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U.S. Securities and Exchange Commission
Washington, D.C. 20549
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Form 10-K
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Annual Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended December 31, 1997
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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 West Randolph Street
Chicago, Illinois 60606
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I.R.S. Employer Identification
Number 36-1253600
Telephone number (800) 257-0902
Securities registered under Section 12(b) of the Act:
Thirty-Five Year 7 5/8% First Mortgage Bonds,
Series K, due April 1, 2006
These debt securities are registered on the New York Stock Exchange.
We are a wholly owned subsidiary of Ameritech Corporation and meet the
conditions set forth in general instructions J(1)(a) and (b) of Form 10-K,
therefore we are filing this form with reduced disclosure format according
to general instruction J(2).
We have no securities registered under Section 12(g) of the Act. We are
subject to certain filing requirements under Sections 13 and 15 (d) of the
Securities Exchange Act of 1934 and have filed all the required reports
during the preceding 12 months.
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TABLE OF CONTENTS
PART I
Item Page
---- ----
1. Business......................................... 1
2. Properties....................................... 6
3. Legal Proceedings................................ 7
4. Submission of Matters to a Vote of Security
Holders (Omitted pursuant to General Instruction J(2)).
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters (Inapplicable).
6. Selected Financial and Operating Data............ 8
7. Management's Discussion and Analysis of Results of
Operations (Abbreviated pursuant to
General Instruction J(2))....................... 9
8. Financial Statements and Supplementary Data...... 16
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.......... 28
PART III
10. Directors and Executive Officers of the Registrant
(Omitted pursuant to General Instruction J(2)).
11. Executive Compensation (Omitted pursuant to
General Instruction J(2)).
12. Security Ownership of Certain Beneficial Owners
and Management (Omitted pursuant to General
Instruction J(2)).
13. Certain Relationships and Related Transactions
(Omitted pursuant to General Instruction J(2)).
PART IV
14. Exhibits, Financial Statement Schedules,
and Reports on Form 8-K......................... 29
Glossary......................................... 31
i
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When reading this annual report, you should be familiar with the
terminology unique to our business. We have defined a number of
terms in the Glossary on page 31.
PART I
Item 1. Business.
The Company
Illinois Bell Telephone Company, incorporated under the laws of
the State of Illinois, has its principal office at 225 West
Randolph Street, Chicago, Illinois 60606 (telephone number 1-800-
257-0902). We are one of the five wholly owned landline
communications subsidiaries of Ameritech Corporation, incorporated
in 1983 under the laws of the State of Delaware. Ameritech is the
parent company of numerous other communications businesses with
principal executive offices located at 30 South Wacker Drive,
Chicago, Illinois 60606 (telephone number 1-800-257-0902).
Illinois Bell is managed by its sole shareowner rather than a board
of directors as permitted by Illinois law.
Ameritech is a global diversified, full-service communications
company which provides local and long distance telephone and
cellular service, paging, security, cable TV, Internet access and
directory publishing services. Ameritech's 1997 revenues were
$16.0 billion. The products and services of the Ameritech
companies are marketed under the "Ameritech" brand identity, in all
50 states and 40 countries. Illinois Bell is regionally identified
and does business as "Ameritech Illinois," selling principally
landline local telephone service as described below.
The Telecommunications Act
The Telecommunications Act of 1996 (the 1996 Act), signed into
law in February 1996, was intended to stimulate competition in the
market for communications services and to remove barriers that
prevented the telecommunications, cable TV and broadcast industries
from entering each others' businesses. The 1996 Act addresses
various aspects of competition within, and regulation of, the
communications industry. It provides that all conduct or
activities subject to the consent decree issued at the time of AT&T
Corp.'s (AT&T) court-approved divestiture in 1984 of certain assets
to seven regional holding companies (RHCs), including Ameritech,
are now subject to the provisions of the 1996 Act. Among other
things, the law defines the conditions under which Ameritech and
the other RHCs may offer long distance service and provides certain
mechanisms intended to facilitate local exchange competition. The
1996 Act gives the Federal Communications Commission (FCC)
authority to determine when incumbent local exchange carriers have
satisfied the statutory criteria required to provide long distance
service in an in-region state, including meeting a 14-point
competitive checklist. For the RHCs, immediate relief under the
law included permission to provide in and out-of-region cellular
long distance, out-of-region landline long distance and certain
incidental long distance services.
Since passage of the 1996 Act, there have been numerous
challenges to the rules, discussed further in the section on
Regulatory Environment - Federal. It is difficult to determine how
the rules will evolve and exactly what effect competition fostered
by the 1996 Act will have on our business over time.
Illinois Bell's Full Service Communications Business
Illinois Bell is responsible within its service areas for
providing telephone and other communications services, subject to
regulation by the FCC and the state regulatory commission, the
Illinois Commerce Commission (ICC). We furnish a wide variety of
advanced communications services, including local exchange and toll
service and network access, and communications products to
business, residential and communications company customers in an
operating area comprised of 16 Local Access and Transport Areas
(LATAs) in Illinois. These LATAs are generally centered on a city
or other identifiable community of interest, and each LATA marks
the boundary within which we may provide telephone service. We
provide two basic types of communications services:
- - We transport communications traffic between a customer's
equipment and the telephone exchange offices located within the
same LATA (intraLATA service). These services include local
exchange, private line and intraLATA toll services (including
800 and special services for data, radio and video transport).
- - In addition, we provide exchange access service, which links a
subscriber's telephone or other equipment to the transmission
facilities of long distance carriers, which in turn provide
communications service between LATAs (interLATA, or long
distance, service).
<PAGE>
We serve about 80% of the population and 20% of the area of
Illinois. The remainder of the state is served by nonaffiliated
telephone companies.
In addition, we provide public telephone and local and toll
operator services (including collect calls, third number billing,
person-to-person and calling card calls). A national directory
assistance service is offered by us in Chicago and by another
Ameritech company in Detroit and Grand Rapids, with plans to expand
across the Ameritech region. We offer call management services
(including voice mail, Caller ID, call waiting and call
forwarding), as well as digital network services (such as online
database access and fax messaging, document sharing functions and
video conferencing for desktop computers). We provide billing and
collection services for several companies, including billing for
long distance services offered by certain long distance carriers.
We currently offer a single monthly statement for phone service and
a variety of other Ameritech services as well as around-the-clock
customer service, for all residential, small business and home
office customers.
We market our local phone services on a wholesale basis to
certain other companies that resell our network services. Our
customers are other network and information providers, including
cellular and personal communications services and competing local
service companies, who buy our services to use in their product
offerings.
In 1997, we added 365,000 customer access lines, including
133,000 residential and business lines we acquired in November 1997
with the purchase of the telecommunications assets of Sprint's
local exchange business in suburban Chicago. We now serve more
than 6,838,000 lines in Illinois, a 5.6% increase over lines served
in 1996 (3.6% without the lines acquired from Sprint). Customer
access line growth was fueled by second line additions and
increased business usage. Demand for speed and access drove record
growth in our data services. Sales of high speed access lines and
high speed circuits increased. Demand for call management services
grew as customers sought greater convenience and control over their
telephone communications.
We have an agreement with Ameritech Publishing, Inc. (API), an
Ameritech subsidiary, Ameritech Publishing of Illinois, Inc. (API-
IL), The Reuben H. Donnelley Corporation (Donnelley), and AM-DON, a
partnership between Donnelley and API-IL. Effective January 1,
1991, the obligations of the individual parties regarding
publication of classified directories were assigned to the
partnership, which does business as DonTech. Under this agreement,
DonTech published, printed and delivered classified directories and
we provided listings to DonTech and performed the billing and
collection services for the directories as an agent for the
partnership. In consideration for the operations we performed, the
partnership paid a guaranteed amount each year, plus an increment
for growth, and reimbursed us for various expenses we incurred in
publishing alphabetical directories. The DonTech partnership
agreement was renegotiated, effective September 1, 1997, affirming
DonTech's role as the exclusive local sales agency in Illinois and
northwest Indiana. Beginning in 1998, publication of classified
directories became the responsibility of APIL Partners, a
partnership of API and API-IL.
Ameritech Services, Inc. (ASI), a company we own jointly with
the other four Ameritech landline communications subsidiaries,
provides us with technical services, procurement, marketing, human
resources management and regulatory planning, as well as labor
contract bargaining oversight and coordination. ASI is a shared
resource, providing operational support for the five landline
communications subsidiaries and integrated communications and
information systems for all Ameritech companies.
In 1997, about 88% of our total operating revenues were from
communications services and the remainder were principally from
billing and collection services, rents, directory advertising and
other miscellaneous nonregulated operations. About 76% of the
revenues from communications services were attributable to
intrastate operations.
Regulatory Environment - Federal
Among other things, the FCC develops and implements policies
concerning interstate communications by wire. In addition to
developing regulations to carry out the intent of the 1996 Act, the
FCC prescribes for certain communications companies a uniform
system of accounts and rules for apportioning costs between
regulated and nonregulated services. The FCC, in consultation with
representatives of state regulatory commissions, is also
responsible for the principles and standard procedures used to
separate regulated property, plant and equipment costs, revenues,
expenses, taxes and reserves between those applicable to interstate
services under FCC jurisdiction and those applicable to intrastate
services under the respective state regulatory commission's
jurisdiction.
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Local competition
The 1996 Act directed the FCC to establish rules and regulations
to enforce the law and to preempt specific state provisions in
certain circumstances. As required by the 1996 Act, in August 1996
the FCC adopted rules to implement the local competition
provisions. The rules required local exchange carriers, including
Illinois Bell, among other duties, to:
- - provide interconnection to any telecommunications carrier at any
technically feasible point, equal in quality to that provided
for the local exchange carrier's own operations;
- - provide those carriers with access to network elements on an
unbundled basis; and
- - offer for resale, at wholesale rates, any telecommunications
services that the local exchange carrier provides at retail to
subscribers who are not telecommunications carriers.
The FCC's rules addressed pricing for interconnection, unbundled
network elements and resale of telecommunications services. In
October 1996, in an order entered in an appeal filed by certain
local exchange carriers, the United States Court of Appeals for the
Eighth Circuit stayed the portion of the FCC rules with respect to
pricing and the FCC's so-called "pick and choose" rule that would
allow requesting carriers to pick and choose among individual
provisions of existing interconnection agreements. The United
States Supreme Court declined to overturn the appeals court stay.
In July 1997, the court of appeals struck down several provisions
of the FCC's August 1996 order designed to implement the
interconnection provisions of the 1996 Act, ruling that:
- - the FCC's pricing guidelines intrude upon the rights of state
regulatory commissions to implement key elements of the 1996
Act;
- - the FCC lacks jurisdiction to review state regulatory commission
decisions regarding interconnection agreements between incumbent
local exchange carriers and their competitors;
- - the FCC's pick and choose rule does not promote negotiated
agreements and is unreasonable;
- - local exchange carriers must provide unbundled network elements
(including operations support systems and certain other
services) in a manner that allows competing carriers to combine
them, but they need not actually combine the elements; and
- - the 1996 Act does not require incumbent local exchange carriers
to provide competitors with superior quality connections.
In October 1997, the Eighth Circuit Court overturned the FCC
ruling requiring the Ameritech landline communications subsidiaries
and other incumbent local exchange carriers to resell bundled
network services at unbundled wholesale rates. As a result of the
court's decision, if new entrants to the local exchange market wish
to purchase network elements at unbundled discounted prices, they
must recombine the elements themselves. The incumbent local
exchange carriers had maintained that when a new entrant seeks a
preexisting combination of network elements, they are purchasing a
service for resale and do not qualify for the deep discounts
applicable to unbundled network elements.
In January 1998, the Eighth Circuit Court ordered the FCC to
uphold the court's earlier ruling transferring the power of the
federal agency to set terms on prices and connections to local
phone networks to the state commissions. The order came a day
before the United States Supreme Court agreed to consolidate
numerous appeals centering on the 1996 Act filed by AT&T, MCI, the
FCC and others. Barring additional action, the case will be argued
before the Supreme Court in October 1998.
In December 1997, the United States District Court in Wichita
Falls, Texas, declared unconstitutional a key part of the 1996 Act
that excludes only the RHCs' landline communications companies from
the long distance market. Two of those companies, SBC
Communications Inc. and US West Communications, Inc. initiated the
lawsuit. Long distance industry opponents of the ruling, the FCC
and the Department of Justice asked the court for an injunction
barring SBC Communications, US West and Bell Atlantic Corporation,
which joined in the suit, from preparing to provide in-region long
distance service until the court ruled on their stay requests. In
February 1998, the court issued two orders - the final judgment
giving legal effect to the court's earlier opinion and an order
staying that decision pending resolution of appeals from it. The
court denied the motions for injunctions.
<PAGE>
In addition, BellSouth Communications, Inc. brought two appeals
to the United States Court of Appeals for the District of Columbia
challenging the constitutionality of many of the same provisions of
the 1996 Act for which SBC Communications and US West sought review
in the Texas District Court. One action challenges the section of
the 1996 Act covering electronic publishing and another challenges
the sections which address long distance. Ameritech has intervened
in this later appeal. Consequently, the Fifth Circuit Court and
the D.C. Circuit Court are deciding the constitutionality of the
provisions of the 1996 Act specifically applicable to the RHCs'
landline communications companies.
Price Cap Reform
Our interstate revenues are regulated by a price cap mechanism
rather than by rate-of-return regulation. The FCC's price cap
regulatory scheme sets maximum limits on the prices that local
exchange carriers can charge other carriers to access their
facilities to originate or terminate interstate long distance calls
and other communications. The limits are adjusted each year to
reflect inflation, a productivity factor and certain other cost
changes. Under price caps, local exchange carriers have increased
flexibility to change prices of access services, as well as prices
for interstate intraLATA service, provided they do not exceed the
allowed price cap.
In May 1997, the FCC issued three closely related orders
addressing revisions to the original price cap plan, interstate
access charge reform and funding for universal service. The new
price cap rules reduced access charges by increasing the price cap
productivity offset factor to 6.5% from the prior 5.3% and by
applying this factor uniformly to all access providers. The new
rates were effective July 1, 1997 and local exchange carriers were
required to compute the new rates as if the 6.5% productivity
factor had been in effect since July 1, 1996.
Access Charge Reform
The FCC's original access charge structure was adopted at the
time of the divestiture by AT&T. These policies were designed
primarily to promote competition in the interstate long distance
market by ensuring that all long distance companies would be able
to originate and terminate their traffic over incumbent local
exchange carriers' networks at just, reasonable and
nondiscriminatory rates. Although these policies contemplated long
distance competition, they did not attempt to address the potential
effects of local or access competition. In December 1996, the FCC
laid out its proposals on access charge reform, asking for comments
on a number of steps it proposed to take to restructure the fees to
make the system compatible with the pro-competitive deregulatory
framework established by the 1996 Act.
In its May 1997 access charge reform order, the FCC adopted
changes to its tariff structure requiring usage-sensitive recovery
that is more reflective of the way in which costs are incurred. In
general, the order provides that only costs incurred on a usage-
sensitive basis should be recovered in per-minute access charges
and costs not incurred on a usage-sensitive basis should be
recovered through flat rate charges.
Universal Service
In November 1996, the Federal-State Universal Service Joint
Board issued its recommendations to the FCC for reforming the
existing system of subsidizing universal basic telephone service.
The goal was to preserve and advance universal service in a manner
that permits local telephone markets to move from monopoly to
competition. The FCC's May 1997 ruling required creation of a
multi-billion-dollar universal service fund for subsidizing low-
income customers, high cost service areas rural health care
providers, schools and libraries. Telecommunications service
providers began to pay into this new universal service fund
beginning on January 1, 1998. Subsidies to low-income and rural
customers became available on that date and funds for linking
schools and libraries to the Internet will be available as needed.
Other FCC Matters
The FCC ruled in April 1997 that Ameritech has met all
competitive requirements under the pay phone portion of the 1996
Act. The move to deregulate pay phone services culminated in
October 1997, when responsibility for setting the price of a local
pay phone call was transferred from state regulators to the
competitive marketplace. Many of the provisions included in the
1996 Act, which served as the road map for pay phone deregulation,
were patterned after competitive pay phone measures already in
place in Illinois and Michigan.
<PAGE>
Regulatory Environment - State
We are also subject to regulation by the ICC with respect to
certain intrastate rates and services. In 1994, the ICC approved
Advantage Illinois, providing a framework for regulating Illinois
Bell by capping prices for noncompetitive services. At the same
time, the ICC approved a cap on the monthly line charge for our
residential customers and residential calling rates within local
calling areas at November 1994 levels for five years. In return
for these price protections, the ICC removed a ceiling on our
earnings to reflect the increasingly competitive communications
industry and to create incentives for us to invest in new
technology, develop new services and improve efficiency. In 1996,
we offered dialing parity in our local toll markets, giving our
customers the ability to choose an alternate carrier for intraLATA
toll calls. In July 1997, we reduced rates by $54 million
annually. Lower prices are reflected in several product and
service areas, but the largest portion of the reductions comes from
increased volume discounts for certain local calls. 1997 marked
the fourth consecutive year of price reductions, now totaling $461
million, under the Advantage Illinois price cap plan.
Other state matters
In January 1998, the Michigan Public Service Commission ruled
that Ameritech Michigan owes compensation under interconnection
agreements to other local exchange carriers. This compensation
relates to calls made by Ameritech Michigan customers to the
Internet via Internet service providers who, in turn, are the
customers of those other local exchange carriers. Similar issues
involving the interpretation of the interconnection agreements are
the subject of regulatory proceedings pending in Illinois and the
other states in Ameritech's region. These issues ultimately may be
determined by the FCC, where a docket is currently pending.
Long Distance Services
InterLATA long distance is a $2.8 billion market in our local
service area. Under the 1996 Act, Ameritech and the other RHCs
must open their respective local markets to competition by
implementing a 14-point checklist before they can offer interLATA
long distance service to their local landline customers. In
considering an application to offer interLATA long distance
service, the FCC must determine whether or not an RHC has satisfied
the statutory criteria, including the competitive checklist,
compliance with structural and accounting rules, and whether its
entry into long distance is consistent with the public interest.
An RHC is restricted from providing interLATA long distance service
until the FCC determines that the statutory criteria have been met.
The FCC gives substantial weight to Department of Justice
recommendations in reviewing RHC applications to enter the market.
In preparation, we have negotiated or arbitrated numerous
agreements with competitors to allow interconnection access to our
network elements at cost-based rates and purchase of our local
services at wholesale rates for resale to the public.
FCC rules require that interLATA long distance service be
offered by Ameritech's long distance subsidiary, Ameritech
Communications Inc., which is certified to provide long distance
service in all states outside the Ameritech five-state region.
Accordingly, Ameritech Communications' entry into this market will
not generate long distance revenues for Illinois Bell.
With passage of the 1996 Act, Ameritech and the other RHCs were
allowed to provide long distance service to their cellular
customers, regardless of location.
Evolution of the Industry
Growing customer need for new services, new technologies,
regulatory reform and corporate alliances are accelerating the pace
of change and creating intense competition in the communications
industry. That will mean greater choice, an explosion of new
products and services and better values for consumers. More
competition in our industry is inevitable.
With the passage of the 1996 Act and earlier regulatory
initiatives, our local service market has been opened to
competition from long distance carriers, cable TV providers and
other local service providers. Interconnection agreements with
these providers require us to allow access to our network elements
at cost-based rates or purchase of our local services for resale at
wholesale rates. These agreements may result in some downward
pressure on local service revenues as a portion of our revenue
shifts from local service at retail rates to network access at
wholesale rates.
It is impossible to predict the specific impact of the 1996 Act
and other changes in the industry on our business or financial
results. Notwithstanding the potential for an adverse effect on
certain of our revenue streams, we expect to capture a significant
portion of the expected growth in the communications marketplace,
building on our strengths and branching into new services that are
a logical extension of our business.
<PAGE>
Patents, Trademarks and Other Intellectual Property
Illinois Bell, through its parent, Ameritech, has rights to use
various patents, copyrights, trademarks and other intellectual
property necessary to conduct our business. We do not believe that
the expiration of any of our intellectual property, or the
nonrenewal of rights to use it, would have a material adverse
affect on our business.
Illinois Bell's Human Resources
We employed 14,929 people as of December 31, 1997, compared with
14,785 as of December 31, 1996. The Communications Workers of
America (CWA) and the International Brotherhood of Electrical
Workers (IBEW) represent about 12,700 of the Company's employees.
Of those so represented, about 14% are represented by the CWA and
about 86% are represented by the IBEW, both of which are affiliated
with the AFL-CIO. Current three-year contracts expire this summer,
the IBEW on June 28, 1998 and the CWA on August 8, 1998.
Item 2. Properties.
General
The large number and widespread locations of Illinois Bell's
properties make it difficult to provide detailed descriptions of
the physical characteristics of the individual components. In
general, however, we can categorize our investment in property,
plant and equipment at year-end 1997 as follows:
- - "Land and Buildings," consisting of land we own including
improvements (namely central and administrative offices),
represents 8% of our total investment;
- - "Central office equipment," including switching and transmission
equipment and related facilities, represents 41%;
- - "Cable, wiring and conduit (or outside plant)," including aerial
cable, poles, underground cable, conduit and wiring, represents
42%;
- - "Other," including motor vehicles, computers and other support
assets, represents 8%; and
- - "Plant under construction" represents 1%.
Capital Expenditures
We believe that investment in our business will:
- - facilitate the introduction of new products and services;
- - enhance our responsiveness to ever-increasing competitive
challenges; and
- - increase the operating efficiency and productivity of our
network.
Our total investment in property, plant and equipment increased
from about $8.1 billion at year-end 1992 to $9.6 billion at year-
end 1997. Growth in capital expenditures was driven by demand in
our business and regulatory requirements, such as those related to
the 1996 Act. Capital expenditures, the single largest use of our
funds, were $672 million in 1997, $632 million in 1996 and $490
million in 1995.
Our capital spending is based on customer needs and Ameritech's
overall business plans. Investments in technologies that will
enable us to provide customers with new products and services
represent a high priority. We continued to modernize our network
throughout 1997. By investing in our telecommunications
infrastructure, we can anticipate and meet the demands on the
network by customers seeking Internet access, high speed data
transmission, information management and other communications
services.
Under the Advantage Illinois plan, we are committed to making
$3.0 billion in capital and other network expenditures over the
five year period ending in 1999. This commitment includes Illinois
Bell's capital expenditures and specifically excludes capital
expenditures of other Ameritech companies in Illinois.
<PAGE>
Item 3. Legal Proceedings.
The United States District Court for the District of Columbia
signed and approved a Plan of Reorganization in connection with
AT&T's divestiture, effective January 1, 1984, of certain assets to
the RHCs, including Ameritech. The Plan provides for the
recognition and payment of liabilities that are attributable to
predivestiture events (including transactions to implement the
divestiture) but that do not become certain until after the
divestiture. These contingent liabilities relate principally to
litigation and other claims with respect to the Bell Companies'
(the former Bell telephone company subsidiaries of AT&T) rates,
taxes, contracts, equal employment matters, environmental matters
and torts (including business torts, such as alleged violations of
the antitrust laws).
With respect to these liabilities, under agreements entered into
at divestiture AT&T and the Bell Companies will share:
- - the costs of any judgment or other determination of liability
entered by a court or administrative agency;
- - the costs of defending the claim (including attorneys' fees and
court costs); and
- - the cost of interest or penalties with respect to any judgment
or determination.
Unless the affected parties agree otherwise, the general rule is
that responsibility for contingent liabilities will be divided
among AT&T and the Bell Companies on the basis of their relative
net investment (defined as total assets less accumulated
depreciation) as of January 1, 1984. Different allocation rules
apply to liabilities which relate exclusively to predivestiture
interstate or intrastate operations.
In January 1995, Ameritech and the other RHCs agreed to
terminate the sharing arrangement among the Bell Companies with
respect to predivestiture contingent liabilities for certain
matters. AT&T did not enter into the agreement and, accordingly,
the sharing arrangement remains in effect with respect to AT&T's
pre-divestiture liabilities and AT&T's share of Bell Company
predivestiture liabilities.
In November 1997, we reached an agreement in principle to settle
class action lawsuits regarding our inside wire maintenance and
LINE-BACKERr services. Those customers who subscribe to these
services pay a monthly fee to cover repairs to inside telephone
wiring and jacks. They thereby avoid charges for labor and
material at the time of repair. The lawsuits charged unfair sales
practices and violations of the antitrust laws allegedly arising
from our sales and marketing practices. The settlement consists
of, among other things, free calling cards and pay-per-use services
over specified time periods, as well as billing credits.
We are also subject to claims arising in the ordinary course of
business. Although we cannot be sure of the outcome of any
litigation, in management's opinion any financial impact would not
have a material effect on our financial results.
<PAGE>
PART II
Item 6. Selected Financial and Operating Data.
ILLINOIS BELL TELEPHONE COMPANY AND SUBSIDIARY
SELECTED FINANCIAL AND OPERATING DATA
(Dollars in Millions)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Revenues
Local service........... $2,197.7 $2,105.9 $1,958.4 $1,919.4 $1,834.2
Interstate
network access......... 780.3 773.1 757.5 734.9 701.5
Intrastate
network access......... 157.0 103.5 95.0 92.3 80.4
Long distance........... 218.1 251.1 246.4 226.7 162.3
Other................... 455.1 429.5 356.7 304.7 297.0
-------- -------- -------- -------- --------
Total revenues........... 3,808.2 3,663.1 3,414.0 3,278.0 3,075.4
Operating expenses*...... 2,770.9 2,676.7 2,396.8 2,648.6 2,307.5
-------- -------- -------- -------- --------
Operating income......... 1,037.3 986.4 1,017.2 629.4 767.9
Interest expense......... 115.2 116.3 117.2 105.7 117.5
Other (income) expense,
net..................... (14.7) (10.7) (7.5) (9.0) 12.3
Income taxes............. 373.2 365.9 334.2 206.3 220.9
-------- -------- -------- -------- --------
Income before
extraordinary item...... 563.6 514.9 573.3 326.4 417.2
Extraordinary item **.... - - - (728.6) -
-------- -------- -------- -------- --------
Net income (loss)........ $ 563.6 $ 514.9 $ 573.3 $ (402.2) $ 417.2
-------- -------- -------- -------- --------
Total assets............. $5,515.9 $5,190.3 $4,980.3 $4,797.3 $6,176.2
Property, plant
and equipment, net...... $3,997.4 $3,829.9 $3,755.3 $3,809.5 $5,038.5
Capital expenditures,
net..................... $ 672.0 $ 631.8 $ 489.8 $ 503.0 $ 536.9
Long-term debt........... $1,011.7 $1,012.3 $1,061.2 $1,062.2 $1,077.0
Debt ratio............... 59.9 % 57.7 % 56.5 % 58.9 % 47.6 %
Return on average
equity.................. 40.4 % 40.8 % 51.7 % (22.8)% 22.3 %
Return on average
total capital........... 21.3 % 20.9 % 24.8 % (8.3)% 14.7 %
Pretax interest
coverage................ 9.1 8.6 9.0 6.1 6.4
Customer lines,
end of year (000s) ..... 6,838 6,473 6,258 5,983 5,763
Customer lines served by -
Digital electronic
offices................ 83.5 % 82.6 % 82.0 % 81.5 % 64.6 %
Analog electronic
offices................ 16.5 % 17.4 % 18.0 % 18.5 % 35.4 %
Customer lines
per employee............ 458 438 423 382 324
Employees, end of year... 14,929 14,785 14,791 15,678 17,785
- -------------------
* As discussed in Note E to the financial statements, 1995
operating expenses include a net work force restructuring
credit of $57.1 million, while 1994 operating expenses
include a nonmanagement work force restructuring charge of
$196.5 million.
** We had a noncash after-tax extraordinary charge in 1994 of
$728.6 million as a result of discontinuing the application
of FAS 71 (accounting in a regulatory environment).
<PAGE>
Item 7. Management's Discussion and Analysis of Results of Operations.
(Dollars in Millions)
Following is a discussion and analysis of our results of
operations for the year ended December 31, 1997 and for the year
ended December 31, 1996, which is based on the Consolidated
Statements of Income and Accumulated Deficit. Other pertinent data
is also set forth in Selected Financial and Operating Data.
Results of Operations
Revenues
Total operating revenues were $3,808.2 million for 1997 and
$3,663.1 million for 1996. The increase of $145.1 million or 4.0%
consisted of the following:
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Local service......... $2,197.7 $2,105.9 $ 91.8 4.4
Local service revenues include basic monthly service fees and
usage charges, fees for call management services, installation and
connection charges and public phone revenues. Local service
revenues increased in 1997 due primarily to greater sales of call
management services, such as call waiting and Caller ID, as well as
increased usage of these services on a pay-per-use basis. Access
lines in service increased 5.6% to 6,838,000 as of December 31,
1997 compared with 6,473,000 as of December 31, 1996. The year end
1997 access line count reflects approximately 133,000 additional
access lines from the November 1, 1997 acquisition of the local
exchange assets of Sprint Corporation in suburban Chicago, formerly
known as Central Telephone Company of Illinois, or Centel. Without
the access lines from this acquisition, access line growth would
have been 3.6% over 1996 year-end levels, largely due to second
line additions by residential and small business customers for
Internet access and data transport. Rate decreases partially
offset these increases.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Network access
Interstate........... $ 780.3 $ 773.1 $ 7.2 0.9
Intrastate........... 157.0 103.5 53.5 51.7
Network access revenues are fees charged to interexchange
carriers that use our local landline communications network to
connect customers to their long distance network. In addition, end
users pay flat rate access fees to connect to the long distance
networks. These revenues result from both interstate and
intrastate services. Interstate network access revenues increased
in 1997 due primarily to an increase in network minutes of use
resulting from overall growth in the volume of calls handled for
interexchange carriers. Demand for dedicated services increased,
resulting from growth in the number of Internet service providers
and other high-capacity users of our network. This increase was
partially offset by net rate reductions. Minutes of use related to
interstate calls increased by 7.1% in 1997 compared with the prior
year.
Intrastate network access revenues increased in 1997 due
primarily to volume increases, largely due to increased demand for
network access by alternative providers of intraLATA toll service.
The impact of an unfavorable billing adjustment recorded in 1996
also contributed to the increase in 1997. This increase was
partially offset by a refund to interexchange carriers related to
certain pay phone use fees in the second quarter of 1997, as well
as net rate reductions. Minutes of use related to intrastate calls
increased by 32.7% compared with the prior year.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Long distance......... $ 218.1 $ 251.1 $ (33.0) (13.1)
<PAGE>
Long distance service revenues result from customer calls to
locations outside of their local calling areas, but within the same
Local Access and Transport Area (LATA). Long distance service
revenues decreased in 1997 due primarily to volume decreases.
Implementation of Dial-1-plus capability in Illinois resulted in
increased competition from alternative providers of intraLATA toll
services. In addition, other carriers began to record revenue from
their customers' use of intraLATA toll services, where previously
they had allowed us to provide these services and record these
revenues in exchange for access charge payments. Although we are
no longer recording these revenues, we are no longer incurring the
corresponding access charge expenses.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Other................. $ 455.1 $ 429.5 $ 25.6 6.0
Other revenues include revenues derived from directory
advertising, billing and collection services, inside wire
installation and maintenance services and other miscellaneous
services. Other revenues increased in 1997 due to growth in
equipment sales and other nonregulated services, such as voice
messaging and inside wire installation and maintenance.
Operating Expenses
Total operating expenses in 1997 increased by $94.2 million or
3.5% to $2,770.9 million. The increase was due primarily to
increased depreciation expense and other operating expenses,
partially offset by a decrease in taxes other than income taxes, as
discussed below.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Employee-related
expenses............. $ 811.1 $ 795.1 $ 16.0 2.0
Employee-related expenses increased in 1997 due primarily due to
increases in wage rates and employee incentive expenses, and an
increase in other employee benefits. Decreases in overtime
expenses and payroll taxes partially offset these increases.
Most of our nonmanagement work force (about 85% of total
employees) is represented by either the Communications Workers of
America (CWA) or the International Brotherhood of Electrical
Workers (IBEW). In September 1995, memberships of the two unions
ratified three-year contracts with Ameritech, expiring on June 28,
1998 for the IBEW and August 8, 1998 for the CWA. The contracts
included basic wage increases and signing bonuses, and address
issues such as wages, benefits, employment security, training and
retraining and other conditions of employment. In addition, union
employees now receive their annual bonuses in the form of Ameritech
stock instead of cash.
There were 14,929 employees as of December 31, 1997, compared
with 14,785 as of December 31, 1996.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Depreciation and
amortization......... $ 616.0 $ 570.4 $ 45.6 8.0
Depreciation and amortization expense increased in 1997 due
primarily to higher average 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.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Other operating
expenses............. $1,270.0 $1,219.4 $ 50.6 4.2
Other operating expenses increased in 1997 due primarily to a
one-time pretax charge of $55.1 million ($33.2 million after-tax),
resulting from our agreement to settle litigation related to our
inside wire maintenance and LINE-BACKERr services (see Note H).
Higher contract and affiliated services expenses related primarily
to systems programming and reengineering, as well as higher access
charge expenses resulting from increased calling volumes and
increased advertising expenses, resulting from increased sales
efforts, also contributed to the increase. Lower use fees for
switching system software, combined with a decrease in
uncollectibles resulting from improved collections of past-due
accounts, partially offset these increases.
<PAGE>
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Taxes other than
income taxes......... $ 73.8 $ 91.8 $ (18.0) (19.6)
Taxes other than income taxes consist of property taxes, gross
receipts taxes and other taxes not directly related to earnings.
Taxes other than income taxes decreased in 1997 due primarily to a
decrease in property taxes and capital stock taxes as a result of
favorable tax appeals in 1997.
Other Income and Expenses
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Interest expense...... $ 115.2 $ 116.3 $ (1.1) (0.9)
Interest expense decreased in 1997 due primarily to decreases in
average short-term debt balances. Higher interest rates on short-
term debt partially offset this decrease.
Change
Income Percent
1997 1996 (Expense) Change
---- ---- -------- ------
Other income,
net.................. $ 14.7 $ 10.7 $ 4.0 37.4
Other income, net includes equity earnings of affiliates,
interest income and other nonoperating items. Other income
increased in 1997 due primarily to higher equity earnings from
Ameritech Services, Inc. (ASI), largely resulting from ASI's gain
on the sale of its investment in Bellcore in November 1997.
Increase Percent
1997 1996 (Decrease) Change
---- ---- -------- ------
Income taxes.......... $ 373.2 $ 365.9 $ 7.3 2.0
Income taxes increased in 1997 due primarily to the tax impacts
resulting from the centralization of the administration of benefits
for employees as further discussed in Note B, as well as the
increase in pretax earnings discussed above. The effect of
additional deferred taxes recorded in the first quarter of 1996,
resulting from our discontinuance of regulatory accounting,
partially offset this increase.
<PAGE>
Other Matters
Competition
Because of the 1996 Act, the communications landscape is rapidly
changing. The law, among other things, was designed to foster
local exchange competition by establishing a regulatory framework
to govern the provision of local and long distance
telecommunications services. The 1996 Act permits Ameritech and
the other RHCs to provide interLATA long distance services only
after satisfying the conditions of the new law for opening local
markets to competition and demonstrating to the FCC that such
provision is in the public interest. The 1996 Act establishes a
national policy that calls for competition and open markets, not
regulatory management, as the basic business environment. This
public policy change opens a host of business opportunities for
providers of all forms of communications, enabling them to become
full service providers of voice, video, data, local and long
distance services for their customers. As a result of the new law,
consumers can expect to see more choices and receive greater value
for these and other services.
With the passage of the 1996 Act and earlier regulatory
initiatives, our local service markets have been opened to
competition from interexchange carriers, cable TV providers and
other local service providers. Interconnection agreements with
these providers require us to allow access to network elements at
cost-based rates or services at wholesale rates for resale to the
public. Competitive entry by these providers 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 at lower rates.
We have signed a significant number of interconnection and
resale agreements with competitors as required by the 1996 Act to
gain permission for Ameritech to offer interLATA long distance
service. 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 long distance
revenues for Illinois Bell to offset the potential revenue decline
brought by local service competition.
It is impossible to predict the specific impact of the 1996 Act
and other changes in the industry on our business or financial
results. Notwithstanding the potential for an adverse effect on
our revenue streams, we intend to pursue growth opportunities in
our local exchange business.
Regulatory developments
In July 1997, the Eighth Circuit Court of Appeals in St. Louis
struck down several provisions of an August 1996 FCC order
regarding the interconnection provisions of the 1996 Act. The
Court ruled, among other things, that the FCC's pricing guidelines
intrude upon the rights of state commissions to implement key
elements of the 1996 Act and that the FCC lacks jurisdiction to
review state commission decisions regarding interconnection
agreements between incumbent local exchange carriers (LECs) and
their competitors. The Court also ruled that the FCC's requirement
allowing requesting carriers to pick and choose among individual
provisions of other interconnection agreements does not promote
negotiated agreements and is unreasonable.
The Court also ruled, and clarified in a subsequent October
rehearing order, that if new entrants to the local exchange market
wish to purchase network elements at cost-based prices, they must
combine the elements themselves. The United States Supreme Court
is scheduled to review these and related rulings in October 1998,
with a decision expected late this year or the beginning of next
year.
In January 1998, the Eighth Circuit Court ordered the FCC to
uphold the court's earlier ruling transferring the power of the
federal agency to set terms on prices and connections to local
phone networks to the state commissions. The order came a day
before the United States Supreme Court agreed to consolidate
numerous appeals centering on the 1996 Act filed by AT&T, MCI, the
FCC and others. Barring additional action, the case will be argued
before the Supreme Court in October 1998.
In December 1997, the United States District Court in Wichita
Falls, Texas, declared unconstitutional a key part of the 1996 Act
that excludes only the RHCs' landline communications companies from
the long distance market. Two of those companies, SBC
Communications Inc. and US West Communications, Inc. initiated the
lawsuit. Long distance industry opponents of the ruling, the FCC
and the Department of Justice asked the court for an injunction
barring SBC Communications, US West and Bell Atlantic Corporation,
<PAGE>
which joined in the suit, from preparing to provide in-region long
distance service until the court ruled on their stay requests. In
February 1998, the court issued two orders - the final judgment
giving legal effect to the court's earlier opinion and an order
staying that decision pending resolution of appeals from it. The
court denied the motions for injunctions.
In addition BellSouth Communications, Inc. brought two appeals
to the United States Court of Appeals for the District of Columbia
challenging the constitutionality of many of the same provisions of
the 1996 Act for which SBC Communications and US West sought review
in the Texas District Court. One action challenges the section of
the 1996 Act covering electronic publishing and another challenges
the sections which address long distance. Ameritech has intervened
in this later appeal. Consequently, the Fifth Circuit Court and
the D.C. Circuit Court are deciding the constitutionality of the
provisions of the 1996 Act specifically applicable to the RHCs'
landline communications companies.
On May 7, 1997, the FCC issued three closely related orders
addressing revisions to the price cap plan for LECs, interstate
access charge reform and funding for universal service. In its
access charge reform order, the FCC adopted changes to its tariff
structure requiring LECs to use rates that reflect the type of
costs incurred.
The new price cap rules are reducing access charges by
increasing the price cap productivity offset factor to 6.5% from
the prior 5.3% and by applying this factor uniformly to all access
providers. The new rates were effective July 1, 1997 and LECs were
required to compute the new rates as if the 6.5% productivity
factor had been in effect since July 1, 1996.
The new rules also require creation of a multi-billion-dollar
interstate universal service fund for subsidizing low-income
customers, high cost service areas, rural health care providers,
schools and libraries. Telecommunications service providers began
paying into the universal service fund starting January 1, 1998.
Subsidies to low-income and rural customers became available
January 1, 1998, and funds for linking schools and libraries to the
Internet will be available as needed.
We do not expect these reforms to have a material impact on our
revenue streams; however, the nature and timing of these reforms
may evolve as the FCC considers input from state commissions,
potential legal challenges and the ongoing implementation of other
provisions of the Telecommunications Act of 1996.
Advantage Illinois
On October 11, 1994, the Illinois Commerce Commission (ICC or
Commission) approved an alternative regulation proposal - Advantage
Illinois- that we initially filed in December 1992. The ICC order
eliminated rate-of-return regulation and replaced it with price
regulation.
The order included initial rate reductions of $93.2 million.
These reductions included the elimination of monthly touch-tone
charges for all customers and the lowering of monthly charges for
business customers who have their own PBX call processing
equipment. Other reductions included lower usage rates for certain
calls and lower charges for carrier access. The order also imposed
a five-year cap on basic residential rates and allowed us to set
our own depreciation rates.
We implemented subsequent rate changes related to noncompetitive
services in July of 1995, 1996 and 1997, and we will implement
additional changes each July thereafter for the life of the plan
based on changes in the Gross Domestic Product Price Index (GDPPI)
and other factors for the previous calendar year. Effective July
10, 1997, we reduced rates by $54.0 million annually under the
adjustment process of the price regulation plan. These rate
reductions primarily impacted local service revenues.
Dial-1-plus
We implemented intra-MSA (Market Service Area; similar to LATA
boundaries but within state borders) presubscription on April 7,
1996 pursuant to the Customers First Order issued by the ICC on
April 7, 1995. Presubscription allows customers to select one
carrier for inter-MSA interstate calling and a second carrier for
nonlocal intra-MSA calls. Nonlocal intra-MSA calls include all
Band C calls (more than 15 miles) plus intra-MSA toll calls between
our territory and that of an independent company. As a result, our
customers may now select an alternate long distance carrier for
Band C calls by presubscribing their Band C calls and intra-MSA
toll calls to that carrier.
<PAGE>
Year 2000 costs
We currently operate numerous date-sensitive computer
applications and network systems throughout our business. As the
century change approaches, it is essential for us to ensure that
these systems properly recognize the year 2000 and continue to
process operational and financial information. In May 1996, we
began, through ASI, our internal assessment of our requirements and
made appropriate inquiries of vendors and consultants. We believe
that we have identified most application software and systems
issues and we are making changes to allow for almost a full year of
additional testing in 1999. During the next two years, Ameritech
and all of its subsidiaries, including Illinois Bell, anticipate
incurring additional costs in this effort of approximately $200
million, and expect to incur these costs ratably during this time
frame. However because of the complexity of the issue and possible
unidentified risks, actual costs may vary from the estimate.
Management believes we can incur these costs without adversely
affecting future operating results.
New accounting pronouncements
In June 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (FAS) 130,
"Reporting Comprehensive Income." This statement establishes
standards for reporting and display of comprehensive income and
requires that all components of comprehensive income be reported in
a financial statement having the same prominence as other financial
statements. For us, FAS 130 is effective in 1998, and it requires
reclassification of prior period financial statements provided for
comparative purposes. Adoption of this standard should have little
effect on our financial statements, since the new requirements
primarily involve modifications to the way that existing
information is displayed.
Also in June 1997, the FASB issued 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 in that year.
Comparative information for earlier years must be restated.
In March 1998, the American Institute of Certified Public
Accountants 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.
Disclosures about market risk
We are exposed to market risks primarily from changes in
interest rates. To manage our exposure to these fluctuations,
Ameritech occasionally enters into various hedging transactions
that have been authorized according to documented policies and
procedures. Ameritech does not use derivatives for trading
purposes, or to generate income or to engage in speculative
activity, and Ameritech never uses leveraged derivatives.
Our exposure to interest rate fluctuations results primarily
from our borrowings from the Ameritech short-term funding pool,
which Ameritech funds using commercial paper borrowings, and from
potential changes in the fair value of our fixed rate bonds and
debentures. With respect to short-term and long-term debt,
Ameritech measures the duration of its overall debt portfolio,
including debt issued by Illinois Bell, to determine its exposure
to interest rate fluctuations. Ameritech then uses derivatives,
including interest rate swaps and swaptions, to manage the duration
of the portfolio.
<PAGE>
As of December 31, 1997, Ameritech estimated the potential loss
that it could incur from adverse changes in interest rates using
the value-at-risk estimation model. The value-at-risk model uses
historical interest rates to estimate the volatility of these rates
in future periods, and to estimate a potential loss in fair market
value using statistical modeling techniques. Using a confidence
level of 95%, Ameritech estimated that we could incur potential
fair value losses of $6.6 million related to our fixed-rate bonds
and debentures in a given one day period. These fair value losses
would have no impact on our results of operations or financial
condition. They did not estimate potential losses related to the
short-term funding pool because their commercial paper borrowings
are not readily attributable to individual subsidiaries.
The 95% confidence interval signifies Ameritech's degree of
confidence that actual losses would not exceed the estimated
losses. The estimated loss disregards the possibility that
interest rates could move in our favor, since the value-at-risk
model assumes that all movements in these rates will be adverse.
Actual experience has shown that gains and losses tend to offset
each other over time, and it is highly unlikely that we could
experience losses such as these over an extended period of time.
These amounts should not be considered projections of future
losses, since actual results may differ significantly depending
upon activity in the financial markets.
Private securities litigation reform act safe harbor statement
The above discussion contains certain forward-looking statements
that involve potential risks and uncertainties. Our future results
could differ materially from those discussed herein. Factors that
could cause or contribute to such differences include:
- - changes in economic and market conditions,
- - effects of state and federal regulation, and
- - the impact of new technologies.
You should not place undue reliance on these forward-looking
statements, which are applicable only as of the date hereof. We
have no obligation to revise or update these forward-looking
statements to reflect events or circumstances that arise after the
date hereof or to reflect the occurrence of unanticipated events.
<PAGE>
Item 8. Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareowner of Illinois Bell Telephone Company
We have audited the accompanying consolidated balance sheets of
Illinois Bell Telephone Company (an Illinois Corporation) and
subsidiary as of December 31, 1997 and 1996, and the related
consolidated statements of income and accumulated deficit and cash
flows for each of the three years in the period ended December 31,
1997. These financial statements and the schedule referred to
below are the responsibility of the company's management. Our
responsibility is to express an opinion on these financial
statements and this schedule based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also
includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred
to above present fairly, in all material respects, the financial
position of Illinois Bell Telephone Company and subsidiary as of
December 31, 1997 and 1996, and the results of their operations and
their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
Our audits are made for the purpose of forming an opinion on the
basic financial statements taken as a whole. The financial
statement schedule included in Item 14(a)(2) is presented for
purposes of complying with the Securities and Exchange Commission's
rules and is not a required part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied
in the audits of the basic financial statements and, in our
opinion, fairly states in all material respects the financial data
required to be set forth therein in relation to the basic financial
statements taken as a whole.
ARTHUR ANDERSEN LLP
Chicago, Illinois
January 13, 1998
<PAGE>
ILLINOIS BELL TELEPHONE COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME AND ACCUMULATED DEFICIT
(Dollars in Millions)
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
Revenues
Local service................... $ 2,197.7 $ 2,105.9 $ 1,958.4
Interstate network access....... 780.3 773.1 757.5
Intrastate network access....... 157.0 103.5 95.0
Long distance................... 218.1 251.1 246.4
Other........................... 455.1 429.5 356.7
--------- --------- ---------
3,808.2 3,663.1 3,414.0
--------- --------- ---------
Operating expenses
Employee-related expenses....... 811.1 795.1 789.2
Depreciation and amortization... 616.0 570.4 537.9
Other operating expenses........ 1,270.0 1,219.4 1,060.4
Restructuring credits........... - - (57.1)
Taxes other than income taxes... 73.8 91.8 66.4
--------- --------- ---------
2,770.9 2,676.7 2,396.8
--------- --------- ---------
Operating income.................. 1,037.3 986.4 1,017.2
Interest expense.................. 115.2 116.3 117.2
Other income, net................. 14.7 10.7 7.5
--------- --------- ---------
Income before income taxes........ 936.8 880.8 907.5
Income taxes...................... 373.2 365.9 334.2
--------- --------- ---------
Net income........................ 563.6 514.9 573.3
Accumulated deficit,
beginning of year................ (383.6) (465.8) (608.5)
Less, dividends................... 517.4 432.7 430.6
--------- --------- ---------
Accumulated deficit,
end of year...................... $ (337.4) $ (383.6) $ (465.8)
========= ========= =========
The accompanying notes are an integral part of the financial statements.
<PAGE>
ILLINOIS BELL TELEPHONE COMPANY AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
(Dollars in Millions)
As of December 31,
-------------------
1997 1996
---- ----
Assets
Current assets
Cash and temporary
cash investments..................... $ 20.9 $ -
Receivables, net
Customers and agents
(less allowance for
uncollectibles of $79.2 and
$81.6, respectively)................ 826.7 836.9
Ameritech and affiliates............. 5.6 53.0
Other................................ 63.1 23.4
Material and supplies................. 10.8 18.7
Prepaid and other..................... 23.9 17.0
--------- ---------
951.0 949.0
--------- ---------
Property, plant and equipment
In service............................ 9,510.9 8,788.0
Under construction.................... 75.4 48.9
--------- ---------
9,586.3 8,836.9
Less, accumulated depreciation........ 5,588.9 5,007.0
--------- ---------
3,997.4 3,829.9
--------- ---------
Investments, principally
in affiliates.......................... 114.2 85.6
Other assets and deferred charges....... 453.3 325.8
--------- ---------
Total assets............................. $ 5,515.9 $ 5,190.3
========= =========
Liabilities and shareowner's equity
Current liabilities
Debt maturing within one year
Ameritech............................ $ 1,077.6 $ 735.3
Other................................ 0.9 51.5
Accounts payable
Ameritech Services, Inc. (ASI)....... 63.2 178.7
Ameritech and affiliates............. 48.2 20.8
Other................................ 223.3 244.1
Other current liabilities............. 351.1 292.1
--------- ---------
1,764.3 1,522.5
--------- ---------
Long-term debt.......................... 1,011.7 1,012.3
--------- ---------
Deferred credits and other long-term liabilities
Accumulated deferred
income taxes......................... 284.0 244.9
Unamortized investment
tax credits.......................... 40.5 49.6
Postretirement benefits
other than pensions.................. 906.5 921.1
Long-term payable to ASI.............. 23.7 25.5
Other................................. 83.2 93.2
--------- ---------
1,337.9 1,334.3
--------- ---------
Shareowner's equity
Common stock ($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....... 100.6 66.0
Accumulated deficit................... (337.4) (383.6)
--------- ---------
1,402.0 1,321.2
--------- ---------
Total liabilities and
shareowner's equity..................... $ 5,515.9 $ 5,190.3
========= =========
The accompanying notes are an integral part of the financial statements.
<PAGE>
ILLINOIS BELL TELEPHONE COMPANY AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Millions)
Year Ended December 31,
-----------------------
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net income ........................ $ 563.6 $ 514.9 $ 573.3
Adjustments to net income:
Restructuring credits,
net of tax..................... - - (30.4)
Depreciation and amortization... 616.0 570.4 537.9
Deferred income taxes, net...... 37.7 18.8 76.8
Investment tax credits, net..... (9.1) (11.4) (14.2)
Capitalized interest............ (2.6) (3.6) (2.8)
Change in accounts receivable... 17.9 (98.1) (119.0)
Change in material and supplies. (3.6) (11.2) (9.4)
Change in certain other
current assets................. (6.8) 9.4 8.1
Change in accounts payable...... (108.9) 9.6 (73.3)
Change in certain other
current liabilities............ 60.2 105.2 (100.6)
Change in certain noncurrent
assets and liabilities......... (69.6) (66.7) (0.3)
Other operating activities, net. (2.4) (16.8) (22.2)
--------- --------- ---------
Net cash from operating
activities....................... 1,092.4 1,020.5 823.9
--------- --------- ---------
Cash flows from investing activities:
Capital expenditures, net......... (669.6) (628.8) (487.0)
Additional investments............ (187.6) - -
Proceeds from
disposals of property,
plant and equipment, net........ 10.5 2.2 7.8
Other investing activities, net... 1.2 0.2 0.8
--------- --------- ---------
Net cash from investing
activities....................... (845.5) (626.4) (478.4)
--------- --------- ---------
Cash flows from financing activities:
Intercompany financing, net....... 342.3 191.3 67.3
Retirements of long-term debt..... (51.4) - (31.2)
Dividend payments................. (517.4) (586.9) (388.4)
Other financing activities, net... 0.5 1.2 -
--------- --------- ---------
Net cash from financing
activities....................... (226.0) (394.4) (352.3)
--------- --------- ---------
Net increase (decrease) in cash and
temporary cash investments........ 20.9 (0.3) (6.8)
Cash and temporary cash
investments, beginning of year... - 0.3 7.1
--------- --------- ---------
Cash and temporary cash
investments, end of year......... $ 20.9 $ - $ 0.3
========= ========= =========
The accompanying notes are an integral part of the financial statements.
<PAGE>
ILLINOIS BELL TELEPHONE COMPANY AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in Millions)
A. Significant Accounting Policies
Nature of Operations - Illinois Bell Telephone Company is a
wholly owned subsidiary of Ameritech Corporation (Ameritech).
Ameritech is also the parent of Indiana Bell Telephone Company,
Incorporated; Michigan Bell Telephone Company; The Ohio Bell
Telephone Company; and Wisconsin Bell, Inc. (referred to with
Illinois Bell collectively as the "Ameritech landline
communications subsidiaries"). We provide a wide variety of
communications services in Illinois, including local exchange and
toll service, and network access and telecommunications products.
See discussion of Competition and Regulatory developments in
Other Matters in Management's Discussion and Analysis of Results of
Operations.
Basis of Accounting - We have prepared the financial statements
in accordance with generally accepted accounting principles (GAAP).
The financial statements include the accounts of Illinois Bell and,
through March 31, 1995, our wholly owned subsidiary, Illinois Bell
Administration Center, Inc. (IBAC). As of November 1, 1997, the
financial statements also include the accounts of Ameritech
Illinois Metro, Inc., a wholly owned subsidiary formed to acquire
and operate the assets of Sprint Corporation's local exchange
business in suburban Chicago (formerly known as Central Telephone
Company of Illinois or Centel). All significant intercompany
transactions have been eliminated.
Use of Estimates - The preparation of financial statements in
conformity with GAAP requires management to make estimates and
assumptions that affect the reported amounts of assets and
liabilities as of the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
Transactions with Affiliates - We have various agreements with
affiliated companies. Below is a description of the significant
arrangements followed by a table of the amounts involved.
1. Ameritech Services, Inc. (ASI) - ASI, an Ameritech-
controlled affiliate in which we have 33% ownership, provides
planning, development, management, procurement and support services
to all of the Ameritech landline communications subsidiaries. We
also provide certain services and facilities to ASI.
1997 1996 1995
---- ---- ----
Purchases of
materials and charges
for services from ASI..... $ 804.6 $ 790.7 $ 733.8
Recovery of
costs for services
provided to ASI........... 20.4 19.0 20.1
2. Ameritech (our parent) - Ameritech provides various
administrative, planning, financial and other services to us, which
are billed at cost.
1997 1996 1995
---- ---- ----
Charges incurred.......... $ 47.0 $ 42.4 $ 34.4
3. Ameritech Publishing, Inc. (API), a wholly owned subsidiary
of Ameritech doing business as Ameritech Advertising Services - We
had a contract with DonTech, a partnership between API and the
Reuben H. Donnelley Corporation, under which DonTech published,
printed and delivered classified directories and we provided
listings to DonTech and performed billing and collection services
as an agent for the partnership. Under a new agreement effective
September 1, 1997, DonTech will continue as the exclusive local
sales agent for these directories, and publication of the
directories will now be the responsibility of APIL Partners, a
partnership between API and Ameritech Publishing of Illinois, Inc.
(API-IL). In 1997 DonTech made payments to us for license fees and
billing and collection services.
1997 1996 1995
---- ---- ----
Fees paid to Illinois Bell
by DonTech............... $ 75.0 $ 75.0 $ 75.0
<PAGE>
4. Ameritech Information Systems, Inc. (AIS), a wholly owned
subsidiary of Ameritech - We reimburse AIS for costs incurred by
AIS in connection with the sale of network services by AIS
employees.
1997 1996 1995
---- ---- ----
Charges incurred........... $ 52.4 $ 34.8 $ 25.2
5. Bell Communications Research, Inc. (Bellcore) - Bellcore
provides research and technical support to the landline
communications subsidiaries. Prior to November 1997, ASI had a one-
seventh ownership interest in Bellcore and billed us for costs. In
November 1997, ASI sold its interest in Bellcore. The amount for
1997 below includes charges incurred through the date Bellcore was
sold.
1997 1996 1995
---- ---- ----
Charges incurred........... $ 31.8 $ 26.3 $ 29.1
Property, Plant and Equipment - Property, plant and equipment
are stated at original cost. The provision for depreciation is
based principally on the straight-line remaining life and the
straight-line equal life group methods of depreciation applied to
individual categories of property, plant and equipment with similar
characteristics.
The following is a summary of average lives used to determine
the provision for depreciation:
Asset Category Years
-------------- -----
Central office equipment
Digital switching.................. 7
Circuit accounts................... 7
Copper and fiber cable
and wire facilities................. 15
All other............................ various
Generally, when depreciable plant is retired, the amount at
which such plant has been carried in property, plant and equipment
in service is charged to accumulated depreciation. The cost of
maintenance and repairs of plant is charged to expense.
Investments - Our investment in ASI (33% ownership and $83.0
million as of December 31, 1997) is reflected in the financial
statements using the equity method of accounting. We carry all
other investments at cost. Derivative transactions, if any, are
executed by Ameritech. We had no derivative transactions in 1997
or 1996.
Material and Supplies - We state inventories of new and reusable
material and supplies at the lower of cost or market with cost
generally determined on an average-cost basis.
Income Taxes - Ameritech includes Illinois Bell in the federal
income tax return filed by Ameritech and its subsidiaries. We
determine our provision for income taxes on a separate company
basis.
We determine deferred tax assets and liabilities at the end of
each period based on differences between the financial statement
bases of assets and liabilities and the tax bases of those same
assets and liabilities, using the currently enacted statutory tax
rates. We measure deferred income tax expense as the change in the
net deferred income tax asset or liability during the year.
We use the deferral method of accounting for investment tax
credits by amortizing realized credits as reductions to tax expense
over the life of the plant that gave rise to the credits.
Temporary Cash Investments - Temporary cash investments are
stated at cost which approximates market value. We consider all
highly liquid, short-term investments with an original maturity of
three months or less to be cash equivalents.
Advertising Costs - We charge advertising costs to operations as
incurred.
Revenue Recognition - We generally recognize revenues as
services are provided or products are delivered to customers. We
bill certain local telephone revenues in advance, resulting in
deferred revenues.
<PAGE>
Short-Term Financing Arrangement - Ameritech provides short-term
financing and cash management services to its subsidiaries,
including Illinois Bell. Ameritech issues commercial paper and
notes and secures bank loans to fund the working capital
requirements of its subsidiaries and invests short-term excess
funds on their behalf. Ameritech charged us interest of $38.1
million in 1997, $35.8 million in 1996 and $38.3 million in 1995.
(See Note F).
Reclassifications - We made certain reclassifications to the
December 31, 1996 balances to correspond to the presentation as of
December 31, 1997.
B. Investments and Acquisitions
In June 1997, Ameritech centralized the administration of
benefits for employees who had retired from Illinois Bell and other
subsidiaries as of December 31, 1996. In connection therewith, we
hold approximately $30.0 million in preferred stock issued by the
Ameritech subsidiary responsible for administration of these
benefits. This subsidiary began paying benefits on our behalf in
July 1997. We account for these benefit payments made on our
behalf as a capital contribution in the shareowner's equity section
of the consolidated balance sheets, with a corresponding reduction
in the postretirement benefit obligation. This contribution for
the year ended December 31, 1997 was $34.3 million.
Effective November 1, 1997, following regulatory approval, our
subsidiary completed the purchase from Sprint Corporation (Sprint)
of the assets of Sprint's local exchange business in suburban
Chicago (Central Telephone Company of Illinois or Centel). Centel
served approximately 133,000 residential and business customers in
a small portion of Chicago and part or all of ten Chicago suburbs.
We funded the $160 million purchase using short-term debt from
Ameritech, and accounted for this acquisition as a purchase.
Goodwill from this purchase was approximately $50 million, which we
are amortizing over a period of 40 years.
C. Income Taxes
The components of income tax expense were as follows:
1997 1996 1995
---- ---- ----
Federal
Current........................ $ 282.0 $ 292.9 $ 211.7
Deferred, net................... 30.8 7.3 87.5
Investment tax credits, net..... (9.1) (11.4) (14.2)
--------- --------- ---------
Total............................. 303.7 288.8 285.0
--------- --------- ---------
State and local
Current......................... 62.6 65.6 33.2
Deferred, net................... 6.9 11.5 16.0
--------- --------- ---------
Total........................... 69.5 77.1 49.2
--------- --------- ---------
Total income tax expense.......... $ 373.2 $ 365.9 $ 334.2
========= ========= =========
Total income taxes paid were $372.1 million, $308.0 million and
$312.6 million in 1997, 1996 and 1995, respectively.
The following is a reconciliation of the statutory federal
income tax rate for each of the past three years to our effective
tax rate (computed by dividing total income tax expense by income
before income taxes):
1997 1996 1995
---- ---- ----
Statutory federal income
tax rate......................... 35.0% 35.0% 35.0%
State income taxes, net of
federal benefit................. 4.8 5.7 3.5
Reduction in tax expense due to
amortization of investment tax
credits........................ (0.6) (0.8) (1.0)
Other............................ 0.6 1.6 (0.7)
-------- -------- --------
Effective income tax rate......... 39.8% 41.5% 36.8%
======== ======== ========
<PAGE>
As of December 31, 1997 and 1996 the components of long-term
accumulated deferred income taxes were as follows:
1997 1996
---- ----
Deferred tax assets
Postretirement and
postemployment benefits....... $ 361.1 $ 381.0
Other.......................... 19.7 21.0
--------- ---------
380.8 402.0
--------- ---------
Deferred tax liabilities
Accelerated depreciation....... 536.1 532.6
Prepaid pension cost........... 123.0 111.5
Other.......................... 5.7 2.8
--------- ---------
664.8 646.9
--------- ---------
Net deferred tax liability...... $ 284.0 $ 244.9
========= =========
Deferred income taxes in current assets and liabilities relate
primarily to temporary differences resulting from vacation pay and
uncollectibles, and amounts in 1997 and 1996 were not material. We
had valuation allowances against certain deferred tax assets
aggregating $12.0 million as of December 31, 1997 and 1996.
D. Property, Plant and Equipment
The components of property, plant and equipment are as follows:
1997 1996
---- ----
Land............................ $ 38.4 $ 37.4
Buildings....................... 786.5 784.4
Central office equipment........ 3,916.2 3,470.6
Cable, wiring and conduit....... 4,014.8 3,753.6
Other........................... 755.0 742.0
--------- ---------
9,510.9 8,788.0
Under construction.............. 75.4 48.9
--------- ---------
9,586.3 8,836.9
Less, accumulated depreciation.. 5,588.9 5,007.0
--------- ---------
$ 3,997.4 $ 3,829.9
========= =========
Depreciation expense on property, plant and equipment was $616.0
million, $570.4 million and $537.9 million in 1997, 1996 and 1995,
respectively.
E. Employee Benefit Plans
Pension Plans - Ameritech maintains noncontributory defined
benefit pension plans for substantially all of our employees, as
well as postretirement healthcare and life insurance plans for
substantially all retirees and their dependents. We accrue the
cost of postretirement benefits granted to employees as expense
over the period in which the employee renders services and becomes
eligible to receive benefits. The costs of these plans for current
and future retirees is determined using the projected unit credit
actuarial method.
The pension plans were amended in 1996 to provide a 4.5% pension
increase, effective February 1, 1997, to retirees who retired prior
to April 1, 1994 and are receiving annuity pension benefits. More
recent retirees receive lower rates of increase. Our funding
policy is to contribute an amount up to the maximum that can be
deducted for federal income tax purposes. Due to the funded status
of the plans, we have made contributions only to the nonqualified
plan. The following table provides information on our pension
credits and postretirement benefit costs for the Ameritech plans:
1997 1996 1995
---- ---- ----
Pension credits............. $ (26.9) $ (40.7) $ (33.8)
Postretirement
benefit costs............. 85.9 95.6 88.6
<PAGE>
Ameritech allocates pension credits to us based upon the
percentage of compensation for the management plan and based on
number of employees for the nonmanagement plan. They allocate
retiree health care cost to us on a per participant basis, whereas
group life insurance is allocated based on compensation levels.
For the pension plans, the fair value of plan assets available for
plan benefits as of December 31, 1997 exceeded the projected
benefit obligations. For the postretirement health care and life
insurance plans, the postretirement benefit obligation as of
December 31, 1997 exceeded the fair value of plan assets available
for plan benefits.
Ameritech has provided for part of the cost of the
postretirement plans by making contributions for health care
benefits to voluntary employee benefit association trust funds
(VEBAs) and maintaining retirement funding accounts (RFAs) to
provide life insurance benefits. Ameritech intends to continue to
fund the nonmanagement VEBA. The nonmanagement VEBA and the RFAs
earn income without tax. Plan assets consist principally of
corporate securities and bonds.
The Financial Accounting Standards Board (FASB) issued FAS 132,
"Employers' Disclosures about Pensions and Other Postretirement
Benefits," in February 1998. The new standard does not change the
measurement or recognition of costs for pension or other
postretirement plans. It standardizes disclosures and eliminates
those that are no longer useful.
Certain disclosures are required to be made of the components of
pension credits, postretirement benefit costs and the funded status
of the plans, including the actuarial present value of accumulated
plan benefits, accumulated or projected benefit obligation and the
fair value of plan assets. We do not present such disclosures
because the structure of the Ameritech plans does not permit the
plans' data to be readily disaggregated.
Ameritech has advised us of the following assumptions used to
calculate pension credits, postretirement benefit costs and the
funded status of the plans:
Pension Benefits Retiree Health and Life
---------------- ----------------------
1997 1996 1997 1996
---- ---- ---- ----
Discount rate................ 7.0 % 7.5 % 7.0 % 7.5 %
Expected return
Pension plans............... 8.4 % 8.0 % - -
VEBAs....................... - - 8.4 % 8.0 %
RFAs........................ - - 8.4 % 8.0 %
Compensation increase rate... 4.1 % 4.2 % 4.1 % 4.2 %
The assumed health care cost trend rate for 1997 was 8.0% and
8.4% in 1996 and is assumed to decrease by 0.4% per year to 4.0% in
2007 and remain at that level. A one percentage-point increase in
the assumed health care cost trend rate would have increased the
1997 annual expense by approximately 16.7%, while a one percentage-
point decrease in the assumed health care cost trend rate would
have decreased 1997 annual expense by approximately 13.4%.
Work Force and Other Restructuring - In March 1994, we announced
a plan to reduce our existing nonmanagement work force.
Approximately 3,500 employees left Illinois Bell as a result of
this restructuring.
The cumulative gross program cost totaled $335.7 million,
partially offset by settlement gains of $196.3 million for an
aggregate pretax net program cost of $139.4 million, or $88.0
million after-tax. We recorded a pretax charge of $196.5 million,
or $118.4 million after-tax in 1994, and in 1995 a credit of $57.1
million, or $30.4 million after-tax, as a result of this
restructuring.
Management Work Force Reductions - Effective January 1, 1995,
management employees who are asked to leave Illinois Bell will
receive a severance payment under the Management Separation Benefit
Program (MSBP). We account for this benefit in accordance with FAS
112, "Employers' Accounting for Postemployment Benefits," accruing
the separation cost when incurred. The number of employees leaving
under the MSBP and the predecessor plan was 10 in 1997, 73 in 1996
and 57 in 1995.
<PAGE>
Settlement gains result from the payment of lump-sum
distributions from the pension plans to former employees and are
recorded as a credit to other operating expense. Settlement gains,
net of termination costs, under the plans were $0.6 million, $5.5
million and $8.9 million in 1997, 1996 and 1995, respectively. The
involuntary plans are funded from our operations and required cash
payments of $0.2 million, $1.7 million and $1.4 million in 1997,
1996 and 1995, respectively.
F. Debt Maturing Within One Year
We include debt maturing within one year as debt in the
computation of debt ratios. Debt maturing within one year
consisted of the following as of December 31:
1997 1996
---- ----
Notes payable - Ameritech....... $ 1,077.6 $ 735.3
Long-term debt maturing
within one year................ 0.9 51.5
--------- ---------
Total........................... $ 1,078.5 $ 786.8
========= =========
Weighted average interest
rate of notes payable,
year-end....................... 5.8% 5.4%
========= =========
Long-term debt maturing within one year in 1996 consisted
primarily of our First Mortgage bonds Series G, 4 7/8%, which
matured in July 1997.
G. Long-Term Debt
Long-term debt consists principally of mortgage bonds and
debentures issued by us.
The following table sets forth interest rates, scheduled
maturities and other information on long-term debt outstanding as
of December 31:
1997 1996
---- ----
First Mortgage bonds:
Series H, 4 3/8%, due July 1, 2003...... $ 50.0 $ 50.0
Series K, 7 5/8%, due April 1, 2006..... 200.0 200.0
Forty year 8 1/2% debentures,
due April 22, 2026...................... 275.0 275.0
Thirty-one year 7 1/4% debentures,
due March 15, 2024...................... 200.0 200.0
Thirty year 7 1/8% debentures,
due July 1, 2023........................ 100.0 100.0
Thirty-one year 6 5/8% debentures,
due February 1, 2025.................... 100.0 100.0
Ten year 5 4/5% notes,
due February 1, 2004.................... 100.0 100.0
--------- ---------
1,025.0 1,025.0
Capital lease obligations ................. 3.2 4.2
Unamortized discount, net ................. (16.5) (16.9)
--------- ---------
Total ..................................... $ 1,011.7 $ 1,012.3
========= =========
The Company has filed a registration statement with the
Securities and Exchange Commission for issuance of up to $550.0
million in unsecured debt securities. As of December 31, 1997,
$200.0 million of debt had been issued under this shelf
registration.
Over the next five years, no debt issues are scheduled to be
retired.
Substantially all of our property, plant and equipment is
subject to lien under the indenture covering first mortgage bonds.
<PAGE>
H. Commitments and Contingencies
We lease certain facilities and equipment used in our operations
under both operating and capital leases. Rental expense under
operating leases was $37.7 million, $31.1 million and $29.8 million
for 1997, 1996 and 1995, respectively. In addition, rental expense
for the leasing of equipment through Ameritech's lease financing
subsidiary was approximately $8.7 million in 1997. As of December
31, 1997, the aggregate minimum rental commitments under external
noncancelable leases were approximately as follows:
Years Operating Capital
----- --------- -------
1998.............................. $ 9.9 $ 1.1
1999.............................. 9.7 0.8
2000.............................. 9.4 0.7
2001.............................. 9.5 2.2
2002.............................. 9.3 0.3
Thereafter........................ 61.9 -
-------- --------
Total minimum lease commitments... $ 109.7 $ 5.1
========
Less amount representing
interest costs.................. 1.0
--------
Present value of minimum
lease payments.................. $ 4.1
========
In November 1997, we reached an agreement in principle to settle
a class action lawsuit regarding our inside wire maintenance and
LINE-BACKERr services, subject to court approval. Those customers
who subscribe to these services pay a monthly fee to cover repairs
to inside telephone wiring and jacks. They thereby avoid charges
for labor and material at the time of repair.
The lawsuit charged unfair sales practices and violations of the
antitrust laws allegedly arising from our sales and marketing
practices. The settlement consists of, among other things, free
calling card and pay-per-use services over specified time periods,
as well as billing credits. Although the value to the class
members is much greater, we recorded a pretax charge of
approximately $55.1 million ($33.2 million after-tax) in the fourth
quarter of 1997 based on the negotiated settlement terms.
I. Financial Instruments
The following table presents the estimated fair value of our
financial instruments as of December 31, 1997 and 1996:
1997
-------------
Carrying Fair
Value Value
----- -----
Cash and temporary cash
investments.................... $ 20.9 $ 20.9
Debt............................ 2,123.7 2,230.1
Long-term payable to ASI
(for postretirement benefits).. 23.7 23.7
Other assets.................... 4.8 4.8
Other liabilities............... 5.7 5.7
1996
-------------
Carrying Fair
Value Value
----- -----
Cash and temporary cash
investments.................... $ - $ -
Debt............................ 1,833.6 1,845.6
Long-term payable to ASI
(for postretirement benefits).. 25.5 25.5
Other assets.................... 5.3 5.3
Other liabilities............... 4.7 4.7
<PAGE>
We used the following methods and assumptions to estimate the
fair value of financial instruments:
Cash and temporary cash investments - The carrying value
approximates fair value because of the short-term maturity of these
instruments.
Debt - The carrying amount (including accrued interest) of debt
maturing within one year approximates fair value because of the
short-term maturities involved. We estimated the fair value of
long-term debt based on the year-end quoted market price for the
same or similar issues.
Other assets and liabilities - These financial instruments
consist primarily of other investments and customer deposits. We
based the fair values of these items on expected cash flows or, if
available, quoted market prices.
Long-term payable to ASI (for postretirement benefits) -
Carrying value approximates fair value.
J. Stock Options
During 1995, the Financial Accounting Standards Board issued FAS
123, "Accounting for Stock-Based Compensation." This pronouncement
requires that Ameritech calculate the value of stock options at the
date of grant using an option pricing model. Ameritech elected the
"pro forma, disclosure only" option permitted under FAS 123,
instead of recording a charge to operations. Some of our
management personnel receive Ameritech stock options; however, the
portion of the option programs allocable to our employees is not
significant.
K. Additional Financial Information
As of December 31,
------------------
1997 1996
---- ----
Consolidated Balance Sheets
Other current liabilities:
Accrued payroll....................... $ 27.1 $ 21.3
Compensated absences.................. 54.1 53.3
Accrued taxes......................... 69.3 101.7
Income taxes deferred one year........ (32.2) (38.7)
Advance billings and customer
deposits............................ 87.8 86.0
Accrued interest...................... 25.7 31.5
Other................................. 119.3 37.0
--------- ---------
Total................................ $ 351.1 $ 292.1
========= =========
Advertising costs were $63.3 million, $53.3 million and $52.6
million in 1997, 1996 and 1995, respectively. Interest paid was
$121.0 million, $120.4 million and $118.0 million in 1997, 1996 and
1995, respectively.
No customer accounted for more than 10% of revenues in 1997,
1996 or 1995.
L. Other Income, Net
The components of other income, net were as follows:
1997 1996 1995
---- ---- ----
Equity earnings of ASI..... $ 18.1 $ 12.7 $ 11.9
Other, net................. (3.4) (2.0) (4.4)
--------- --------- ---------
Total.................... $ 14.7 $ 10.7 $ 7.5
========= ========= =========
<PAGE>
M. Quarterly Financial Information (Unaudited)
Operating Net
Revenues Income Income
-------- ------ ------
1997
----
First Quarter ............. $ 928.4 $ 242.8 $ 132.4
Second Quarter ............ 974.2 271.9 150.1
Third Quarter ............. 938.5 259.7 135.2
Fourth Quarter ............ 967.1 262.9 145.9
-------- -------- --------
1997 Total .............. $3,808.2 $1,037.3 $ 563.6
======== ======== ========
1996
----
First Quarter ............. $ 897.1 $ 240.3 $ 130.8
Second Quarter ............ 918.8 249.5 131.6
Third Quarter ............. 908.9 219.6 113.8
Fourth Quarter ............ 938.3 277.0 138.7
-------- -------- --------
1996 Total .............. $3,663.1 $ 986.4 $ 514.9
======== ======== ========
The fourth quarter of 1997 includes a one-time pretax charge of
$55.1 million ($33.2 million after-tax), related to the LINE-
BACKERr litigation settlement previously discussed in Note H.
We have included all adjustments necessary for a fair statement
of results for each period.
N. Calculation of Ratio of Earnings to Fixed Charges
The ratio of earnings to fixed charges of Illinois Bell for the
years ended December 31, 1997, 1996, 1995, 1994 and 1993 was 8.18,
7.73, 7.99, 5.45, and 5.82, respectively.
For the purpose of calculating this ratio, (i) we have
calculated earnings by adding to income before interest expense and
extraordinary item the amount of related taxes on income, the
portion of rentals representative of the interest factor and
undistributed equity earnings, (ii) we consider one-third of rental
expense to be the amount representing return on capital, and (iii)
fixed charges comprise total interest expense, capitalized interest
and such portion of rentals.
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.
We have agreed with our accountants on all matters concerning
accounting principles and practices, financial statement
disclosure, auditing scope and procedure during the period covered
by this annual report.
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as part of the report:
(1) Financial Statements:
Page
----
Selected Financial and Operating Data..................... 8
Report of Independent Public Accountants.................. 16
Statements:
Consolidated Statements of
Income and Accumulated Deficit........................ 17
Consolidated Balance Sheets............................. 18
Consolidated Statements of Cash Flows................... 19
Notes to Consolidated Financial Statements.............. 20
(2) Financial Statement Schedule:
II Valuation and Qualifying Accounts.................. 33
Glossary............................................... 31
We have omitted financial statement schedules other than the
one listed above because the required information is contained
in the financial statements and notes, or because such schedules
are not required or applicable.
(3) Exhibits:
We incorporate by reference the exhibits identified in
parentheses below, which are on file with the SEC.
Exhibit
Number
------
3a - Illinois Bell's Certificate of Incorporation, as amended
and restated March 21, 1990 (Exhibit 3a to Form 10-K for
1989, File No. 1-2222).
3b - Illinois Bell's By-laws effective March 21, 1990
(Exhibit 3b to Form 10-K for 1989, File No. 1-2222).
4b We are not required to file documents which define
the rights of holders of long and intermediate term
debt of Illinois Bell. We have agreed to furnish a
copy of these documents to the SEC on request.
10a - Reorganization and Divestiture Agreement between
American Telephone and Telegraph Company, American
Information Technologies Corporation and Affiliates,
dated as of November 1, 1983 (Exhibit 10a to Form 10-K
for 1983 for American Information Technologies
Corporation, File No. 1-8612).
10b - Agreement Concerning Illinois Bell Mortgage Bonds with
American Telephone and Telegraph Company dated January
1, 1984 (Exhibit (10)(ii)(B)8 to Form 10-K for 1983,
File No. 1-2222).
10c - Ordinance authorizing the Company to construct, maintain
and operate a telephone system in the City of Chicago,
effective July 30, 1931 (Exhibit 5-C to Registration
Statement No. 2-42370).
12 - Computation of ratio of earnings to fixed charges for
the five years ended December 31, 1997.
23 - Consent of Arthur Andersen LLP.
27 - Financial Data Schedule for the year ended December 31,
1997.
(b) Reports on Form 8-K:
We did not file a Form 8-K during the fourth quarter of 1997.
<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
/s/ Ronald G. Pippin
-----------------------------
Ronald G. Pippin,
Vice President and Comptroller
March 12, 1998
Under the requirement of the Securities Exchange Act of 1934,
the following people have signed this report on our behalf in
the capacities indicated.
Principal Executive Officer:
/s/ Douglas L. Whitley
-----------------------------
Douglas L. Whitley,
President
Principal Financial and Accounting Officer:
/s/ Ronald G. Pippin
-----------------------------
Ronald G. Pippin,
Vice President and Comptroller
Ameritech Corporation:
/s/ Barry K. Allen
-----------------------------
Barry K. Allen,
Executive Vice President,
Regulatory and Wholesale Operations
The sole shareowner of the registrant, which is
a statutory close corporation managed by the
shareowner rather than by a board of directors.
March 12, 1998
<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.
Bell Companies -
- --------------
the former Bell telephone subsidiaries of AT&T, including
Ameritech's five local exchange companies in Illinois, Indiana,
Michigan, Ohio and Wisconsin.
Bundled (unbundled) network elements -
- ------------------------------------
two or more components of a regulated service for which one
inclusive rate is charged; separate components of a regulated
service for which separate rates are charged.
Call management services -
- -------------------------
services that add value and convenience for phone customers, such
as call waiting, call forwarding and Caller ID. These services are
sold to customers individually or in packages.
Customer premises equipment (CPE) -
- ----------------------------------
communications equipment owned by customers, including telephones,
faxes and switches.
Data services -
- ----------------------
services that use advanced technology to allow faster network
access to the Internet and other multimedia and data services.
Derivative -
- ----------
an instrument that derives its value from the value of something
else, usually a price index, an interest rate, a foreign exchange
rate, or the price of a financial instrument or commodity.
Dial-1-plus -
- ---------
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.
Hedging -
- -------------------
risk management activities involving derivatives.
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.
<PAGE>
GLOSSARY (cont'd.)
Intrastate revenues -
- --------------------
that portion of revenues regulated by state rather than federal
authorities.
Landline -
- --------
referring to conventional wired phone service.
Local access -
- ------------
the local portion of long distance calls.
Local access and transport area (LATA) -
- ---------------------------------------
the boundary within which a local telephone company may provide
phone service. It is usually centered around a city or other
identifiable community of interest.
Local exchange carriers (LECs) -
- -------------------------------
those companies primarily involved in providing local phone service
and access to the local phone network, including Ameritech's
landline communications subsidiaries in Illinois, Indiana,
Michigan, Ohio and Wisconsin.
Operations support systems (OSS) -
- ---------------------------------
the databases and information used to support the provision of
telephone service to end users.
Price caps -
- -----------
a form of regulation that sets maximum limits on the prices that
LECs can charge for access services instead of limits on rate of
return or profits.
Productivity factor -
- --------------------
a portion of the interstate price cap formula that requires LECs to
reduce the price cap based on an assumed increase in productivity.
RHCs -
- ----
the seven regional holding companies formed in connection with the
court-approved divestiture of certain assets of AT&T Corp.,
formerly American Telephone and Telegraph Company. With the 1997
mergers of two of the RHCs, Pacific Telesis Group into SBC
Communications Inc. and NYNEX Corporation into Bell Atlantic
Corporation, five RHCs remain.
Securities and Exchange Commission (SEC) -
- -----------------------------------------
the federal agency that regulates the issuance and trading of
public debt and equity securities in the United States and monitors
compliance with these regulations.
Switched Minutes of Use -
- -----------------------
the measure of time used to bill IXC's for access to our public
switched network.
Universal service -
- ------------------
a concept designed to ensure access to the telecommunications
network in rural and low-income areas at affordable prices.
Funding typically comes from urban telecommunication operators.
<PAGE>
ILLINOIS BELL TELEPHONE COMPANY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ALLOWANCE FOR UNCOLLECTIBLES
(Dollars in Millions)
COL. A COL. B COL. C COL. D COL. E
------ ------ ----------------- ------ ------
Additions
-----------------
Balance at Charged Charged Balance
Beginning to to Other at End of
of Period Expense (a) Accounts (b) Deductions (c) Period
--------- ---------- ----------- ------------- ------
Year 1997........ $ 81.6 $ 83.9 $139.4 $ 225.7 $ 79.2
Year 1996........ 48.8 106.4 114.5 188.1 81.6
Year 1995........ 43.9 42.8 66.2 104.1 48.8
----------------------
(a)Excludes direct charges and credits to expense on the statements of
income and accumulated deficit related to interexchange carrier
receivables.
(b)Includes principally amounts related to the interexchange carrier
receivables which are being billed by us and amounts previously
written off which were credited directly to this account when
recovered, as well as a reclassification in 1996 of $15.7 million from
current liabilities to more accurately state the allowance.
(c)Amounts written off as uncollectible.
Exhibit 12
ILLINOIS BELL TELEPHONE COMPANY AND SUBSIDIARY
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(Dollars in Millions)
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
1. EARNINGS
a) Income before interest expense,
income tax, extraordinary
item and undistributed
equity earnings (2)...... $1,053.2 $ 996.6 $1,027.4 $ 633.3 $ 750.1
b) Portion of rental expense
representative of the
interest factor (1)...... 12.6 10.4 9.9 8.8 10.8
-------- -------- -------- -------- --------
Total 1(a) and 1(b)..... $1,065.8 $1,007.0 $1,037.3 $ 642.1 $ 760.9
======== ======== ======== ======== ========
2. FIXED CHARGES
a) Total interest expense
including capital
lease obligations........ $ 115.2 $ 116.3 $ 117.2 $ 105.7 $ 117.5
b) Capitalized interest ..... 2.6 3.6 2.8 3.3 2.4
c) Portion of rental expense
representative of the
interest factor (1)...... 12.6 10.4 9.9 8.8 10.8
-------- -------- -------- -------- --------
Total 2(a) through 2(c). $ 130.4 $ 130.3 $ 129.9 $ 117.8 $ 130.7
======== ======== ======== ======== ========
RATIO OF EARNINGS TO
FIXED CHARGES................. 8.18 7.73 7.99 5.45 5.82
======== ======== ======== ======== ========
(1) One-third of rental expense is considered to be the amount representing
return on capital.
(2) The results for 1995 reflect a $57.1 million pretax credit primarily
from settlement gains resulting from lump sum pension payments from the
pension plan to former employees who left the business in the
nonmanagement work force restructuring. Results for 1994 reflect a
$196.5 million pretax charge associated with the nonmanagement work
force restructuring.
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the
incorporation by reference of our report dated January 13, 1998,
included in this Form 10-K for the year ended December 31, 1997, into
Illinois Bell Telephone Company's previously filed Registration
Statement File No. 33-50007.
ARTHUR ANDERSEN LLP
Chicago, Illinois
March 12, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
ILLINOIS BELL TELEPHONE COMPANY'S DECEMBER 31, 1997 CONSOLIDATED
FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 20,900<F1>
<SECURITIES> 0
<RECEIVABLES> 974,600
<ALLOWANCES> 79,200
<INVENTORY> 10,800
<CURRENT-ASSETS> 951,000
<PP&E> 9,586,300
<DEPRECIATION> 5,588,900
<TOTAL-ASSETS> 5,515,900
<CURRENT-LIABILITIES> 1,764,300
<BONDS> 1,011,700
0
0
<COMMON> 1,638,800
<OTHER-SE> (236,800)
<TOTAL-LIABILITY-AND-EQUITY> 5,515,900
<SALES> 0<F1><F2>
<TOTAL-REVENUES> 3,808,200
<CGS> 0<F3>
<TOTAL-COSTS> 2,770,900
<OTHER-EXPENSES> (14,700)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 115,200
<INCOME-PRETAX> 936,800
<INCOME-TAX> 373,200
<INCOME-CONTINUING> 563,600
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 563,600
<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 OTHER OPERATING EXPENSES
IN OUR FINANCIAL STATEMENTS AND THE "TOTAL COST" TAG, PER REGULATION
S-X, RULE 5-03(B).
</FN>
</TABLE>
