cover
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U.S. Securities and Exchange Commission
Washington, D.C. 20549
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Form 10-Q
(Mark one)
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[x] Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 1999
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or
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[ ] Transition Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
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Commission File Number 1-3499
Michigan Bell Telephone Company
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A Michigan Corporation
-----------------------------
444 Michigan Avenue
Detroit, Michigan 48226
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I.R.S. Employer Identification
Number 38-0823930Telephone
number (800) 257-0902
MICHIGAN BELL IS A WHOLLY OWNED SUBSIDIARY OF AMERITECH CORPORATION AND
MEETS THE CONDITIONS IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q.
WE ARE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT UNDER GENERAL
INSTRUCTION H(2).
We have filed all reports required to be filed by Section 13 or 15 (d) of
the Securities Exchange Act of 1934 during the preceding 12 months, and
have been subject to those filing requirements for the past 90 days.
Yes X No
---- ----
At July 31, 1999, 120,526,415 common shares were outstanding.
i
TABLE OF CONTENTS
PART I
FINANCIAL INFORMATION
ITEM Page
- ---- ----
1. Financial Statements
Condensed Statements of Income and
Accumulated Deficit for
the three and six months ended
June 30, 1999 and 1998 1
Condensed Balance Sheets as of
June 30, 1999 and December 31, 1998 2-3
Condensed Statements of Cash Flows for
the six months ended June 30, 1999 and 1998 4
Notes to Condensed Financial Statements 5-8
2. Management's Discussion and Analysis
of Results of Operations 9-22
PART II
OTHER INFORMATION
6. Exhibits and Reports on Form 8-K 23
Glossary 25-26
Page i
1
Item 1 - Financial Statements
-----------------------------
CONDENSED STATEMENTS OF INCOME AND ACCUMULATED DEFICIT
(Dollars in Millions)
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
--------------- ---------------
1999 1998 1999 1998
---- ---- ---- ----
Revenues
Local service................. $ 433.0 $ 406.4 $ 848.6 $ 795.9
Interstate network access..... 181.3 164.2 356.7 325.5
Intrastate network access..... 62.6 75.4 112.2 127.1
Long-distance service......... 180.7 179.4 360.8 360.6
Other......................... 82.3 70.6 149.6 136.6
--------- --------- --------- ---------
939.9 896.0 1,827.9 1,745.7
--------- --------- --------- ---------
Operating expenses
Employee-related expenses..... 168.0 167.5 331.1 328.9
Depreciation and amortization. 150.0 139.0 297.7 275.3
Other operating expenses...... 270.3 269.9 538.5 530.3
Taxes other than income taxes. 39.9 39.6 80.4 79.2
--------- --------- --------- ---------
628.2 616.0 1,247.7 1,213.7
--------- --------- --------- ---------
Operating income................ 311.7 280.0 580.2 532.0
Interest expense................ 13.2 20.3 27.7 41.1
Other (income) expense, net..... 0.7 (3.6) (1.0) (5.8)
--------- --------- --------- ---------
Income before income taxes...... 297.8 263.3 553.5 496.7
Income taxes.................... 109.2 96.2 203.4 182.1
--------- --------- --------- ---------
Net income...................... 188.6 167.1 350.1 314.6
Accumulated deficit,
beginning of period........... (263.3) (295.0) (275.4) (299.5)
Less, dividends declared.... 167.7 119.6 317.1 262.6
--------- --------- --------- ---------
Accumulated deficit,
end of period................. $ (242.4) $ (247.5) $ (242.4) $ (247.5)
========= ========= ========= =========
See Notes to Condensed Financial Statements.
Page 1
2
CONDENSED BALANCE SHEETS
(Dollars in Millions)
June 30, 1999 Dec. 31, 1998
-------------- -------------
(Unaudited) (Derived from
Audited
Financial
Statements)
ASSETS
Current assets
Cash and temporary cash investments......... $ 13.1 $ 13.2
Receivables, net
Customers................................. 609.2 645.8
Ameritech and affiliates.................. 3.4 --
Other..................................... 12.5 28.2
Material and supplies....................... 18.0 20.6
Prepaid and other........................... 32.5 26.9
--------- ---------
688.7 734.7
--------- ---------
Property, plant and equipment................ 8,906.3 8,695.6
Less, accumulated depreciation............... 6,085.2 5,830.0
--------- ---------
2,821.1 2,865.6
--------- ---------
Investments, primarily in affiliates......... 84.9 94.0
Other assets and deferred charges............ 422.7 396.4
--------- ---------
Total assets................................. $ 4,017.4 $ 4,090.7
========= =========
See Notes to Condensed Financial Statements.
Page 2
3
CONDENSED BALANCE SHEETS (continued)
(Dollars in Millions)
June 30, 1999 Dec. 31, 1998
-------------- -------------
(Unaudited) (Derived from
Audited
Financial
Statements)
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities
Debt maturing within one year
Ameritech................................ $ 162.5 $ 389.6
Other.................................... 154.1 155.1
Accounts payable
Ameritech Services, Inc. (ASI)............ 107.2 69.0
Ameritech and affiliates.................. 56.4 54.2
Other..................................... 208.1 171.4
Other current liabilities.................. 319.8 298.5
--------- ---------
1,008.1 1,137.8
--------- ---------
Long-term debt.............................. 496.7 496.1
--------- ---------
Deferred credits and other long-term liabilities
Accumulated deferred income taxes.......... 132.7 138.9
Unamortized investment tax credits......... 27.8 30.5
Postretirement benefits
other than pensions...................... 644.7 648.0
Long-term payable to ASI................... 15.8 17.2
Other ..................................... 81.4 69.7
--------- ---------
902.4 904.3
--------- ---------
Shareowner's equity
Common shares - ($14 2/7 par value;
120,810,000 shares authorized;
120,526,415 issued and outstanding)...... 1,721.8 1,721.8
Proceeds in excess of par value............ 130.8 106.1
Accumulated deficit........................ (242.4) (275.4)
--------- ---------
1,610.2 1,552.5
--------- ---------
Total liabilities and shareowner's equity... $ 4,017.4 $ 4,090.7
========= =========
See Notes to Condensed Financial Statements.
Page 3
4
CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Six Months Ended
June 30
-------------
1999 1998
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................... $ 350.1 $ 314.6
Adjustments to net income
Depreciation and amortization............... 297.7 275.3
Deferred income taxes, net.................. (12.5) (14.3)
Investment tax credits, net................. (2.7) (3.5)
Capitalized interest........................ (0.7) (0.8)
Change in accounts receivable, net.......... 48.9 (10.6)
Change in material and supplies............. (0.5) (17.9)
Change in certain other current assets...... (4.8) (3.1)
Change in accounts payable.................. 77.1 41.8
Change in certain other current
liabilities................................ 27.6 75.8
Change in certain other noncurrent
assets and liabilities..................... 3.9 (14.1)
Other operating activities, net............. 7.9 5.1
-------- --------
Net cash from operating activities............ 792.0 648.3
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.......................... (247.1) (212.8)
Other investing activities.................... 2.8 --
Proceeds from (costs of) disposals of
property, plant and equipment................ (2.2) 1.6
-------- --------
Net cash from investing activities............ (246.5) (211.2)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Intercompany financing, net................... (227.1) (50.2)
Retirements of long-term debt................. (1.4) (1.4)
Dividend payments............................. (317.1) (262.6)
-------- --------
Net cash from financing activities............ (545.6) (314.2)
-------- --------
Net change in cash and
temporary cash investments................... (0.1) 122.9
Cash and temporary cash investments,
beginning of period.......................... 13.2 12.8
-------- --------
Cash and temporary cash investments,
end of period................................ $ 13.1 $ 135.7
======== ========
See Notes to Condensed Financial Statements.
Page 4
5
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in Millions)
JUNE 30, 1999
NOTE 1: Preparation of Interim Financial Statements
We have prepared the unaudited condensed financial statements in this
report by following Securities and Exchange Commission rules that
permit reduced disclosure for quarterly period reports. These
financial statements include estimates and assumptions that affect
the reported amounts of assets and liabilities and the amounts of
revenues and expenses. Actual amounts could differ from those
estimates. We believe these statements include all adjustments
necessary for a fair statement of results for each period shown. We
believe our disclosures are adequate to make the presented
information clear. You should read these financial statements in
conjunction with the financial statements and notes included in our
1998 Annual Report on Form 10-K and the quarterly report on Form 10-Q
previously filed in 1999.
When reading these financial statements, you should be familiar with
the terminology unique to our business. We have defined a number of
terms in the glossary on pages 25 and 26.
Note 2: 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, as discussed below. 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.
Federal regulatory approvals
- ----------------------------
On March 23, 1999, the Department of Justice negotiated and agreed to
a consent decree with Ameritech and SBC that would provide a basis
for Department of Justice clearance of both the 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 April 5, 1999, Ameritech announced an agreement to sell 20
Midwestern cellular properties for $3.27 billion in cash to a venture
of GTE Corporation and Georgetown Partners, effectively meeting U.S.
Department of Justice conditions for approval of the SBC-Ameritech
Merger. The sale, which is contingent on the closing of the Merger,
eliminates the overlapping cellular properties that would result from
the Merger. The venture, led by GTE and including Georgetown
Partners, will acquire Ameritech's cellular properties in Chicago,
St. Louis and surrounding areas of
Page 5
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NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in Millions)
June 30, 1999
Note 2: Proposed Merger with SBC Communications Inc. (cont'd.)
Federal regulatory approvals (cont'd.)
- --------------------------------------
Illinois, northwestern Indiana and Missouri. These properties
include a population of 11.4 million and serve nearly 1.5 million
cellular customers. Approximately 1,500 of Ameritech's cellular
employees have been selected to transfer to GTE upon completion of
the sale.
The required 60-day comment period on the proposed consent decree
ended on June 28, 1999. No comments were received. The Department
of Justice has informed the U.S. District Court in Washington, D.C.
that the proposed consent decree is now ready for court approval and
entry.
On June 29, 1999, the FCC staff announced a comprehensive set of
proposed Merger conditions negotiated with Ameritech and SBC. The
FCC staff has indicated that they expect to recommend to the
Commission that the Merger be approved with the proposed conditions,
subject to receipt of any comments from the public. The proposed
conditions were released for public comment and more than 50 comments
were filed by the July 19th deadline. A joint Ameritech/SBC reply
and some additional public comments were filed on July 26, 1999.
Some of the more significant Merger conditions negotiated with the
FCC include:
- - a 6-month acceleration of the combined (Ameritech and SBC)
facilities-based entry into 30 out-of-region local markets with
potential to pay $40 million for each failure to enter any of these
markets;
- - common operational support systems across all 13 states served by
the combined Ameritech and SBC, providing competitors uniformity in
ordering, provisioning service and billing their customers (as well
as related training for small competitors);
- - large discounts for resold local service and unbundled loops (and
the provision of the unbundled network element platform) to
encourage competition in the residential market;
- - stringent performance monitoring, reporting and enforcement
measures with the potential for $1 billion in payments if
performance measures are not met;
- - implementation of advanced services such as ADSL, through a
separate subsidiary, with broad availability to include rural and
low-income urban customers;
- - waiver of minimum monthly charges for 3 years when Ameritech is
allowed to provide interLATA long-distance service;
- - extension of a program to provide financial assistance to low-
income customers in all 13 states; and
- - adoption and implementation of "shared transport" as currently
offered by SBC.
Page 6
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NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in Millions)
June 30, 1999
Note 2: Proposed Merger with SBC Communications Inc. (cont'd.)
State regulatory approvals
- --------------------------
On April 8, 1999, the Public Utilities Commission of Ohio (PUCO)
approved the Merger based on a settlement agreement between the PUCO
staff, Ameritech, SBC, the Ohio Consumers' Counsel and certain
consumer groups and new competitors of Ameritech in Ohio. The
settlement, among other things, guarantees certain workforce levels
in Ohio for two years, extends the Advantage Ohio price cap plan for
basic residential phone rates, provides for certain discounts for
resold local residential service and residential unbundled local
loops to foster residential competition, sets various competitive and
service quality benchmarks (and establishes monetary penalties if
those benchmarks are not met), and provides financing for consumer
education and community technology funds. A group of Merger
opponents filed a motion for a rehearing with the PUCO, but the PUCO
denied the motion on June 2, 1999.
On April 26, 1999, the hearing examiners of the Illinois Commerce
Commission (ICC) issued a revised proposed order approving the Merger
subject to certain conditions. However, upon review by the ICC, the
commissioners had further questions. In response, Ameritech and SBC
amended the joint application to provide additional information, and
the record was reopened to consider it. Three days of additional
hearings were held on July 13-15, 1999. Ameritech expects that the
matter will be referred to the ICC in August for a decision. Under
Illinois law, the ICC must render a decision in September 1999.
On May 5, 1999, the Indiana Utility Regulatory Commission (IURC)
issued an order asserting that the Merger is subject to IURC approval
under state law. Ameritech disagreed with the IURC's assertion of
authority to approve the Merger and appealed to the Indiana Supreme
Court this assertion of authority by the IURC. On July 30, 1999, the
Indiana Supreme Court issued an opinion finding that the IURC did not
have jurisdiction over the Merger and vacated the IURC's May 5th
order.
The Public Utilities Commission of Nevada (PUCN) issued an order on
July 29, 1999, requiring SBC to "show cause" why the PUCN does not
have jurisdiction to approve the Merger.
Note 3: 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 on 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 is under appeal, in the first quarter of 1999 our pay
phone revenues were reduced by approximately $6.9 million to reflect
the impact of all of these retroactive reductions.
Page 7
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NOTES TO CONDENSED FINANCIAL STATEMENTS
(Dollars in Millions)
June 30, 1999
Note 4: Segment Information
Michigan Bell is a wholly owned subsidiary of Ameritech Corporation.
Ameritech has organized its operations using customer-focused
business units. 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 Michigan Bell are included in
the results of several business units, and accordingly, Michigan Bell
is not managed as a separate entity. However, all of the business
units that include the results of Michigan Bell are reflected in
Ameritech's communications segment. Michigan Bell therefore has
operations in only one reportable segment: communications. We derive
revenues from local service, network access, long-distance service
and other miscellaneous products and services. Revenues derived from
each of these services are shown in separate captions on the income
statements on page 1.
Note 5: Accounting for Software Costs
We implemented a new accounting requirement, Statement of Position
(SOP) 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use," effective January 1, 1999. This SOP,
issued by the American Institute of Certified Public Accountants
(AICPA) in March 1998, provides authoritative guidance for the
capitalization of certain costs related to computer software
developed or obtained for our internal applications.
Since the implementation of the SOP on January 1, 1999, Ameritech and
all of its subsidiaries decreased operating expenses in the first six
months of 1999 by $61.0 million, including $2.0 million for Michigan
Bell. Ameritech currently anticipates an annual net operating
expense reduction of $200 million for all of 1999. 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. We are amortizing most capitalized software over
five years.
Page 8
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Item 2 - Management's Discussion and Analysis
of Results of Operations
The following is a discussion and analysis of the changes in
revenues, operating expenses and other income and expenses for the
first six months of 1999 as compared with the first six months of
1998.
RESULTS OF OPERATIONS
- ---------------------
Revenues
- --------
Our revenues in the first six months of 1999 were $1,827.9 million
and were $1,745.7 million for the same period in 1998, an increase of
$82.2 million. Growth in sales of call management services and
access lines, as well as increases in switched minutes of use were
the primary reasons for the increase. Net rate reductions, resulting
primarily from annual access charge reductions, partially offset
these increases.
- ---------------------------------------------------------------------
Local service
- -------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 848.6 $ 795.9 $ 52.7 6.6
Local service revenues include basic monthly service fees and usage
charges, fees for call management services, installation and
connection charges, certain data services and most public phone
revenues. Local service revenues increased for the six months ended
June 30, 1999 due largely to increased sales of call management
services and additional lines, resulting from the proliferation of
fax machines, Internet usage and computer connections. Local service
revenues also increased as a result of rate increases for central
office and listing services. Access line growth of 2.0% over the
prior year period also contributed to the increase.
There were 5,491,000 access lines in service as of June 30, 1999,
compared with 5,382,000 as of June 30, 1998.
- ---------------------------------------------------------------------
Network access
- --------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Interstate
- ----------
Six Months Ended $ 356.7 $ 325.5 $ 31.2 9.6
Intrastate
- ----------
Six Months Ended $ 112.2 $ 127.1 $ (14.9) (11.7)
Network access revenues are fees charged to interexchange carriers
that use our local landline communications network to connect
customers to their long-distance networks. In addition, end users
pay flat rate access fees to connect to the long-distance network.
These revenues result from both interstate and intrastate services.
Interstate network access revenues increased for the six months ended
June 30, 1999 due primarily to an increase in network minutes of use,
resulting from overall growth in the volume of calls handled for
interexchange carriers, and greater demand
Page 9
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Network access (cont'd.)
- ------------------------
for dedicated services by Internet service providers and other high-
capacity users. Rate reductions, resulting primarily from the FCC
annual access charge filing effective July 1, 1998, partially offset
the increase. These rate reductions were partially offset by
increased end user fees resulting from the number portability
surcharge effective February 1, 1999. Interstate minutes of use for
the six months ended June 30, 1999 increased by 6.5% over the same
period last year.
Intrastate network access revenues decreased for the six months ended
June 30, 1999 as a result of 1998 revenues including $20 million from
a favorable court ruling which found that interexchange carriers were
not entitled to access charge discounts for intraLATA toll services
prior to the time that Ameritech is allowed to offer interLATA long-
distance services in the state of Michigan. Intrastate access
revenues also decreased as a result of rate decreases implemented in
July 1998 with the FCC annual access charge filing reductions and due
to the unfavorable Michigan Public Service Commission (MPSC) primary
interexchange carrier charge (PICC) ruling. These decreases were
partially offset by increased network usage and an increase in end
user rates.
See also discussion in Other Matters, Regulatory Considerations under
Dial 1 + regarding proceedings in Michigan.
Intrastate minutes of use for the six months ended June 30, 1999
increased by 11.1% over the same period last year.
- ---------------------------------------------------------------------
Long-distance service
- ---------------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 360.8 $ 360.6 $ 0.2 0.1
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 increased for the six months ended June 30, 1999 due
primarily to rate increases implemented in July 1998. These
increases were substantially offset by decreased calling volumes
resulting from increased competition from alternative intraLATA toll
providers. We expanded Dial 1+ capability to our entire service area
in May 1999.
- ---------------------------------------------------------------------
Other
- -----
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 149.6 $ 136.6 $ 13.0 9.5
Other revenues include revenues derived from the sale of white page
directory listings, billing and collection services, inside wire
installation and maintenance services and other miscellaneous
services. Other revenues increased for the six months ended June 30,
1999 due primarily to an increase in miscellaneous nonoperating
revenues, due to implementation of a late payment charge, as well as
increased voice mail, inside wire installation and maintenance
services and white page directory listing revenues. Other revenues
also increased as a result of an increase in equipment sales. These
increases were partially offset by a $6.9 million revenue reduction
resulting from a FCC ruling which lowered the pay phone per call
compensation we receive from other communications companies, as well
as the on-going impact of these lower rates. (See Note 3).
Page 10
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Operating expenses
- ------------------
Total operating expenses for the six months ended June 30, 1999
increased $34.0 million, or 2.8% to $1,247.7 million. Increases in
other operating expenses and depreciation and amortization expenses
were the primary reasons for the increase, as discussed below.
- ---------------------------------------------------------------------
Employee-related expenses
- -------------------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 331.1 $ 328.9 $ 2.2 0.7
Employee-related expenses increased for the six months ended June 30,
1999 primarily due to increases in wage rates reflecting a new union
contract effective in mid-1998, as well as increases in overtime and
benefits expense. These increases were partially offset by lower
average force levels compared with the prior year period.
We employed 10,902 employees as of June 30, 1999, compared with 11,939
as of June 30, 1998.
- ---------------------------------------------------------------------
Depreciation and
amortization
- ------------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 297.7 $ 275.3 $ 22.4 8.1
Depreciation and amortization expense increased for the six months
ended June 30, 1999 due primarily to higher property, plant and
equipment balances. Higher depreciation rates on certain asset
categories also contributed to the increases, as we used shorter
depreciable lives for newer technologies.
- ---------------------------------------------------------------------
Other operating expenses
- ------------------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 538.5 $ 530.3 $ 8.2 1.5
Other operating expenses increased for the six months ended June 30,
1999 due primarily to higher material, professional services and bad
debt expenses. Higher access charge expenses resulting from state
commission rulings regarding calls to the Internet also contributed
to the increase. These rulings (which we are contesting) require
local exchange carriers to pay reciprocal compensation for calls by
their customers to the Internet via Internet service providers (ISPs)
who, in turn, are customers of competing local exchange carriers.
These increases were partially offset by decreased affiliate services
and advertising expenses. Effective January 1, 1999, we adopted
Statement of Position (SOP) 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use," which
required the capitalization of $2.0 million in software costs that
previously would have been expensed. (See Note 5).
Page 11
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Taxes other than income taxes
- -----------------------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 80.4 $ 79.2 $ 1.2 1.5
Taxes other than income taxes consist of property taxes, gross
receipts taxes and other taxes not directly related to earnings.
Taxes other than income taxes increased in the period ended June 30,
1999 due primarily to an increase in property taxes.
- ---------------------------------------------------------------------
Other income and expenses
- -------------------------
Interest expense
- ----------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 27.7 $ 41.1 $ (13.4) (32.6)
Interest expense decreased for the six months ended June 30, 1999 due
primarily to lower average long-term debt balances, resulting from
the redemption of $350 million in long-term debt in December 1998.
This decrease was partially offset by increased interest on short-
term debt, reflecting higher average short-term debt balances
following the long-term debt redemption.
- ---------------------------------------------------------------------
Other (income) expense, net
- ---------------------------
Change
June 30 (Income) Percent
------------
(dollars in millions) 1999 1998 Expense Change
------------------- ---- ---- -------- ------
Six Months Ended $ (1.0) $ (5.8) $ 4.8 (82.8)
Other (income) expense, net includes equity in earnings of
affiliates, interest income and other nonoperating items. Other
income decreased for the six months ended June 30, 1999 due primarily
to a decrease in equity earnings from Ameritech Services, Inc. (ASI)
and decreased interest income on funds invested in the Ameritech
short-term funding pool. These decreases in other income were
partially offset by lower miscellaneous nonoperating expenses.
- ---------------------------------------------------------------------
Income taxes
- ------------
June 30 Increase Percent
------------
(dollars in millions) 1999 1998 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 203.4 $ 182.1 $ 21.3 11.7
Income taxes increased for the six months ended June 30, 1999 due
primarily to the increase in pretax earnings, as discussed above.
- ---------------------------------------------------------------------
Ratio of earnings to fixed charges
- ----------------------------------
The ratio of earnings to fixed charges for the six months ended June
30 was 17.72 in 1999 and 11.93 in 1998.
The increase in the ratio is primarily the result of the decrease in
interest expense following the redemption of $350 million of long-
term debt in December 1998. The increase is also the result of the
increase in revenues which were only partially offset by increased
expenses, due to cost containment efforts.
Page 12
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Other Matters
- -------------
Regulatory Considerations
- -------------------------
The Telecommunications Act of 1996
In general, the Telecommunications Act of 1996 (the 1996 Act)
includes provisions designed to open local exchange markets to
competition and to afford the regional holding 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.
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).
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 or in future
arbitrations.
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. On April 16, 1999, in response to the Supreme
Court's decision, the FCC issued a Second Further Notice of
Rulemaking regarding which network elements should be made available
to competitors.
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-
Page 13
14
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory Considerations (cont'd.)
- -----------------------------------
Local Interconnection and Unbundled Access (cont'd.)
run incremental cost (TELRIC) pricing methodology, was not before the
Supreme Court, and will be addressed by the Eighth Circuit Court on
remand. On June 10, 1999, the Eighth Circuit Court issued a briefing
schedule for the open issues on remand and we filed our opening brief
on July 16, 1999. The case is set for oral argument on September 17,
1999. Pending judicial resolution of the appropriate pricing
methodologies and a determination by the FCC of which unbundled
network elements 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.
On June 1, 1999, the U.S. Supreme Court vacated and remanded a
separate 1998 Eighth Circuit Court decision regarding shared
transport. In that earlier decision, the Eighth Circuit Court had
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 Michigan Bell and the remaining four
Ameritech landline communications subsidiaries, 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, we have 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. In the
interim, the FCC concluded that state commissions may determine in
both arbitrations and disputes under existing interconnection
agreements whether reciprocal compensation should be paid for this
traffic.
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.
Page 14
15
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory Considerations (cont'd.)
- -----------------------------------
Reciprocal Compensation (cont'd.)
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 Web
site, which is often in another state. This echoed an earlier FCC
opinion and order in response to a federal tariff 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.
We believe that this FCC ruling confirms our 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. On June 18, 1999, however, the U.S. Court of
Appeals for the Seventh Circuit issued an opinion affirming an order
of the ICC directing Ameritech's landline communications subsidiary
in Illinois to pay reciprocal compensation on this traffic under
existing interconnection agreements. The Seventh Circuit reviewed
only the issue of whether the ICC's determination - that the parties
intended under their interconnection agreements that calls to ISPs
would be subject to reciprocal compensation - violated federal law.
The Seventh Circuit declined to review any contract issues and
concluded that the ICC's determination did not violate federal law
since it was expressly permitted under the FCC's ruling discussed
above. Ameritech has sought rehearing of this Seventh Circuit Court
decision and will continue to pursue judicial appeals of other
contrary state commission determinations.
Other appeals by Ameritech's landline communications subsidiaries of
adverse decisions are currently pending before the U.S. District
Courts in Michigan, Indiana and Ohio. The U.S. District Court in
Wisconsin recently dismissed an appeal by Ameritech's Wisconsin
landline communications subsidiary, without reaching the merits of
the case. Ameritech intends to appeal that dismissal.
We continue to believe that reciprocal compensation is not required
in these circumstances under the February 1999 FCC order. However,
there can be no assurance as to the ultimate judicial or regulatory
outcome or that the Ameritech landline communications subsidiaries,
including Michigan Bell, will not be required to continue to make
such reciprocal compensation payments under existing interconnection
agreements or in future arbitrations. Currently, all of the
Ameritech landline communications subsidiaries, including Michigan
Bell, are making reciprocal compensation payments (or arranging for
future true-up payments), under protest, pursuant to existing
interconnection agreements with CLECs providing services to ISPs.
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).
Page 15
16
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory Considerations (cont'd.)
- -----------------------------------
Universal Service, Access Charge Reform and Price Caps (cont'd.)
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 with the Illinois, Michigan and
Wisconsin state commissions seeking lower access charges. The state
commissions in Illinois (the Illinois Commerce Commission) and
Michigan (the MPSC), in response to such filings, 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 we receive from this charge
will decrease to the extent that we are 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. We have 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
price cap index assuming that the 6.5% factor had been in effect
since July 1996. Certain parties sought judicial review of the Price
Cap Order. The D.C. Circuit Court issued a decision remanding the
case to the FCC to explain the productivity offset factor.
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 Michigan 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 was released on July 16, 1999, and required
a reduced surcharge from $0.41 to $0.28 per line and appropriate
refunds, which were accrued in the second quarter of 1999.
Page 16
17
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory Considerations (cont'd.)
- -----------------------------------
Dial 1 +
In 1996, the MPSC issued two Orders requiring Michigan Bell to
provide statewide dialing parity (the ability to choose an alternate
carrier for intraLATA toll calls by dialing 1 before the phone
number), or to discount intraLATA toll access rates by 55% where
dialing parity was not implemented. The Michigan Court of Appeals
issued a stay of the MPSC Orders in January 1997, pending a
determination of Michigan Bell's appeal on the merits, and
subsequently declined a motion to vacate the stay.
In May 1998, the Court of Appeals issued a decision which reversed
the 1996 MPSC Orders. The Court concluded that, under the plain
language of the Michigan Telecommunications Act (MTA), Michigan Bell
was required to provide intraLATA toll dialing parity to no more than
10% of its customers on January 1, 1996, until Ameritech obtained
interLATA relief. The Court of Appeals also reversed the imposition
of a 55% discount on access charges.
The Michigan Supreme Court granted applications for leave to appeal
filed by several interexchange carriers (IXCs), the MPSC and the
Michigan Attorney General. While its application for leave to appeal
was pending, one IXC filed another MPSC complaint asking the
Commission to reinstate the 55% discount on access charges and to
issue a new mandate for dialing parity. The MPSC granted the IXC's
complaint and required immediate implementation for the remaining 30%
of our access lines in its January 19, 1999 Order. Ameritech filed a
motion for stay of the MPSC's Order with the Michigan Court of
Appeals on January 22, 1999. The Michigan Court of Appeals granted
that stay on February 9, 1999.
Pursuant to a March 23, 1999 FCC order, on April 9, 1999, we filed an
amended implementation plan with respect to the remaining 30% of
access lines for which dialing parity had not been implemented. On
April 12, 1999, the MPSC approved the plan. Intrastate toll dialing
parity was implemented statewide for Michigan Bell access lines on
May 12, 1999.
On June 8, 1999, the Michigan Supreme Court issued an opinion which
affirmed in part and reversed in part the May, 1998 Michigan Court of
Appeals decision. In its ruling, the Michigan Supreme Court
concluded that the MPSC's 1996 orders were illegal and of no effect,
because the MPSC's authority to require the implementation of
intraLATA dialing parity had been suspended from November 30, 1995
through July 1, 1997 by the MTA. The Court held that the MPSC's 1994
and 1995 orders requiring statewide implementation were
"grandfathered" and "saved" by a savings clause in the MTA, and so
were reinstated into effect following July 1, 1997.
The Michigan Supreme Court found that the MPSC had authority to
require a 55% discount on access charges, but that such authority was
linked to its authority to require dialing parity. Thus, its
authority to require a discount was suspended for a similar time
period from November 30, 1995 to July 1, 1997. The Court remanded
the case to the MPSC solely for the purposes of calculating what
monies might be due to the parties in accordance with this ruling.
By separate order, the Michigan Supreme Court remanded Ameritech's
appeal of the MPSC's January 19, 1999 order to the Michigan Court of
Appeals for consideration in light of the Michigan Supreme Court's
opinion.
Page 17
18
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Long-distance Services
- ----------------------
InterLATA long-distance is a $2.3 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.
In August 1997, the FCC denied Ameritech's application to provide
long-distance service in Michigan, stating in its order that
Ameritech failed to meet three of the 14 requirements included in the
competitive checklist. The order set forth various actions that we
must take in order to demonstrate compliance with the checklist. We
continue to work toward full long-distance entry consistent with the
1996 Act and under terms and conditions that make economic sense for
Ameritech.
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 states outside
the Ameritech five-state region. Accordingly, Ameritech's entry into
this market will not generate long-distance revenues for Michigan
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.
Year 2000 Readiness Disclosure
- ------------------------------
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 includes it,
potentially causing data miscalculations or inaccuracies or
operational malfunctions or failures.
Page 18
19
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 Readiness Disclosure (cont'd.)
- ----------------------------------------
Ameritech has established a centrally managed, companywide initiative
to identify, evaluate and address Year 2000 issues. Begun in May
1996, Ameritech's Year 2000 effort covers our 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 our business units and the phases often are
conducted in parallel, as of June 30, 1999, we believe that the
inventory and assessment phases are complete and the remediation,
testing and deployment phases are substantially complete.
As of June 30, 1999, nearly all of the network elements requiring
corrective activity, including 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
June 30, 1999, all of Ameritech's identified IT applications,
including those determined to be mission-critical, have been
remediated. A substantial majority of these 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 expected
to be completed during the third quarter of 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, 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 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, in most instances, Ameritech has no method of
compelling such disclosure, of assessing the accuracy of information
they may provide or 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 the key suppliers
as part of a supplier compliance program to seek to minimize such
risks.
There also may 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
Page 19
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 Readiness Disclosure (cont'd.)
- ----------------------------------------
service. We have 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 Michigan Bell, will incur expenses of
approximately $230 million through 2001 in connection with our
anticipated Year 2000 efforts, of which approximately $150 million
had been incurred through June 30, 1999. The timing of our expenses
may vary and is not necessarily indicative of readiness efforts or
progress to date. We anticipate that a portion of our Year 2000
expenses will not be incremental costs, but rather will represent the
redeployment of existing IT resources. Ameritech also expects to
incur certain capital improvement costs (totaling approximately $14
million) to support this project. Such capital costs (approximately
$12 million as of June 30, 1999) are being incurred sooner than
originally planned but, for the most part, would have been required
in the normal course of business.
As with 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 of 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 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, electric, gas and other public 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.
As part of our Year 2000 initiative, Ameritech is evaluating
scenarios that may occur as a result of the century change and is
continuing to develop 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
operational 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.
Page 20
21
Management's Discussion and Analysis
of Results of Operations (cont'd.)
New Accounting Pronouncements
- -----------------------------
FAS 133
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, as amended, is effective for all fiscal quarters of fiscal
years beginning after June 15, 2000, 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, depending on the nature and magnitude of
derivative activity in which we engage and the changes in market
conditions with respect to foreign currencies, 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.
Audit Report on Continuing Property Records
- -------------------------------------------
On March 12, 1999, the FCC released the results of a staff-level
audit of the property records of certain central office equipment
maintained by Ameritech's landline communications subsidiaries,
including Michigan Bell, and the other RHCs. Based solely on a
physical verification audit using statistical sampling techniques,
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 communications 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 is currently seeking additional public comments on issues
raised by the audit results.
Page 21
22
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Private Securities Litigation Reform Act Safe Harbor Statement
- --------------------------------------------------------------
Some of the information presented in, or in connection with this
report may constitute "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995 that involve
potential risks and uncertainties. Our future results could differ
materially from those discussed here. Some of the factors that could
cause or contribute to such differences include:
- - Changes in economic and market conditions that impact the demand
for our products and services;
- - 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 Michigan 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 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 22
23
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
--------
12 Computation of Ratio of Earnings to Fixed Charges for
the six months ended June 30, 1999 and June 30, 1998.
27 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
We did not file a Form 8-K during the quarter ended June
30, 1999.
Page 23
24
SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, an
authorized company official has signed this report on our behalf.
MICHIGAN BELL TELEPHONE COMPANY
-------------------------------
(Registrant)
Date: August 2, 1999 /s/ Ronald G. Pippin
----------------------
Ronald G. Pippin
Vice President and Comptroller
(Principal Accounting Officer)
Page 24
25
GLOSSARY
Access charges -
- ---------------
fees that local phone companies charge to long-distance carriers for
the handling of long-distance calls on our local network.
Access line -
- ------------
a telephone line for voice, data or video reaching from a local phone
company to a home or business.
ADSL (Asymmetric Digital Subscriber Line) -
- ------------------------------------------
a technology that uses the existing copper phone wiring serving
virtually all homes and businesses to provide customers network
access to the Internet and other popular multimedia and data services
at speeds 50 times faster than an ordinary phone line.
Advanced data services -
- ----------------------
services that use advanced technology to allow faster network access
to the Internet and other multimedia and data services.
Call management services -
- -------------------------
software-based services that add value and convenience for phone
customers, such as call waiting, call forwarding and Caller ID.
These services are sold to customers individually or in "packages."
Customer premises equipment (CPE) -
- ----------------------------------
communications equipment owned by customers, including telephones,
faxes and switches.
Dial 1 + -
- ---------
a feature that allows local phone customers to designate a carrier
other than the local service provider for toll calls within their
calling area by simply dialing 1 plus the telephone number.
Digital -
- --------
an alternative to traditional analog communications, digital systems
transport information in computer code for improved clarity and
quality.
Federal Communications Commission (FCC) -
- ----------------------------------------
the federal agency responsible for regulating the interstate aspects
of telecommunications activities.
Financial Accounting Standards Board (FASB) -
- --------------------------------------------
the independent body responsible for setting accounting and financial
reporting standards to be followed by U.S. business enterprises.
Gross receipts taxes -
- ---------------------
state and local taxes based upon the gross operating revenues earned
in a particular jurisdiction. These taxes may be imposed on general
businesses or public utilities in lieu of other taxes.
Interconnection -
- ----------------
allowing a competitive local service provider to use the local phone
company's network, or elements of the network, to provide local phone
service to its customers.
Interexchange carriers (IXCs) -
- ------------------------------
those companies primarily involved in providing long-distance voice
and data transmission services, such as AT&T, MCI 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.
Intrastate revenues -
- --------------------
that portion of revenues regulated by state rather than federal
authorities.
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26
GLOSSARY (cont'd.)
Landline communications subsidiaries -
- -----------------------------------
the subsidiaries of Ameritech engaged primarily in providing local
phone service and network access in the states of Illinois, Indiana,
Michigan, Ohio and Wisconsin.
Local access and transport area (LATA) -
- ---------------------------------------
the boundary within which a local telephone company may provide phone
service. It is usually centered around a city or other identifiable
community of interest.
Local exchange carriers (LECs) -
- -------------------------------
those companies primarily involved in providing local phone service
and access to the local phone network, including Ameritech's landline
communications subsidiaries in Illinois, Indiana, Michigan, Ohio and
Wisconsin.
Operations support systems (OSS) -
- ---------------------------------
the databases and information used to support the provision of
telephone service to end users.
Price caps -
- -----------
a form of regulation that sets maximum limits on the prices that LECs
can charge for access services instead of limits on rate of return or
profits.
Productivity factor -
- --------------------
a portion of the interstate price cap formula that requires LECs to
reduce the price cap based on an assumed increase in productivity.
Regional holding companies (RHCs) -
- -----------------------------------
the seven regional holding companies formed in connection with the
court-approved divestiture, effective January 1, 1984, of certain
assets of AT&T Corp. With the 1997 mergers of Pacific Telesis Group
into SBC Communications Inc. and NYNEX Corporation into Bell Atlantic
Corporation, five regional holding companies, including Ameritech,
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 long-distance companies for access
to the local phone network on a usage-sensitive basis.
Unbundled network element -
- -------------------------
any feature, function or capability used in the provision of
telecommunications service that is made available by local exchange
carriers to other telecommunications providers separate from other
network elements and for a separate fee.
Universal service -
- ------------------
a concept designed to ensure access to the telecommunications network
in rural and low-income areas at affordable prices. Funding
typically comes from urban telecommunication operators.
Voice-grade equivalent line -
- ----------------------------
a channel or other portion of a high capacity access line that can be
used to transmit voice or data traffic. For example, one DS1 circuit
is capable of handling 24 voice-grade and/or data lines.
Voice mail -
- ------------
a service that automatically answers calls, records messages and
distributes them.
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