<PAGE>
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U.S. Securities and Exchange Commission
Washington, D.C. 20549
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Form 10-Q
(Mark one)
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[x] Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 1998
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or
- -------------------------------------------
[ ] Transition Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from to
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Commission File Number 1-2222
Illinois Bell Telephone Company
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An Illinois Corporation
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225 W. Randolph Street
Chicago, Illinois 60606
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I.R.S. Employer Identification
Number 36-1253600
Telephone number (800) 257-0902
ILLINOIS BELL IS A WHOLLY OWNED SUBSIDIARY OF AMERITECH CORPORATION AND
MEETS THE CONDITIONS IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q.
WE ARE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT UNDER GENERAL
INSTRUCTION H(2).
We have filed all reports required to be filed by Section 13 or 15 (d) of
the Securities Exchange Act of 1934 during the preceding 12 months, and
have been subject to those filing requirements for the past 90 days.
Yes X No
---- ----
At July 31,1998, 81,938,121 common shares were outstanding.
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TABLE OF CONTENTS
PART I
ITEM Page
- ---- ----
1. Financial Statements
Condensed Consolidated Statements of Income and
Accumulated Deficit for the three and six months
ended June 30, 1998 and 1997 1
Condensed Consolidated Balance Sheets as of
June 30, 1998 and December 31, 1997 2-3
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 1998 and 1997 4
Notes to Condensed Consolidated Financial Statements 5
2. Management's Discussion and Analysis
of Results of Operations 6-17
3. Quantitative and Qualitative
Disclosures about Market Risk 18
PART II
6. Exhibits and Reports on Form 8-K 19
Glossary 21-22
i
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Item 1 - Financial Statements
-----------------------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND ACCUMULATED DEFICIT
(Dollars in Millions)
(Unaudited)
Three Months Ended Six Months Ended
June 30 June 30
---------------- ----------------
1998 1997 1998 1997
---- ---- ---- ----
Revenues
Local service................. $ 583.6 $ 556.3 $ 1,146.4 $ 1,093.5
Interstate network access..... 206.9 212.8 405.1 408.3
Intrastate network access..... 33.2 35.6 67.6 68.3
Long distance service......... 54.6 57.2 108.8 113.7
Other......................... 116.6 112.3 238.9 218.8
--------- --------- --------- ---------
994.9 974.2 1,966.8 1,902.6
--------- --------- --------- ---------
Operating expenses
Employee-related expenses..... 210.6 204.1 419.5 404.1
Depreciation and amortization. 163.2 150.2 326.5 299.0
Other operating expenses...... 317.5 326.3 634.6 640.7
Taxes other than income taxes. 18.6 21.7 38.6 44.1
--------- --------- --------- ---------
709.9 702.3 1,419.2 1,387.9
--------- --------- --------- ---------
Operating income................ 285.0 271.9 547.6 514.7
Interest expense................ 30.8 28.1 61.7 56.8
Other income, net............... 0.5 1.5 1.3 3.5
--------- --------- --------- ---------
Income before income taxes...... 254.7 245.3 487.2 461.4
Income taxes.................... 107.3 95.2 206.0 178.9
--------- --------- --------- ---------
Net income...................... 147.4 150.1 281.2 282.5
Accumulated deficit,
beginning of period........... (345.5) (385.2) (337.4) (383.6)
Less, dividends declared.... 103.2 117.6 245.1 251.6
--------- --------- --------- ---------
Accumulated deficit,
end of period................. $ (301.3) $ (352.7) $ (301.3) $ (352.7)
========= ========= ========= =========
See Notes to Condensed Consolidated Financial Statements.
Page 1
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CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in Millions)
June 30, 1998 Dec. 31, 1997
-------------- -------------
(Unaudited) (Derived from
Audited
Financial
Statements)
ASSETS
Current assets
Cash and temporary cash investments......... $ 43.0 $ 20.9
Receivables, net
Customers................................. 769.5 826.7
Ameritech and affiliates.................. 45.5 5.6
Other..................................... 37.3 63.1
Material and supplies....................... 33.5 10.8
Prepaid and other........................... 27.8 23.9
--------- ---------
956.6 951.0
--------- ---------
Property, plant and equipment................ 9,826.7 9,586.3
Less, accumulated depreciation............... 5,815.0 5,588.9
--------- ---------
4,011.7 3,997.4
--------- ---------
Investments, primarily in affiliates......... 109.3 114.2
Other assets and deferred charges............ 482.0 453.3
--------- ---------
Total assets................................. $ 5,559.6 $ 5,515.9
========= =========
See Notes to Condensed Consolidated Financial Statements.
Page 2
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CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(Dollars in Millions)
June 30, 1998 Dec. 31, 1997
-------------- -------------
(Unaudited) (Derived from
Audited
Financial
Statements)
LIABILITIES AND SHAREOWNER'S EQUITY
Current liabilities
Debt maturing within one year
Ameritech................................. $ 964.0 $ 1,077.6
Other..................................... 1.4 0.9
Accounts payable
Ameritech Services, Inc. (ASI)............ 91.0 63.2
Ameritech and affiliates.................. 59.7 48.2
Other..................................... 257.6 223.3
Other current liabilities.................. 367.4 351.1
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1,741.1 1,764.3
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Long-term debt.............................. 1,011.6 1,011.7
--------- ---------
Deferred credits and other long-term liabilities
Accumulated deferred income taxes.......... 295.8 284.0
Unamortized investment tax credits......... 37.2 40.5
Postretirement benefits
other than pensions...................... 904.7 906.5
Long-term payable to ASI................... 21.8 23.7
Other...................................... 73.0 83.2
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1,332.5 1,337.9
--------- ---------
Shareowner's equity
Common shares - ($20 par value;
100,000,000 shares authorized;
81,938,121 issued and outstanding)....... 1,638.8 1,638.8
Proceeds in excess of par value............ 136.9 100.6
Accumulated deficit........................ (301.3) (337.4)
--------- ---------
1,474.4 1,402.0
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Total liabilities and shareowner's equity... $ 5,559.6 $ 5,515.9
========= =========
See Notes to Condensed Consolidated Financial Statements.
Page 3
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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
(Unaudited)
Six Months Ended
June 30
-------------
1998 1997
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income.................................... $ 281.2 $ 282.5
Adjustments to net income
Depreciation and amortization............... 326.5 299.0
Deferred income taxes, net.................. (14.5) 12.7
Investment tax credits, net................. (3.3) (4.4)
Capitalized interest........................ (1.6) (1.3)
Change in accounts receivable, net.......... 43.1 50.3
Change in material and supplies............. (27.9) 0.8
Change in certain other current assets...... (3.9) (3.2)
Change in accounts payable.................. 73.6 47.4
Change in certain other current
liabilities................................ 43.4 19.1
Change in certain other noncurrent
assets and liabilities..................... (7.8) (24.8)
Other operating activities, net............. 5.7 7.5
-------- --------
Net cash from operating activities............ 714.5 685.6
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.......................... (332.2) (293.2)
Additional investments........................ -- (30.0)
Proceeds from (cost of) disposals of
property, plant and equipment................ (0.7) 3.1
Other investing activities, net............... -- (0.2)
-------- --------
Net cash from investing activities............ (332.9) (320.3)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Intercompany financing, net................... (113.6) (113.3)
Retirements of long-term debt................. (0.8) (0.8)
Dividend payments............................. (245.1) (251.6)
Other financing activities, net............... -- 0.6
-------- --------
Net cash from financing activities............ (359.5) (365.1)
-------- --------
Net change in cash and
temporary cash investments................... 22.1 0.2
Cash and temporary cash investments,
beginning of period.......................... 20.9 --
-------- --------
Cash and temporary cash investments,
end of period................................ $ 43.0 $ 0.2
======== ========
See Notes to Condensed Consolidated Financial Statements.
Page 4
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions)
June 30, 1998
NOTE 1: Preparation of Interim Financial Statements
We have prepared the unaudited condensed consolidated financial
statements in this report by following Securities and Exchange
Commission rules that permit reduced disclosure for quarterly period
reports. These financial statements include estimates and
assumptions that affect the reported amounts of assets and
liabilities and the amounts of revenues and expenses. Actual amounts
could differ from those estimates. We believe these statements
include all adjustments necessary for a fair statement of results for
each period shown. We believe our disclosures are adequate to make
the presented information clear. You should read these financial
statements in conjunction with the financial statements and notes
included in our 1997 Annual Report on Form 10-K and the quarterly
report on Form 10-Q previously filed in 1998.
When reading these financial statements, you should be familiar with
the terminology unique to our business. We have defined a number of
terms in the glossary on pages 21 and 22.
NOTE 2: Merger Agreement
On May 11, 1998, our parent (Ameritech Corporation) jointly announced
with SBC Communications Inc. (SBC) a definitive agreement to merge an
SBC subsidiary with Ameritech in a transaction in which each share of
Ameritech common stock will be converted into and exchanged for 1.316
shares of SBC common stock. After the merger, Ameritech will be a
wholly owned subsidiary of SBC. The transaction was approved by the
Board of Directors of each company and is intended to be accounted
for as a pooling of interests and to be a tax-free reorganization.
The merger is subject to the satisfaction of certain conditions and
regulatory approvals, as well as approval by the shareowners of each
company.
Page 5
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Item 2 - Management's Discussion and Analysis
of Results of Operations
The following is a discussion and analysis of the changes in
revenues, operating expenses and other income and expenses for the
first six months of 1998 as compared with the same period last year.
RESULTS OF OPERATIONS
- ---------------------
Revenues
- --------
Our revenues in the first six months of 1998 were $1,966.8 million
and were $1,902.6 million for the same period in 1997, an increase of
$64.2 million. Growth in sales of call management services and
demand for data services and access lines, as well as increases in
switched minutes of use resulting from higher network usage volumes,
were the primary reasons for the increase. Net rate reductions and
decreased long distance revenues partially offset these increases.
- ---------------------------------------------------------------------
Local service
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $1,146.4 $1,093.5 $ 52.9 4.8
Local service revenues include basic monthly service fees and usage
charges, fees for call management services, installation and
connection charges, certain data services and most public phone
revenues. Local service revenues increased for the six months ended
June 30, 1998 due largely to increased sales of call management
services, resulting from strong growth in both the number of features
in service and usage of services on a pay-per-use basis. Higher
network usage volumes, resulting primarily from access line growth of
5.9% over the prior year period, as well as rate increases, also
contributed to the increase.
There were 6,949,000 access lines in service as of June 30, 1998
compared with 6,559,000 as of June 30, 1997 (restated to standardize
counting of voice-grade equivalent lines).
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Network access
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June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Interstate
- ----------
Six Months Ended $ 405.1 $ 408.3 $ (3.2) (0.8)
Intrastate
- ----------
Six Months Ended $ 67.6 $ 68.3 $ (0.7) (1.0)
Network access revenues are fees charged to interexchange carriers
that use our local landline communications network to connect
customers to their long distance networks. In addition, end users
pay flat rate access fees to connect to the long distance networks.
These revenues result from both interstate and intrastate services.
Page 6
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Network access (cont'd.)
- ------------------------
Interstate network access revenues decreased for the six months ended
June 30, 1998 due primarily to a change in reporting classification
of certain pay phone revenues from network access to other
miscellaneous revenues beginning in the first quarter of 1998. This
change in classification decreased interstate network access revenues
by approximately $26.0 million in the first six months of 1998
compared with the prior year. Rate reductions, resulting primarily
from access charge reform effective July 1, 1997, also contributed to
the decrease. An increase in network minutes of use, resulting from
overall growth in the volume of calls handled for interexchange
carriers, and greater demand for dedicated services by Internet
service providers and other high-capacity users, partially offset
these decreases. Interstate minutes of use for the six months ended
June 30, 1998 increased by 9.3% over the same period last year.
Intrastate network access revenues decreased for the six months ended
June 30, 1998 due primarily to rate decreases. Volume increases,
largely resulting from increased network usage by alternative
providers of intraLATA toll services, partially offset the rate
decreases. Intrastate minutes of use for the six months ended June
30, 1998 increased by 19.0% over the same period last year.
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Long distance service
- ---------------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 108.8 $ 113.7 $ (4.9) (4.3)
Long distance service revenues result from customer calls to
locations outside of their local calling areas, but within the same
Local Access and Transport Area (LATA).
Long distance service revenues decreased for the six months ended
June 30, 1998 due primarily to increased competition from alternative
intraLATA toll providers, resulting from the implementation of Dial
1+ capability. In addition, other carriers are moving to retain
revenue from their customers' use of intraLATA toll calling services,
where previously they had allowed us to provide these services in
exchange for access charge payments to them. Although we no longer
earn these revenues, we also no longer incur the related access
charge expenses.
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Other
- -----
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 238.9 $ 218.8 $ 20.1 9.2
Other revenues include revenues from directory advertising, billing
and collection services, inside wire installation and maintenance
services and other miscellaneous services. Other revenues increased
for the six months ended June 30, 1998 due primarily to a change in
reporting classification of certain pay phone revenues from network
access to other revenues, as previously discussed. Increases in
revenues from nonregulated services, such as voice messaging, billing
and collection, and equipment sales, also contributed to the
increase. A decrease in revenues from inside wire installation and
maintenance services partially offset the increases.
Page 7
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Operating expenses
- ------------------
Total operating expenses for the six months ended June 30, 1998
increased by $31.3 million or 2.3 percent to $1,419.2 million. The
increase was due primarily to increased depreciation expense and
employee-related expenses, partially offset by a decrease in other
operating expenses, as discussed below.
- ---------------------------------------------------------------------
Employee-related expenses
- -------------------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 419.5 $ 404.1 $ 15.4 3.8
Employee-related expenses increased for the six months ended June 30,
1998 primarily due to increases in wage rates and overtime expenses,
as well as increased average force levels compared with the prior
year period. Decreases in employee medical benefits and other
employee-related expenses partially offset the increase.
During June 1998, the International Brotherhood of Electrical Workers
(IBEW) ratified a new five-year contract effective June 28, 1998.
The contract provides basic wage increases of 11.2% (compounded) over
three years. In addition, the contract addresses benefits, pensions,
work rules and other wage-related items. The contract will be
reopened in 2001 to address economic wage issues for the final two
years of the contract. The IBEW represents approximately 75% of our
employees.
The Communications Workers of America (CWA) have reached similar
terms under an agreement ratified by union membership on July 17,
1998. The CWA contract is effective August 9, 1998 and expires on
March 31, 2001. The contract provides basic wage increases of 11.2%
(compounded) over the contract period, and also addresses benefits,
pensions, work-rules and other wage-related items. The CWA
represents approximately 10% of our employees.
We employed 14,869 employees as of June 30, 1998, compared with
14,967 as of June 30, 1997.
- ---------------------------------------------------------------------
Depreciation and
amortization
- ------------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 326.5 $ 299.0 $ 27.5 9.2
Depreciation and amortization expense increased for the six months
ended June 30, 1998 due primarily to higher property, plant and
equipment balances. Higher depreciation rates on certain asset
categories also contributed to the increase, as we used shorter
depreciable lives for newer technologies.
- --------------------------------------------------------------------
Other operating expenses
- ------------------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 634.6 $ 640.7 $ (6.1) (1.0)
Page 8
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Other operating expenses (cont'd.)
- ---------------------------------
Other operating expenses decreased for the six months ended June 30,
1998 due primarily to a decrease in contract services expenses for
computer programming and engineering efforts, combined with a
decrease in materials costs compared with the prior year period.
Higher access charge expenses resulting from state commission rulings
regarding calls to the Internet via Internet service providers
(ISPs), partially offset the decreases. These rulings (which we are
contesting) require local exchange carriers to pay reciprocal
compensation for calls by their customers to the Internet via ISPs
who, in turn, are customers of competing local exchange carriers. We
have accrued all disputed charges and set aside approximately $42.1
million in segregated funds pending final resolution of these
disputes.
Increased expenses for affiliated services such as billing system
development and network support, combined with higher cost of sales
resulting from increased marketing and sales efforts, partially
offset the decreases.
- ---------------------------------------------------------------------
Taxes other than income taxes
- -----------------------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 38.6 $ 44.1 $ (5.5) (12.5)
Taxes other than income taxes consist of property taxes, gross
receipts taxes and other taxes not directly related to earnings.
Taxes other than income taxes decreased for the six months ended June
30, 1998 due primarily to a decrease in capital stock taxes resulting
from tax reforms. Gross receipts taxes also decreased slightly due
to lower current-year accruals for these taxes.
- ---------------------------------------------------------------------
Other income and expenses
- -------------------------
Interest expense
- ----------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 61.7 $ 56.8 $ 4.9 8.6
Interest expense increased for the six months ended June 30, 1998 due
primarily to increased interest on borrowings from the Ameritech
short-term funding pool, reflecting higher average pool balances.
Lower interest on long-term debt, resulting from decreased average
debt balances, partially offset the increase.
- ---------------------------------------------------------------------
Other income, net
- -----------------
Change
June 30 Income Percent
------------
(dollars in millions) 1998 1997 (Expense) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 1.3 $ 3.5 $ (2.2) (62.9)
Other income, net includes equity in earnings of affiliates, interest
income and other nonoperating items. Other income decreased for the
six months ended June 30, 1998 due primarily to decreased equity
earnings from Ameritech Services, Inc. (ASI), as well as an increase
in nonoperating expenses. An increase in interest income partially
offset the decreases.
Page 9
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
Income taxes
- ------------
June 30 Increase Percent
------------
(dollars in millions) 1998 1997 (Decrease) Change
------------------- ---- ---- -------- ------
Six Months Ended $ 206.0 $ 178.9 $ 27.1 15.1
Income taxes increased for the six months ended June 30, 1998 due
primarily to the increase in pretax earnings discussed above. The
tax impacts of the centralization of administration of benefits for
employees also contributed to the increase.
- ---------------------------------------------------------------------
Ratio of earnings to fixed charges
- ----------------------------------
The ratio of earnings to fixed charges for the six months ended June
30 was 7.99 in 1998 and 8.11 in 1997.
Page 10
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Management's Discussion and Analysis
of Results of Operations (cont'd.)
OTHER MATTERS
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Competitive environment
- -----------------------
The Telecommunications Act of 1996 (the "1996 Act") establishes a
national policy that calls for competition and open markets, rather
than regulatory management, as the basic industry business
environment. This public policy change has further opened
opportunities for providers of all forms of communications services
and products, potentially enabling them to become either niche or
full-service providers of voice, video, data, local and long distance
services for their customers.
Technological developments, marketplace demand and legislative,
regulatory and judicial actions have expanded the types of services
and products available from an increasing number of companies,
creating growth opportunities within the global communications
industry. Our competitive strategy includes positioning ourselves to
take advantage of such growth opportunities, by continuing to branch
into new services that are logical extensions of our business.
With the passage of the 1996 Act and other regulatory initiatives,
our local service markets have been more extensively opened to new
competitors, many of which are believed to have initially targeted
high-volume business customers in densely populated areas.
Interconnection agreements with competitive service providers require
us to provide interconnection or access to unbundled network elements
at cost-based rates and telecommunications services at discounted,
wholesale rates. These agreements and applicable tariffs may result
in some downward pressure on local service revenues, as a portion of
our revenue shifts from local service at retail prices to network
access and wholesale services at lower rates. Further, FCC rules
require that interLATA long distance service be offered by a separate
Ameritech subsidiary. As a result, Ameritech's entry into this
market will not generate revenues for Illinois Bell to offset the
potential revenue decline brought by local service competition.
Although we cannot predict with certainty the impact that these and
other developments ultimately may have on our future business,
results of operations or financial condition, especially given the
type of legal and regulatory uncertainties described below, we
believe that over time market competition and regulatory change will
provide opportunities to accelerate growth.
Regulatory considerations
- -------------------------
The Telecommunications Act of 1996
In general, the 1996 Act includes provisions designed to open local
exchange markets to competition and afford the regional Bell
operating companies ("RBOCs") or their affiliates, the competitive
opportunity to provide interLATA (long distance) services. Under the
1996 Act, the RBOCs' ability to provide in-region long distance
services is dependent upon their satisfaction of, among other
conditions, a 14 point "competitive checklist" of specific
requirements, including compliance with interconnection, network
element access and resale service obligations and related pricing
standards and provision of number portability, and their
demonstration that entry into the in-region long distance market
would be in the public interest.
Page 11
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
The Telecommunications Act of 1996 (cont'd.)
A U.S. District Court in Texas ruled that certain line-of-business
restrictions in the 1996 Act, including the requirement in Section
271 that the RBOCs must comply with the competitive checklist before
being permitted to provide long distance services, constitute an
unconstitutional bill of attainder by virtue of their exclusive
applicability to the RBOCs. Appeals of this decision by various
parties are pending before the U.S. Court of Appeals for the Fifth
Circuit, with the lower court decision stayed pending resolution of
such appeals. These appeals were argued before the Fifth Circuit
Court of Appeals on July 9, 1998.
In two other cases, constitutional challenges to some of the
provisions of the 1996 Act governing the RBOCs have been presented to
the U.S. Court of Appeals for the District of Columbia Circuit (the
"D.C. Circuit Court"). In May 1998, the D.C. Circuit Court found
that Section 274 of the 1996 Act, covering electronic publishing
activities, did not constitute an unconstitutional bill of attainder.
The second action pending before the D.C. Circuit Court, in which
Ameritech has intervened, challenges the constitutionality of the
long distance provisions of Section 271 of the 1996 Act. This case
is scheduled for oral argument in September 1998.
Local Interconnection and Unbundled Access
In July 1997, and in an October 1997 rehearing, the U.S. Circuit
Court of Appeals for the Eighth Circuit (the "Eighth Circuit Court")
vacated several provisions of an August 1996 FCC order regarding the
interconnection provisions of the 1996 Act (the "FCC Order"), ruling
that such provisions represented improper preemptions of state
authority or were inconsistent with statutory requirements of the
1996 Act. The Eighth Circuit Court ruled, among other things, that:
the states have exclusive jurisdiction over the pricing for local
interconnection, unbundled network elements and local service resale
involving incumbent local exchange carriers ("ILECs") and competitive
local exchange carriers ("CLECs"); the FCC cannot lawfully allow
CLECs to "pick and choose" among isolated, individual provisions from
other interconnection agreements; and the FCC cannot require ILECs
either to recombine or "rebundle" unbundled network elements for
CLECs or to provide them with a preassembled network platform (or
existing combinations of two or more network elements) at network
element prices. These rulings of the Eighth Circuit Court were
appealed by various parties, including the FCC.
The Eighth Circuit Court upheld certain aspects of the FCC Order.
These included, among other things: the classification of
operational support services, operator services, directory assistance
and vertical services as unbundled network elements; the definition
of "technically feasible" interconnection to exclude economic
considerations; and the ability of CLECs to provide complete
telecommunications services by recombining network elements without
providing any of their own facilities. Ameritech has appealed these
matters, among others.
The U.S. Supreme Court has agreed to review the Eighth Circuit Court
decision. Oral arguments are scheduled for October 1998.
In August 1997, the FCC revised its local competition rules and
required ILECs to make available a new purported network element
known as "shared transport," which would include access to all of an
ILEC's transmission facilities. Ameritech and other ILECs appealed
this matter to the Eighth Circuit Court. On August 10, 1998, the
Eighth Circuit Court upheld the FCC's determination that shared
transport is a network element and that it should be made available
by ILECs to entrants on an unbundled basis. Ameritech intends to
seek judicial review of this decision.
Page 12
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Local Interconnection and Unbundled Access (cont'd.)
At present, local interconnection matters and unbundled network
element pricing continue to be resolved through interconnection
agreement negotiations or state commission arbitration provisions.
We are continuing to negotiate and enter into interconnection
agreements and pursue, through appropriate proceedings, timely
recovery of the costs of providing interconnection services so as to
promote a fair competitive environment, especially as local and long
distance markets are opened to competition at different times. The
outcome of these activities is subject to significant legal and
regulatory uncertainties, as outlined above.
Reciprocal Compensation
A number of CLECs are engaged in regulatory and judicial proceedings
with us and various other ILECs with respect to the payment of
reciprocal compensation to the CLECs for calls originating on the
ILECs' networks for dial-up connections to access the Internet via
ISPs served by the CLECs' networks. The CLECs have asserted that
such reciprocal compensation is provided for by interconnection
agreements between the CLECs and the ILECs. Together with other
ILECs, we have maintained that we are not required to make such
reciprocal compensation payments, because such traffic is interstate
access service, not local, and therefore is not covered by applicable
local interconnection agreements.
A U.S. District Court in Illinois has ruled that we will be required
to make reciprocal compensation payments in these circumstances under
its applicable interconnection agreements, but has issued a brief
stay of its order to permit an appeal. Cases involving appeals by
other Ameritech subsidiaries of adverse regulatory determinations are
pending in U.S. District Courts in Michigan and Wisconsin. The issue
of whether reciprocal compensation is payable with respect to
Internet traffic also is pending before the FCC, in the context of a
request for expedited clarification of the issue filed in June 1997
by the Association for Local Telecommunications Service. We believe
that reciprocal compensation is not required in such circumstances,
and that such view ultimately will be upheld in pending or future
appellate judicial proceedings or through FCC determination.
However, there can be no assurance as to that outcome or that we will
not be required in the future to begin to make such reciprocal
compensation payments under existing interconnection agreements. We
have made periodic accruals of amounts which may become payable in
the event our view is not ultimately upheld.
Number Portability
On May 5, 1998, the FCC entered an order to allow us and other
telecommunications carriers to recover over a five-year period their
carrier-specific costs of implementing long-term number portability.
Long-term number portability allows customers to retain their local
telephone numbers in the event they change local exchange carriers.
We began implementing long-term number portability on March 31, 1998,
consistent with the FCC implementation schedule. The FCC order
permits such cost recovery to begin no earlier than February 1, 1999,
in the form of a surcharge from customers to whom number portability
is available.
Universal Service, Access Charge Reform and Price Cap Order
In May 1997, the FCC issued three closely-related orders that
established rules to implement the universal service provisions of
the 1996 Act (the "Universal Service Order") and to revise both
interstate access charge pricing (the "Access Reform Order") and the
price cap plan for certain ILECs (the "Price Cap Order").
Page 13
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Regulatory considerations (cont'd.)
- -----------------------------------
Universal Service The FCC's Universal Service Order provides that
all interstate telecommunications providers will be required to
contribute to universal service funding, based on retail
telecommunications revenues. The Universal Service Order establishes
a multi-billion dollar interstate universal service fund to help link
eligible schools and libraries and low-income consumers and rural
health care providers to the global telecommunications network
(including the Internet). The FCC directed the phase-in of these
funds during 1998, with a reduced funding rate for the first six
months of 1998.
Access Reform In its Access Reform Order, the FCC restructured
interstate access pricing and adopted changes to its tariff structure
requiring LECs subject to price cap legislation to use rates that
reflect the type of costs incurred. A significant portion of the
services that had been charged using minutes-of-use pricing instead
becomes chargeable using a combination of minutes-of-use rates and
flat-rate charges. The net effect of these changes has been to
decrease minutes-of-use charges and increase per line charges. The
majority of these mandated pricing changes first became effective in
January 1998, with additional changes to be phased in at the
beginning of each subsequent year through 2001. The Access Reform
Order also continued in place existing rules by which ILECs may not
assess interstate access charges on ISPs and purchasers of unbundled
network elements. Together with other ILECs, Ameritech has appealed
certain aspects of the Access Reform Order to the Eighth Circuit
Court, where a decision is pending. In the meantime, we have
implemented state changes that mirror the federal access reform
structure. Various interexchange carriers opposing such changes have
filed complaints before the Illinois and Michigan state commissions.
Price Cap Order Our interstate services are subject to price cap
regulation, which limits prices rather than profits. The Price Cap
Order effectively reduced access charges by increasing the price cap
productivity offset factor to 6.5% from the previous 5.3% and by
applying this factor uniformly to all access providers. The order
also required LECs subject to price cap regulation to set their 1997
price cap index assuming that the 6.5% factor had been in effect
since July 1996. Certain parties have sought judicial review of the
Price Cap Order, and a decision by the D. C. Circuit Court with
respect to these matters is now pending.
We currently cannot predict the precise impact of these regulatory
changes on our business, especially as their nature and timing may
evolve in connection with judicial and FCC consideration of other
provisions of the 1996 Act.
Illinois rate reductions
- ------------------------
Effective July 13, 1998, we reduced rates by $19.0 million annually
under the adjustment process of a price regulation plan approved by
the Illinois Commerce Commission in October 1994. These rate
reductions will primarily impact local service revenues.
Year 2000 readiness
- -------------------
The Year 2000 issue exists because many computer systems and
applications, including those embedded in equipment and facilities,
use two digit rather than four digit date fields to designate an
applicable year. As a result, the systems and applications may not
properly recognize the year 2000 or process data which includes it,
potentially causing data miscalculations or inaccuracies or
operational malfunctions or failures.
Page 14
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 readiness (cont'd.)
- -----------------------------
Ameritech has established a centrally-managed, company-wide
initiative to identify, evaluate and address Year 2000 issues. Begun
in May 1996, Ameritech's Year 2000 effort covers network and
supporting infrastructure for provision of local switched and data
telecommunications services, as well as operational and financial
information technology ("IT") systems and applications, end-user
computing resources and building systems, such as security, elevator
and heating and cooling systems. In addition, the project includes a
review of the Year 2000 compliance efforts of key suppliers and other
principal business partners and, as appropriate, the development of
joint business support and continuity plans for Year 2000 issues.
While this initiative is broad in scope, it has been structured to
identify and prioritize our efforts for mission critical systems,
network elements and products and key business partners.
Work is progressing in the following phases: inventory, assessment,
remediation, testing, deployment and monitoring. Although the pace
of the work varies among Ameritech's business units and the phases
are often conducted in parallel, the inventory and assessment phases
have been substantially completed as of June 30, 1998 and the
remediation phase is in progress. As part of the testing phase,
Ameritech intends to conduct independent verification testing of
selected network component upgrades received from suppliers. In
addition, selected Year 2000 upgrades are slated to undergo testing
in a controlled environment that replicates the current network and
is equipped to simulate the turn of the century and leap year dates.
Under the current Year 2000 plan, Ameritech has established a target
date of January 1, 1999 for remediation of critical systems, network
elements and products, subject to additional Year 2000 testing and
responsive actions. Ameritech's ability to meet that target date is
dependent upon the timely provision of necessary upgrades and
modifications by suppliers and contractors. In some instances, third
party upgrades or modifications are not expected to be available
until late 1998; accordingly, Ameritech's testing and redeployment of
affected items may be delayed into 1999. In addition, Ameritech
cannot guarantee that third parties on whom we depend for essential
services (such as electric utilities, interexchange carriers, etc.)
will convert their critical systems and processes in a timely manner.
Failure or delay by any of these parties could significantly disrupt
our business. However, Ameritech has established a supplier
compliance program, and is working with its key suppliers to minimize
such risks.
Ameritech and all of its subsidiaries, including Illinois Bell,
expect to incur total expenses of approximately $210 million through
2001 in connection with anticipated Year 2000 efforts, in addition to
approximately $40 million in total expenses incurred through June 30,
1998 for matters historically identified as Year 2000-related. The
timing of these expenses may vary and is not necessarily indicative
of readiness efforts or progress to date. We anticipate that a
portion of our Year 2000 expenses will not be incremental costs, but
rather will represent the redeployment of existing IT resources.
Ameritech as a whole also expects to incur certain capital
improvement costs (totaling approximately $30 million) to support
this project. Such capital costs are being incurred sooner than
originally planned, but, for the most part, would have been required
in the normal course of business.
As part of its Year 2000 initiative, Ameritech is evaluating
scenarios that may occur as a result of the century change and is in
the process of developing contingency and business continuity plans
tailored for Year 2000-related occurrences. Contingency planning to
maintain and restore service in the event of natural disasters, power
failures and software-related problems has been part
Page 15
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
Year 2000 readiness (cont'd.)
- -----------------------------
of our standard operation for many years, and we are working with
Ameritech to leverage this experience in the development of plans
tailored to meet Year 2000-related challenges. These plans are
expected to assess the potential for business disruption in various
scenarios, and to provide for key operational back-up, recovery and
restoration alternatives.
The above information is based on current best estimates, which were
derived using numerous assumptions of future events, including the
availability and future costs of certain technological and other
resources, third party modification actions and other factors. Given
the complexity of these issues and possible as yet unidentified
risks, actual results may vary materially from those anticipated and
discussed above. Specific factors that might cause such differences
include, among others, the availability and cost of personnel trained
in this area, the ability to locate and correct all affected computer
code, the timing and success of remedial efforts of our third party
suppliers and similar uncertainties.
New accounting pronouncements
- -----------------------------
FAS 131
In June 1997, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (FAS) 131, "Disclosures
about Segments of an Enterprise and Related Information." This
statement supersedes FAS 14, "Financial Reporting of Segments of a
Business Enterprise," by establishing new standards for the way that
a public business enterprise reports operating segment information in
its annual and interim financial statements. In general, FAS 131
requires reporting of financial information as it is used by senior
company management for evaluating performance and deciding how to
allocate resources. The statement is effective in 1998, but need not
be applied to interim financial statements this year. Comparative
information for earlier years must be restated. We will adopt FAS
131 beginning with our 1998 Annual Report on Form 10-K.
AICPA SOP 98-1
In March 1998, the American Institute of Certified Public Accountants
(AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use."
This SOP provides authoritative guidance for the capitalization of
certain computer software costs developed or obtained for our
internal applications, such as:
- - external direct costs of materials and services, such as
programming costs,
- - payroll costs for employees devoting time to the software project,
and
- - interest costs to be capitalized.
Costs incurred during the preliminary project stage, as well as
training and data conversion costs, are to be expensed as incurred.
The SOP is effective for fiscal years beginning after December 15,
1998, however earlier application is encouraged. We have not yet
quantified the impacts of adopting this SOP on our financial
statements and have not determined the timing of our adoption. We
have historically expensed most computer software costs as incurred.
FAS 133
In June 1998 the FASB issued FAS 133, "Accounting for Derivative
Instruments and Hedging Activities." This statement provides
standardized accounting and disclosure guidance for derivative
instruments and the derivative portion of
Page 16
<PAGE>
Management's Discussion and Analysis
of Results of Operations (cont'd.)
New accounting pronouncements (cont'd.)
- ---------------------------------------
FAS 133 (cont'd.)
certain similar contracts. It amends FAS 52, "Foreign Currency
Translation" and FAS 107, "Disclosures about Fair Values of
Financial Instruments," and it supersedes a number of financial
accounting standards previously issued by the FASB and several
interpretations from the Emerging Issues Task Force.
The statement requires entities that use derivative instruments to
measure these instruments at fair value and record them as assets
or liabilities on the balance sheet. It also requires entities to
reflect the gains or losses associated with changes in the fair
value of these derivatives, either in earnings or as a separate
component of comprehensive income, depending on the nature of the
underlying contract or transaction.
FAS 133 is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999, and is to be adopted as of the
beginning of the fiscal year. At the time of adoption, all
derivative instruments are to be measured at fair value and
recorded on the balance sheet. Any differences between fair value
and carrying amount at that time will be recorded as a cumulative
effect of a change in accounting principle, in either net income or
other comprehensive income, as appropriate. Adoption of this
statement may or may not have a material impact on our results of
operations or financial position in a given year, depending upon
the nature and magnitude of derivative activity that we engage in
and the changes in market conditions with respect to interest rates
or other underlying values. We have not yet quantified the impacts
of the initial adoption of FAS 133 on our results of operations or
financial condition, nor have we determined when we will implement
the new standard.
Private Securities Litigation Reform Act safe harbor statement
- --------------------------------------------------------------
Some of the information presented in, or in connection with, this
report may constitute "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995
that involve potential risks and uncertainties. Our future results
could differ materially from those discussed here. Some of the
factors that could cause or contribute to such differences include:
- - changes in economic and market conditions that impact the demand
for our products and services;
- - greater than anticipated competition from new entrants into the
local exchange, intraLATA toll or data markets;
- - regulatory developments that impact the telecommunications
industry, as well as pending regulatory issues under state
jurisdiction;
- - potential additional costs to comply with the regulatory
requirements of entry into the interLATA long distance market;
- - the impact of new technologies and the potential effect of
delays in development or deployment of such technologies; and,
- - the potential impact of issues related to year 2000 software
compliance.
You should not place undue reliance on these forward-looking
statements, which are applicable only as of August 13, 1998. We
have no obligation to revise or update these forward-looking
statements to reflect events or circumstances that arise after
August 13, 1998 or to reflect the occurrence of unanticipated
events.
Page 17
<PAGE>
Item 3 - Quantitative and Qualitative
Disclosures about Market Risk
-----------------------------
We have not included quantitative and qualitative disclosures about
market risk as of June 30, 1998 because Illinois Bell's value at risk
has not changed significantly since December 31, 1997. Quantitative
and qualitative disclosures about market risk were included in our
1997 Annual Report on Form 10-K.
Page 18
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
---------------------------------
(a) Exhibits
--------
12 Computation of Ratio of Earnings to Fixed Charges for
the six months ended June 30, 1998 and June 30, 1997.
27 Financial Data Schedule.
(b) Reports on Form 8-K
-------------------
We did not file a Form 8-K during the quarter ended June
30, 1998.
Page 19
<PAGE>
SIGNATURES
Under the requirements of the Securities Exchange Act of 1934, an
authorized company official has signed this report on our behalf.
ILLINOIS BELL TELEPHONE COMPANY
-------------------------------
(Registrant)
Date: August 13, 1998 /s/ Ronald G. Pippin
----------------------
Ronald G. Pippin
Vice President and Comptroller
(Duly Authorized Signatory and
Principal Accounting Officer)
Page 20
<PAGE>
GLOSSARY
Access charges -
- ---------------
fees that local phone companies charge to long distance carriers for
the handling of long distance calls on our local network.
Access line -
- ------------
a telephone line for voice, data or video reaching from a local
phone company to a home or business.
Call management services -
- -------------------------
services that add value and convenience for phone customers, such as
call waiting, call forwarding and Caller ID. These services are
sold to customers individually or in "packages".
Customer premises equipment (CPE) -
- ----------------------------------
communications equipment owned by customers, including telephones,
faxes and switches.
Dial 1+ -
- ---------
a feature that allows local phone customers to designate a carrier
other than the local service provider for toll calls within their
calling area by simply dialing 1 plus the telephone number.
Digital -
- --------
an alternative to traditional analog communications, digital systems
transport information in computer code for improved clarity and
quality.
Federal Communications Commission (FCC) -
- ----------------------------------------
the federal agency responsible for regulating the interstate aspects
of telecommunications activities.
Financial Accounting Standards Board (FASB) -
- --------------------------------------------
the independent body responsible for setting accounting and
financial reporting standards to be followed by U.S. business
enterprises.
Gross receipts taxes -
- ---------------------
state and local taxes based upon the gross operating revenues earned
in a particular jurisdiction. These taxes may be imposed on general
businesses or public utilities in lieu of other taxes.
Interconnection -
- ----------------
allowing a competitive local service provider to use the local phone
company's network, or elements of the network, to provide local
phone service to its customers.
Interexchange carriers (IXCs) -
- ------------------------------
those companies primarily involved in providing long distance voice
and data transmission services, such as AT&T, MCI and Sprint.
Internet -
- ---------
the global web of networks that connects computers around the world,
providing rapid access to information from multiple sources.
Internet service providers (ISPs) -
- ----------------------------------
those companies providing access to the Internet and other computer-
based information networks.
Intrastate revenues -
- --------------------
that portion of revenues regulated by state rather than federal
authorities.
Local access and transport area (LATA) -
- ---------------------------------------
the boundary within which a local telephone company may provide
phone service. It is usually centered around a city or other
identifiable community of interest.
Local exchange carriers (LECs) -
- -------------------------------
those companies primarily involved in providing local phone service
and access to the local phone network, including Ameritech's
landline communications subsidiaries in Illinois, Indiana, Michigan,
Ohio and Wisconsin.
Page 21
<PAGE>
GLOSSARY (cont'd.)
Operations support systems (OSS) -
- ---------------------------------
the databases and information used to support the provision of
telephone service to end users.
Price caps -
- -----------
a form of regulation that sets maximum limits on the prices that
LECs can charge for access services instead of limits on rate of
return or profits.
Productivity factor -
- --------------------
a portion of the interstate price cap formula that requires LECs to
reduce the price cap based on an assumed increase in productivity.
Securities and Exchange Commission (SEC) -
- -----------------------------------------
the federal agency that regulates the issuance and trading of public
debt and equity securities in the United States and monitors
compliance with these regulations.
Switched Minutes of Use -
- -----------------------
the measure of time used to bill IXC's for access to our public
switched network.
Unbundled network element -
- -------------------------
any feature, function or capability used in the provision of
telecommunications service that is made available by local exchange
carriers to other telecommunications providers separate from other
network elements and for a separate fee.
Universal service -
- ------------------
a concept designed to ensure access to the telecommunications
network in rural and low-income areas at affordable prices. Funding
typically comes from urban telecommunication operators.
Page 22
EXHIBIT 12
ILLINOIS BELL TELEPHONE COMPANY
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Unaudited)
(Dollars in Millions)
Six Months Ended
June 30
---------------
1998 1997
---- ----
1. EARNINGS
a) Income before interest expense,
income taxes and undistributed
equity earnings .................... $ 554.2 $ 525.7
b) Portion of rental expense
representative of the
interest factor (1)................. 6.9 7.7
-------- --------
Total 1(a) and 1(b)..................... $ 561.1 $ 533.4
-------- --------
2. FIXED CHARGES
a) Total interest expense including
capital lease obligations........... $ 61.7 $ 56.8
b) Capitalized interest................. 1.6 1.3
c) Portion of rental expense
representative of the
interest factor (1)................. 6.9 7.7
-------- --------
Total 2(a) through 2(c)................. $ 70.2 $ 65.8
-------- --------
3. RATIO OF EARNINGS TO FIXED CHARGES....... 7.99 8.11
===== =====
(1) We consider one third of total rental expense to represent return on
capital.
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
ILLINOIS BELL TELEPHONE COMPANY'S JUNE 30, 1998 CONSOLIDATED
FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 43,000<F1>
<SECURITIES> 0
<RECEIVABLES> 963,800
<ALLOWANCES> (111,500)
<INVENTORY> 33,500
<CURRENT-ASSETS> 956,600
<PP&E> 9,826,700
<DEPRECIATION> 5,815,000
<TOTAL-ASSETS> 5,559,600
<CURRENT-LIABILITIES> 1,741,100
<BONDS> 1,011,600
0
0
<COMMON> 1,638,800
<OTHER-SE> (164,400)
<TOTAL-LIABILITY-AND-EQUITY> 5,559,600
<SALES> 0<F1><F2>
<TOTAL-REVENUES> 1,966,800
<CGS> 0<F3>
<TOTAL-COSTS> 1,419,200
<OTHER-EXPENSES> (1,300)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 61,700
<INCOME-PRETAX> 487,200
<INCOME-TAX> 206,000
<INCOME-CONTINUING> 281,200
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 281,200
<EPS-PRIMARY> 0.00
<EPS-DILUTED> 0.00
<FN>
<F1>WE HAVE NOT STATED SECURITIES SEPARATELY IN THE FINANCIAL STATEMENTS
BECAUSE THEY ARE NOT MATERIAL. WE HAVE INCLUDED THEM IN THE "CASH" TAG.
<F2>NET SALES OF TANGIBLE PRODUCTS IS NOT MORE THAN 10% OF TOTAL OPERATING
REVENUES. WE THEREFORE HAVE NOT STATED THESE SALES SEPARATELY IN THE
FINANCIAL STATEMENTS, PER REGULATION S-X, RULE 5-03(B). WE HAVE INCLUDED
THESE SALES IN THE "TOTAL REVENUES" TAG.
<F3>WE HAVE INCLUDED COST OF TANGIBLE GOODS SOLD IN COST OF SERVICE AND
PRODUCTS IN THE FINANCIAL STATEMENTS AND THE "TOTAL COST" TAG, PER REGULATION
S-X, RULE 5-03(B).
</FN>
</TABLE>
