Selected Financial and Operating Data
Dollars in millions except per share amounts
- --------------------------------------------------------------------------------
At December 31 or for the year
ended: 1998 1 1997 2 1996 1995 1994
- --------------------------------------------------------------------------------
Financial Data
- --------------------------------------------------------------------------------
Operating revenues $ 28,777$ 26,681 $ 25,202 $ 23,356 $ 22,555
- --------------------------------------------------------------------------------
Operating expenses $ 21,891$ 23,103 $ 18,976 $ 17,878 $ 17,216
- --------------------------------------------------------------------------------
Operating income $ 6,886 $ 3,578 $ 6,226 $ 5,478 $ 5,339
- --------------------------------------------------------------------------------
Interest expense $ 993 $ 1,043 $ 901 $ 1,043 $ 1,010
- --------------------------------------------------------------------------------
Equity in net income of affiliates $ 236 $ 201 $ 207 $ 120 $ 226
- --------------------------------------------------------------------------------
Income taxes $ 2,306 $ 984 $ 2,070 $ 1,632 $ 1,575
- --------------------------------------------------------------------------------
Income from continuing operations
before extraordinary loss and
cumulative effect of accounting
changes 3 $ 4,068 $ 1,674 $ 3,387 $ 3,132 $ 2,962
- --------------------------------------------------------------------------------
Net income (loss) $ 4,023 $ 1,674 $ 3,477 $ (3,577)$ 2,985
================================================================================
Earnings per common share:
Income from continuing operations
before extraordinary loss and
cumulative effect of accounting
changes 3 $ 2.08 $ 0.86 $ 1.73 $ 1.60 $ 1.53
- --------------------------------------------------------------------------------
Net income (loss) $ 2.06 $ 0.86 $ 1.78 $ (1.83)$ 1.54
================================================================================
Earnings per common share-Assuming
Dilution:
Income from continuing operations
before extraordinary loss and
cumulative effect of accounting
changes 3 $ 2.05 $ 0.85 $ 1.72 $ 1.60 $ 1.53
- --------------------------------------------------------------------------------
Net income (loss) $ 2.03 $ 0.85 $ 1.77 $ (1.82)$ 1.54
================================================================================
Total assets $45,066 $ 44,836 $ 42,057 $ 40,361 $ 49,525
- --------------------------------------------------------------------------------
Long-term debt $11,612 $ 13,176 $ 12,100 $ 11,592 $ 11,698
- --------------------------------------------------------------------------------
Construction and capital
expenditures $ 5,927 $ 6,230 $ 5,855 $ 4,729 $ 4,262
- --------------------------------------------------------------------------------
Free cash flow 4 $ 2,454 $ 1,366 $ 2,046 $ 2,572 $ 3,058
- --------------------------------------------------------------------------------
Dividends declared per common
share 5 $ 0.935 $ 0.895 $ 0.86 $ 0.825 $ 0.79
- --------------------------------------------------------------------------------
Book value per common share $ 6.52 $ 5.38 $ 5.22 $ 4.50 $ 7.36
- --------------------------------------------------------------------------------
Ratio of earnings to fixed charges 5.89 2.77 5.22 5.12 4.99
- --------------------------------------------------------------------------------
Debt ratio 48.86% 57.07% 56.83% 63.04% 48.71%
- --------------------------------------------------------------------------------
Weighted Average Common Shares
Outstanding (000,000) 1,957 1,945 1,956 1,955 1,936
- --------------------------------------------------------------------------------
Weighted Average Common Shares
Outstanding With Dilution
(000,000) 1,984 1,962 1,967 1,963 1,940
- --------------------------------------------------------------------------------
End of Period Common Shares
Outstanding (000,000) 1,959 1,954 1,942 1,960 1,952
- --------------------------------------------------------------------------------
Operating Data
- --------------------------------------------------------------------------------
Network access lines in
service (000) 37,252 35,727 34,003 32,385 31,173
- --------------------------------------------------------------------------------
Access minutes of use (000,000) 148,560 139,470 128,716 112,874 100,800
- --------------------------------------------------------------------------------
Wireless customers (000) 6,851 5,951 4,827 3,995 3,158
- --------------------------------------------------------------------------------
Number of employees 129,850 128,100 119,270 117,260 120,140
- --------------------------------------------------------------------------------
1 As detailed in management's discussion and analysis of Results of Operations,
1998 results include charges for strategic initiatives related to the merger
with Southern New England Telecommunications Corporation (SNET) and gains on
sales of certain non-core businesses. Excluding these items, SBC reported an
adjusted income from continuing operations before extraordinary loss and
cumulative effect of accounting change of $4,117 and an adjusted net income
of $4,072 for 1998.
2 As detailed in management's discussion and analysis of Results of Operations,
1997 results include charges for several items including strategic initiatives
and ongoing merger integration costs, gain on the sale of SBC's interests in
Bell Communications Research, Inc. and a first quarter after-tax settlement
gain. Excluding these items, SBC reported an adjusted net income of $3,450
for 1997.
3 1998, Early retirement of debt and Change in directory accounting; 1996,
Change in directory accounting; 1995, Discontinuance of Regulatory Accounting;
and 1994, Income from spun-off operations.
4 Free cash flow is net cash provided by operating activities less construction
and capital expenditures.
5 Dividends declared by SBC's Board of Directors; these amounts do not include
dividends declared and paid by Pacific Telesis Group and SNET prior to their
respective mergers.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Dollars in millions except per share amounts
SBC Communications Inc. (SBC) is a holding company whose subsidiaries and
affiliates operate predominantly in the communications services industry.
SBC's subsidiaries and affiliates provide landline and wireless
telecommunications services as well as equipment and directory advertising
both domestically and worldwide.
The consolidated financial results reflect SBC's mergers with Southern New
England Telecommunications Corporation (SNET) in 1998 and Pacific Telesis
Group (PAC) in 1997 as pooling of interests (see Note 2 of Notes to
Consolidated Financial Statements).
SBC's principal wireline subsidiaries are Southwestern Bell Telephone Company
(SWBell), providing telecommunications services in Texas, Missouri, Oklahoma,
Kansas and Arkansas (five-state area), Pacific Bell (PacBell, which also
includes Pacific Bell Information Services), The Southern New England
Telephone Company (SNETel) and Nevada Bell (collectively referred to as the
Telephone Companies). SBC's principal wireless subsidiaries are Southwestern
Bell Mobile Systems, Inc. (Mobile Systems), Pacific Bell Mobile Services
(PBMS) and SNET Cellular, Inc. SBC's principal directory subsidiaries are
Southwestern Bell Yellow Pages, Inc. (SWBYP), Pacific Bell Directory (PB
Directory) and SNET Information Services, Inc. The Telephone Companies are
subject to regulation by each of the states in which they operate and by the
Federal Communications Commission (FCC).
This discussion should be read in conjunction with the consolidated financial
statements and the accompanying notes.
Results of Operations
Summary
Financial results, including percentage changes from the prior year, are
summarized as follows:
- -------------------------------------------------------------------------------
Percent Change
-----------------
1998 1997
vs. vs.
1998 1997 1996 1997 1996
- -------------------------------------------------------------------------------
Operating revenues $ 28,777 $ 26,681 $ 25,202 7.9% 5.9%
Operating expenses $ 21,891 $ 23,103 $ 18,976 (5.2)% 21.7%
Income before
extraordinary loss and
cumulative effect of
accounting change $ 4,068 $ 1,674 $ 3,387 - -
Extraordinary loss $ (60) - - - -
Cumulative effect of
accounting change $ 15 - $ 90 - -
Net income $ 4,023 $ 1,674 $ 3,477 - -
===============================================================================
In 1998 and 1996, SBC reflected a cumulative effect of accounting change
related to accounting for directory revenues and expenses (see Note 1 of
Notes to Consolidated Financial Statements). In 1998, SBC incurred an
extraordinary loss related to the early retirement of debt at PacBell (see
Note 10 of Notes to Consolidated Financial Statements).
Results for 1998 and 1997 also include several items that SBC normalizes for
management purposes. For 1998, normalizing items included $219 of gains on
sales of certain non-core businesses, principally the required disposition of
SBC's interest in Mobile Telephone Networks (MTN), a South African national
cellular company, due to SBC's investment in Telkom SA Limited (Telkom), and
$268 of charges related to strategic initiatives resulting from the merger
integration process with SNET. For 1997, normalizing items included $1,899
of costs related to strategic initiatives resulting from the merger
integration process with PAC, the impact of several second quarter 1997
regulatory rulings and charges for ongoing merger integration costs (see Note
2 of Notes to Consolidated Financial Statements for further discussion of
merger integration costs), as well as $33 of gain on the sale of the
Telephone Companies' interests in Bell Communications Research, Inc.
(Bellcore) and $90 of first quarter 1997 settlement gain at PAC associated
with lump-sum pension payments that exceeded the projected service and
interest costs for 1996 retirements. Collectively these items decreased
income before extraordinary loss and cumulative effect of accounting change
by $49 and $1,776 in 1998 and 1997. Excluding these items, 1998 income
before extraordinary loss and cumulative effect of accounting change would
have been $4,117, or 19.3% higher than 1997 earnings of $3,450. The
corresponding diluted per share amounts would be $2.08 in 1998, or 18.2%
higher than $1.76 in 1997.
Excluding these items, the 1998 increase in income before extraordinary loss
and cumulative effect of accounting change was due primarily to broad-based
growth in demand for SBC's Wireline, Wireless and Directory operations.
Results for 1998 also reflect reduced dilution from Personal Communications
Services (PCS) operations in California and Nevada. Demand growth was also
the primary factor contributing to the 1997 increases, partially offset by a
high level of expenses for the introduction of PCS in California and Nevada.
Segment Results
SBC has four reportable segments: Wireline, Wireless, Directory and Other.
The Wireline segment provides landline telecommunications services, including
local, network access and long distance services, messaging and Internet
services and sells customer premise and private business exchange equipment.
The Wireless segment provides wireless telecommunications services, including
local and long distance services, and sells wireless equipment. The
Directory segment sells advertising for and publication of yellow pages and
white pages directories and electronic publishing. The Other segment
includes SBC's international investments and other domestic operating
subsidiaries. (See Note 9 of Notes to Consolidated Financial Statements.)
SBC evaluates performance of these segments based on income before income
taxes, adjusted for normalizing items. Normalizing items for 1998 and 1997
are described above. There were no normalizing items for 1996.
Collectively, these normalizing items had the effect of reducing operating
revenues in 1998 and 1997 by $8 and $188 and increasing operating expenses in
1998 and 1997 by $422 and $2,550, as well as affecting non-operating income
and expenses. If all of the normalizing items were included in their
respective segments, the effect would be to increase (reduce) each segment's
income before income tax in 1998 and 1997 as follows: Wireline $(306) and
$(2,007); Wireless $(49) and $(100); Directory $12 and $(75); and Other $268
and $0. The following sections will discuss SBC's operations excluding these
normalizing items.
Operating Revenues
Following are SBC's normalized operating revenues, including segment totals
and percentage changes from the prior year (reductions of $8 in 1998 and $188
in 1997 are excluded):
- --------------------------------------------------------------------------------
Percent Change
-----------------
1998 1997
vs. vs.
1998 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Wireline $ 22,210 $ 20,926 $ 19,919 6.1% 5.1%
Wireless 4,185 3,697 3,137 13.2 17.9
Directory 2,393 2,286 2,145 4.7 6.6
Other 85 57 43 49.1 32.6
Corporate, adjustments &
eliminations (88) (97) (42) (9.3) -
==============================================================
Total Normalized Operating
Revenues $ 28,785 $ 26,869 $ 25,202 7.1% 6.6%
================================================================================
Wireline
Wireline operating revenues increased $1,284, or 6.1%, in 1998 and $1,007, or
5.1%, in 1997. Components of Wireline operating revenues, including
percentage changes from the prior year, are as follows:
- --------------------------------------------------------------------------------
Percent Change
-----------------
1998 1997
vs. vs.
1998 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Local service $ 11,154 $ 10,434 $ 9,513 6.9% 9.7%
Network access:
Interstate 4,612 4,494 4,354 2.6 3.2
Intrastate 1,917 1,884 1,851 1.8 1.8
Long distance service 2,353 2,351 2,523 0.1 (6.8)
Other 2,174 1,763 1,678 23.3 5.1
=============================================================
Total Wireline $ 22,210 $ 20,926 $ 19,919 6.1% 5.1%
================================================================================
Local Service revenues increased $720, or 6.9%, in 1998 and $921, or
9.7%, in 1997 due primarily to increases in demand which totaled $656
and $799 in 1998 and 1997, including increases in access lines and
vertical services revenues. The number of access lines increased by
4.3% and 5.1% in 1998 and 1997. Approximately 40% and 31% of access
line growth in 1998 and 1997 was due to sales of additional access lines
to existing residential customers. In both years, approximately 46% of
the access line growth was in California and 32% was in Texas. Access
lines in Texas and California account for approximately 75% of the
Telephone Companies' access lines. Vertical services revenues, which
include custom calling options, Caller ID, voice mail and other enhanced
services, increased by approximately 20% in both years and totaled
approximately $1,892 and $1,582 in 1998 and 1997.
Additionally, local service revenues increased as a result of several
regulatory actions that also had the effect of decreasing one or more
other types of operating revenues. In 1998 and 1997, federal payphone
regulation, introduction of extended area service plans and the
introduction of the California High Cost Fund (CHCFB) collectively
increased local service revenues by approximately $157 and $211, and
decreased long distance revenue by approximately $53 and $117,
interstate network access revenue by $20 and $53, intrastate network
access revenue by approximately $24 and $26 and other operating revenue
by approximately $7 and $0. The net effect on Wireline operating
revenue was an increase of $53 and $15 in 1998 and 1997. The California
Public Utilities Commission (CPUC) has stated that the CHCFB is intended
to directly subsidize the provision of service to high-cost areas and
allow PacBell to set competitive rates for other services.
These increases in local service revenues were partially offset by
decreases of approximately $43 and $18 resulting from cellular
interconnection rate reductions in 1998 and 1997. Rate reductions under
CPUC price cap orders also reduced 1997 local service revenues by
approximately $56.
Network Access Interstate network access revenues increased $118, or
2.6%, in 1998 and $140, or 3.2%, in 1997 due largely to increases in
demand for access services by interexchange carriers, and growth in
revenues from end-user charges attributable to an increasing access line
base, which collectively resulted in an increase of approximately $420
and $361 in 1998 and 1997. Partially offsetting these increases were
the effects of rate reductions of approximately $189 in 1998 and $120 in
1997 related to the FCC's productivity factor adjustment, access reform
and other changes and regulatory shifts related to payphone deregulation
of approximately $20 and $53 as noted in local service above.
Additional decreases in 1998 totaling approximately $76 resulted from an
increase in universal service fund net payments implemented in the first
quarter of 1998 that exceeded the 1997 net payments of long-term
support, which were designed to subsidize universal service. The net
federal universal fund payments and receipts will be exogenous factors
in future federal price cap filings. Interstate network access revenues
in 1997 also had a net decrease of approximately $42 due to the reversal
of 1996 revenue sharing and proposed 1996 tariff decrease estimates at
the Telephone Companies.
Intrastate network access revenues increased $33 in both 1998 and 1997,
due largely to increases in demand totaling approximately $79 and $121
in 1998 and 1997, including usage by alternative intraLATA toll
carriers. These increases in 1998 and 1997 were partially offset by
state regulatory rate reductions at PacBell and SWBell totaling
approximately $23 and $50 and the effects of the CHCFB described above
in local service totaling approximately $24 and $26.
Long Distance Service revenues were relatively unchanged in 1998 and
decreased approximately $172, or 6.8%, in 1997. Long distance service
revenues decreased due to the effect of the regulatory shifts discussed
in local service above of approximately $53 and $117 in 1998 and 1997
related to the CHCFB, introduction of extended area service plans and
payphone deregulation, price competition from alternative intraLATA toll
carriers of approximately $43 and $100 in 1998 and 1997 at SWBell and
SNETel and regulatory rate reductions of approximately $34 in 1997.
These decreases were offset in 1998 and partially offset in 1997 by
revenues from increased toll messages and demand at PacBell totaling
approximately $48 and $45 in 1998 and 1997 and increased customer
migration to SNET All Distance (trademark), an interstate and intrastate
toll service, of approximately $20 and $42 in 1998 and 1997. In addition,
revenues in 1998 increased by approximately $22 due to the net effect of
regulatory rate orders and local exchange carrier billing settlements.
Other operating revenues increased $411, or 23.3%, in 1998 and $85, or
5.1%, in 1997 due primarily to increased sales from nonregulated
products and services at the Telephone Companies totaling approximately
$201 and $72 in 1998 and 1997, increased equipment sales at the
Telephone Companies of approximately $92 and $6 in 1998 and 1997 and
revenues from new business initiatives, primarily Internet services,
totaling approximately $71 and $39 in 1998 and 1997. In addition, net
payments for state universal funds of approximately $15 in 1998
contributed to the increase. These increases were partially offset in
1998 by approximately $7 related to the CHCFB, discussed in local
service above.
Wireless
Wireless operating revenues increased $488, or 13.2%, in 1998 and $560, or
17.9%, in 1997. Components of Wireless operating revenues, including
percentage changes from the prior year, are as follows:
- --------------------------------------------------------------------------------
Percent Change
-----------------
1998 1997
vs. vs.
1998 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Subscriber $ 3,783 $ 3,372 $ 2,907 12.2% 16.0%
Other 402 325 230 23.7 41.3
==============================================================
Total Wireless $ 4,185 $ 3,697 $ 3,137 13.2% 17.9%
================================================================================
Subscriber revenues consist of wireless local service and long distance.
Wireless subscriber revenues increased $411, or 12.2%, in 1998 and $465,
or 16%, in 1997 due primarily to growth in the number of customers of
15.1% and 23.3%, partially offset by declines in average revenue per
customer. Increases in 1997 wireless subscriber revenues of
approximately $103 also resulted from the introduction of PCS operations
in California, Nevada and Oklahoma. At December 31, 1998, SBC had
5,924,000 traditional cellular customers, 81,000 resale customers and
846,000 PCS customers. At December 31, 1997, SBC had 5,526,000
traditional cellular customers, 60,000 resale customers and 365,000 PCS
customers.
Other wireless revenues increased $77, or 23.7%, in 1998 and $95, or
41.3%, in 1997 due primarily to increases in equipment revenue
attributable to growth in the number of customers and conversion to
digital equipment.
Directory
Directory operating revenues increased $107, or 4.7%, in 1998 and $141, or
6.6%, in 1997. Directory operating revenues, including percentage changes
from the prior year, are as follows:
- --------------------------------------------------------------------------------
Percent Change
-----------------
1998 1997
vs. vs.
1998 1997 1996 1997 1996
================================================================================
Total Directory $ 2,393 $ 2,286 $ 2,145 4.7% 6.6%
================================================================================
Directory operating revenues increased in 1998 due mainly to increased
demand, including benefits from merger initiatives. Also contributing to the
increase was approximately $17 from directory rescheduling from the first
quarter of 1999 into the fourth quarter of 1998. Directory advertising
revenues increased in 1997 due mainly to increased demand and the publication
of directories in 1997 that were not published in 1996 due to rescheduling.
Operating Expenses
Following are SBC's normalized operating expenses, including percentage
changes from the prior year(additions of $422 in 1998 and $2,550 in 1997
are excluded):
- --------------------------------------------------------------------------------
Percent Change
----------------
1998 1997
vs. vs.
1998 1997 1996 1997 1996
- --------------------------------------------------------------------------------
Operations and support:
Wireline $ 12,711 $ 12,291 $ 11,464 3.4% 7.2%
Wireless 2,786 2,610 1,994 6.7 30.9
Directory 1,227 1,230 1,159 (0.2) 6.1
Other 152 93 46 63.4 -
Corporate, adjustments &
eliminations (363) (368) (153) (1.4) -
- ----------------------------------------------------------------
Total operations and support 16,513 15,856 14,510 4.1 9.3
Depreciation and amortization * 4,956 4,697 4,466 5.5 5.2
- ----------------------------------------------------------------
Total Normalized Operating
Expenses $ 21,469 $ 20,553 $ 18,976 4.5% 8.3%
================================================================================
* See Note 9 of Notes to Consolidated Financial Statements for breakdown by
segment.
Wireline
Operations and support expenses increased $420, or 3.4%, in 1998 and
$827, or 7.2%, in 1997. Increases for 1998 include costs of
approximately $262 related to progress in the merger implementation
process including centralizing support functions and other merger
initiatives at SWBell and PacBell. Offsetting these increased costs
were reductions in 1998 primarily related to realization of merger
initiative benefits that totaled approximately $317. These reductions
included lower use of contract labor, primarily at PacBell, lower costs
associated with customer number portability and reduced research and
development costs. Operations and support expense also increased in
1998 due to costs associated with reciprocal compensation for the
termination of Internet traffic of approximately $136 at the Telephone
Companies (see "Federal Regulation" for further discussion about
reciprocal compensation). Increased expenses in 1998 of approximately
$55 related to new business initiatives, primarily voice mail, Internet,
long distance and cable. Additional costs in 1998 totaling
approximately $172 related to increased wages and salaries, benefits,
materials and right to use fees. Comparisons to 1997 are also impacted
by the absence of the recognition of 1997 pension settlement gains
relating to 1997 retirees after the merger with PAC totaling
approximately $136.
Increases in 1997 include costs for wages, salaries, benefits, sales
commissions and contract labor totaling approximately $327. Increases
in 1997 also include costs associated with customer number portability
after the merger with PAC, interconnection, other regulatory mandated
network enhancements and materials of approximately $414. Increased
expenses in 1997 of approximately $156 related to new business
initiatives, primarily voice mail, Internet, long distance and cable.
These increases were partially offset by a reduction related to the
recognition of pension settlement gains discussed above.
Wireless
Wireless expenses increased $176, or 6.7%, in 1998 and $616, or 30.9%,
in 1997 due primarily to growth in the number of customers and increased
equipment sales. The large increase in 1997 expenses includes
approximately $362 of expenses from the introduction of PCS operations.
These increases were partially offset by decreased customer acquisition
costs of 11% and 4% in 1998 and 1997.
Directory
Directory expenses remained relatively unchanged in 1998 as lower costs
resulting from the merger integration process, including decreased
employee-related costs, were offset by expenses from increased demand
and directory rescheduling discussed in directory operating revenue
above. Directory expenses increased in 1997 due mainly to increased
demand and the publication of directories in 1997 that were not
published in 1996 due to rescheduling.
Depreciation and Amortization expense is primarily in the Wireline and
Wireless segments. In total, depreciation and amortization increased
$259, or 5.5%, in 1998 due primarily to increased depreciation expense
of $201 in the Wireline segment and $41 in the Wireless segment
resulting from overall higher plant levels. The increase in 1998 was
partially offset by reduced depreciation at PacBell related to analog
switching equipment of $42. Total depreciation and amortization
increased $231, or 5.2%, in 1997. The increase was due to increased
depreciation expense of $193 in the Wireline segment and $141 in the
Wireless segment resulting from overall higher plant levels. The
wireless increase was due primarily to the launch of PCS operations.
Reduced depreciation of $107 at PacBell related to analog switching
equipment partially offset the increase.
Interest Expense on a consolidated basis for 1998 decreased by $50, or 4.8%,
in 1998 and increased by $142, or 15.8%, in 1997. Interest expense for 1998
includes $3 of one-time charges for SNET merger-approval costs and 1997
includes $27 associated with one-time charges, primarily interest on the PAC
merger-approval costs. Excluding these charges, interest expense for 1998
decreased $26, or 2.6%, and increased $115, or 12.8%, for 1997. The 1998
decrease was due primarily to reductions in interest expense resulting from
lower average debt levels and lower weighted average interest rates,
partially offset by lower capitalization of interest during construction.
The 1997 increase was due primarily to increased average debt levels.
Equity in Net Income of Affiliates increased $35 in 1998 and decreased $6 in
1997. The 1998 increase reflects increased equity in net income of $78 from
SBC's investment in Telefonos de Mexico, S.A. de C.V. (Telmex), Mexico's
national telecommunications company, SBC's May 1997 investment in Telkom and
SBC's wireless operations. Also contributing to the increase were lower
losses resulting from reduced involvement in Tele-TV. These increases were
partially offset by a reduction of $53 in contribution from investments in
Switzerland, France and Israel, primarily resulting from expenditures on long
distance and wireless in Switzerland and long distance in France and Israel.
The 1997 decrease reflects decreased equity in net income of $49 from
Telmex. This lower income resulted from the change in the functional
currency used by SBC to record its interest in Telmex from the peso to the
U.S. dollar beginning in 1997 and SBC's reduced ownership percentage after
the sale of Telmex L shares. Results also reflect preoperating expenses of
$32 in several international investments, including long distance in France,
Switzerland and Israel and cellular communications in Taiwan, and decreased
contribution of $13 from SBC's wireless operations. These decreases were
mainly offset by equity in net income of $58 from Telkom and $27 in lower
losses from Tele-TV.
SBC's earnings from foreign affiliates will continue to be generally
sensitive to exchange rate changes in the value of the respective local
currencies. SBC's foreign investments are recorded under U.S. generally
accepted accounting principles, which include adjustments for the purchase
method of accounting and exclude certain adjustments required for local
reporting in specific countries, such as inflation adjustments.
Other Income (Expense) - Net for 1998 and 1997 includes amounts that SBC
management normalized for reviewing results. Normalizing amounts for 1998
include $358 in gains on the sale of non-core businesses, primarily the
required disposition of SBC's interest in MTN and the sale of SBC Media
Ventures, Inc., pending from the prior year. Amounts for 1997 reflect gains
of $54 from the sale of SBC's interests in Bellcore and $32 in second quarter
charges related to SBC's strategic initiatives, primarily writeoffs of
nonoperating plant. Absent these items, other income (expense) for 1998,
1997 and 1996 was $(113), $(100) and $(75).
During 1998, several offsetting transactions impacted other income and
expense contributing to the normalized increase of net other expense of $13.
SBC recognized other expense of $237 related to an impairment of an
international investment and investments in certain wireless technologies,
primarily wireless video. Also increasing other expense were higher minority
interest, lower interest income and call premiums and unamortized discounts
on early retirement of debt at SWBell that totaled $67 more than the previous
year. Offsetting these decreases were other income related to a special
dividend of $158 received from a software affiliate and gains of $127
recognized on the sales and the charitable contribution of SBC's
available-for-sale investment in Telewest Communications plc (see Note 7 of
Notes to Consolidated Financial Statements for further discussion of the
gains). Movement in the market value of Telmex L shares requires a market
valuation adjustment on certain SBC debt redeemable either in cash or Telmex
L shares. Additionally, Telmex under their repurchase program from time to
time repurchases enough shares in the market that SBC is required to sell
part of its Telmex L share holdings to Telmex to remain under 10% ownership
of Telmex. The net of these activities contributed $90 more to other income
than in 1997. Also affecting comparisons with 1997 was approximately $64 in
royalties and gains recognized in 1997.
During 1997, there were also several offsetting transactions contributing to
the normalized increase in net other expense of $25. Higher minority
interest, including distributions paid on an additional $500 of Trust
Originated Preferred Securities (TOPrS) sold by PAC in June 1996, and lower
interest income resulted in $43 more net expense than in 1996. The net
activity related to market movement on Telmex L shares increased other
expense by $47 more than in 1996. Partially offsetting these net other
expenses were royalty payments associated with software developed by an
affiliate and other investment gains totaling $64.
Income Taxes for 1998 include taxes related to the sale of certain non-core
businesses discussed in other income (expense) - net and tax benefits
associated with merger integration initiatives relating to SNET. Income
taxes for 1997 reflect the tax effect of charges for strategic initiatives
resulting from SBC's comprehensive review of operations and the impact of
several regulatory rulings. Income taxes for 1997 also included taxes on the
first quarter pension settlement gain discussed in operations and support.
The net effective tax rate on these items was lower as a result of
non-deductible items included in the charge and valuation adjustments to
certain deferred tax assets which may not be utilized due to restrictions
associated with the merger. Excluding these items, income taxes for 1998 and
1997 would have been $2,332 and $1,951. Income taxes for 1998 were higher
due primarily to higher income before income taxes. Income taxes for 1997,
excluding the non-recurring items, were slightly lower than income taxes for
1996 of $2,070.
Extraordinary Loss In 1998, SBC recorded an extraordinary loss of $60
related to the refinancing of $684 of long-term debt at PacBell.
Cumulative Effect of Accounting Change As discussed in Note 1 of Notes to
Consolidated Financial Statements, SNET Information Services, Inc. and PB
Directory changed their methods of recognizing directory publishing revenues
and related expenses effective January 1, 1998 and January 1, 1996,
respectively. The cumulative after-tax effect of applying the new method to
prior years for SNET Information Services, Inc. was recognized as of January
1, 1998 as a one-time, non-cash gain applicable to continuing operations of
$15, or $0.01 per share. The gain is net of deferred taxes of $11. The
one-time gain recognized as of January 1, 1996 for PB Directory was $90, net
of deferred taxes of $53, or $0.05 per share. Management believes the change
to the issue basis method is preferable because it is the method generally
followed in the publishing industry, including SWBYP, and better reflects the
operating activity of the businesses. These accounting changes are not
expected to have a significant effect on net income in future periods.
Operating Environment and Trends of the Business
Regulatory Environment
Overview
The telecommunications industry is in a period of dynamic transition from a
tightly regulated industry overseen by multiple regulatory bodies to a
market-driven industry monitored by state and federal agencies. The
Telephone Companies' wireline telecommunications operations remain subject to
regulation by the eight state regulatory commissions for intrastate services
and by the FCC for interstate services.
Consolidation of companies is occurring within the marketplace for local
telephone service and across other telecommunications services, such as long
distance, cellular, cable television, Internet and other data transmission
services. Companies operating in some of these markets are also expanding
into others, such as the provision of local service by long distance
companies. Additionally, new technologies are also affecting the way people
view and use communications services.
The telecommunications industry is also changing internationally, as
government-owned telephone monopolies are being privatized in many countries
and competitive entrants are authorized. U.S.-controlled companies may
acquire or form investment, joint venture or strategic relationships with
these newly privatized companies or their new competitors involving any or
all of the range of telecommunications services. Foreign-controlled
companies also may acquire or form such relationships with U.S. companies.
SBC is aggressively representing its interests before federal and state
regulatory bodies, courts, Congress and state legislatures. SBC will
continue to evaluate the increasingly competitive nature of its business, and
develop appropriate competitive, legislative and regulatory strategies.
Wireline
Federal Regulation
Through affiliates, SBC offers landline interLATA long distance services to
customers in selected areas outside the Telephone Companies' operating
areas. Further, SBC offers interLATA long distance services to customers in
Connecticut through SNET America, Inc. (SAI). Under the Telecommunications
Act of 1996 (Telecom Act), before being permitted to offer landline interLATA
long distance service in any state within the regulated operating areas of
SWBell, PacBell and Nevada Bell, SBC must apply for and obtain state-specific
approval from the FCC. The FCC's approval, which involves consultation with
the United States Department of Justice and the appropriate state commission,
requires favorable determinations that certain of the Telephone Companies
have entered into interconnection agreement(s) that satisfy a 14-point
"competitive checklist" with predominantly facilities-based carrier(s) that
serve residential and business customers or, alternatively, that certain of
the Telephone Companies have a statement of terms and conditions effective in
that state under which they offer the "competitive checklist" items. The FCC
must also make favorable public interest and structural separation
determinations in connection with each application. See "State Regulation"
for status of the state applications.
In December 1997, the United States District Court for the Northern District
of Texas ruled that parts of the Telecom Act were unconstitutional on the
grounds that they improperly discriminate against certain subsidiaries of SBC
by imposing restrictions that prohibit certain of the Telephone Companies by
name from offering interLATA long distance and other services that other
Local Exchange Carriers (LECs) are free to provide. In September 1998, the
United States Court of Appeals for the Fifth Circuit (5th Circuit) reversed
this decision and ruled that the challenged provisions of the Telecom Act
were constitutional. In January 1999, the United States Supreme Court
(Supreme Court) declined to hear an appeal of the 5th Circuit's decision.
Interconnection In August 1996, the FCC issued rules by which competitors
could connect with LECs' networks, including those of the Telephone
Companies. Among other things, the rules addressed unbundling of network
elements, pricing for interconnection and unbundled elements, and resale of
retail telecommunications services. The FCC rules were appealed by numerous
parties, including SBC.
In July 1997, the United States Court of Appeals for the Eighth Circuit (8th
Circuit) held that the FCC did not have the authority to promulgate rules
related to the pricing of local intrastate telecommunications and that its
rules in that regard were invalid. The 8th Circuit also overturned the FCC's
rules which allowed competitors to "pick and choose" among the terms and
conditions of approved interconnection agreements. In October 1997, the 8th
Circuit issued a subsequent decision clarifying that the Telecom Act does not
require the incumbent LECs to deliver network elements to competitors in
anything other than completely unbundled form.
In September 1997, a number of parties, including SBC, filed petitions to
enforce the July 1997 ruling of the 8th Circuit that the right to set local
exchange prices, including the pricing methodology used, is reserved
exclusively to the states. The petitions responded to the FCC's rejection of
Ameritech Corporation's interLATA long distance application in Michigan, in
which the FCC stated it intended to apply its own pricing standards to
Regional Holding Company (RHC) interLATA applications. The petitioners
asserted the FCC was violating state authority. On January 22, 1998, the 8th
Circuit ordered the FCC to abide by the July 1997 ruling and reiterated that
the FCC cannot use interLATA long distance applications made by SBC and other
RHC wireline subsidiaries wishing to provide interLATA long distance to
attempt to reimpose the pricing standards ruled invalid in July 1997 by the
8th Circuit.
In January 1999, the Supreme Court ruled on an appeal of the 8th Circuit's
order. The ruling held that the Telecom Act gives the FCC the authority to
set guidelines for states to follow in setting prices under the Telecom Act,
and reinstated the FCC rules allowing those seeking to interconnect to "pick
and choose" specific provisions from previous interconnection agreements.
Because the 8th Circuit's decision did not address the lawfulness of the
content of the FCC pricing guidelines, the Supreme Court remanded that issue
to the 8th Circuit for further consideration. The ruling also upheld FCC
rules forbidding incumbent LECs from separating already combined network
elements, but remanded back to the FCC its determination of which network
elements must be made available. The Supreme Court also held that, before the
FCC could require telecommunications carriers to make a particular network
element available to requesting carriers, the FCC must first consider as to
proprietary elements, whether access to the elements was necessary and
whether the failure to provide access to a particular element would impair
the requesting carrier's ability to provide the service it seeks to offer.
The effect of this ruling on the telecommunications industry cannot be
determined at this time.
Reciprocal Compensation Reciprocal compensation is billed to SBC's
subsidiaries by Competitive Local Exchange Carriers (CLECs) for the
termination of certain local exchange traffic to CLEC customers. SBC
believes that under the Telecom Act the state commissions have authority to
order reciprocal compensation for intrastate or local traffic, while only the
FCC has authority over interstate and interexchange traffic. SBC believes
most Internet traffic is interexchange and interstate. Several state
commissions, including the CPUC in an October 1998 order, have taken the
position that Internet communications is intrastate or local traffic and
ordered SBC to pay reciprocal compensation to certain CLECs pursuant to then
existing contracts. State commissions in the five-state area other than
Kansas have also issued orders finding that SBC is required to pay reciprocal
compensation to certain CLECs. In June 1998, a U.S. District Court in Texas
affirmed the Texas Public Utility Commission's (TPUC) determination and
upheld payment of reciprocal compensation, holding that an Internet call is
comprised of two portions, and that the TPUC has jurisdiction over the local
portion of the traffic and the FCC over the Internet component. Similar
decisions regarding Internet traffic have been made by other state
commissions. SBC has sought review or reconsideration of these cases.
The question whether Internet communications should be classified as
local/intrastate or interstate traffic for reciprocal compensation purposes
is the subject of a pending FCC proceeding and the FCC is expected to rule on
this issue in the near future. SBC's subsidiaries have been recording
amounts sought by certain CLECs for the termination of Internet traffic to
Internet Service Providers.
Asymmetrical Digital Subscriber Line (ADSL) is a high-speed data service
principally used for Internet access. In June 1998, SBC filed with the FCC a
petition requesting relief for ADSL from pricing, unbundling and resale
regulatory restrictions. The FCC denied the petition and declared that
incumbents, such as the Telephone Companies, must offer such services for
resale at a discount and must offer unbundled access to the equipment used in
ADSL provisioning to the extent possible. SBC has filed with the FCC a
petition for reconsideration of this order. The FCC sought comments on
offering the incumbent LECs the option of providing deregulated advanced
services through an affiliate with appropriate safeguards.
The effects of the FCC decisions on the above topics are dependent on many
factors including, but not limited to, the ultimate resolution of the pending
appeals; the number and nature of competitors requesting interconnection,
unbundling or resale; and the results of the state regulatory commissions'
review and handling of related matters within their jurisdictions.
Accordingly, SBC is not able to assess the impact of the FCC orders and
proposed rulemaking at this time.
State Regulation
The following provides an overview of state regulation in the eight states in
which the Telephone Companies operated at December 31, 1998.
- --------------------------------------------------------------------------------
Number of
Signed
Wireline
Alternative Interconnection Long Distance
State Regulation 1 Dialing Parity 2 Agreements 3 Application Status
- --------------------------------------------------------------------------------
Arkansas Yes, indefinite Presently not 54 Decision expected
required prior in 1999 4
to long distance
authorization
- --------------------------------------------------------------------------------
California Yes, ends Proceeding 66 Decision expected
1/2002 pending in 1999 4
- --------------------------------------------------------------------------------
Connecticut Yes, ends Dialing parity 13 Long distance
2/2001 exists service provided by
the retail entity 5
- --------------------------------------------------------------------------------
Kansas Yes, indefinite Commission 55 Decision expected
ordered in 1999 4
implementation
by 2/1999; state
statute
presently
prohibits
requirement
before long
distance
authorization
- --------------------------------------------------------------------------------
Missouri Yes, indefinite Proceeding 61 Decision expected
pending in 1999 4
- --------------------------------------------------------------------------------
Nevada Yes, ends Presently not 19 No activity
12/2002 required prior
to long distance
approval;
proceeding
pending
- --------------------------------------------------------------------------------
Oklahoma Yes, ends Ordered by 3/1999 52 Decision expected
2/2001 in 1999 4
- --------------------------------------------------------------------------------
Texas Yes, ends TPUC deferred 175 Decision expected
9/2001 its decision in 1999 4
pending FCC
issuance of new
dialing parity
rules; state
statute
presently
prohibits
requirement
before long
distance
authorization
- --------------------------------------------------------------------------------
Other significant notes:
1 Alternative regulation is other than rate of return regulation.
2 In a January 1999 decision, the Supreme Court ruled that the FCC had
the authority to issue rules implementing intrastate and intraLATA dialing
parity. Several interexchange carriers are arguing in pending state
proceedings that the ruling requires immediate implementation of dialing
parity, preempting state requirements. The Telephone Companies take the
position that dialing parity requirements should be consistent with state
laws and that they should not be required to provide intraLATA toll
dialing parity prior to receiving authorization to provide interLATA long
distance services. In states where dialing parity exists, customers are
able to subscribe to an intraLATA toll carrier just as they do for long
distance services.
3 Interconnection agreements are signed with CLECs for the purpose of
allowing the CLECs to exchange local calls with the incumbent telephone
company.
4 Awaiting determination by state commissions on the Telephone Companies'
compliance with the 14-point competitive checklist. FCC approval is
required subsequent to state determination.
5 SNETel is restricted from providing interLATA long distance service in
any of the other Telephone Companies' operating regions.
The following presents highlights of certain regulatory developments.
California In October 1998, the CPUC issued a decision modifying the current
regulatory framework for PacBell effective January 1, 1999. The decision
adopted PacBell's proposal that the current cap on basic residential rates be
continued for three more years, through 2001, with the CPUC retaining the
ability to adjust basic telephone rates. The decision suspended earnings
sharing, rate of return reviews and the use of earnings caps and floors
through 2001. In addition, the decision adopted PacBell's proposal to
eliminate depreciation reviews and granted PacBell the freedom to set its own
depreciation rates and methodology. It also continued the suspension of the
productivity factor adjustment. In addition, the CPUC decision eliminated
most future exogenous cost adjustments, including the recovery of future
costs related to a 1993 accounting change for postretirement benefits other
than pensions. Management currently estimates the items embodied within the
new regulatory framework will have the net effect of reducing annual revenue
by approximately $100 from 1999 through 2004.
In July 1998, the CPUC issued a rate rebalancing decision related to its 1996
order on universal service. The CPUC's decision was implemented
prospectively beginning September 1, 1998 and reduces PacBell's non-basic
local service, network access and long distance service revenues by $305
annually to offset the approximately $305 annually that PacBell expects to
receive from the CHCFB. Beginning in February 1997, PacBell, and all other
California telecommunications carriers, began collecting funds via customer
surcharges consistent with the CPUC's 1996 decision. The CPUC has yet to
decide on the specific mechanism to be employed to ensure the distribution of
funds collected by PacBell and other carriers from February 1997 through
August 1998 is revenue neutral.
Connecticut In January 1997, SNET submitted to the Connecticut Department of
Public Utility Control (DPUC) its proposal on corporate restructure. The
proposal recommended that SNETel functions be split: ownership and
maintenance of switching and transmission network facilities, i.e., all
wholesale functions, would remain in the telephone company, SNETel, and all
retail functions would go to SAI, which was the long distance subsidiary.
Both would be wholly-owned by SNET. In June 1997, the DPUC granted SNET
permission to restructure its telephony operations, with several DPUC-imposed
modifications.
Under the plan, all retail operations (retail marketing and customer service)
have been transferred to SAI, and SAI will be treated by the regulators like
all other CLECs. SNET local service customers will choose their provider via
a balloting process, which has been scheduled for September 1999. All
wholesale services and the network infrastructure will remain with SNETel,
which will be restricted to meeting the needs of CLECs, including SAI and
other wholesale customers. SAI can buy its wholesale service from SNETel or
any other wholesale provider. SAI has been providing interstate and
international long distance service since 1993, and received certification to
provide local service and intrastate toll in Connecticut in 1997.
Missouri Effective September 26, 1997, the Missouri Public Service
Commission (MPSC) determined that SWBell is subject to price cap regulation.
Prices in effect as of December 31, 1996 are the initial maximum allowable
rates for services and cannot be adjusted until January 1, 2000 for basic and
access services and on January 1, 1999 for non-basic services. On an
exchange basis where a competitor began operations, the freeze on maximum
allowable rates for non-basic services was removed. After January 1, 2000,
caps for basic and access services may be adjusted based on one of two
government indices. After January 1, 1999, caps for non-basic services may
be increased up to 8% per year. In an exchange where competition for basic
local service exists for five years, services will be declared competitive
and subject to market pricing unless the MPSC finds effective competition
does not exist. The Office of Public Counsel and MCI WorldCom, Inc. (MCI
WorldCom) sought judicial review of the MPSC determination and in May 1998
the state circuit court affirmed the MPSC decision.
Texas Under the Public Utility Regulatory Act, which became effective in May
1995 (PURA), SWBell elected to move from rate of return regulation to price
regulation with elimination of earnings sharing. Basic local service rates
are capped at existing levels for four years following the election, i.e.,
until September 1999. The TPUC is prohibited from reducing switched access
rates charged by LECs to interexchange carriers while rates are capped.
LECs electing price regulation are committed to network and infrastructure
improvement goals, including expansion of digital switching and advanced
high-speed services to qualifying public institutions, such as schools,
libraries and hospitals, requesting the services. PURA also established an
infrastructure grant fund for use by public institutions in upgrading their
communications and computer technology. The 1997 Texas legislative session
changed the funding for this infrastructure grant fund from annually
collecting $150 for ten years to a fixed percentage (1.25%) applied to all
telecommunications providers' sales taxable revenues. The law also provides
a cap of $1,500 for the life of the fund. SWBell's annual payments were
approximately $36 in 1997 and $56 in 1998. Due to the industry's growth in
revenues, the fund should be completely funded before the original ten years.
PURA establishes local exchange competition by allowing companies that desire
to provide local exchange services to apply for certification by the TPUC,
subject to certain buildout requirements, resale restrictions and minimum
service requirements. PURA provides that SWBell will remain the default
carrier of "1 plus" intraLATA long distance traffic in its territory until
SWBell is allowed to carry interLATA long distance. In 1996, MCI WorldCom
and AT&T Corp. (AT&T) sued the state of Texas, alleging that PURA violates
the Texas state constitution, and claiming that PURA establishes
anticompetitive barriers designed to prevent MCI WorldCom, AT&T and Sprint
Corporation (Sprint) from providing local services within Texas. The FCC,
also in response to petitions filed by AT&T and MCI WorldCom, preempted and
voided portions of PURA that required certain buildout requirements.
Furthermore, the FCC also preempted rules that excluded competitors from
entering markets with fewer than 31,000 access lines and which made resale of
Centrex phone services subject to a limited property restriction. AT&T and
MCI WorldCom have dismissed their suits regarding this matter. In October
1997, SWBell filed with the FCC a petition for reconsideration regarding the
preemption of the property restriction for Centrex services. This issue is
still pending before the FCC.
Competition
Wireline
Competition continues to increase for telecommunications and information
services. Recent changes in legislation and regulation have increased the
opportunities for alternative service providers offering telecommunications
services. Technological advances have expanded the types and uses of
services and products available. As a result, SBC faces increasing
competition as well as new opportunities in significant portions of its
business.
Recent state legislative and regulatory developments allow increased
competition for local exchange services. Companies wishing to provide
competitive local service have filed numerous applications with each of the
state commissions throughout the Telephone Companies' regulated operating
areas, and the commissions of each state have been approving these
applications since late 1995. Under the Telecom Act, companies seeking to
interconnect to the Telephone Companies' networks and exchange local calls
must enter into interconnection agreements with the Telephone Companies.
These agreements are then subject to approval by the appropriate state
commission. SBC has reached approximately 495 interconnection and resale
agreements with competitive local service providers, and most have been
approved by the relevant state commission. AT&T, MCI WorldCom and other
competitors are reselling SBC local exchange services, and as of December 31,
1998, there were approximately 800,000 SBC access lines supporting services
of resale competitors throughout the Telephone Companies' regulated operating
areas, most of them in Texas and California. Many competitors have placed
facilities in service and have begun advertising campaigns and offering
services. SBC also was granted facilities-based and resale operating
authority in certain territories served by other LECs and now offers local
exchange service offerings to these areas.
In California, the CPUC authorized facilities-based local services
competition effective January 1996 and resale competition effective March
1996. While the CPUC has established local competition rules and interim
prices, several issues still remain to be resolved, including final rates for
resale and LEC provisioning and pricing of certain network elements to
competitors. PacBell has incurred substantial costs implementing local
competition and number portability. In November 1998, the CPUC issued a
decision allowing PacBell to begin recovery of local competition
implementation costs.
In Texas, the TPUC set rates in December 1997 that SWBell may charge for
access and interconnection to its telephone network. The TPUC decision sets
pricing for dozens of network components and completes a consolidated
arbitration between SWBell and six of its wholesale customers, including AT&T
and MCI WorldCom.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing
with AT&T and MCI WorldCom and on selected items with Metropolitan Fiber
Systems. Among other terms, the orders established discount rates for resale
of SWBell services and prices for unbundled network elements. SWBell
appealed the interconnection agreement resulting from the first arbitration
proceeding on November 5, 1997; a decision is still pending. A second
arbitration process to address other interconnection issues with AT&T has
concluded, and the MPSC ordered that a conforming interconnection agreement
be filed. SWBell appealed this order in April 1998.
The Telephone Companies expect increased competitive pressure in 1999 and
beyond from multiple providers in various markets, including facilities-based
CLECs, interexchange carriers and resellers. At this time, management is
unable to assess the effect of competition on the industry as a whole, or
financially on SBC, but expects both losses of market share in local service
and gains resulting from new business initiatives, vertical services and new
service areas. Competition also continues to intensify in the Telephone
Companies' intraLATA long distance markets. For example, it is estimated
that providers other than PacBell now serve more than half of the business
intraLATA long distance customers in PacBell's service areas. In addition,
if intraLATA toll dialing parity is required, competition in intraLATA long
distance markets is expected to increase.
In the international arena, Telmex was granted a concession in 1990, which
expired in August 1996, as the sole provider of long distance services in
Mexico. Several large competitors have received licenses to compete with
Telmex and have begun operations. As of December 31, 1998, Telmex has
retained approximately 75% of its long distance customers. Telmex's share of
international long distance traffic is expected to decline significantly when
the proportional return mechanism, which guarantees Telmex the same
percentage of incoming traffic as outgoing traffic, expires at the end of
1999. Aggressive local competition is expected in 1999, primarily in the
business segment.
Wireless
In 1993, the FCC adopted an order allocating radio spectrum and licenses for
PCS. PCS utilizes wireless telecommunications digital technology at a higher
frequency radio spectrum than cellular. Like cellular, it is designed to
permit access to a variety of communications services regardless of
subscriber location. In an FCC auction, which concluded in March 1995, PCS
licenses were awarded in 51 major markets. SBC or affiliates acquired PCS
licenses in the Major Trading Areas of Los Angeles-San Diego, California; San
Francisco-Oakland-San Jose, California; Memphis, Tennessee; Little Rock,
Arkansas; and Tulsa, Oklahoma. The California licenses cover substantially
all of California and Nevada. SBC is currently operational in all of its
major California-Nevada markets and Tulsa, Oklahoma. During 1996, SBC
received several AT&T cellular networks in Arkansas in exchange for SBC's PCS
licenses in Memphis, Tennessee, and Little Rock, Arkansas, and other
consideration.
PCS service was formally launched in all the major California and Nevada
markets at different times throughout 1997, with the buildout to other areas
continuing. The network incorporates the Global System for Mobile
Communications standard, which is widely used in Europe. PBMS is selling PCS
as an off-the-shelf product in retail stores, through exclusive agents and in
company-owned stores across California and Nevada. Significant competition
exists, particularly from the two established cellular companies in each
market.
In an FCC auction that concluded in January 1997, SBC acquired eight
additional PCS licenses for Basic Trading Areas that are within the
five-state area.
SBC also has state-approved interconnection agreements to receive reciprocal
compensation from interexchange carriers and other local service providers
accessing its wireless networks in all states where it provides wireless
services.
Companies that were granted licenses in areas where SBC also provides
wireless service include subsidiaries and affiliates of AT&T, Sprint and
other RHCs. Significant competition from PCS providers exists in SBC's major
markets. Competition has been based upon both price and service packaging,
such as unlimited calling plans, and has contributed to SBC's decline in
average subscriber revenue per wireless customer.
Under the Telecom Act of 1996, SBC may offer interLATA long distance over its
wireless network both inside and outside the regulated operating areas. SBC
has entered the wireless long distance markets, and offers wireless long
distance service in all of its wireless service areas.
Directory
SWBYP, PB Directory and SNET Information Services, Inc. face competition from
over 100 publishers of printed directories in their operating areas. Direct
and indirect competition also exists from other advertising media, including
newspapers, radio, television and direct mail providers, as well as from
directories offered over the Internet.
Other Business Matters
New Accounting Standards In June 1998, the Financial Accounting Standards
Board issued Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities" (FAS 133), which will require all derivatives to be
recorded on the balance sheet at fair value, and will require changes in the
fair value of the derivatives to be recorded in net income or comprehensive
income. FAS 133 must be adopted for years beginning after June 15, 1999,
with earlier adoption permitted. Management is currently evaluating the
impact of the change in accounting required by FAS 133, but is not able to
quantify the effect at this time.
See Note 1 of Notes to Consolidated Financial Statements for a discussion of
the new accounting standard on software costs.
Wireless Acquisition See Note 17 of Notes to Consolidated Financial
Statements for a discussion of the acquisition of Comcast Cellular
Corporation.
Long Distance Agreement On February 8, 1999, SBC announced an agreement with
Williams Communications (Williams), a subsidiary of Williams Cos., Inc.,
under which Williams will serve as SBC's long distance provider. As part of
this agreement, SBC plans to acquire 10% of the common stock of Williams.
This investment will occur simultaneously with an initial public offering of
common stock by Williams, scheduled for the second quarter of 1999.
Merger See Note 3 of Notes to Consolidated Financial Statements for a
discussion of the merger agreement with Ameritech Corporation.
SBC's Year 2000 Project SBC operates numerous date-sensitive computer
applications and systems throughout its businesses. Since 1996, SBC has been
working to upgrade its networks and computer systems to properly recognize
the Year 2000 and continue to process critical operational and financial
information. Companywide teams are in place to address and resolve Year 2000
issues and processes are under way to evaluate and manage the risks and costs
associated with preparing SBC's date-impacted systems and networks for the
new millennium.
SBC is using a four-step methodology to address the issue. The methodology
consists of inventory and assessment, hardware and software fixes, testing
and deployment. SBC measures its progress by tracking the number of
completed hardware and software applications, network components, personal
computers and building facilities that can correctly process Year 2000 dates.
Inventory and assessment is estimated to require 20% of the overall effort
and includes the identification of items (i.e., line-by-line review of
software code, switch generics, vendor products, etc.) that could be impacted
by the Year 2000 and the determination of the work effort required to ensure
compliance. The inventory and assessment phase has been completed. This
process involved reviewing over 340 million lines of software code, 1,200
central office switches, 7,000 company buildings, conducting an inventory and
assessment of 117,000 personal computers, and coordinating with 1,300
suppliers of 14,000 products to obtain adequate assurance they will be Year
2000 compliant or determine and address any appropriate contingency plans or
backup systems.
Making the hardware and software fixes is the second phase of the process and
is estimated to require 25% of the overall effort. This activity involves
modifying program code, upgrading computer software and upgrading or
replacing hardware. As of December 31, 1998, the hardware and software fixes
were substantially complete.
Testing involves ensuring that hardware and software fixes will work properly
in 1999 and beyond and occurs both before and after deployment. Testing is
estimated to comprise 45% of the overall effort. Testing began early in
1998, is more than two-thirds complete, and will continue through 1999 to
allow for thorough testing before the Year 2000. Contingency plans and
backup systems are currently being written.
Deployment involves placing the "fixed" systems into a live environment to
ensure they are working properly. Additional testing is done after
deployment as well. Deployment is estimated to require 10% of the overall
effort. More than half of the deployment phase was completed as of December
31, 1998.
SBC expects to spend approximately $265 on the entire project, with
approximately $140 spent through December 31, 1998. As testing and hardware
and software fixes are estimated to require most of the expenditures, there
is not a strict correlation between expenditures and project completion.
The activities involved in SBC's Year 2000 project necessarily require
estimates and projections, as described above, of activities and resources
that will be required in the future. These estimates and projections could
change as work progresses on the project.
Liquidity and Capital Resources
SBC had $460 of cash and cash equivalents available at December 31, 1998.
Commercial paper borrowings as of December 31, 1998 totaled $1,044. SBC has
entered into agreements with several banks for lines of credit totaling
$1,460, all of which may be used to support commercial paper borrowings (see
Note 10 of Notes to Consolidated Financial Statements). SBC had no
borrowings outstanding under these lines of credit as of December 31, 1998.
Cash from Operating Activities
During 1998, as in 1997 and 1996, SBC's primary source of funds continued to
be cash generated from operations, as shown in the Consolidated Statements of
Cash Flows. Net cash provided by operating activities exceeded SBC's
construction and capital expenditures during 1998, as in 1997 and 1996; this
excess is referred to as free cash flow, a supplemental measure of
liquidity. SBC generated free cash flow of $2,454, $1,366 and $2,046 in
1998, 1997 and 1996.
Cash from Investing Activities
To provide high-quality communications services to its customers, SBC,
particularly its Wireline and Wireless operations, must make significant
investments in property, plant and equipment. The amount of capital
investment is influenced by demand for services and products, continued
growth and regulatory commitments.
SBC's capital expenditures totaled $5,927, $6,230 and $5,855 for 1998, 1997
and 1996. Capital expenditures in the Wireline segment were relatively
unchanged in 1998 compared to 1997. The Wireline segment's capital
expenditures increased 12% in 1997 due primarily to demand-related growth,
network upgrades, customer-contracted requirements, ISDN projects and
SWBell's regulatory commitments. The Wireless segment's capital expenditures
decreased 17% and 23% in 1998 and 1997 due primarily to expenditures for
initial buildout of the PCS network and conversion of SBC's largest cellular
markets to digital during 1997 and 1996.
In 1999, management expects total capital spending to be between $6,400 and
$6,800. Capital expenditures in 1999 will relate primarily to the continued
evolution of the Telephone Companies' networks, including amounts agreed to
under regulation plans at SWBell, and continued buildout of Mobile Systems'
markets and PBMS. SBC expects to fund ongoing capital expenditures with cash
provided by operations.
SWBell has substantially completed the additional network and infrastructure
improvements to be made over periods ranging through 2001 to satisfy
regulatory commitments.
Cash from Financing Activities
Dividends declared by the Board of Directors of SBC were $0.935 per share in
1998, $0.895 per share in 1997, and $0.86 per share in 1996. These per share
amounts do not include dividends declared and paid by PAC and SNET prior to
their respective mergers. The total dividends paid by SBC, PAC and SNET were
$1,836 in 1998, $1,755 in 1997 and $1,795 in 1996. Pursuant to the terms of
the merger agreement, PAC reduced its dividend beginning in the second quarter
of 1996. The lower second and third quarter dividends paid in 1996 improved
1996 cash flow by approximately $195. SBC's dividend policy considers both
the expectations and requirements of shareowners, internal requirements of SBC
and long-term growth opportunities.
In February 1998, SBC called $630 of long-term debt for retirement, including
$175 at PacBell and $425 at SWBell, and issued approximately $200 in
debentures at PacBell due February 2008 and approximately $200 in debentures
at SWBell due March 2048. In September 1998, SBC called $175 of long-term
debt for retirement, all at SWBell. In October 1998, PacBell repurchased
$684 of debentures.
Total debt increased during 1997 due primarily to the issuance of medium-term
notes and debentures at the Telephone Companies and debt redeemable either in
cash or Telmex L shares.
During 1996 PAC issued $1,000 of TOPrS, $500 at 7.56% in January 1996 and
$500 at 8.5% in June 1996 (see Note 11 of Notes to Consolidated Financial
Statements). The proceeds were used to retire outstanding short-term debt,
primarily commercial paper that had increased significantly during 1995.
SBC's total capital consists of debt (long-term debt and debt maturing within
one year), TOPrS and shareowners' equity. Total capital increased $108 in 1998
and $1,056 in 1997. The increase in 1998 was due to 1998 earnings, partially
offset by lower debt levels. The increase in 1997 was primarily due to higher
debt levels and 1997 earnings.
SBC's debt ratio was 48.9%, 57.1% and 56.8% at December 31, 1998, 1997 and
1996. The debt ratio is affected by the same factors that affect total
capital.
Market Risk
SBC's capital costs are directly linked to financial and business risks. SBC
seeks to manage the potential negative effects from market volatility and
market risk. Certain financial instruments used to obtain capital are
subject to market risks from fluctuations in market interest rates. The
majority of SBC's financial instruments are medium- and long-term fixed rate
notes and debentures. Fluctuations in market interest rates can lead to
significant fluctuations in the fair value of these notes and debentures. It
is the policy of SBC to manage its debt structure and foreign exchange
exposure in order to manage capital costs, control financial risks and
maintain financial flexibility over the long term. Where appropriate, SBC
will take actions to limit the negative effect of interest and foreign
exchange rates, liquidity and counterparty risks on shareowner value.
Quantitative Information about Market Risk
- --------------------------------------------------
Foreign Exchange Risk Sensitivity Analysis
- --------------------------------------------------
U.S. Dollar Net Underlying
Value of Net Foreign
Foreign Currency
December 31, Exchange Transaction
1998 Contracts Exposures
- --------------------------------------------------
Swiss Franc $ 24 $ 24
Japanese Yen 142 142
French Franc 37 37
Chilean Peso 32 32
- --------------------------------------------------
Total Exposure $ 235 $ 235
- --------------------------------------------------
Note: There is no net exposed long/short currency position and no foreign
exchange loss from a 10% depreciation of the U.S. dollar.
The preceding table describes the effects of a change in the value of the
Swiss franc, Japanese yen, Chilean peso and French franc given a hypothetical
10% depreciation of the U.S. dollar. Since the identified exposure is fully
covered with forward contracts, changes in the value of the U.S. dollar which
affect the value of the underlying foreign currency commitment are fully
offset by changes in the value of the foreign currency contract. If the
underlying currency transaction exposure changed, the resulting mismatch
would expose the company to currency risk of the foreign exchange contract.
For this reason, all contracts are related to firm commitments and matched by
maturity and currency.
Equity Price Risk Sensitivity Analysis
SBC is exposed to equity price risk related to the change in the price of
AirTouch Communications, Inc. (AirTouch) common stock related to the
settlement of employee stock options. At December 31, 1998, the net
appreciated value of the equity swap contract entered in 1994 was $26, while
the value of the underlying employee stock option exposures for AirTouch
common stock was $25, leaving a net exposed long equity position of $1. If
the value of AirTouch common stock increased by 26%, the net exposed long
equity position would increase by $1 to $2. Since January 1, 1995, the
average yearly share price of AirTouch common stock has increased 26%. The
equity swap contract expires April 1999 and the last option grant expires
January 2003. (See Note 11 of Notes to Consolidated Financial Statements.)
In February 1999, management evaluated the exposure to future appreciation of
AirTouch common stock and the benefit to "unwinding" the swap. As a result,
SBC began exiting the equity swap contract, receiving cash for the
appreciated value of the contract and recognizing a minimal gain. Once
exited, SBC will record in other income (expense) - net future changes in the
value of the underlying employee stock option exposure. If the value of
AirTouch common stock were to increase by an additional 26% from mid-February
1999, SBC would record additional expense of approximately $8.
Interest Rate Sensitivity
The principal amount by expected maturity, average interest rate and fair
value of SBC's liabilities that are exposed to interest rate risk are
described in Notes 10 and 11 of Notes to Consolidated Financial Statements.
Following are SBC's interest rate derivatives subject to interest rate risk
(none of these derivatives mature in 2000 through 2003):
- -----------------------------------------------------------
Maturity
- -----------------------------------------------------------
Fair
After Value
1999 2003 Total 12/31/98
- -----------------------------------------------------------
Interest Rate Derivatives
- -----------------------------------------------------------
Interest Rate Swaps
- -----------------------------------------------------------
Receive Variable/Pay
Fixed Notional Amount 1 $50 - $50 $(1)
Fixed Rate Payable 7.2% -
Weighted Average Variable
Rate Receivable 2 5.1% -
- -----------------------------------------------------------
Receive Variable/Pay
Fixed Notional Amount 3 - $13 $13 $(1)
Fixed Rate Payable 6.7% 6.7%
Weighted Average Variable
Rate Receivable 4 5.0% 5.5%
===========================================================
1 Receive Variable/Pay Fixed amount is offset equally by $50 in Variable
Rate Debt maturing in 1999 with an average interest rate of 4.5% and a
fair value of $50.
2 Weighted Average Variable Rate Receivable based on current and the implied
forward rates in the yield curve at the reporting date for Constant
Maturity Treasury minus 20 basis points.
3 Receive Variable/Pay Fixed amount offsets $13 in lease obligation due
after 2003 with an average interest rate of 5.8% and a fair value of $13.
4 Weighted Average Variable Rate Receivable based on current and the implied
forward rates in the yield curve at the reporting date for One Month LIBOR.
As a result of interest rate fluctuations, if SBC were to terminate the
contracts, it would be required to pay $2 to replace the fixed rate flows or
"unwind" the interest swaps. SBC does not intend to terminate the $50
contract as it is linked to the variable rate debt issued by SBC that also
matures in 1999.
There has been no material change in the updated market risks since December
31, 1997.
Qualitative Information about Market Risk
Foreign Exchange Risk
From time to time SBC makes investments in operations in foreign countries,
is paid dividends, receives proceeds from sales or borrows funds in foreign
currency. Before making an investment, or in anticipation of a foreign
currency receipt, SBC will often enter into forward foreign exchange
contracts. The contracts are used to provide currency at a fixed rate.
SBC's policy is to measure the risk of adverse currency fluctuations by
calculating the potential dollar losses resulting from changes in exchange
rates that have a reasonable probability of occurring. SBC covers the
exposure that results from changes that exceed acceptable amounts. SBC does
not speculate in foreign exchange markets.
Equity Risk
SBC has exposure to risk of market changes related to its recorded liability
for outstanding employee stock options for common stock of AirTouch (spun-off
operations). SBC plans to make open market purchases of the stock of
spun-off operations to satisfy its obligation for options that are
exercised. Off-balance-sheet risk exists to the extent the market price of
AirTouch rises in value. As discussed in "Equity Price Risk Sensitivity
Analysis" above, SBC evaluated the exposure to future appreciation of
AirTouch common stock and is exiting a swap contract related to the options
by April 1999.
Interest Rate Risk
SBC issues debt in fixed and floating rate instruments. Interest rate swaps
are used for the purpose of controlling interest expense by fixing the
interest rate of floating rate debt. When market conditions favor issuing
debt in floating rate instruments, and SBC prefers not to take the risk of
floating rates, SBC will enter interest rate swap contracts to obtain
floating rate payments to service the debt in exchange for paying a fixed
rate. SBC does not seek to make a profit from changes in interest rates.
SBC manages interest rate sensitivity by measuring potential increases in
interest expense that would result from a probable change in interest rates.
When the potential increase in interest expense exceeds an acceptable amount,
SBC reduces risk through the issuance of fixed rate instruments and
purchasing derivatives.
Cautionary Language Concerning Forward-Looking Statements
Information set forth in this report contains forward-looking statements that
are subject to risks and uncertainties. SBC claims the protection of the
safe harbor for forward-looking statements provided by the Private Securities
Litigation Reform Act of 1995.
The following factors could cause SBC's future results to differ materially
from those expressed in the forward-looking statements: (1) adverse economic
changes in the markets served by SBC or changes in available technology; (2)
the final outcome of various FCC rulemakings and judicial review, if any, of
such rulemakings; (3) the final outcome of various state regulatory
proceedings in SBC's eight-state area, and judicial review, if any, of such
proceedings; and (4) the timing of entry and the extent of competition in the
local and intraLATA toll markets in SBC's eight-state area. Readers are
cautioned that other factors discussed in this report, although not
enumerated here, also could materially impact SBC's future earnings.
SBC Communications Inc.
Consolidated Statements of Income
Dollars in millions except per share amounts
- --------------------------------------------------------------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------------------
Operating Revenues
Landline local service $ 11,100 $ 10,334 $ 9,465
Wireless subscriber 3,783 3,372 2,907
Network access 6,512 6,215 6,203
Long distance service 2,355 2,352 2,523
Directory advertising 2,420 2,280 2,156
Other 2,607 2,128 1,948
- --------------------------------------------------------------------------------------------
Total operating revenues 28,777 26,681 25,202
- --------------------------------------------------------------------------------------------
Operating Expenses
Operations and support 16,714 17,802 14,510
Depreciation and amortization 5,177 5,301 4,466
- --------------------------------------------------------------------------------------------
Total operating expenses 21,891 23,103 18,976
- --------------------------------------------------------------------------------------------
Operating Income 6,886 3,578 6,226
- --------------------------------------------------------------------------------------------
Other Income (Expense)
Interest expense (993) (1,043) (901)
Equity in net income of affiliates 236 201 207
Other income (expense) - net 245 (78) (75)
- --------------------------------------------------------------------------------------------
Total other income (expense) (512) (920) (769)
- --------------------------------------------------------------------------------------------
Income Before Income Taxes, Extraordinary Loss and
Cumulative Effect of Accounting Change 6,374 2,658 5,457
- --------------------------------------------------------------------------------------------
Income taxes 2,306 984 2,070
- --------------------------------------------------------------------------------------------
Income Before Extraordinary Loss and Cumulative
Effect of Accounting Change 4,068 1,674 3,387
Extraordinary Loss from Early Extinguishment of Debt,
net of tax (60) - -
Cumulative Effect of Accounting Change, net of tax 15 - 90
- --------------------------------------------------------------------------------------------
Net Income $ 4,023 $ 1,674 $ 3,477
============================================================================================
Earnings Per Common Share:
Income Before Extraordinary Loss and Cumulative
Effect of Accounting Change $ 2.08 $ 0.86 $ 1.73
Net Income $ 2.06 $ 0.86 $ 1.78
- --------------------------------------------------------------------------------------------
Earnings Per Common Share-Assuming Dilution:
Income Before Extraordinary Loss and Cumulative
Effect of Accounting Change $ 2.05 $ 0.85 $ 1.72
Net Income $ 2.03 $ 0.85 $ 1.77
============================================================================================
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</FN>
SBC Communications Inc.
Consolidated Balance Sheets
Dollars in millions except per share amounts
- -----------------------------------------------------------------------------------------
December 31,
---------------------------
1998 1997
- -----------------------------------------------------------------------------------------
Assets
Current Assets
Cash and cash equivalents $ 460 $ 410
Short-term cash investments 6 320
Accounts receivable - net of allowances for uncollectibles of
$472 and $430 5,790 5,344
Prepaid expenses 414 357
Deferred income taxes 489 660
Other current assets 379 426
- -----------------------------------------------------------------------------------------
Total current assets 7,538 7,517
- -----------------------------------------------------------------------------------------
Property, Plant and Equipment - Net 29,920 29,068
- -----------------------------------------------------------------------------------------
Intangible Assets - Net of Accumulated Amortization of
$741 and $1,047 3,087 3,663
- -----------------------------------------------------------------------------------------
Investments in Equity Affiliates 2,514 2,740
- -----------------------------------------------------------------------------------------
Other Assets 2,007 1,848
- -----------------------------------------------------------------------------------------
Total Assets $ 45,066 $ 44,836
=========================================================================================
Liabilities and Shareowners' Equity
Current Liabilities
Debt maturing within one year $ 1,551 $ 2,139
Accounts payable and accrued liabilities 7,980 8,330
Dividends payable 458 441
- -----------------------------------------------------------------------------------------
Total current liabilities 9,989 10,910
- -----------------------------------------------------------------------------------------
Long-Term Debt 11,612 13,176
- -----------------------------------------------------------------------------------------
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 1,990 1,569
Postemployment benefit obligation 5,220 5,200
Unamortized investment tax credits 359 431
Other noncurrent liabilities 2,116 2,030
- -----------------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities 9,685 9,230
- -----------------------------------------------------------------------------------------
Corporation-obligated mandatorily redeemable preferred
securities of subsidiary trusts# 1,000 1,000
- -----------------------------------------------------------------------------------------
Shareowners' Equity
Preferred shares ($1 par value, 10,000,000 authorized:
none issued) - -
Common shares ($1 par value, 7,000,000,000 authorized:
issued 1,987,532,349 at December 31, 1998 and
1,984,141,868 at December 31, 1997) 1,988 992
Capital in excess of par value 9,139 9,966
Retained earnings 3,396 1,204
Guaranteed obligations of employee stock ownership
plans (ESOP) (147) (219)
Deferred compensation - leveraged ESOP (LESOP) (82) (119)
Treasury shares (28,217,018 at December 31, 1998 and
29,741,356 at December 31, 1997, at cost) (882) (730)
Accumulated other comprehensive income (632) (574)
- -----------------------------------------------------------------------------------------
Total shareowners' equity 12,780 10,520
- -----------------------------------------------------------------------------------------
Total Liabilities and Shareowners' Equity $ 45,066 $ 44,836
=========================================================================================
<FN>
# The trusts contain assets of $1,030 in principal amount of the Subordinated
Debentures of Pacific Telesis Group.
The accompanying notes are an integral part of the consolidated financial statements.
</FN>
SBC Communications Inc.
Consolidated Statements of Cash Flows
Dollars in millions, increase (decrease) in cash and cash equivalents
- -------------------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------------------
Operating Activities
Net income $ 4,023 $ 1,674 $ 3,477
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,177 5,301 4,466
Undistributed earnings from investments in
equity affiliates (56) (100) (138)
Provision for uncollectible accounts 513 566 438
Amortization of investment tax credits (72) (82) (82)
Deferred income tax expense 533 239 485
Extraordinary loss, net of tax 60 - -
Cumulative effect of accounting change, net of tax (15) - (90)
Changes in operating assets and liabilities:
Accounts receivable (959) (902) (1,097)
Other current assets (8) (56) 301
Accounts payable and accrued liabilities (187) 1,431 591
Other - net (628) (475) (450)
- -------------------------------------------------------------------------------------------
Total adjustments 4,358 5,922 4,424
- -------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 8,381 7,596 7,901
- -------------------------------------------------------------------------------------------
Investing Activities
Construction and capital expenditures (5,927) (6,230) (5,855)
Investments in affiliates (85) (26) (74)
Purchase of short-term investments (42) (916) (1,005)
Proceeds from short-term investments 355 1,029 816
Dispositions 1,140 578 96
Acquisitions - (1,118) (442)
Other 11 13 19
- -------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (4,548) (6,670) (6,445)
- -------------------------------------------------------------------------------------------
Financing Activities
Net change in short-term borrowings with original
maturities of three months or less (367) (563) (974)
Issuance of other short-term borrowings 2 1,079 209
Repayment of other short-term borrowings (8) (805) (134)
Issuance of long-term debt 413 1,597 988
Repayment of long-term debt (1,121) (602) (443)
Early extinguishment of debt and related call premiums (765) (6) -
Issuance of trust originated preferred securities - - 1,000
Purchase of fractional shares - (15) -
Issuance of common shares 64 - 111
Purchase of treasury shares (498) (87) (650)
Issuance of treasury shares 308 293 52
Dividends paid (1,811) (1,724) (1,765)
Other - (7) (103)
- -------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (3,783) (840) (1,709)
- -------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 50 86 (253)
- -------------------------------------------------------------------------------------------
Cash and cash equivalents beginning of year 410 324 577
- -------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Year $ 460 $ 410 $ 324
===========================================================================================
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</FN>
SBC Communications Inc.
Consolidated Statements of Shareowners' Equity
Dollars and shares in millions except per share amounts
- ------------------------------------------------------------------------------------------------------------------------------------
Common Accumulated Treasury
Shares Capital in Retained Guaranteed Deferred Other Shares Total
------------- Excess of Earnings Obligations Compensation Comprehensive ------------- Comprehensive
Shares Amount Par Value (Deficit) of ESOP LESOP Income Shares Amount Income
-----------------------------------------------------------------------------------------------------
Balance, December 31, 1995 991 $ 991 $ 10,002 $ (546) $ (331) $ (242) $ (578) (11) $ (481) $ -
Net income for the year
($1.78 per share) - - - 3,477 - - - - - 3,477
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of income tax
benefit of $28 - - - - - - (59) - - (59)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Comprehensive Income 3,418
- ------------------------------------------------------------------------------------------------------------------------------------
Dividends to shareowners
($0.86 per share) - - (115) (1,680) - - - - - -
Reduction of debt
associated with ESOP - - - - 55 - - - - -
Cost of LESOP trust shares
allocated to employee accounts - - - - - 81 - - - -
Issuance of common shares - - 20 - - - - - - -
Purchase of treasury shares - - - - - - - (13) (650) -
Issuance of treasury shares - - 21 - - - - 4 146 -
Other - - 3 14 - - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 991 991 9,931 1,265 (276) (161) (637) (20) (985) 3,418
- ------------------------------------------------------------------------------------------------------------------------------------
Net income for the year
($0.86 per share) - - - 1,674 - - - - - 1,674
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of income tax
expense of $38 - - - - - - 63 - - 63
- ------------------------------------------------------------------------------------------------------------------------------------
Total Comprehensive Income 1,737
- ------------------------------------------------------------------------------------------------------------------------------------
Dividends to shareowners
($0.895 per share) - - - (1,755) - - - - - -
Reduction of debt
associated with ESOP - - - - 57 - - - - -
Cost of LESOP trust shares
allocated to employee accounts - - - - - 42 - - - -
Issuance of common shares 1 1 39 - - - - - - -
Purchase of treasury shares - - - - - - - (2) (87) -
Issuance of treasury shares - - (38) - - - - 7 335 -
Other - - 34 20 - - - - 7 -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1997 992 992 9,966 1,204 (219) (119) (574) (15) (730) 1,737
- ------------------------------------------------------------------------------------------------------------------------------------
Net income for the year
($2.06 per share) - - - 4,023 - - - - - 4,023
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of income tax
benefit of $37 - - - - - - (58) - - (58)
Unrealized gain on
available-for-sale
securities - - - - - - 60 - - 60
Less: reclassification
adjustment for gains
included in net income - - - - - - (60) - - (60)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Comprehensive Income 3,965
- ------------------------------------------------------------------------------------------------------------------------------------
Dividends to shareowners
($0.935 per share) - - - (1,836) - - - - - -
Two-for-one stock split 993 993 (993) - - - - (15) - -
Reduction of debt
associated with ESOP - - - - 72 - - - - -
Cost of LESOP trust shares
allocated to employee accounts - - - - - 37 - - - -
Issuance of common shares 3 3 74 - - - - - - -
Purchase of treasury shares - - - - - - - (12) (498) -
Issuance of treasury shares - - (33) - - - - 14 346 -
Other - - 125 5 - - - - - -
====================================================================================================================================
Balance, December 31, 1998 1,988 $1,988 $ 9,139 $ 3,396 $ (147) $ (82) $ (632) (28)$ (882) $ 3,965
====================================================================================================================================
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</FN>
Notes to Consolidated Financial Statements
Dollars in millions except per share amounts
Note 1. Summary of Significant Accounting Policies
Basis of Presentation - The consolidated financial statements include the
accounts of SBC Communications Inc. and its majority-owned subsidiaries
(SBC). The statements reflect SBC's mergers with Pacific Telesis Group (PAC)
and Southern New England Telecommunications Corporation (SNET) as pooling of
interests (see Note 2). SBC's subsidiaries and affiliates operate
predominantly in the communications services industry, providing landline and
wireless telecommunications services and equipment and directory advertising
both domestically and worldwide.
SBC's principal wireline subsidiaries are Southwestern Bell Telephone Company
(SWBell), providing telecommunications services in Texas, Missouri, Oklahoma,
Kansas and Arkansas, Pacific Bell (PacBell, which also includes Pacific Bell
Information Services), The Southern New England Telephone Company and Nevada
Bell (collectively referred to as the Telephone Companies). SBC's principal
wireless subsidiaries are Southwestern Bell Mobile Systems, Inc., Pacific
Bell Mobile Services and SNET Cellular, Inc. SBC's principal directory
subsidiaries are Southwestern Bell Yellow Pages, Inc. (SWBYP), Pacific Bell
Directory (PB Directory) and SNET Information Services, Inc.
All significant intercompany transactions are eliminated in the consolidation
process. Investments in partnerships, joint ventures and less than
majority-owned subsidiaries are principally accounted for under the equity
method. Earnings from certain foreign investments accounted for under the
equity method are included for periods ended within three months of SBC's
year end.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates. Certain amounts in
prior period financial statements have been reclassified to conform to the
current year's presentation.
Income Taxes - Deferred income taxes are provided for temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for tax purposes.
Investment tax credits earned prior to their repeal by the Tax Reform Act of
1986 are amortized as reductions in income tax expense over the lives of the
assets which gave rise to the credits.
Cash Equivalents - Cash equivalents include all highly liquid investments
with original maturities of three months or less.
Deferred Charges - Directory advertising costs are deferred until the
directory is published and advertising revenues related to these costs are
recognized.
Revenue Recognition/Cumulative Effect of Accounting Change - SBC recognizes
revenues as earned. Amounts billed in advance of the period in which service
is rendered are recorded as a liability.
SNET Information Services, Inc. prior to January 1, 1998, and PB
Directory, prior to January 1, 1996, recognized revenues and expenses
related to publishing directories using the "amortization" method, under
which revenues and expenses were recognized over the lives of the
directories, generally one year. Effective January 1, 1998, for SNET
Information Services, Inc. and January 1, 1996, for PB Directory, the
accounting was changed to the "issue basis" method of accounting, which
recognizes the revenues and expenses at the time the related directory is
published. The change in methodology was made because the issue basis
method is generally followed in the publishing industry, including SWBYP,
and better reflects the operating activity of the business.
The cumulative after-tax effect of applying the changes in method to prior
years was recognized as of January 1, 1998 and 1996 as one-time, non-cash
gains of $15, or $0.01 per share and $90, or $0.05 per share. The gains
are net of deferred taxes of $11 and $53. Had the current method been
applied during prior periods, income before extraordinary loss and
cumulative effect of accounting change would not have been materially
affected.
Property, Plant and Equipment - Property, plant and equipment is stated at
cost. The cost of additions and substantial betterments of property,
plant and equipment is capitalized. The cost of maintenance and repairs
of property, plant and equipment is charged to operating expenses.
Property, plant and equipment is depreciated using straight-line methods
over their estimated economic lives, generally ranging from 3 to 50
years. In accordance with composite group depreciation methodology, when
a portion of the Telephone Companies' depreciable property, plant and
equipment is retired in the ordinary course of business, the gross book
value is charged to accumulated depreciation; no gain or loss is
recognized on the disposition of this plant.
Intangible Assets - Intangible assets consist primarily of wireless
cellular and Personal Communications Services (PCS) licenses, customer
lists and the excess of consideration paid over net assets acquired in
business combinations. These assets are being amortized using the
straight-line method, over periods generally ranging from 5 to 40 years.
At December 31, 1998 and 1997, amounts included in net intangible assets
for licenses were $2,141 and $2,261. Management periodically reviews the
carrying value and lives of all intangible assets based on expected future
cash flows.
Software Costs - The costs of computer software purchased or developed for
internal use are expensed as incurred. However, initial operating system
software costs are capitalized and amortized over the estimated economic
lives of the associated hardware. The American Institute of Certified
Public Accountants has issued a Statement of Position (SOP) that requires
capitalization of certain computer software expenditures beginning in 1999.
Management continues to evaluate the impact of the change in accounting
required by the SOP and anticipates that it will increase net income by
less than $200 in 1999. With comparable levels of software expenditures,
the SOP would tend to increase net income in comparison with SBC's current
method of accounting for software costs. However, the increases would be
largest in the year of adoption with diminishing levels of increases
compared with current accounting throughout the amortization period.
Consequently, given otherwise comparable income levels excluding software,
and otherwise comparable software expenditures, the effect of the SOP
would be to increase income in the first year and decrease income in each
subsequent year until the number of years affected by the SOP equals the
amortization period.
Advertising Costs - Costs for advertising products and services or
corporate image are expensed as incurred (see Note 18).
Foreign Currency Translation - Local currencies are generally considered
the functional currency for SBC's share of foreign operations, except in
countries considered highly inflationary. SBC translates its share of
foreign assets and liabilities at current exchange rates. Revenues and
expenses are translated using average rates during the year. The ensuing
foreign currency translation adjustments are recorded as a separate
component of shareowners' equity. Other transaction gains and losses
resulting from exchange rate changes on transactions denominated in a
currency other than the local currency are included in earnings as
incurred.
Derivative Financial Instruments - SBC does not invest in any derivatives
for trading purposes. From time to time as part of its risk management
strategy, SBC uses immaterial amounts of derivative financial instruments
including interest rate swaps to hedge exposures to interest rate risk on
debt obligations, and foreign currency forward exchange contracts to hedge
exposures to changes in foreign currency rates for transactions related to
its foreign investments. Derivative contracts are entered into for
hedging of firm commitments only. SBC currently does not recognize the
fair values of these derivative financial investments or their changes in
fair value in its financial statements. Interest rate swap settlements
are recognized as adjustments to interest expense in the consolidated
statements of income when paid or received. Foreign currency forward
exchange contracts are set up to coincide with firm commitments. Gains
and losses are deferred until the underlying transaction being hedged
occurs, and then are recognized as part of that transaction. PAC entered
into an equity swap contract to hedge exposure to risk associated with its
recorded liability for certain outstanding employee stock options relating
to stock of AirTouch Communications Inc. (AirTouch) (see Note 15). The
equity swap contract and its liability are recorded at fair value in the
balance sheet as other assets or liabilities. Equity swap settlements are
recorded in interest expense in the consolidated statements of income when
paid or received.
Note 2. Mergers with SNET and PAC
On April 1, 1997, SBC and PAC completed the merger of an SBC subsidiary
with PAC, in a transaction in which each outstanding share of PAC common
stock was exchanged for 1.4629 shares of SBC common stock (equivalent to
approximately 626 million shares). With the merger, PAC became a
wholly-owned subsidiary of SBC. The transaction has been accounted for as
a pooling of interests and a tax-free reorganization.
Transaction costs and one-time charges relating to the closing of the
merger were $359 ($215 net of tax) including, among other items, the
present value of amounts to be returned to California ratepayers as a
condition of the merger and expenses for investment banker and
professional fees. Of this total, $287 ($180 net of tax) is included in
expenses in 1997, and $72 ($35 net of tax) in 1996. The amounts due to
ratepayers are being paid out over five years, from 1998 to 2002.
On October 26, 1998, SBC and SNET completed the merger of an SBC
subsidiary with SNET, in a transaction in which each share of SNET common
stock was exchanged for 1.7568 shares of SBC common stock (equivalent to
approximately 120 million shares). SNET became a wholly-owned subsidiary
of SBC effective with the merger and the transaction has been accounted
for as a pooling of interests and a tax-free reorganization. Financial
statements for prior periods have been restated to include the accounts of
SNET. Transaction costs related to the merger were $40 ($26 net of tax).
Operating revenues, income before extraordinary loss and cumulative effect
of accounting change and net income of the separate companies for the
pre-merger periods of the last three periods were as follows:
-----------------------------------------------------------------------------
Nine
Months
Ended
September 30, Year Ended December 31,
----------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------
Operating revenues:
SBC $ 19,495 $ 24,659 $ 23,260
SNET 1,606 2,022 1,942
=============================================================================
Combined $ 21,101 $ 26,681 $ 25,202
=============================================================================
Income before extraordinary loss and
cumulative effect of accounting
change:
SBC $ 3,085 $ 1,474 $ 3,189
SNET 164 198 193
Adjustments 3 2 5
=============================================================================
Combined $ 3,252 $ 1,674 $ 3,387
=============================================================================
Net income:
SBC $ 3,085 $ 1,474 $ 3,279
SNET 179 194 193
Adjustments 3 6 5
=============================================================================
Combined $ 3,267 $ 1,674 $ 3,477
=============================================================================
The combined results include the effect of changes applied retroactively
to conform the accounting methodologies between SNET and SBC for pension
and postemployment benefits. SBC believes the new method is more
prevalent and better reflects the operations of the business.
Post-merger initiatives
During the second quarter of 1997, SBC announced after-tax charges of $1.6
billion related to several strategic decisions resulting from the merger
integration process that began with the April 1, 1997 closing of its
merger with PAC, which included $165 ($101 after tax) of charges related
to several regulatory rulings during the second quarter of 1997 and $281
($176 after tax) for merger approval costs. The decisions resulted from
an extensive review of operations throughout the merged company and
include significant integration of operations and consolidation of some
administrative and support functions.
During the fourth quarter of 1998, SBC again performed a complete review
of all operations affected by the merger with SNET to determine the impact
on ongoing merger integration processes. Review teams examined
operational functions and evaluated all strategic initiatives. As a result
of this review, SBC announced net after-tax charges of $268 related to
strategic decisions arising from the review and expensing of
merger-related costs incurred by SNET.
One-time charges related to the strategic decisions reached by the review
teams totaled $403 ($249 after tax) in the fourth quarter of 1998 and $2
billion ($1.3 billion after tax) in the second quarter of 1997. At
December 31, 1998 and 1997, remaining accruals for anticipated cash
expenditures related to these decisions were approximately $323 and $432.
Reorganization SBC is centralizing several key functions that will
support the operations of the Telephone Companies, including network
planning, strategic marketing and procurement. It is also consolidating a
number of corporate-wide support activities, including research and
development, information technology, financial transaction processing and
real estate management. The Telephone Companies will continue as separate
legal entities. These initiatives continue to result in the creation of
some jobs and the elimination and realignment of others, with many of the
affected employees changing job responsibilities and in some cases
assuming positions in other locations.
SBC recognized charges of approximately $82 ($50 net of tax) during the
fourth quarter of 1998 and $338 ($213 net of tax) during the second
quarter of 1997 in connection with these initiatives. The charges were
comprised mainly of postemployment benefits, primarily related to
severance, and costs associated with closing down duplicate operations,
primarily contract cancellations. Other charges arising out of the
mergers related to relocation, retraining and other effects of
consolidating certain operations are being recognized in the periods those
charges are incurred. The initial integration process subsequent to the
PAC merger resulted in SBC incurring expenses for these merger-related
items in advance of any substantial synergistic benefits. During the
second half of 1997, these merger-related charges totaled $501 ($304 net
of tax).
Impairments/asset valuation As a result of SBC's merger integration
plans, strategic review of domestic operations and organizational
alignments, SBC reviewed the carrying values of related long-lived assets
in the fourth quarter of 1998 and the second quarter of 1997. The reviews
were conducted company-wide, although the fourth quarter 1998 review
focused primarily on SNET. These reviews included estimating remaining
useful lives and cash flows and identifying assets to be abandoned. Where
this review indicated impairment, discounted cash flows related to those
assets were analyzed to determine the amount of the impairment. As a
result of these reviews, SBC wrote off some assets and recognized
impairments to the value of other assets, recording a combined charge of
$321 ($199 after tax) in the fourth quarter of 1998 and $965 ($667 after
tax) in the second quarter of 1997.
The 1998 impairments and writeoffs primarily related to recognition of an
impairment of the assets supporting SNET's video and telephony operations,
and also included charges for required changes in wireless equipment,
inventory and sites. The 1997 impairments and writeoffs related primarily
to the wireless digital TV operations in southern California, certain
analog switching equipment in California, certain rural and other
telecommunications equipment in Nevada, selected wireless equipment,
duplicate or obsolete equipment, cable within commercial buildings in
California, certain nonoperating plant and other assets.
Pacific and Southwestern video curtailment/purchase commitments SBC also
announced in 1997 that it was scaling back its limited direct investment
in video services in the areas also served by PacBell and SWBell. As a
result of this curtailment, SBC halted construction on the Advanced
Communications Network (ACN) in California. As part of an agreement with
the ACN vendor, SBC paid the liabilities of the ACN trust that owned and
financed ACN construction, incurred costs to shut down all construction
previously conducted under the trust and received certain consideration
from the vendor. In the second quarter of 1997, SBC recognized net
expense of $553 ($346 after tax) associated with these activities. During
the third quarter of 1997, SBC recorded the corresponding short-term debt
of $610 previously incurred by the ACN trust on its balance sheet.
Additionally, SBC curtailed certain other video-related activities
including discontinuing its broadband network video trials in Richardson,
Texas, and San Jose, California, substantially scaling back its
involvement in the Tele-TV joint venture and withdrawing its operations in
territory served by SWBell from the Americast venture. Americast partners
are disputing the withdrawal in arbitration and litigation, the outcome of
which cannot be predicted, but is not expected to have a material impact
on SBC's financial condition or results of operations. The collective
impact of these decisions and actions by SBC resulted in a charge of $145
($92 after tax) in the second quarter of 1997.
Note 3. Merger Agreement with Ameritech Corporation
On May 11, 1998, SBC announced a definitive agreement to merge an SBC
subsidiary with Ameritech Corporation (Ameritech) in a transaction in
which each share of Ameritech common stock will be converted into and
exchanged for 1.316 shares of SBC common stock (equivalent to
approximately 1,450 million shares). After the merger, Ameritech will be
a wholly-owned subsidiary of SBC. The transaction, which has been
approved by the board of directors and shareowners of each company, is
intended to be accounted for as a pooling of interests and to be a
tax-free reorganization. The merger is subject to certain regulatory
approvals, including the Federal Communications Commission (FCC) and state
commissions in Ohio and Illinois. If approvals are granted, the
transaction is expected to close in 1999.
SBC and Ameritech own competing cellular licenses in several markets,
including, but not limited to, Chicago, Illinois, and St. Louis, Missouri
(Overlapping Cellular Licenses). In an effort to comply with the FCC's
rules and regulations and certain provisions of the Merger Agreement, SBC
and Ameritech expect to be required by the FCC to divest one of the
Overlapping Cellular Licenses in each market and are attempting to
determine the manner in which an Overlapping Cellular License in each
market should be divested.
The pro forma effect on SBC's consolidated statements of income had the
merger occurred on January 1, 1996 is as follows:
-----------------------------------------------------------------
Pro Forma (unaudited): 1998 1997 1996
-----------------------------------------------------------------
Operating revenues $ 45,931 $ 42,679 $ 40,119
Income before extraordinary loss
and cumulative effect of
accounting change $ 7,674 $ 3,970 $ 5,521
Net income $ 7,629 $ 3,970 $ 5,611
-----------------------------------------------------------------
Basic earnings per share:
Income before extraordinary loss
and cumulative effect of
accounting change $ 2.25 $ 1.17 $ 1.62
Net income $ 2.24 $ 1.17 $ 1.65
-----------------------------------------------------------------
Diluted earnings per share:
Income before extraordinary loss
and cumulative effect of
accounting change $ 2.23 $ 1.16 $ 1.61
Net income $ 2.21 $ 1.16 $ 1.64
=================================================================
This pro forma information does not include the effect of changes, which
will be applied retroactively, to conform accounting methodologies between
SBC and Ameritech. Based on information currently available, management
estimates the conforming changes will not materially affect the pro forma
operating revenues or income before extraordinary loss and cumulative
effect of accounting change. Additionally, the pro forma information also
does not include any potential cost savings which may result from the
integration of SBC's and Ameritech's operations or future transaction
costs relating to the merger (which are estimated to be less than $90),
nor does it consider any reorganization costs or costs associated with the
disposition of the Overlapping Cellular Licenses that may be required.
Management is unable to quantify the potential cost savings that may
result from the integration of SBC and Ameritech. The financial impact of
the reorganization costs or costs associated with the disposition of the
Overlapping Cellular Licenses cannot be determined pending the resolution
of the disposal.
Note 4. Pacific Telesis Group Financial Information
The following table presents summarized financial information for PAC at
December 31, or for the year then ended:
----------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------
Balance Sheets
Current assets $ 3,037 $ 2,835 $ 2,474
Noncurrent assets 15,428 14,150 14,134
Current liabilities 5,278 4,513 3,527
Noncurrent liabilities 10,482 10,413 10,308
============================================================================
Income Statements
Operating revenues $ 11,302 $ 10,101 $ 9,588
Operating income (loss) 2,612 (166) 2,198
Income (loss) before extraordinary loss
and cumulative effect of accounting changes 1,240 (546) 1,057
Net income (loss) 1,180 (224) 1,142
============================================================================
SBC has not provided separate financial statements and other disclosures
for PAC as management has determined that such information is not material
to the holders of the Trust Originated Preferred Securities (TOPrS) (see
Note 11), which have been guaranteed by SBC. This information is provided
as a supplement only.
Note 5. Earnings Per Share
A reconciliation of the numerators and denominators of basic earnings per
share and diluted earnings per share for income before extraordinary loss
and cumulative effect of accounting change for the years ended
December 31, 1998, 1997 and 1996 are shown in the table below.
--------------------------------------------------------------------------
Year Ended December 31, 1998 1997 1996
--------------------------------------------------------------------------
Numerators
Numerator for basic earnings per share:
Income before extraordinary loss and
cumulative effect of accounting change $4,068 $1,674 $3,387
--------------------------------------------------------------------------
Dilutive potential common shares:
Other stock-based compensation 4 3 2
--------------------------------------------------------------------------
Numerator for diluted
earnings per share $4,072 $1,677 $3,389
==========================================================================
Denominators
Denominator for basic earnings per share:
Weighted average number of common
shares outstanding (000) 1,956,610 1,944,617 1,956,200
--------------------------------------------------------------------------
Dilutive potential common shares (000):
Stock options 21,701 12,926 7,385
Other stock-based compensation 5,542 4,388 3,410
--------------------------------------------------------------------------
Denominator for diluted
earnings per share 1,983,853 1,961,931 1,966,995
==========================================================================
Basic earnings per share:
Income before extraordinary loss and
cumulative effect of accounting change $ 2.08 $ 0.86 $ 1.73
Extraordinary loss (0.03) - -
Cumulative effect of accounting change 0.01 - 0.05
--------------------------------------------------------------------------
Net income $ 2.06 $ 0.86 $ 1.78
==========================================================================
Diluted earnings per share:
Income before extraordinary loss and
cumulative effect of accounting change $ 2.05 $ 0.85 $ 1.72
Extraordinary loss (0.03) - -
Cumulative effect of accounting change 0.01 - 0.05
--------------------------------------------------------------------------
Net income $ 2.03 $ 0.85 $ 1.77
==========================================================================
Note 6. Property, Plant and Equipment
Property, plant and equipment is summarized as follows at December 31:
------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------
Land $ 442 $ 434
Buildings 6,842 6,502
Central office equipment 28,019 25,864
Cable, wiring and conduit 30,916 29,943
Other equipment 5,897 5,926
Under construction 1,350 1,546
------------------------------------------------------------------------
73,466 70,215
Accumulated depreciation and amortization 43,546 41,147
------------------------------------------------------------------------
Property, plant and equipment-net $ 29,920 $ 29,068
========================================================================
SBC's depreciation expense as a percentage of average depreciable plant
was 7.2%, 7.4% and 6.9% for 1998, 1997 and 1996.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1998, 1997 and
1996 were $440, $386 and $346. At December 31, 1998, the future minimum
rental payments under noncancelable operating leases for the years 1999
through 2003 were $1,817, $2,652, $2,519, $2,553 and $2,508 and $7,096
thereafter. Capital leases are not significant.
Note 7. Investment in Telewest Communications plc
During 1998, SBC owned up to 15% of Telewest Communications plc
(Telewest), the largest cable television operator in the United Kingdom.
Due to restrictions existing on the sale of SBC's interest in Telewest,
SBC accounted for its investment using the cost method of accounting.
During the third quarter of 1998, as a result of Telewest's merger with
General Cable, Telewest entered into a new agreement with its key
shareholders, including SBC, which lifted those restrictions. SBC was
then required to account for its investment in Telewest as
available-for-sale securities pursuant to Financial Accounting Standards
Board Statement No. 115, "Accounting for Certain Investments in Debt and
Equity Securities" (FAS 115). Under FAS 115, available-for-sale
securities are measured at fair value in the statement of financial
position, and unrealized holding gains and losses are excluded from
earnings and reported as a net amount in a separate component of
shareowners' equity until realized. During 1998, SBC sold approximately
90% of its Telewest investment for $425 and made a charitable contribution
of the remainder. The net effect from Telewest transactions for the year
ended December 31, 1998 was to increase net income by $60.
Note 8. Equity Investments
Investments in affiliates accounted for under the equity method include
SBC's investment in Telefonos de Mexico, S.A. de C.V. (Telmex), Mexico's
national telecommunications company. SBC is a member of a consortium that
holds all of the AA shares of Telmex stock, representing voting control of
the company. Another member of the consortium, Carso Global Telecom, S.A.
de C.V., has the right to appoint a majority of the directors of Telmex.
SBC also owns L shares which have limited voting rights. Throughout 1998,
SBC sold portions of its L shares in response to open market share
repurchases by Telmex, so that its total equity investment remained below
10% of Telmex's total equity capitalization.
Other major equity investments held by SBC include a 1997 investment of
approximately $760 in Telkom SA Limited (Telkom), the state-owned
telecommunications company of South Africa (see Note 17), an indirect 15%
ownership in Cegetel, a joint venture providing a broad range of
telecommunications offerings in France, investments in Chilean
telecommunications operations and minority ownership of several domestic
wireless properties.
The following table is a reconciliation of SBC's investments in equity
affiliates:
-----------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------
Beginning of year $ 2,740 $ 1,964 $ 1,616
Additional investments 55 1,076 337
Equity in net income 236 201 207
Dividends received (167) (90) (70)
Currency translation adjustments (110) (135) (94)
Reclassifications and other
adjustments (240) (276) (32)
=======================================================================
End of year $ 2,514 $ 2,740 $ 1,964
=======================================================================
The currency translation adjustment for 1998 primarily reflects the effect
of exchange rate fluctuations on SBC's investment in South Africa. Other
adjustments for 1998 reflect a write-down of an international investment
and the sale of portions of SBC's Telmex L shares.
Currency translation adjustments for 1997 primarily reflect the effect of
the exchange rate fluctuations on SBC's investments in South African and
French telecommunications companies. Other adjustments for 1997 reflect
the sale of portions of SBC's Telmex L shares and the change to the cost
method of accounting in 1997 for SBC's 1995 investment in South African
wireless operations which were sold during the third quarter of 1998 (see
Note 17).
Undistributed earnings from equity affiliates were $918 and $862 at
December 31, 1998 and 1997.
Note 9. Segment Information
SBC has four reportable segments: Wireline, Wireless, Directory and
Other. The Wireline segment provides landline telecommunications
services, including local, network access and long distance services,
messaging and Internet services and sells customer premise and private
business exchange equipment. The Wireless segment provides wireless
telecommunications services, including local and long distance services,
and sells wireless equipment. The Directory segment sells advertising for
and publication of yellow pages and white pages directories and electronic
publishing. The Other segment includes SBC's international investments
and other domestic operating subsidiaries.
These segments are strategic business units that offer different products
and services and are managed accordingly. SBC evaluates performance based
on income before income taxes, adjusted for normalizing items. For 1998,
normalizing items included gains on sales of certain non-core businesses,
principally the required disposition of SBC's interest in Mobile Telephone
Networks (MTN), a South African national cellular company, due to SBC's
investment in Telkom, and charges related to strategic initiatives
resulting from the merger integration process with SNET. For 1997,
normalizing items included the costs related to strategic initiatives
resulting from the merger integration process with PAC, the impact of
several second quarter 1997 regulatory rulings and charges for ongoing
merger integration costs (see Note 2), as well as the gain on the sale of
the Telephone Companies' interest in Bell Communications Research, Inc.
(Bellcore) and the first quarter 1997 settlement gain at PAC associated
with lump-sum pension payments that exceeded the projected service and
interest costs for 1996 retirements. The effect of any normalizing
adjustments is shown separately in the table below. The accounting
policies of the segments are the same as those described in Note 1.
Transactions between segments are reported at fair value.
Corporate, adjustments and eliminations include corporate activities, the
elimination of intersegment transactions, and other adjustments. Included
in other adjustments are differences in accounting between subsidiary and
consolidated financial statements for postretirement benefits at PacBell
and the treatment of conforming accounting adjustments arising out of the
pooling of interests with SNET and PAC that were required to be treated as
changes in accounting principles by the subsidiaries.
- ---------------------------------------------------------------------------------------------------------------------------------
Corporate,
At December 31, 1998 or for the Adjustments & Normalizing
year ended Wireline Wireless Directory Other Eliminations Adjustments Total
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues from external customers $ 22,097 $ 4,184 $ 2,320 $ 82 $ 102 $ (8) $ 28,777
Intersegment revenues 113 1 73 3 (190) - -
Depreciation and amortization 4,265 583 31 - 77 221 5,177
Equity in net income of affiliates - 25 - 211 - - 236
Interest expense 861 179 11 37 (98) 3 993
Income before income taxes 4,364 490 1,131 269 195 (75) 6,374
Segment assets 33,427 7,161 1,385 2,854 239 - 45,066
Investment in equity method
investees 34 232 - 2,274 (26) - 2,514
Expenditures for additions to
long-lived assets 5,178 644 30 11 64 - 5,927
=================================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------------
Corporate,
At December 31, 1997 or for the Adjustments & Normalizing
year ended Wireline Wireless Directory Other Eliminations Adjustments Total
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues from external customers $ 20,718 $ 3,696 $ 2,197 $ 57 $ 201 $ (188)$ 26,681
Intersegment revenues 208 1 89 - (298) - -
Depreciation and amortization 4,095 491 28 - 83 604 5,301
Equity in net income of affiliates (5) 9 - 206 (9) - 201
Interest expense 837 152 4 25 (2) 27 1,043
Income before income taxes 3,736 355 1,043 192 75 (2,743) 2,658
Segment assets 32,018 7,071 1,227 3,398 1,122 - 44,836
Investment in equity method
investees 34 229 - 2,503 (26) - 2,740
Expenditures for additions to
long-lived assets 5,275 776 38 - 141 - 6,230
=================================================================================================================================
- ---------------------------------------------------------------------------------------------------------------------------------
Corporate,
At December 31, 1996 or for the Adjustments & Normalizing
year ended Wireline Wireless Directory Other Eliminations Adjustments Total
- ---------------------------------------------------------------------------------------------------------------------------------
Revenues from external customers $ 19,751 $ 3,137 $ 2,077 $ 34 $ 203 $ - $ 25,202
Intersegment revenues 168 - 68 9 (245) - -
Depreciation and amortization 3,954 397 28 1 86 - 4,466
Equity in net income of affiliates (5) 22 - 226 (36) - 207
Interest expense 766 107 5 34 (11) - 901
Income before income taxes 3,789 567 970 178 (47) - 5,457
Expenditures for additions to
long-lived assets 4,712 1,006 32 5 100 - 5,855
=================================================================================================================================
Geographic Information
SBC's investments outside of the United States are primarily accounted for
under the equity method of accounting and do not record in operating
revenues and expenses the revenues and expenses of the individual
companies in which SBC invests. Long-lived assets consist primarily of
the book value of these investments.
------------------------------------------------------------
Year Ended December 31, 1998 1997 1996
------------------------------------------------------------
Revenues:
United States $ 28,692 $ 26,624 $ 25,168
Mexico 15 21 25
South Africa 48 22 3
France 4 5 3
Chile 1 2 2
Other foreign 17 7 1
------------------------------------------------------------
Total $ 28,777 $ 26,681 $ 25,202
============================================================
------------------------------------------------
December 31, 1998 1997
------------------------------------------------
Long-Lived Assets:
United States $ 31,135 $ 30,229
Mexico 836 733
South Africa 694 837
France 557 543
United Kingdom - 339
Chile 59 295
Other foreign 214 234
------------------------------------------------
Total $ 33,495 $ 33,210
================================================
Note 10. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
-----------------------------------------------------------------------------
1998 1997
--------------------------------------------------------------------------
SWBell
Debentures
5.38%-5.88% 2003-2006 $ 500 $ 500
6.13%-6.88% 2000-2048 1,750 1,550
7.00%-7.75% 2009-2027 1,150 1,750
---------------------------------------------------------------------------
3,400 3,800
Unamortized discount-net of premium (38) (36)
---------------------------------------------------------------------------
Total debentures 3,362 3,764
---------------------------------------------------------------------------
Notes
5.04%-7.67% 1998-2010 1,063 1,236
Unamortized discount (5) (6)
---------------------------------------------------------------------------
Total notes 1,058 1,230
---------------------------------------------------------------------------
PacBell
Debentures
4.62%-5.88% 1999-2006 475 475
6.00%-6.88% 2002-2034 1,194 1,194
7.12%-7.75% 2008-2043 1,587 2,250
8.50% 2031 29 225
---------------------------------------------------------------------------
3,285 4,144
Unamortized discount-net of premium (65) (89)
---------------------------------------------------------------------------
Total debentures 3,220 4,055
---------------------------------------------------------------------------
Notes
6.12%-8.70% 2001-2009 1,500 1,300
Unamortized discount (18) (18)
---------------------------------------------------------------------------
Total notes 1,482 1,282
---------------------------------------------------------------------------
Other notes and debentures
4.37%-6.98% 1998-2007 501 633
7.00%-10.50% 1998-2033 2,048 2,033
---------------------------------------------------------------------------
2,549 2,666
Unamortized premium-net of discount 61 65
---------------------------------------------------------------------------
Total other notes and debentures 2,610 2,731
---------------------------------------------------------------------------
Guaranteed obligations of ESOP 1
8.41%-9.40% 2000 127 198
---------------------------------------------------------------------------
Capitalized leases 260 294
---------------------------------------------------------------------------
Total long-term debt,
including current maturities 12,119 13,554
Current maturities (507) (378)
---------------------------------------------------------------------------
Total long-term debt $ 11,612 13,176
===========================================================================
1 See Note 14.
In February and September 1998, SBC called $805 of long-term debt for
retirement. SBC recognized after-tax charges of $11 associated with the
calling of this debt.
In October 1998, PacBell repurchased $684 of long-term debt. The
repurchases resulted in a $60 after-tax extraordinary loss, net of taxes
of $42.
At December 31, 1998, the aggregate principal amounts of long-term debt
and average interest rate scheduled for repayment for the years 1999
through 2003 were $507 (6.6%), $574 (6.4%), $1,034 (7.5%), $980 (6.7%),
$749 (6.3%) with $8,406 (6.9%) due thereafter. As of December 31, 1998,
SBC was in compliance with all covenants and conditions of instruments
governing its debt.
Debt maturing within one year consists of the following at December 31:
------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------
Commercial paper $ 1,044 $ 1,412
Current maturities of long-term debt 507 378
Other short-term debt - 349
------------------------------------------------------------------------
Total $ 1,551 $ 2,139
========================================================================
The weighted average interest rate on commercial paper debt at
December 31, 1998 and 1997 was 5.49% and 6.02%. SBC has entered into
agreements with several banks for compensated lines of credit totaling
$655 and uncompensated lines of credit totaling $805, thus total lines of
credit available are $1,460, all of which may be used to support
commercial paper borrowings. SBC had no borrowings outstanding under
these lines of credit as of December 31, 1998 or 1997.
Note 11. Financial Instruments
The carrying amounts and estimated fair values of SBC's long-term debt,
including current maturities and other financial instruments, are
summarized as follows at December 31:
-------------------------------------------------------------------------
1998 1997
-------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------------------------------------------------------------------------
SWBell debentures $3,362 $3,531 $3,764 $3,828
SWBell notes 1,058 1,129 1,230 1,271
PacBell debentures 3,220 3,463 4,055 4,337
PacBell notes 1,482 1,590 1,282 1,342
Other notes and debentures 2,610 2,725 2,731 2,947
TOPrS 1,000 1,029 1,000 1,034
Guaranteed obligations of ESOP 1 127 132 198 207
========================================================================
1 See Note 14.
The fair values of SBC's long-term debt were estimated based on quoted
market prices, where available, or on the net present value method of
expected future cash flows using current interest rates. The fair value of
the TOPrS was estimated based on quoted market prices. The carrying
amounts of commercial paper debt approximate fair values.
SBC does not hold or issue any financial instruments for trading
purposes. SBC's cash equivalents and short-term investments are recorded
at amortized cost. The carrying amounts of cash and cash equivalents and
short-term investments and customer deposits approximate fair values.
Pacific Telesis Financing I and II (the Trusts) were formed for the
exclusive purpose of issuing preferred and common securities representing
undivided beneficial interests in the Trusts and investing the proceeds
from the sales of TOPrS in unsecured subordinated debt securities of PAC.
Under certain circumstances, dividends on TOPrS could be deferred for up to
a period of five years. PAC sold $1 billion of TOPrS, $500 at 7.56% in
January 1996 through Pacific Telesis Financing I and $500 at 8.5% in
June 1996 through Pacific Telesis Financing II. As of December 31, 1998,
the Trusts held subordinated debt securities of PAC in principal amounts of
$516 and $514 with interest rates of 7.56% and 8.5%. Both issues of TOPrS
were priced at $25 per share, have an original 30-year maturity that may be
extended up to 49 years, are callable five years after date of sale at par
and are included on the balance sheet as corporation-obligated mandatorily
redeemable preferred securities of subsidiary trusts. The proceeds were
used to retire short-term indebtedness, primarily commercial paper. SBC
has guaranteed payment of the obligations of the TOPrS.
Derivatives
SBC entered into an equity swap contract to hedge exposure to risk of
market changes related to its recorded liability for outstanding employee
stock options for common stock of AirTouch (spun-off operations) and
associated stock appreciation rights (SARs) (see Note 15). In February
1999, SBC began exiting the equity swap contract, receiving cash for the
appreciated value of the contract and recognizing a minimal gain. Once
exited, SBC will record in other income (expense) - net future changes in
the value of the underlying employee stock option exposure. SBC plans to
make open-market purchases of the stock of spun-off operations to satisfy
its obligation for options that are exercised. Off-balance-sheet risk
exists to the extent the market price of the stock of spun-off operations
rises above the market price reflected in the liability's current carrying
value. The equity swap hedged this exposure and minimized the impact of
market fluctuations. The contract entitled SBC to receive settlement
payments to the extent the price of the common stock of spun-off operations
rose above the notional value of $23.74 per share, but imposed an
obligation to make payments to the extent the price declined below this
level. The swap also obligated SBC to make a monthly payment of a fee
based on LIBOR. The total notional amount of the contract, $13 and $19 as
of December 31, 1998 and 1997, covered the approximate number of the
outstanding options and SARs of spun-off operations on that date. SBC
periodically adjusted downward the outstanding notional amount as the
options and SARs were exercised.
Both the equity swap and SBC's liability for the stock options and SARs of
spun-off operations are carried in the balance sheet at their market
values, which were immaterial as of December 31, 1998 and 1997. Gains and
losses from quarterly market adjustments of the carrying amounts were
substantially offsetting. As of December 31, 1998 and 1997, the
accounting loss that would have been incurred from nonperformance by the
counterparty to the equity swap was $26 and $14.
Note 12. Income Taxes
Significant components of SBC's deferred tax liabilities and assets are as
follows at December 31:
-------------------------------------------------------------------
1998 1997
-------------------------------------------------------------------
Depreciation and amortization $ 3,959 $ 3,679
Equity in foreign subsidiaries 357 253
Other 355 2,052
-------------------------------------------------------------------
Deferred tax liabilities 4,671 5,984
-------------------------------------------------------------------
Employee benefits 1,707 2,528
Unamortized investment tax credits 91 174
Currency translation adjustments 333 303
Other 1,244 2,140
-------------------------------------------------------------------
Deferred tax assets 3,375 5,145
-------------------------------------------------------------------
Deferred tax assets valuation allowance 36 70
-------------------------------------------------------------------
Net deferred tax liabilities $ 1,332 $ 909
===================================================================
The decrease in the valuation allowance is the result of an evaluation of
the uncertainty associated with the realization of certain deferred tax
assets. The valuation allowance is maintained in deferred tax assets for
certain unused federal and state loss carryforwards.
The components of income tax expense are as follows:
----------------------------------------------------------------------------
1998 1997 1996
----------------------------------------------------------------------------
Federal:
Current $ 1,583 $ 786 $ 1,443
Deferred-net 437 76 364
Amortization of investment tax credits (72) (82) (82)
----------------------------------------------------------------------------
1,948 780 1,725
----------------------------------------------------------------------------
State and local:
Current 262 41 224
Deferred-net 96 163 121
----------------------------------------------------------------------------
358 204 345
----------------------------------------------------------------------------
Total $ 2,306 $ 984 $ 2,070
============================================================================
A reconciliation of income tax expense and the amount computed by applying
the statutory federal income tax rate (35%) to income before income taxes,
extraordinary loss and cumulative effect of accounting change is as
follows:
-----------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------
Taxes computed at federal statutory rate $ 2,231 $ 930 $ 1,910
Increases (decreases) in income taxes
resulting from:
Amortization of investment tax credits
over the life of the plant that gave
rise to the credits (47) (53) (53)
State and local income taxes-net of
federal income tax benefit 233 133 224
Other-net (111) (26) (11)
-----------------------------------------------------------------------------
Total $ 2,306 $ 984 $ 2,070
=============================================================================
Note 13. Employee Benefits
Pensions - Substantially all employees of SBC are covered by one of
various noncontributory pension and death benefit plans. The pension
benefit formula used in the determination of pension cost for
nonmanagement employees is based on a flat dollar amount per year of
service according to job classification. For PAC managers, benefits
accrue in separate account balances based on a fixed percentage of each
employee's monthly salary with interest. For all other managers, benefits
accrue in separate account balances based on a fixed percentage of each
employee's monthly salary plus interest or are determined based upon a
stated percentage of adjusted career income. Both the bargaining-unit and
management employees of SNET have a cash balance pension plan.
Accordingly, pension benefits are determined as a single account balance
and grow each year with pay and interest credits.
SBC's objective in funding the plans, in combination with the standards of
the Employee Retirement Income Security Act of 1974 (as amended), is to
accumulate funds sufficient to meet its benefit obligations to employees
upon their retirement. Contributions to the plans are made to a trust for
the benefit of plan participants. Plan assets consist primarily of
stocks, U.S. government and domestic corporate bonds, index funds and real
estate.
The following table presents the change in the pension plan benefit
obligation for the years ended December 31:
------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------
Benefit obligation at beginning of the year $ 18,116 $ 16,330
Service cost - benefits earned during the period 339 300
Interest cost on projected benefit obligation 1,265 1,237
Amendments 254 402
Actuarial gain 566 1,398
Special termination benefits 53 -
Benefits paid (1,723) (1,551)
------------------------------------------------------------------------
Benefit obligation at end of year $ 18,870 $ 18,116
========================================================================
The following table presents the change in pension plan assets for the
years ended December 31 and the pension plans' funded status at December 31:
------------------------------------------------------------------
1998 1997
------------------------------------------------------------------
Fair value of plan assets at beginning
of the year $ 24,998 $ 22,428
Actual return on plan assets 3,753 4,111
Benefits paid (1,720) (1,541)
------------------------------------------------------------------
Fair value of plan assets at end of year $ 27,031 $ 24,998
==================================================================
Funded status $ 8,161 $ 6,882
Unrecognized prior service cost 1,312 1,221
Unrecognized net gain (8,327) (7,081)
Unamortized transition asset (759) (895)
------------------------------------------------------------------
Prepaid pension cost $ 387 $ 127
==================================================================
The following table presents amounts recognized in SBC's Consolidated
Balance Sheets at December 31:
----------------------------------------------------------------
1998 1997
----------------------------------------------------------------
Prepaid pension cost $ 819 $ 545
Accrued pension liability (432) (418)
----------------------------------------------------------------
Net amount recognized $ 387 $ 127
================================================================
Net pension cost is composed of the following:
---------------------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------------------
Service cost - benefits earned during
the period $ 339 $ 300 $ 317
Interest cost on projected benefit
obligation 1,265 1,237 1,226
Expected return on plan assets (1,771) (1,640) (1,664)
Amortization of prior service cost 27 15 (19)
Recognized actuarial gain (99) (115) (92)
---------------------------------------------------------------------------
Net pension benefit $ (239) $ (203) $ (232)
===========================================================================
Significant weighted average assumptions used in developing pension
information include:
-----------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------
Discount rate for determining projected
benefit obligation 7.0% 7.25% 7.5%
Long-term rate of return on plan assets 8.5% 8.5% 8.5%
Composite rate of compensation increase 4.3% 4.3% 4.3%
=============================================================================
The projected benefit obligation is the actuarial present value of all
benefits attributed by the pension benefit formula to previously rendered
employee service. It is measured based on assumptions concerning future
interest rates and employee compensation levels. Should actual experience
differ from the actuarial assumptions, the benefit obligation will be
affected.
In April 1997, management amended the pension plan for non-PAC managers to
a cash balance pension plan effective June 1, 1997. Under the new plan,
participants accrue benefits based on a percentage of pay plus interest.
In addition, a transition benefit is phased in over five years. The new
plan also requires computation of a grandfathered benefit using the old
formula for five years. Participants receive the greater of the cash
balance benefit or the grandfathered benefit. The new cash balance plan
allows lump sum benefit payments in addition to annuities. This change
did not have a significant impact on SBC's net income for 1997.
In March 1996, management amended the pension plan for PAC managers from a
final pay plan to a cash balance plan effective July 1, 1996. An enhanced
transition benefit, based on frozen pay and service as of
June 30, 1996, was established to preserve benefits already accrued by
salaried employees under the final pay plan and resulted in an increase in
earned benefits for most employees. SBC also updated the actuarial
assumptions used in valuing the PAC plans to reflect changes in market
interest rates and recent experience, including a change in its assumption
concerning future ad hoc increases in pension benefits. Taken together,
these changes increased net income by approximately $125 during 1996.
Approximately 4,200 employees left PacBell during 1996 under retirement or
voluntary and involuntary severance programs and received special pension
benefits and cash incentives in connection with the PacBell restructuring
and related force reduction programs. Annual pension cost excludes $64 of
additional pension benefits charged to PacBell's restructuring reserve in
1996.
During 1997, a significant amount of lump sum pension payments resulted in
a partial settlement of PAC's pension plans. Therefore, net settlement
gains in the amount of $299 were recognized in 1997. Of this amount, $152
was recognized in the first quarter of 1997 and related primarily to
managers who terminated employment in 1996. These gains are not included
in the net pension cost shown in the preceding table.
In connection with a voluntary early-out offer that provided enhanced
pension benefits, approximately 1,135 employees left SNET during 1996.
Annual pension cost excludes $65 of net settlement gains charged to SNET's
restructuring reserve in 1996.
Supplemental Retirement Plans - SBC also provides senior and middle
management employees with nonqualified, unfunded supplemental retirement
and savings plans. These plans include supplemental defined pension
benefits as well as compensation deferral plans, some of which include a
corresponding match by SBC based on a percentage of the compensation
deferral. Expenses related to these plans were $105, $90 and $90 in 1998,
1997 and 1996. Liabilities of $1,008 and $897 related to these plans have
been included in other noncurrent liabilities in SBC's Consolidated
Balance Sheets at December 31, 1998 and 1997.
Postretirement Benefits - SBC provides certain medical, dental and life
insurance benefits to substantially all retired employees under various
plans and accrues actuarially determined postretirement benefit costs as
active employees earn these benefits. Employees retiring after certain
dates will pay a share of the costs of medical coverage that exceed a
defined dollar medical cap. Such future cost-sharing provisions have been
reflected in determining SBC's postretirement benefit costs. SBC
maintains Voluntary Employee Beneficiary Association trusts to fund
postretirement benefits. Assets consist principally of stocks and U.S.
government and corporate bonds.
The following table sets forth the change in the benefit obligation for
the years ended December 31:
-----------------------------------------------------------------------
1998 1997
-----------------------------------------------------------------------
Benefit obligation at beginning of the year $ 7,701 $ 7,112
Service cost - benefits earned during the period 109 106
Interest cost on projected benefit obligation 537 516
Amendments 363 (48)
Actuarial gain (220) 397
Benefits paid (410) (382)
-----------------------------------------------------------------------
Benefit obligation at end of year $ 8,080 $ 7,701
=======================================================================
The following table sets forth the change in plan assets for the years
ended December 31 and the plans' funded status at December 31:
-------------------------------------------------------------------
1998 1997
-------------------------------------------------------------------
Fair value of plan assets at beginning
of the year $ 3,826 $ 2,926
Actual return on plan assets 847 677
Employer contribution 354 462
Benefits paid (248) (239)
-------------------------------------------------------------------
Fair value of plan assets at end of year $ 4,779 $ 3,826
===================================================================
Funded status $ (3,301) $ (3,875)
Unrecognized prior service cost 286 (13)
Unrecognized net gain (1,912) (1,175)
-------------------------------------------------------------------
Accrued postretirement benefit obligation $ (4,927) $ (5,063)
===================================================================
Postretirement benefit cost is composed of the following:
---------------------------------------------------------------------------
1998 1997 1996
---------------------------------------------------------------------------
Service cost-benefits earned during
the period $ 109 $ 106 $ 105
Interest cost on accumulated postretirement
benefit obligation (APBO) 537 516 512
Expected return on assets (272) (220) (181)
Other - net 6 (14) 5
---------------------------------------------------------------------------
Postretirement benefit cost $ 380 $ 388 $ 441
===========================================================================
The fair value of plan assets restricted to the payment of life insurance
benefits was $844 and $987 at December 31, 1998 and 1997. At December 31,
1998 and 1997, the accrued life insurance benefits included in the APBO
benefit obligation were $367 and $93.
The assumed medical cost trend rate in 1999 is 7.0%, decreasing linearly
to 5.5% in 2002, prior to adjustment for cost-sharing provisions of the
medical and dental plans for active and certain recently retired
employees. The assumed dental cost trend rate in 1999 is 5.75%, reducing
to 5.0% in 2002. Raising the annual medical and dental cost trend rates
by one percentage point increases the APBO as of December 31, 1998 by $488
and increases the aggregate service and interest cost components of the
net periodic postretirement benefit cost for 1998 by approximately $34.
Decreasing the annual medical and dental cost trend rates by one
percentage point decreases the APBO as of December 31, 1998 by $408 and
decreases the aggregate service and interest cost components of the net
periodic postretirement benefit cost for 1998 by approximately $27.
Significant assumptions for the discount rate, long-term rate of return on
plan assets and composite rate of compensation increase used in developing
the APBO and related postretirement benefit costs were the same as those
used in developing the pension information.
Note 14. Other Employee Benefits
Employee Stock Ownership Plans - SBC maintains contributory savings plans
which cover substantially all employees. Under the savings plans, SBC
matches a stated percentage of eligible employee contributions, subject to
a specified ceiling.
SBC has four leveraged ESOPs as part of the existing savings plans. Two
of the ESOPs were funded with notes issued by the savings plans to various
lenders, the proceeds of which were used to purchase shares of SBC's
common stock in the open market. These notes are unconditionally
guaranteed by SBC and therefore presented as a reduction to shareowners'
equity and an increase in long-term debt. They will be repaid with SBC
contributions to the savings plans, dividends paid on SBC shares and
interest earned on funds held by the ESOPs.
The third ESOP purchased PAC treasury shares in exchange for a promissory
note from the plan to PAC. Since PAC is the lender, this note is not
reflected as a liability and the remaining cost of unallocated trust
shares is carried as a reduction of shareowners' equity. Principal and
interest on the note are paid from employer contributions and dividends
received by the trust. All PAC shares were exchanged for SBC shares
effective with the merger April 1, 1997. The provisions of the ESOP were
unaffected by this exchange.
The fourth ESOP acquired SNET shares with the proceeds of notes issued by
the savings plans, which SNET guaranteed, through a third party. The SNET
common stock was acquired through open market purchases, in exchange for a
promissory note from the plan to SNET. SNET periodically makes cash
payments to the ESOP that, together with dividends received on shares held
by the ESOP, are used to make interest and principal payments on both
loans. All SNET shares were exchanged for SBC shares effective with the
merger October 26, 1998. The provisions of the ESOP were unaffected by
this exchange.
SBC's match of employee contributions to the savings plans is fulfilled
with shares of stock allocated from the ESOPs and with purchases of SBC's
stock in the open market. Shares held by the ESOPs are released for
allocation to the accounts of employees as employer matching contributions
are earned. Benefit cost is based on a combination of the contributions
to the savings plans and the cost of shares allocated to participating
employees' accounts. Both benefit cost and interest expense on the notes
are reduced by dividends on SBC's shares held by the ESOPs and interest
earned on the ESOPs' funds.
Information related to the ESOPs and the savings plans is summarized below:
-----------------------------------------------------------------------------
1998 1997 1996
-----------------------------------------------------------------------------
Benefit expense-net of dividends and
interest income $ 55 $ 59 $ 76
Interest expense-net of dividends and
interest income 16 21 30
-----------------------------------------------------------------------------
Total expense $ 71 $ 80 $ 106
=============================================================================
Company contributions for ESOPs $ 110 $ 112 $ 121
=============================================================================
Dividends and interest income for debt service $ 58 $ 63 $ 67
=============================================================================
SBC shares held by the ESOPs are summarized as follows at December 31:
------------------------------------------------------------------------
1998 1997
------------------------------------------------------------------------
Unallocated 11,505,123 17,210,803
Committed to be allocated 1,245,335 282,388
Allocated to participants 47,425,671 45,966,307
------------------------------------------------------------------------
Total 60,176,129 63,459,498
========================================================================
Note 15. Stock-Based Compensation
Under various SBC plans, senior and other management employees and
non-employee directors have received stock options, SARs, performance
shares and nonvested stock units to purchase shares of SBC common stock.
Options issued through December 31, 1998 carry exercise prices equal to
the market price of the stock at the date of grant and have maximum terms
ranging from five to ten years. Depending upon the grant, vesting of
options may occur up to four years from the date of grant. Performance
shares are granted to key employees in the form of common stock and/or in
cash based upon the price of common stock at date of grant and are awarded
at the end of a two- or three-year period, subject to the achievement of
certain performance goals. Nonvested stock units also are valued at
market price of the stock at date of grant and vest over a three-year
period. Up to 206 million shares may be issued under these plans.
In 1996, SBC elected to continue measuring compensation cost for these
plans using the intrinsic value-based method of accounting prescribed in
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (FAS 123). Accordingly, no compensation cost
for SBC's stock option plans has been recognized. The compensation cost
that has been charged against income for SBC's other stock-based
compensation plans, primarily SARs and nonvested stock units, totaled $45,
$43 and $22 for 1998, 1997 and 1996. Had compensation cost for stock
option plans been recognized using the fair value based method of
accounting at the date of grant for awards in 1998, 1997 and 1996 as
defined by FAS 123, SBC's net income would have been $3,921, $1,597 and
$3,445, and basic net income per share would have been $2.00, $0.82 and
$1.76.
Options and SARs held by the continuing employees of PAC at the time of
the AirTouch spin-off were supplemented with an equal number of options
and SARs for common shares of spun-off operations. The exercise prices
for outstanding options and SARs held by continuing employees of PAC were
adjusted downward to reflect the value of the supplemental spun-off
operations' options and SARs. The balance sheet reflects a related
liability equal to the difference between the current market price of
spun-off operations stock and the exercise prices of the supplemental
options outstanding (see Note 11). As of December 31, 1998, 459,916
supplemental spun-off operations options and SARs were outstanding with
expiration dates ranging from 1999 to 2003. Outstanding options and SARs
that were held by employees of the wireless operations at the spin-off
date were replaced by options and SARs for common shares of spun-off
operations. The spun-off operations assumed liability for these
replacement options and SARs.
For purposes of these pro forma disclosures, the estimated fair value of
the options granted after 1994 is amortized to expense over the options'
vesting period. Because most employee options vest over a two- to
four-year period, these disclosures will not be indicative of future pro
forma amounts until the FAS 123 rules are applied to all outstanding
non-vested awards. The fair value for these options was estimated at the
date of grant, using a Black-Scholes option pricing model with the
following weighted-average assumptions used for grants in 1998, 1997 and
1996: risk-free interest rate of 5.72%, 6.56% and 6.25%; dividend yield of
2.21%, 3.07% and 4.91%; expected volatility factor of 15%, 15% and 18%;
and expected option life of 5.3, 5.8 and 4.7 years.
Information related to options and SARs is summarized below:
-----------------------------------------------------------------------------
Weighted
Average
Number Exercise
Price
-----------------------------------------------------------------------------
Outstanding at January 1, 1996 60,648,949 $20.89
Granted 25,035,921 23.00
Exercised (3,979,290) 18.73
Forfeited/Expired (2,159,301) 21.59
-----------------------------------------------------------------------------
Outstanding at December 31, 1996
(35,522,826 exercisable at weighted
average price of $20.13) 79,546,279 21.64
Granted 33,560,019 27.28
Exercised (17,548,592) 20.51
Forfeited/Expired (4,817,751) 25.16
-----------------------------------------------------------------------------
Outstanding at December 31, 1997
(40,802,392 exercisable at weighted
average price of $21.02) 90,739,955 23.76
Granted 21,756,535 42.51
Exercised (16,853,425) 22.13
Forfeited/Expired (4,591,616) 31.08
-----------------------------------------------------------------------------
Outstanding at December 31, 1998
(47,493,729 exercisable at weighted
average price of $22.31) 91,051,449 $28.17
=============================================================================
Information related to options and SARs outstanding at December 31, 1998:
-----------------------------------------------------------------------------
$13.50- $17.50- $26.00- $34.00-
Exercise Price Range $17.49 $25.99 $33.99 $43.00
-----------------------------------------------------------------------------
Number of options and SARs:
Outstanding 3,492,843 41,277,620 25,901,002 20,379,984
Exercisable 3,492,843 41,277,620 2,639,149 84,117
Weighted average exercise price:
Outstanding $16.51 $22.39 $27.60 $42.59
Exercisable $16.51 $22.39 $28.21 $42.00
Weighted average remaining
contractual life 3.43 years 6.38 years 8.31 years 5.97 years
=============================================================================
The weighted-average, grant-date fair value of each option granted during
1998, 1997 and 1996 was $8.62, $5.57 and $3.47.
Note 16. Shareowners' Equity
Common Stock Split - On January 30, 1998, the Board of Directors of SBC
declared a two-for-one stock split, effected in the form of a stock
dividend, on the shares of SBC's common stock. Each shareholder of record
on February 20, 1998 received an additional share of common stock for each
share of common stock then held. The stock was issued March 19, 1998.
SBC retained the current par value of $1.00 per share for all shares of
common stock.
Note 17. Acquisitions and Dispositions
During the third quarter of 1998, SBC sold its interest in MTN to the
remaining shareholders of MTN for $337. The sale fulfilled SBC's
obligation to divest MTN as a requirement of the acquisition of Telkom.
The effect on other income (expense) - net and net income from the sale of
MTN was $250 and $162. See Note 7 for the disposition of SBC's interest
in Telewest.
In May 1997, a consortium made up of SBC and Telekom Malaysia Berhad, 60%
owned by SBC, completed the purchase of 30% of Telkom. SBC invested
approximately $760, approximately $600 of which will remain in Telkom.
During 1996, SBC received several AT&T Corp. cellular networks in Arkansas
in exchange for SBC's PCS licenses in Memphis and Little Rock and other
consideration.
These acquisitions were primarily accounted for under the purchase method
of accounting. The purchase prices in excess of the underlying fair value
of identifiable net assets acquired are being amortized over periods not
to exceed 40 years. Results of operations of the properties acquired have
been included in the consolidated financial statements from their
respective dates of acquisition.
The above developments did not have a significant impact on consolidated
results of operations for 1998, 1997 or 1996, nor would they had they
occurred on January 1 of the respective periods.
On January 20, 1999, SBC announced it has agreed to acquire Comcast
Cellular Corporation (Comcast Cellular), the wireless subsidiary of
Comcast Corporation, in a transaction valued at $1,674. Under the terms
of the agreement, SBC will pay $400 in cash and assume Comcast Cellular's
current debt of $1,274. The transaction will be accounted for through the
purchase accounting method. Comcast Cellular offers analog and digital
wireless services to more than 800,000 subscribers in Pennsylvania,
Delaware, New Jersey and Illinois. The largest market in which Comcast
Cellular operates is Philadelphia, Pennsylvania. SBC for several years
has been operating the Illinois properties it is purchasing under a
previous agreement between the two companies. The transaction, which is
subject to regulatory approvals, is expected to be completed by the end of
1999.
Note 18. Additional Financial Information
-----------------------------------------------------------------------------
December 31,
-----------------------
Balance Sheets 1998 1997
-----------------------------------------------------------------------------
Accounts payable and accrued liabilities:
Accounts payable $ 2,865 $ 3,115
Accrued taxes 1,206 1,118
Advance billing and customer deposits 855 764
Compensated future absences 568 558
Accrued interest 249 326
Accrued payroll 338 315
Other 1,899 2,134
-----------------------------------------------------------------------------
Total $ 7,980 $ 8,330
=============================================================================
Statements of Income 1998 1997 1996
-----------------------------------------------------------------------------
Advertising expense $ 594 $ 558 $ 400
=============================================================================
Interest expense incurred $ 1,052 $ 1,168 $ 1,043
Capitalized interest (59) (125) (142)
-----------------------------------------------------------------------------
Total interest expense $ 993 $ 1,043 $ 901
=============================================================================
-----------------------------------------------------------------------------
Statements of Cash Flows 1998 1997 1996
-----------------------------------------------------------------------------
Cash paid during the year for:
Interest $ 1,070 $ 1,014 $ 888
Income taxes, net of refunds $ 1,721 $ 489 $ 1,367
=============================================================================
No customer accounted for more than 10% of consolidated revenues in 1998,
1997 or 1996.
Several subsidiaries of SBC have negotiated contracts with the
Communications Workers of America (CWA), none of which is subject to
renegotiation in 1999. Approximately two-thirds of SBC's employees are
represented by the CWA.
Note 19. Quarterly Financial Information (Unaudited)
-----------------------------------------------------------------------------------
Basic
Earnings
Total Operating (Loss) Stock Price
Calendar Operating Income Net Income Per Common -----------------------------
Quarter Revenues (Loss) (Loss) Share High Low Close
-----------------------------------------------------------------------------------
1998
First 1 $ 6,855 $ 1,775 $ 985 $ 0.50 $ 46.563 $ 35.375 $ 43.375
Second 7,030 1,817 1,020 0.52 44.938 37.125 40.000
Third 2 7,216 1,903 1,262 0.65 44.875 35.000 44.375
Fourth 1,2 7,676 1,391 756 0.39 54.875 41.125 53.625
--------------------------------------------
Annual 1,2 $ 28,777 $ 6,886 $ 4,023 $ 2.06
===================================================================================
1997 3
First $ 6,405 $ 1,685 $ 901 $ 0.46 $ 29.125 $ 24.813 $ 26.250
Second 6,372 (831) (736) (0.38) 30.938 24.625 30.938
Third 6,790 1,573 867 0.45 31.125 26.781 30.719
Fourth 7,114 1,151 642 0.33 38.063 30.000 36.625
--------------------------------------------
Annual $ 26,681 $ 3,578 $ 1,674 $ 0.86
===================================================================================
<FN>
1 Net Income and Earnings per Common Share reflect a cumulative effect of
accounting change of $15, or $0.01 per share in the first quarter from a
change in accounting for directory operations and an extraordinary loss on
retirement of debt of $60, or $0.03 per share in the fourth quarter.
2 Net income in the third quarter includes after-tax gains of $219 for
gains on sales of certain non-core businesses, principally the required
disposition of MTN, due to SBC's investment in Telkom. Net income in the
fourth quarter also includes $268 of charges related to strategic
initiatives resulting from the merger integration process with SNET.
3 Net income (loss) includes $90 in first quarter pension settlement gain
for 1996 retirements (see Note 13), $1.6 billion in second quarter
charges related to post-merger initiatives (see Note 2), $10 and $294 in
third and fourth quarter merger integration costs and $33 in fourth
quarter gain on sale of SBC's interests in Bellcore.
</FN>
Report of Independent Auditors
The Board of Directors and Shareowners
SBC Communications Inc.
We have audited the accompanying consolidated balance sheets of SBC
Communications Inc. (the Company) as of December 31, 1998 and 1997, and the
related consolidated statements of income, shareowners' equity, and cash
flows for each of the three years in the period ended December 31, 1998.
These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits. We did not audit the
1996 financial statements of Pacific Telesis Group, a wholly-owned
subsidiary, which statements reflect total operating revenues constituting
approximately 38% of the Company's related consolidated financial statement
total for the year ended December 31, 1996. Those statements were audited by
other auditors whose report, which has been furnished to us, included an
explanatory paragraph that describes the change in its method of recognizing
directory publishing revenues and related expenses. Our opinion, insofar as
it relates to the 1996 data included for Pacific Telesis Group, is based
solely on the report of the other auditors.
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 and the report
of other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and, for 1996, the report of other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of SBC
Communications Inc. at December 31, 1998 and 1997, and the consolidated
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.
ERNST & YOUNG LLP
San Antonio, Texas
February 12, 1999
Report of Management
The consolidated financial statements have been prepared in conformity with
generally accepted accounting principles. The integrity and objectivity of
the data in these financial statements, including estimates and judgments
relating to matters not concluded by year end, are the responsibility of
management, as is all other information included in the Annual Report, unless
otherwise indicated.
The financial statements of SBC Communications Inc. (SBC) have been audited
by Ernst & Young LLP, independent auditors. Management has made available to
Ernst & Young LLP all of SBC's financial records and related data, as well as
the minutes of shareowners' and directors' meetings. Furthermore, management
believes that all representations made to Ernst & Young LLP during its audit
were valid and appropriate.
Management has established and maintains a system of internal accounting
controls that provides reasonable assurance as to the integrity and
reliability of the financial statements, the protection of assets from
unauthorized use or disposition and the prevention and detection of
fraudulent financial reporting. The concept of reasonable assurance
recognizes that the costs of an internal accounting controls system should
not exceed, in management's judgment, the benefits to be derived.
Management also seeks to ensure the objectivity and integrity of its
financial data by the careful selection of its managers, by organizational
arrangements that provide an appropriate division of responsibility and by
communication programs aimed at ensuring that its policies, standards and
managerial authorities are understood throughout the organization.
Management continually monitors the system of internal accounting controls
for compliance. SBC maintains an internal auditing program that
independently assesses the effectiveness of the internal accounting controls
and recommends improvements thereto.
The Audit Committee of the Board of Directors, which consists of eight
directors who are not employees, meets periodically with management, the
internal auditors and the independent auditors to review the manner in which
they are performing their responsibilities and to discuss auditing, internal
accounting controls and financial reporting matters. Both the internal
auditors and the independent auditors periodically meet alone with the Audit
Committee and have access to the Audit Committee at any time.
/s/ Edward E. Whitacre Jr.
Edward E. Whitacre Jr.
Chairman of the Board and
Chief Executive Officer
/s/ Donald E. Kiernan
Donald E. Kiernan
Senior Vice President, Treasurer
and Chief Financial Officer
Stock Trading Information
SBC is listed on the New York, Chicago and Pacific stock exchanges and
The Swisss Exchange. SBC is traded on the London Stock Exchange through
the SEAQ International Markets facility.
Ticker symbol (NYSE): SBC
Newspaper stock listing: SBC or SBC Comm