 1/2 % debentures,
due October 1, 2011................... 100.0
Forty year 7 7/8 % debentures,
due October 1, 2013................... 200.0
--------
Total.................................. $ 355.0
========
Over the next five years, the seven year 5 3/4% notes with a
principal amount of $100.0 million mature in 2000 and the ten year
6 1/8% notes with a principal amount of $150 million mature in
2003.
H. Commitments and Contingencies
We lease certain facilities and equipment used in our operations
under both operating and capital leases. Rental expense under
operating leases was $28.6 million in 1998, $24.6 million in 1997
and $22.6 million in 1996. In addition, rental expense for the
leasing of equipment through Ameritech's lease financing subsidiary
was approximately $7.9 million in 1998, $5.8 million in 1997 and
$2.8 million in 1996. As of December 31, 1998, the aggregate
minimum rental commitments under external noncancelable leases were
approximately as follows:
Years Operating Capital
----- --------- -------
1999.............................. $ 4.4 $ 0.2
2000.............................. 4.3 0.2
2001.............................. 3.9 0.2
2002.............................. 3.3 0.2
2003.............................. 3.1 0.2
Thereafter........................ 21.4 0.7
-------- --------
Total minimum lease commitments... $ 40.4 $ 1.7
========
Less: amount representing
interest costs........ 0.6
--------
Present value of minimum
lease payments..................... $ 1.1
========
PAGE 26
I. Financial Instruments
The following table presents the estimated fair value of our
financial instruments as of December 31, 1998 and 1997:
1998
-------------
Carrying Fair
Value Value
----- -----
Cash and temporary cash
investments.................... $ 20.7 $ 20.7
Debt............................ 1,056.5 1,091.4
Long-term payable to ASI
(for postretirement benefits).. 13.9 13.9
Other assets.................... 2.5 2.5
Other liabilities............... 2.6 2.6
1997
-------------
Carrying Fair
Value Value
----- -----
Cash and temporary cash
investments.................... $ 1.4 $ 1.4
Debt............................ 1,041.2 1,080.4
Long-term payable to ASI
(for postretirement benefits).. 15.1 15.1
Other assets.................... 2.8 2.8
Other liabilities............... 3.5 3.5
We used the following methods and assumptions to estimate the
fair value of financial instruments:
Cash and temporary cash investments - The carrying value
approximates fair value because of the short-term maturity of these
instruments.
Debt - The carrying amount (including accrued interest) of debt
maturing within one year approximates fair value because of the
short-term maturities involved. We estimated the fair value of
long-term debt based on the year-end quoted market price for the
same or similar issues.
Other assets and liabilities - These financial instruments
consist primarily of other investments and customer deposits. We
based the fair values of these items on expected cash flows or, if
available, quoted market prices.
Long-term payable to ASI (for postretirement benefits) -
Carrying value approximates fair value.
J. Stock Options
During 1995, the Financial Accounting Standards Board issued FAS
123, "Accounting for Stock-Based Compensation." This pronouncement
requires that Ameritech calculate the value of stock options at the
date of grant using an option pricing model. Ameritech elected the
"pro forma, disclosure only" option permitted under FAS 123,
instead of recording a charge to operations. Some of our
management personnel receive Ameritech stock options; however, the
portion of the option programs allocable to our employees is not
significant.
K. Shareowner's Equity
Changes in total shareowner's equity in 1998 and 1997 consisted
of net income and dividend declarations reflected on the statements
of income and accumulated deficit, as well as capital contributions
discussed in Note B. Changes in shareowner's equity in 1996
consisted of only net income and dividends declared. As a wholly
owned subsidiary of Ameritech Corporation, we do not declare
dividends on a per-share basis. Management declares quarterly
dividends at it discretion, typically equal to a substantial
portion of estimated net income for the quarter.
PAGE 27
L. Additional Financial Information
As of December 31,
------------------
1998 1997
---- ----
Balance Sheets
Other current liabilities:
Accrued payroll....................... $ 14.3 $ 14.1
Compensated absences.................. 31.7 31.3
Accrued taxes......................... 132.7 138.2
Income taxes deferred one year........ (30.3) (27.8)
Advance billings and customer
deposits............................ 55.9 58.7
Accrued interest...................... 7.1 14.2
Other................................. 37.1 40.9
--------- ---------
Total................................ $ 248.5 $ 269.6
========= =========
Advertising costs were $28.2 million in 1998, $35.2 million in
1997 and $27.5 million in 1996. Interest paid was $71.1 million in
1998, $62.3 million in 1997 and $61.2 million in 1996.
No customer accounted for more than 10% of revenues in 1998,
1997 or 1996.
M. Other Income, Net
The components of other (income) expense, net were as follows:
1998 1997 1996
---- ---- ----
Equity earnings of ASI..... $ (5.4) $ (11.5) $ (8.1)
Gain on sale of
Champaign Telephone
Company investment....... (3.5) - -
Costs of early
redemption of debt....... 9.7 - -
Other, net................. 0.4 0.3 (1.3)
--------- --------- ---------
Total.................... $ 1.2 $ (11.2) $ (9.4)
========= ========= =========
N. Quarterly Financial Information (Unaudited)
Operating Net
Revenues Income Income
-------- ------ ------
1998
----
First Quarter.............. $ 581.2 $ 142.5 $ 82.0
Second Quarter............. 602.9 125.5 68.3
Third Quarter.............. 594.6 125.9 68.6
Fourth Quarter............. 610.6 130.6 69.7
-------- -------- --------
1998 Total............... $2,389.3 $ 524.5 $ 288.6
======== ======== ========
1997
----
First Quarter.............. $ 569.5 $ 136.5 $ 81.8
Second Quarter............. 589.0 131.0 77.3
Third Quarter.............. 589.0 117.1 63.5
Fourth Quarter............. 592.4 115.3 68.7
-------- -------- --------
1997 Total............... $2,339.9 $ 499.9 $ 291.3
======== ======== ========
The fourth quarter of 1998 includes a one-time pretax charge of
$9.7 million ($6.3 million after-tax) for the costs of early
redemption of $355 million of long-term debt.
We have included all adjustments necessary for a fair statement
of results for each period.
PAGE 28
O. Segment Information
Ohio Bell is a wholly owned subsidiary of Ameritech Corporation.
Ameritech has organized its operations using customer-focused
business units, and Ameritech's management reviews operating
results and allocates resources based on this structure. These
business units aggregate to three reportable segments for Ameritech
as a consolidated entity: communications; information and
entertainment; and international. The operations of Ohio Bell are
included in the results of several business units, and accordingly,
Ohio Bell is not managed as a separate entity. However, all of the
business units that include the results of Ohio Bell are reflected
in Ameritech`s communications segment. Ohio Bell therefore has
operations in only one reportable segment: communications. We
derive revenues from local service, network access, long distance
service and other miscellaneous revenues. Revenues derived from
each of these services are shown in separate captions on the income
statements on page 18.
P. Proposed Merger with SBC Communications Inc.
On May 11, 1998, Ameritech and SBC Communications Inc. (SBC)
jointly announced their signing of a definitive merger agreement
(Merger Agreement). The Merger Agreement provides that a wholly
owned subsidiary of SBC will be merged into Ameritech (the Merger)
and Ameritech will become a wholly owned subsidiary of SBC. The
Merger is intended to be accounted for as a pooling of interests
and to be a tax-free reorganization. In the Merger, each share of
Ameritech common stock (other than shares owned by Ameritech, SBC
or their respective subsidiaries) will be converted into and
exchanged for 1.316 shares of SBC common stock.
The Merger has been approved by the Board of Directors and the
shareowners of each company, but remains subject to various
regulatory approvals, principally by the Federal Communications
Commission (FCC), the Illinois Commerce Commission (ICC) and the
Public Utility Commission of Ohio (PUCO).
On March 23, 1999, the Department of Justice entered into a
consent decree with Ameritech and SBC that would provide a basis
for Department of Justice clearance of both the SBC-Ameritech
merger and SBC's proposed acquisition of Comcast Cellular
Corporation. The consent decree requires the parties to divest
certain "overlapping" cellular properties in 17 markets in
Illinois, Indiana and Missouri, including, as previously undertaken
by Ameritech and SBC, those in Chicago and St. Louis.
On March 29, 1999, the hearing examiners of the ICC issued their
proposed order approving the Merger subject to certain conditions.
The more significant conditions are to return to customers 100% of
the net Merger-related savings, which may be reduced to 50% if
certain performance requirements are met. Further, SBC must ensure
certain employment levels will not be reduced due to
the Merger, and that capital investments and charitable
contributions in Illinois are continued generally at historical
levels. The proposed order is subject to normal due process
proceedings before it goes to the commissioners of the ICC for a
vote. Under Illinois law, such vote must occur on or before June
24, 1999.
In February 1999, the PUCO staff, Ameritech, SBC, the Ohio
Consumers' Counsel and certain consumer groups and new competitors
of Ameritech in Ohio signed a proposed merger settlement agreement.
The proposed settlement, which requires formal PUCO approval, among
other things would guarantee Ameritech Ohio workforce levels for
two years, extend the Advantage Ohio price cap plan for basic
residential phone rates, provide for certain discounts for resold
local residential service and residential unbundled local loops to
foster facilities-based residential competition, set various
competitive and service quality benchmarks and establish monetary
penalties if those benchmarks are not met, and provide financing
for consumer education and community technology funds.
More detailed information relating to the terms and conditions
of the Merger is contained in the Joint Proxy Statement/Prospectus
of Ameritech and SBC dated October 15, 1998.
Item 9. Changes in and Disagreements with Accountants on
Accounting
and Financial Disclosure.
Not applicable.
PAGE 29
PART III
Item 10. Directors and Executive Officers of Registrant.
Omitted pursuant to General Instruction I(2).
Item 11. Executive Compensation.
Omitted pursuant to General Instruction I(2).
Item 12. Security Ownership of Certain Beneficial Owners
and Management.
Omitted pursuant to General Instruction I(2).
Item 13. Certain Relationships and Related Transactions.
Omitted pursuant to General Instruction I(2).
PAGE 30
PART IV
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.
(a) Documents filed as part of the report:
(1) Financial Statements:
Page
----
Selected Financial Data................................... 9
Report of Independent Public Accountants.................. 17
Statements:
Statements of Income and Accumulated Deficit............ 18
Balance Sheets.......................................... 19
Statements of Cash Flows................................ 20
Notes to Financial Statements........................... 21
Financial Statement Schedule
II Valuation and Qualifying Accounts..................... F-1
Glossary.................................................. 33
We have omitted additional financial statement schedules
because the required information is contained in the financial
statements and notes listed above, or because schedules are not
required or applicable.
(3) Exhibits:
We incorporate by reference the exhibits identified in
parentheses below, which are on file with the SEC.
Exhibit
Number
------
3a - Ohio Bell's Articles of Association, as amended April
25, 1974 (Exhibit 3a to Form 10-K for 1980, File No. 1-
6781).
3b - Ohio Bell's Regulations, as restated February 28, 1990
(Exhibit 3b to Form 10-K for 1989, File No. 1-6781).
4a - Close Corporation Agreement with Ameritech Corporation
dated February 28, 1990 (Exhibit (4)(i) to Form 10-K for
1989, File No. 1-6781).
4b - We are not required to file documents which define the
rights of holders of long and intermediate term debt of
Ohio Bell. We have agreed to furnish a copy of these
documents to the SEC on request.
10a - Reorganization and Divestiture Agreement between
American Telephone and Telegraph Company, American
Information Technologies Corporation and Affiliates,
dated as of November 1, 1983 (Exhibit 10a to Form 10-K
for 1983 for American Information Technologies
Corporation, File No. 1-8612).
27 - Financial Data Schedule for the year ended December 31,
1998.
(b) Reports on Form 8-K:
We did not file a Form 8-K during the fourth quarter of 1998.
PAGE 31
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
/s/ Ronald G. Pippin
-----------------------------
Ronald G. Pippin,
Vice President and Comptroller
March 29, 1999
Under the requirement of the Securities Exchange Act of 1934,
the following people have signed this report on our behalf in the
capacities indicated.
Principal Executive Officer:
/s/ Jacqueline F. Woods
-----------------------------
Jacqueline F. Woods,
President
Principal Financial and Accounting Officer:
/s/ Ronald G. Pippin
-----------------------------
Ronald G. Pippin,
Vice President and Comptroller
Ameritech Corporation:
/s/ Barry K. Allen
-----------------------------
Barry K. Allen,
Executive Vice President,
Regulatory and Wholesale Operations
The sole shareowner of the registrant, which is
a statutory close corporation managed by the
shareowner rather than by a board of directors.
March 29, 1999
PAGE 32
GLOSSARY
Access charge -
- ---------------
a fee that local phone companies charge to long-distance carriers
for the handling of long-distance calls on the local network.
Access line -
- -------------
a telephone line for voice, data or video reaching from a local
phone company to a home or business.
Bell operating companies -
- --------------------------
the former Bell telephone subsidiaries of AT&T, including
Ameritech's five landline communications subsidiaries in Illinois,
Indiana, Michigan, Ohio and Wisconsin.
Bundled (unbundled) network elements -
- --------------------------------------
two or more components of a regulated service for which one
inclusive rate is charged; separate components of a regulated
service for which separate rates are charged.
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.
Data communications -
- ---------------------
digital transmissions through wired or wireless networks, usually
linking computers.
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 the 1s and 0s of computer code for
improved clarity and quality.
Federal Communications Commission (FCC) -
- -----------------------------------------
an independent government agency whose mission is to encourage
competition in all communications markets and to protect the public
interest. The FCC develops and implements policy concerning
interstate communications by radio, television, wire, satellite and
cable.
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.
High-capacity lines -
- ---------------------
lines sold to customers that have large-volume data communications
needs - such as long-distance carriers, Internet service providers
and large companies.
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 WorldCom 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.
PAGE 33
GLOSSARY (cont'd.)
Intrastate revenues -
- ---------------------
that portion of revenues regulated by state rather than federal
authorities.
ISDN (Integrated Services Digital Network) -
- --------------------------------------------
a service that carries voice, data and video at the same time and
offers several times the capacity of a conventional phone line.
Landline -
- ----------
referring to conventional wired phone service.
Local access -
- --------------
the local portion of long-distance calls.
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 carrier (LEC) -
- ------------------------------
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.
Long-distance -
- ---------------
voice, data and video communications to locations beyond local
service areas.
Operational 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.
Regional holding companies (RHCs) -
- -----------------------------------
the seven regional holding companies formed in connection with the
court-approved divestiture of certain assets of AT&T Corp.,
formerly American Telephone and Telegraph Company. With the 1997
mergers of two of the RHCs, Pacific Telesis Group into SBC
Communications Inc. and NYNEX Corporation into Bell Atlantic
Corporation, five RHCs remain.
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.
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 -
- ------------------------
a channel or other portion of a high-capacity access line that can
be used to transmit voice or data traffic.
Voice mail -
- ------------
a service that automatically answers calls and distributes
messages.
PAGE 34
THE OHIO BELL TELEPHONE COMPANY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR UNCOLLECTIBLES
(Dollars in Millions)
COL. A COL. B COL. C COL. D COL. E
------ ------ ----------------- ------ ------
Additions
-----------------
Balance at Charged Charged Balance
Beginning to to Other at End of
of Period Expense (a) Accounts (b) Deductions (c) Period
--------- ---------- ----------- ------------- ------
Year 1998...........$ 50.9 $ 44.8 $ 63.7 $ 105.0 $ 54.4
Year 1997........... 37.9 44.5 92.6 124.1 50.9
Year 1996........... 22.2 46.5 65.9 96.7 37.9
----------------------
(a)Excludes direct charges and credits to expense on the statements of
income and accumulated deficit related to interexchange carrier
receivables.
(b)Includes principally amounts related to the interexchange carrier
receivables which are being billed by us and amounts previously
written off which were credited directly to this account when
recovered, as well as the reclassification of $7.0 million in 1996
from current liabilities to more accurately state the allowance.
(c)Amounts written off as uncollectible.
F-1