<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
---------------------
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 1-1150
NEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY
A New York Corporation I.R.S. Employer Identification No. 04-1664340
125 High Street, Boston, Massachusetts 02110
Telephone Number (617) 743-9800
-------------------------
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF NYNEX CORPORATION, MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION H(2).
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
<PAGE>
New England Telephone and Telegraph Company
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
STATEMENTS OF INCOME AND REINVESTED EARNINGS
(Unaudited)
(Dollars in Millions)
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
------------------- ----------------------
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
OPERATING REVENUES (including $59.5, $80.3,
$171.8 and $196.2 from affiliates)........................... $1,140.3 $1,178.5 $3,467.2 $3,425.7
-------- -------- -------- --------
OPERATING EXPENSES
Employee costs, including benefits and taxes................. 282.0 252.9 880.1 822.6
Depreciation and amortization................................ 233.7 223.8 674.8 697.8
Taxes other than income...................................... 36.2 35.4 108.5 104.9
Other (including $213.4, $175.4, $650.6
and $577.3 to affiliates)............................... 361.3 291.0 1,030.4 912.2
-------- -------- -------- --------
913.2 803.1 2,693.8 2,537.5
-------- -------- -------- --------
OPERATING INCOME.................................................. 227.1 375.4 773.4 888.2
OTHER INCOME, NET (including $1.8, $1.4, $5.9
and $6.8 from affiliate)..................................... 2.0 1.5 17.9 7.0
INTEREST EXPENSE (including $.3, $1.1, $(.8)
and $2.7 to affiliate)....................................... 34.4 35.5 104.0 106.5
-------- -------- -------- --------
Income Before Provision for Income Taxes and
Cumulative Effect of Change in Accounting Principle.......... 194.7 341.4 687.3 788.7
PROVISION FOR INCOME TAXES........................................ 73.2 130.9 264.1 303.3
-------- -------- -------- --------
Income Before Cumulative Effect of Change
in Accounting Principle...................................... 121.5 210.5 423.2 485.4
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE
Directory Publishing, Net of Tax............................. --- --- --- 55.2
-------- -------- -------- --------
NET INCOME........................................................ $ 121.5 $ 210.5 $ 423.2 $ 540.6
======== ======== ======== ========
REINVESTED EARNINGS
At beginning of period....................................... $ 184.8 $ 96.9 $ 257.9 $ .1
Add: net income............................................. 121.5 210.5 423.2 540.6
-------- -------- -------- --------
306.3 307.4 681.1 540.7
Deduct: dividends........................................... 187.4 116.7 562.2 350.0
-------- -------- -------- --------
At end of period............................................. $ 118.9 $ 190.7 $ 118.9 $ 190.7
======== ======== ======== ========
</TABLE>
See Notes to Financial Statements.
1
<PAGE>
New England Telephone and Telegraph Company
BALANCE SHEETS
(Unaudited)
(Dollars in Millions)
ASSETS
------
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
CURRENT ASSETS
Cash......................................... $ 10.5 $ 14.2
Accounts receivable:
Trade and other, net of allowances for
uncollectibles of $55.7 and $47.4.. 904.5 912.7
Affiliates.............................. 137.6 98.0
Material and supplies........................ 110.4 99.5
Prepaid expenses............................. 69.0 52.0
Deferred income taxes........................ 31.1 52.6
Other........................................ 75.0 73.9
--------- ---------
1,338.1 1,302.9
--------- ---------
PLANT, PROPERTY AND EQUIPMENT................ 13,234.9 12,720.8
Less accumulated depreciation................ 7,336.0 6,884.8
--------- ---------
5,898.9 5,836.0
--------- ---------
OTHER ASSETS................................. 225.8 176.5
--------- ---------
TOTAL ASSETS................................. $ 7,462.8 $ 7,315.4
========= =========
</TABLE>
See Notes to Financial Statements.
2
<PAGE>
New England Telephone and Telegraph Company
BALANCE SHEETS
(Unaudited)
(Dollars in Millions)
LIABILITIES AND SHAREOWNER'S INVESTMENT
---------------------------------------
<TABLE>
<CAPTION>
September 30, December 31,
1997 1996
------------- ------------
<S> <C> <C>
CURRENT LIABILITIES
Debt maturing within one year:
Note payable to affiliate................. $ 47.0 $ ---
Other..................................... 175.5 175.7
Accounts payable and accrued liabilities:
Affiliates................................ 428.2 544.1
Other..................................... 758.9 549.0
Other liabilities.............................. 103.1 105.6
-------- --------
1,512.7 1,374.4
-------- --------
LONG-TERM DEBT................................. 1,997.0 1,996.4
-------- --------
EMPLOYEE BENEFIT OBLIGATIONS................... 1,718.1 1,562.3
-------- --------
DEFERRED CREDITS AND OTHER LIABILITIES
Deferred income taxes.......................... --- 5.6
Unamortized investment tax credits............. 53.9 59.0
Other.......................................... 34.6 32.2
-------- --------
5,316.3 5,029.9
-------- --------
SHAREOWNER'S INVESTMENT
Common stock-one share, without par value...... 1.0 1.0
Additional paid-in capital..................... 2,026.6 2,026.6
Reinvested earnings............................ 118.9 257.9
-------- --------
2,146.5 2,285.5
-------- --------
TOTAL LIABILITIES AND SHAREOWNER'S INVESTMENT.. $7,462.8 $7,315.4
======== ========
</TABLE>
See Notes to Financial Statements.
3
<PAGE>
New England Telephone and Telegraph Company
STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in Millions)
<TABLE>
<CAPTION>
Nine months ended
September 30,
----------------------
1997 1996
-------- --------
<S> <C> <C>
NET CASH PROVIDED BY OPERATING ACTIVITIES......... $1,204.8 $ 976.1
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to plant, property and equipment........ (721.8) (625.2)
Other, net........................................ (3.8) (19.9)
-------- --------
Net cash used in investing activities............. (725.6) (645.1)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal repayments of capital
lease obligations............................ (.3) (.3)
Net change in note payable to affiliate........... 47.0 38.6
Dividends paid.................................... (491.5) (344.1)
Net change in outstanding checks drawn
on controlled disbursement accounts.......... (38.1) (20.8)
-------- --------
Net cash used in financing activities............. (482.9) (326.6)
-------- --------
NET CHANGE IN CASH................................ (3.7) 4.4
CASH, BEGINNING OF PERIOD......................... 14.2 8.4
-------- --------
CASH, END OF PERIOD............................... $ 10.5 $ 12.8
======== ========
</TABLE>
See Notes to Financial Statements.
4
<PAGE>
New England Telephone and Telegraph Company
NOTES TO FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
New England Telephone and Telegraph Company (the Company) is a wholly owned
subsidiary of NYNEX Corporation (NYNEX). The accompanying unaudited condensed
financial statements have been prepared based upon Securities and Exchange
Commission rules that permit reduced disclosure for interim periods. These
financial statements include certain reclassifications in presentation and
certain retroactive adjustments to conform accounting methodologies as a result
of the merger of Bell Atlantic Corporation (Bell Atlantic) and NYNEX (see Note
2). These financial statements reflect all adjustments which are necessary for
a fair presentation of results of operations and financial position for the
interim periods shown including normal recurring accruals and other items (see
Note 2). The results for the interim periods are not necessarily indicative of
results for the full year. For a more complete discussion of significant
accounting policies and certain other information, refer to the financial
statements filed with the Company's 1996 Form 10-K.
2. BELL ATLANTIC--NYNEX MERGER
On August 14, 1997, Bell Atlantic and NYNEX completed a merger of equals
under a definitive merger agreement entered into on April 21, 1996 and amended
on July 2, 1996. The stockholders of each company approved the merger at special
meetings held in November 1996. Under the terms of the amended agreement, NYNEX
became a wholly owned subsidiary of Bell Atlantic. The merger has been accounted
for as a pooling of interests.
As a result of conforming the accounting methodologies of Bell Atlantic and
NYNEX, the Company has reduced Reinvested Earnings as of December 31, 1995 by a
net $414.8 million primarily for the immediate recognition of the transition
benefit obligation for postretirement benefits other than pensions in accordance
with Statement of Financial Accounting Standards No. 106, "Employers' Accounting
for Postretirement Benefits Other Than Pensions" as if the merger had occurred
as of the beginning of the earliest period presented. In its historical
financial statements, the Company had amortized the transition benefit
obligation over a twenty year period. The net reduction in Reinvested Earnings
also includes amounts reallocated from Additional Paid-in Capital to cover
dividend payments.
Merger-Related Costs
Results of operations for the third quarter of 1997 include merger-related
pre-tax costs totaling approximately $59 million consisting of $6 million for
direct incremental costs, $51 million for employee severance costs, and $2
million for transition and integration costs. These costs include the Company's
allocated share of merger-related costs from Telesector Resources Group, Inc.
(Telesector Resources), an affiliate which provides centralized services on a
contract basis.
Direct incremental costs consist of expenses associated with compensation
arrangements related to completing the merger transaction. Employee severance
costs represent the Company's proportionate share of benefit costs for the
separation by the end 1999 of management employees who are entitled to benefits
under preexisting Bell Atlantic separation pay plans. Transition and
integration costs consist of the Company's proportionate share of costs
associated with integrating the operations of Bell Atlantic and NYNEX.
Additional Charges
In the third quarter of 1997, the Company recorded pre-tax charges of
approximately $47 million in connection with consolidating operations and
combining organizations and for special items arising in the quarter. These
charges include the Company's allocated share of charges from Telesector
Resources. A discussion of these charges follows:
The Company recognized pre-tax charges of approximately $6 million for
special items related to fixed assets.
The Company also recognized pre-tax charges of approximately $19 million
for contingencies associated with various regulatory and legal matters, and
approximately $22 million for other miscellaneous expense items.
3. DIVIDEND
On November 3, 1997, the Company declared and paid a dividend in the amount
of $187.4 million to NYNEX.
5
<PAGE>
New England Telephone and Telegraph Company
4. REVENUES SUBJECT TO POSSIBLE REFUND
Several federal regulatory matters may possibly require the Company to
refund a portion of the revenues collected in the current and prior periods. As
of September 30, 1997, the aggregate amount of revenues estimated to be subject
to possible refund was approximately $41 million for the Company. The outcome of
each pending matter, as well as the time frame within which each will be
resolved, is not presently determinable.
5. LITIGATION AND OTHER CONTINGENCIES
Various legal actions and regulatory proceedings are pending to which the
Company is a party. The Company has established reserves for liabilities in
connection with regulatory and legal matters which it currently deems to be
probable and estimable. The Company does not expect that the ultimate
resolution of these matters in future periods will have a material effect on the
Company's financial position, but it could have a material effect on results of
operations.
6
<PAGE>
New England Telephone and Telegraph Company
Item 2. Management's Discussion and Analysis of Results of Operations
(Abbreviated pursuant to General Instruction H(2).)
This discussion should be read in conjunction with the Financial Statements
and Notes to Financial Statements.
RESULTS OF OPERATIONS
- ---------------------
The Company reported net income for the nine month period ended September
30, 1997 of $423.2 million compared to net income of $540.6 million for the same
period in 1996.
Bell Atlantic--NYNEX Merger
On August 14, 1997, Bell Atlantic and NYNEX completed a merger of equals
under a definitive merger agreement entered into on April 21, 1996 and amended
on July 2, 1996. The stockholders of each company approved the merger at special
meetings held in November 1996. Under the terms of the amended agreement, NYNEX
became a wholly owned subsidiary of Bell Atlantic. The merger has been accounted
for as a pooling of interests.
As a result of conforming the accounting methodologies of Bell Atlantic and
NYNEX, the Company has reduced Reinvested Earnings as of December 31, 1995 by a
net $414.8 million primarily for the immediate recognition of the transition
benefit obligation for postretirement benefits other than pensions in accordance
with Statement of Financial Accounting Standards No. 106, "Employers' Accounting
for Postretirement Benefits Other Than Pensions" as if the merger had occurred
as of the beginning of the earliest period presented. In its historical
financial statements, the Company had amortized the transition benefit
obligation over a twenty year period. The net reduction in Reinvested Earnings
also includes amounts reallocated from Additional Paid-in Capital to cover
dividend payments.
Merger-Related Costs
Results of operations for the third quarter of 1997 include merger-related
pre-tax costs totaling approximately $59 million consisting of $6 million for
direct incremental costs, $51 million for employee severance costs, and $2
million for transition and integration costs. These costs include the Company's
allocated share of merger-related costs from Telesector Resources Group, Inc.
(Telesector Resources), an affiliate which provides centralized services on a
contract basis.
Direct incremental costs consist of expenses associated with compensation
arrangements related to completing the merger transaction. Employee severance
costs represent the Company's proportionate share of benefit costs for the
separation by the end of 1999 of management employees who are entitled to
benefits under preexisting Bell Atlantic separation pay plans. Transition and
integration costs consist of the Company's proportionate share of costs
associated with integrating the operations of Bell Atlantic and NYNEX.
Bell Atlantic expects to incur between $400 million and $500 million (pre-
tax) in additional transition and integration merger-related expenses over the
three years following the closing of the merger. It is anticipated that the
Company will recognize a portion of these costs.
Additional Charges
In the third quarter of 1997, the Company recorded pre-tax charges of
approximately $47 million in connection with consolidating operations and
combining organizations and for special items arising in the quarter. These
charges include the Company's allocated share of charges from Telesector
Resources. A discussion of these charges follows:
The Company recognized pre-tax charges of approximately $6 million for
special items related to fixed assets.
The Company also recognized pre-tax charges of approximately $19 million
for contingencies associated with various regulatory and legal matters, and
approximately $22 million for other miscellaneous expense items.
7
<PAGE>
New England Telephone and Telegraph Company
Other Charges
In 1997, costs associated with the Company's retirement incentive program
totaled $190.3 million for the first nine months, compared to $98.6 million for
the first nine months of 1996.
The retirement incentive costs for the first nine months of 1997 and 1996
include amounts charged to the Company by Telesector Resources for an allocated
portion of the employees who left Telesector Resources under the retirement
incentive program. In the first nine months of 1997, the retirement incentive
costs allocated to the Company by Telesector Resources were $52.5 million,
compared to $11.5 million for the same period of 1996. The total number of
employees who left Telesector Resources under the retirement incentive program
during the first nine months of 1997 and 1996 were 915 and 480, of which 350 and
185 were allocated to the Company for determining the Company's portion of
Telesector Resources' charges for the retirement incentive program. Most of the
cost of the retirement incentives is funded by Bell Atlantic's pension plans.
Cumulative Effect of Change in Accounting - Directory Publishing
The Company changed its method of accounting for directory publishing
revenues and expenses, effective January 1, 1996. The Company adopted the point-
of-publication method, which requires directory revenues and expenses to be
recognized upon publication rather than over the lives of the directories. The
Company recorded an after-tax increase in income of $55.2 million in the first
quarter of 1996, representing the cumulative effect of this accounting change.
- --------------------------------------------------------------------------------
These and other items affecting the comparison of the Company's results of
operations for the nine month periods ended September 30, 1997 and 1996 are
discussed in the following sections. This Management's Discussion and Analysis
should also be read in conjunction with the Company's 1996 Annual Report on Form
10-K.
<TABLE>
<CAPTION>
OPERATING REVENUES STATISTICS
- -----------------------------
1997 1996 % Change
- --------------------------------------------------------------------------------
At September 30
- ---------------
<S> <C> <C> <C>
Access Lines in Service (in thousands)
Residence............................ 4,466 4,353 2.6%
Business............................. 2,278 2,127 7.1
Public............................... 70 73 (4.1)
------ ------
6,814 6,553 4.0
====== ======
Nine Month Period Ended September 30
- ------------------------------------
Access Minutes of Use (in millions)..... 19,562 18,198 7.5
</TABLE>
<TABLE>
<CAPTION>
OPERATING REVENUES
- ------------------
(Dollars in Millions)
Nine Month Period Ended September 30 1997 1996 % Change
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Local service............................. $1,607.2 $1,546.4 3.9%
Network access............................ 1,036.7 1,031.7 .5
Long distance services.................... 504.1 514.2 (2.0)
Ancillary services........................ 145.5 130.7 11.3
Directory and information services........ 173.7 202.7 (14.3)
-------- --------
Total..................................... $3,467.2 $3,425.7 1.2
======== ========
</TABLE>
8
<PAGE>
New England Telephone and Telegraph Company
LOCAL SERVICE REVENUES
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $60.8 3.9%
- --------------------------------------------------------------------------------
Local service revenues are earned by the Company from the provision of
local exchange, local private line, public telephone (pay phone) and value-added
services. Value-added services are a family of services which expand the
utilization of the network. These services include products such as Caller ID,
Call Waiting and Return Call, as well as more mature products such as Touch-
Tone.
Higher usage of network facilities was the primary reason for the increase
in local service revenues in the nine month period ended September 30, 1997.
This growth was generated by an increase in access lines in service of 4.0% from
September 30, 1996 and stronger business message volumes in 1997. Access line
growth reflects primarily higher demand for Centrex services and an increase in
additional residential lines. Higher revenues from private line and switched
data services also contributed to the revenue growth in 1997.
Revenue growth during 1997 was boosted by increased revenues from value-
added services. This increase was principally the result of higher customer
demand and usage, fueled in part by the introduction of new and enhanced
optional features.
Revenue increases were partially offset by the effects of rate reductions
and a rebate issued to customers in Massachusetts in August 1997.
For a discussion of the Telecommunications Act of 1996, which opens the
local exchange market to competition, see "Factors That May Impact Future
Results" beginning on page 13.
NETWORK ACCESS REVENUES
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $5.0 .5%
- --------------------------------------------------------------------------------
Network access revenues are earned from long distance carriers for their
use of the Company's local exchange facilities in providing long distance
services to their customers, and from end-user subscribers. Switched access
revenues are derived from usage-based charges paid by long distance carriers for
access to the Company's network. Special access revenues arise from access
charges paid by long distance carriers and end-users who have private networks.
End-user access revenues are earned from the Company's customers who pay for
access to the network.
Network access revenues increased during the first nine months of 1997 as a
result of higher customer demand as reflected by growth in access minutes of use
of 7.5% over the same period in 1996. Volume growth was boosted by expansion of
the business market, particularly for high capacity services.
Network access revenues in the first nine months of 1997 were negatively
affected by price reductions as mandated by federal and state price cap and
incentive plans. Effective July 1, 1997, the Company implemented price decreases
of approximately $77 million on an annualized basis for interstate access
services, in connection with the Federal Communications Commission's (FCC) price
cap plan. The Company also implemented rate reductions for intrastate access
services in connection with price cap and incentive plans filed in certain state
jurisdictions. Revenues during 1997 were also reduced by special charges of
approximately $18 million for contingencies associated with regulatory matters.
The Company expects that the impact of price decreases, in connection with
the FCC's price cap plan effective July 1, 1997, will be partially offset by
volume increases. For a further discussion of FCC rulemakings concerning price
caps, access charges and universal service, see "Factors That May Impact Future
Results-Recent Developments-FCC Orders" beginning on page 14.
9
<PAGE>
New England Telephone and Telegraph Company
LONG DISTANCE SERVICES REVENUES
1997-1996 (Decrease)
- --------------------------------------------------------------------------------
Nine Months $(10.1) (2.0)%
- --------------------------------------------------------------------------------
Long distance services revenues are earned primarily from calls made
outside a customer's local calling area, but within the same service area of the
Company (intraLATA toll). Other long distance services that the Company provides
include 800 services and Wide Area Telephone Service (WATS).
Increased competition for intraLATA toll, WATS and private line services
and company-initiated price reductions contributed substantially to the
reduction in long distance revenues in 1997. The effect on revenues from
competition for intraLATA toll services increased in the second and third
quarters of 1997 as a result of the introduction of presubscription in several
states. The Company implemented price reductions on certain long distance
services as part of the Company's response to competition. These revenue
decreases were also partially offset by higher calling volumes generated by an
increase in access lines in service.
The Company believes that competition for long distance services, including
the introduction of presubscription, which began in the second quarter of 1997,
will continue to impact future revenue trends. See "Factors That May Impact
Future Results-Competition-IntraLATA Toll Services" on page 15 for a further
discussion of presubscription.
ANCILLARY SERVICES REVENUES
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $14.8 11.3%
- --------------------------------------------------------------------------------
The Company provides ancillary services which include billing and
collection services for long distance carriers and affiliates, customer premises
equipment (CPE) services, facilities rental services for affiliates and non-
affiliates, voice messaging, ISDN and other high bandwidth services.
Higher ancillary services revenues during the first nine months of 1997
were principally the result of higher demand for CPE services. Strong revenue
growth from voice messaging services, principally Answer Call, also contributed
to higher revenues in 1997. The Company also recognized higher revenues as a
result of the introduction of customer late payment fees.
DIRECTORY AND INFORMATION SERVICES REVENUES
1997-1996 (Decrease)
- --------------------------------------------------------------------------------
Nine Months $(29.0) (14.3)%
- --------------------------------------------------------------------------------
Directory and information services revenues consist of payments from an
affiliate, NYNEX Information Resources Company (Information Resources), for
earnings related to publishing directories in Maine, Massachusetts, New
Hampshire, Rhode Island and Vermont in excess of a regulated return and fees
paid by Information Resources for the use of the Company's name in soliciting
directory advertising and in publishing and distributing directories.
The decrease in directory and information services revenues in 1997 was
principally due to reduced payments from Information Resources due to the
effects of merger-related costs, retirement incentive costs and other charges on
Information Resources's earnings related to publishing directories in Maine,
Massachusetts, New Hampshire, Rhode Island and Vermont.
10
<PAGE>
New England Telephone and Telegraph Company
<TABLE>
<CAPTION>
OPERATING EXPENSES
- ------------------
(Dollars in Millions)
Nine Month Period Ended September 30 1997 1996 % Change
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Employee costs, including benefits and taxes.. $ 880.1 $ 822.6 7.0%
Depreciation and amortization................. 674.8 697.8 (3.3)
Taxes other than income....................... 108.5 104.9 3.4
Other operating expenses...................... 1,030.4 912.2 13.0
-------- --------
Total......................................... $2,693.8 $2,537.5 6.2
======== ========
</TABLE>
EMPLOYEE COSTS
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $ 57.5 7.0%
- --------------------------------------------------------------------------------
Employee costs consist of salaries, wages and other employee compensation,
employee benefits and payroll taxes paid directly by the Company. Similar costs
incurred by employees of Telesector Resources, who provide centralized services
on a contract basis, are allocated to the Company and are included in other
operating expenses.
Employee costs increased in the first nine months of 1997 principally as a
result of costs of approximately $51 million associated with the Company's
retirement incentive program. Employee costs were also higher as a result of
annual salary and wage increases, the effect of increased work force levels
principally attributable to higher business volumes, and merger-related costs
recorded in the third quarter of 1997. The Company recognized approximately $32
million in benefit costs for the separation by the end of 1999 of management
employees who are entitled to benefits under preexisting Bell Atlantic
separation pay plans. The Company also recorded approximately $1 million for
direct incremental merger-related costs associated with compensation
arrangements. Merger-related costs associated with employees of Telesector
Resources were allocated to the Company and are included in other operating
expenses.
These expense increases were partially offset by a reduction in benefit
costs caused by a number of factors, including an increase in the discount rate
used to develop pension and postretirement benefit costs, favorable pension plan
asset returns, lower than expected medical claims and plan changes.
For a further discussion of the Company's retirement incentive program see
"Other Matters - Retirement Incentives" on page 16.
DEPRECIATION AND AMORTIZATION
1997-1996 (Decrease)
- --------------------------------------------------------------------------------
Nine Months $(23.0) (3.3)%
- --------------------------------------------------------------------------------
Depreciation and amortization decreased in the first nine months of 1997
principally due to the effect of lower rates of depreciation and amortization,
offset partially by growth in depreciable telephone plant and the recording of
approximately $6 million for special items related to fixed assets in the third
quarter of 1997, as previously mentioned.
11
<PAGE>
New England Telephone and Telegraph Company
TAXES OTHER THAN INCOME
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $3.6 3.4%
- --------------------------------------------------------------------------------
Taxes other than income consist of taxes for gross receipts, property,
capital stock and other nonincome-based items.
The increase in taxes other than income is primarily due to higher
estimates for property taxes.
OTHER OPERATING EXPENSES
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $118.2 13.0%
- --------------------------------------------------------------------------------
Other operating expenses consist of contract services including centralized
services expenses allocated from Telesector Resources, rent, network software
costs, the provision for uncollectible accounts receivable, and other costs.
The increase in other operating expenses was largely attributable to higher
costs for data processing, engineering, right-to-use fees resulting from
software upgrades, and contract and centralized services. The third quarter of
1997 also included merger-related costs and other special items aggregating
approximately $18 million. These charges were comprised of transition merger-
related costs of $.1 million, charges for regulatory contingencies of
approximately $1 million and other miscellaneous expense items of approximately
$17 million. Other operating expenses were further increased by the Company's
allocated share of Telesector Resources' retirement incentive program, employee
severance costs and transition merger-related costs. These increases were
partially offset by lower process re-engineering costs.
OTHER INCOME, NET
1997-1996 Increase
- --------------------------------------------------------------------------------
Nine Months $10.9 155.7%
- --------------------------------------------------------------------------------
The change in other income, net, was primarily attributable to a gain on
the sale of property in the second quarter of 1997. This increase was partially
offset by a small decrease in the income recorded from Telesector Resources
under the equity method.
INTEREST EXPENSE
1997-1996 (Decrease)
- --------------------------------------------------------------------------------
Nine Months $ (2.5) (2.3)%
- --------------------------------------------------------------------------------
Interest expense decreased principally due to a lower level of affiliate
advances to the Company.
EFFECTIVE INCOME TAX
Nine Months Ended September 30
- --------------------------------------------------------------------------------
1997 38.43%
- --------------------------------------------------------------------------------
1996 38.46%
- --------------------------------------------------------------------------------
The effective income tax rate is the provision for income taxes as a
percentage of income before provision for income taxes and cumulative effect of
change in accounting principle. The Company's effective income tax rate was
lower in the first nine months of 1997 principally due to a decrease in pre-tax
income in 1997.
12
<PAGE>
New England Telephone and Telegraph Company
FINANCIAL CONDITION
- -------------------
The Company uses the net cash generated from operations and from external
financing to fund capital expenditures for network expansion and modernization,
and pay dividends. While current liabilities exceeded current assets at
September 30, 1997, September 30, 1996 and December 31, 1996, the Company's
sources of funds, primarily from operations and, to the extent necessary, from
readily available financing arrangements with an affiliate, are sufficient to
meet ongoing operating requirements. Management expects that presently
foreseeable capital requirements will continue to be financed primarily through
internally generated funds. Additional long-term debt may be needed to fund
development activities or to maintain the Company's capital structure to ensure
financial flexibility.
At September 30, 1997, the Company had $500.0 million remaining under a
shelf registration statement filed with the Securities and Exchange Commission
for the issuance of unsecured debt securities.
The Company's debt ratio was 50.8% as of September 30, 1997, compared to
50.3% as of September 30, 1996 and 48.7% as of December 31, 1996.
On November 3, 1997, the Company declared and paid a dividend in the amount
of $187.4 million to NYNEX.
FACTORS THAT MAY IMPACT FUTURE RESULTS
- --------------------------------------
Bell Atlantic- NYNEX Merger
The merger of Bell Atlantic and NYNEX was completed on August 14, 1997.
Bell Atlantic expects to recognize recurring expense savings following
completion of the merger as a result of consolidating operating systems and
other administrative functions and reducing management positions. It is
anticipated that the Company will recognize a portion of these savings.
Telecommunications Industry Changes
The telecommunications industry is undergoing substantial changes as a
result of the Telecommunications Act of 1996 (the Act), other public policy
changes and technological advances. These changes are likely to bring increased
competitive pressures in the Company's current business, but will also open new
markets to Bell Atlantic.
The Act became law on February 8, 1996 and replaced the Modification of
Final Judgment (MFJ). In general, the Act includes provisions that open local
exchange markets to competition and permit Bell Atlantic to provide interLATA
(long distance) services and to engage in manufacturing, previously prohibited
by the MFJ. However, the ability of Bell Atlantic to provide in-region long
distance service is largely dependent on satisfying certain conditions contained
in the Act. The requirements include a 14-point "competitive checklist" of steps
the Company must take which will help competitors offer local service, through
resale, the purchase of unbundled network elements, or through their own
networks. Bell Atlantic must also demonstrate to the FCC that its entry into the
in-region long distance market would be in the public interest.
Bell Atlantic expects to petition the FCC for permission to enter the
in-region long distance market in New York by early 1998 and one or more other
states during the first half of 1998, and anticipates entering the long distance
market in at least one jurisdiction during the second half of 1998. The timing
of Bell Atlantic's long distance entry in each of its 14 jurisdictions depends
on the receipt of FCC approval. There can be no assurance that any approval
will be forthcoming in time to permit Bell Atlantic to enter the in-region long
distance market on this schedule.
A U.S. Court of Appeals recently found that the FCC unlawfully attempted to
preempt state authority in implementing key provisions of the Act. It also
found that several particularly objectionable provisions of the FCC's rules
were inconsistent with the statutory requirements. In particular, it affirmed
that states have exclusive jurisdiction over the pricing of interconnection
elements and that the FCC could not lawfully allow competitors to "pick and
choose" isolated terms out of negotiated interconnection agreements. This
decision should not delay the advent of local competition, since, under the
previous stay of the FCC's rules, a number of interconnection agreements have
been concluded and the state regulatory commissions have proceeded to address
pricing and other standards for local interconnection.
13
<PAGE>
New England Telephone and Telegraph Company
Pursuant to Section 252(f) of the Act, the Company has filed in Maine, New
Hampshire, and Vermont a "Statement of Generally Available Terms and Conditions"
(SGAT) that will provide requesting telecommunications carriers with
interconnection, access to unbundled network elements, ancillary services and
resale of telecommunications services at rates based on forward-looking economic
costs.
On May 1, 1997, the Company originally filed an SGAT with the Maine Public
Utilities Commission (MPUC). A revised SGAT was filed on August 11, 1997. On
October 9, 1997, the MPUC withdrew consideration of the Company's SGAT filing in
response to its earlier decision to postpone a merger requirement that the
Company demonstrate checklist compliance by September 30, 1997. The Commission
has ordered the Company to file a status report on December 15, 1997 detailing
the Company's efforts to meet the Section 271 Competitive Checklist and its
plans to file for Section 271 approval with the FCC.
On July 11, 1997, the Company filed an SGAT with the New Hampshire Public
Utilities Commission (NHPUC). On August 25, 1997, the NHPUC issued an order
that permitted the Company's New Hampshire SGAT to take effect on October 20,
1997 pursuant to Section 252(f)(3) of the Act. The NHPUC will continue to
review the Company's SGAT filing, including a review of the costs underlying
the prices in the SGAT, pursuant to Section 252(f)(4) of the Act. On October
27, 1997, the NHPUC ordered the Company to work with other parties and the NHPUC
Staff to develop a schedule for review of the Company's SGAT and appurtenant
cost studies.
On July 30, 1997, the Company filed an SGAT with the Vermont Public Service
Board (VPSB). On October 29, 1997, the Company's Vermont SGAT went into effect
pursuant to Section 252(f)(3) of the Act. The Company anticipates that the VPSB
will invoke its right under Section 252(f)(4) of the Act to continue to review
an SGAT that has been permitted to take effect.
The Company is unable to predict definitively the impact that the Act will
ultimately have on its business, results of operations or financial condition.
The financial impact will depend on several factors, including the timing,
extent and success of competition in the Company's markets, and the timing,
extent and success of Bell Atlantic's pursuit of new opportunities resulting
from the Act.
The Company anticipates that these industry changes, together with the
rapid growth, enormous size and global scope of these markets, will attract new
entrants and encourage existing competitors to broaden their offerings. Current
and potential competitors in telecommunication services include long distance
companies, other local telephone companies, cable companies, wireless service
providers, and other companies that offer network services. Some of these
companies have a strong market presence, brand recognition and existing customer
relationships, all of which contribute to intensifying competition and may
affect the Company's future revenue growth. See the "Competition" section below
for additional information.
Recent Developments - FCC Orders
On May 7, 1997, the FCC adopted orders to reform the interstate access
charge system, to modify its price cap system and to implement the "universal
service" requirements of the Act. While there are additional decisions pending
on Universal Service and Access Reform, based on the decisions to date the
Company does not believe that these proceedings will result in a material
adverse impact on its results of operations or financial condition.
Access Charges
Interstate access charges are the rates long distance carriers pay for use
and availability of the Company's facilities for the origination and termination
of interstate interLATA service. On May 7, 1997, the FCC adopted changes to the
tariff structures it has prescribed for such charges in order to permit the
Company to recover a greater portion of its costs through rates which reflect
the manner in which those costs are incurred. Beginning in January 1998, the FCC
will require a phased restructuring of access charges, so that interstate costs
of the Company which do not vary based on usage will be recovered from long
distance carriers through flat rate charges, and those interstate costs that do
vary based on usage be recovered from long distance carriers through usage-based
rates. In addition, the FCC will require establishment of separate usage-based
charges for originating and for terminating interstate interLATA traffic.
A portion of the Company's interstate costs are also recovered through flat
monthly charges to subscribers (subscriber line charges). Under the FCC's
order, subscriber line charges for primary residential and single line
businesses will remain unchanged initially, but such charges for additional
residential lines and multi-line businesses will rise.
14
<PAGE>
New England Telephone and Telegraph Company
Price Caps
The FCC also adopted modifications to its price cap rules that affect
access rate levels. Under the FCC's price cap rules, the Company's price cap
index is adjusted annually by an inflation index (GDP-PI) less a fixed
percentage intended to reflect increases in productivity (Productivity Factor).
In the prior year, the Company's Productivity Factor was 5.3%. Effective July 1,
1997, the FCC created a single Productivity Factor of 6.5% for all price cap
companies, and eliminated requirements to share a portion of future interstate
earnings. The FCC required that rates be set as if the higher Productivity
Factor had been in effect since July 1996. Any local exchange company that earns
a rate of return on its interstate services of less than 10.25% in any calendar
year will be permitted to increase its interstate rates in the following year.
The FCC also ordered elimination of recovery for amortized costs associated with
the Company's implementation of equal access to all long distance carriers.
On June 30, 1997, Bell Atlantic made its Annual Access Tariff Filing of
Interstate Rates, which became effective on July 1, 1997. The rates included in
the filing resulted in annual price decreases for the Company totaling
approximately $77 million, of which approximately $2 million is a result of one-
time adjustments which will only be in effect until July 1998.
The FCC is expected to adopt an order in 1998 to address the conditions
under which the FCC would relax or remove existing access rate structure
requirements and price cap restrictions as increased local market competition
develops. The Company is unable to predict the results of this further
proceeding.
Universal Service
The FCC also adopted rules designed to preserve "universal service" by
ensuring that a basket of designated services is widely available and affordable
to all customers, including low-income customers and customers in areas that are
expensive to serve. The FCC's universal service support will approximate $1.5
billion for high cost areas pending completion of further FCC proceedings. The
FCC, in conjunction with the Federal-State Joint Board on Universal Service,
will determine the methodology for determining high cost areas for non-rural
carriers, and the proper amount of federal universal service support for high
cost areas. A new federal high cost universal service support mechanism will
become effective January 1, 1999.
The FCC also adopted rules to implement the Act's requirements to provide
discounted telecommunications services to schools and libraries, beginning
January 1, 1998, and to ensure that not-for-profit rural health care providers
have access to such services at rates comparable to those charged their urban
counterparts.
All telecommunications carriers will be required to contribute funding for
these universal service programs. The federal universal service funding needs
as of January 1, 1998 will require the Company to contribute approximately 2% of
its interstate retail revenues for high cost and low income subsidies. The
Company will also be contributing a portion of its total retail revenues for
schools, libraries and not-for-profit health care. The Company will recover its
contributions through interstate charges to long distance carriers and end
users.
Competition
IntraLATA Toll Services
IntraLATA toll services are calls that originate and terminate within the
same LATA, but cover a greater distance than a local call. These services are
generally regulated by the state regulatory commissions rather than federal
authorities. The state regulatory commissions permit other carriers to offer
intrastate intraLATA toll services in the Company's jurisdictions.
By November 1997, the Company had implemented intraLATA presubscription in
Maine, New Hampshire, Rhode Island and Vermont. The Company expects to offer
intraLATA presubscription in Massachusetts coincident with an offering of long
distance services in that state, as required by the Act. Implementation of
presubscription for intraLATA toll services could have a material negative
effect on intraLATA toll services revenues, especially since Bell Atlantic is
not permitted to offer long distance services at this time. The adverse impact
on intraLATA toll services revenues is expected to be partially offset by an
increase in intraLATA access revenues.
15
<PAGE>
New England Telephone and Telegraph Company
Local Exchange Services
Local exchange services have historically been subject to regulation by
state regulatory commissions. Applications from competitors to provide and
resell local exchange services have been approved in each of the Company's
jurisdictions. The Act is expected to significantly increase the level of
competition in all of the Company's local exchange markets.
Other State Regulatory Matters
The communications services of the Company are subject to regulation by the
state regulatory commissions with respect to intrastate rates and services and
certain other matters. For a discussion on revenues subject to possible refund
see Note 4 to the financial statements on page 6.
OTHER MATTERS
- -------------
Retirement Incentives
The Company had previously disclosed that it expected the total number
of employees who would elect to leave under its current retirement incentive
program through its completion in 1998 to be in the range of 5,300 to 5,700,
consisting of approximately 1,700 management and 3,600 to 4,000 associate
employees. The Company had accrued approximately $395 million of pre-tax
charges in 1993 for severance and postretirement medical benefits under a force
reduction plan.
As of September 30, 1997, 5,570 employees (1,640 management and 3,930
associates ) had elected to leave under the program, and additional charges of
approximately $665 million ($416 million after-tax) had been recorded in
connection with the program. The management portion of the program was
completed as of March 31, 1997.
Based on the experience of employee take rates under the program and
management's most recent assessment of work volume and productivity trends, the
Company is currently considering and discussing with the unions possible changes
in the program for associates. The Company now expects that, if the program
were fully implemented, the total number of employees electing to leave under
the program, and the associated additional charges, would be substantially
greater than previously estimated.
Management's objective is to distribute the program take rates in a
way that allows the Company to match retirements with downsizing caused by
productivity improvements. This effort could result in an extension of the
program.
In connection with the 1993 force reduction plan, the total remaining
reserves were approximately $40 million for employee severance and $52 million
for postretirement medical costs, as of December 31, 1996. During the first nine
months of 1997, employee severance reserves of approximately $29 million were
transferred to the pension liability and $38 million of postretirement medical
liability was applied on a per employee basis for associates who left the
Company under the retirement incentive program. In addition, approximately $1
million of employee severance reserves and $2 million of postretirement medical
liability were transferred from the Company to Telesector Resources during the
first nine months of 1997 for the allocated number of Telesector Resources
associates who left under the retirement incentive program. At September 30,
1997, approximately $10 million of severance reserves and $12 million of
postretirement medical liability remained.
Cautionary Statement Concerning Forward-Looking Statements
Information contained above with respect to expected financial results and
future events and trends in this Management's Discussion and Analysis is
forward-looking, based on the Company's estimates and assumptions and subject to
risks and uncertainties. For those statements, the Company claims the
protection of the safe harbor for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995.
16
<PAGE>
New England Telephone and Telegraph Company
The following important factors could affect the future results of the
Company and could cause those results to differ materially from those expressed
in the forward-looking statements: (i) materially adverse changes in economic
conditions in the markets served by the Company; (ii) the final outcome of FCC
rulemakings with respect to interconnection agreements, access charge reform and
universal service; (iii) the timing of presubscription for intraLATA toll
services; (iv) future state regulatory actions and economic conditions in the
Company's operating area; and (v) the extent, timing and success of competition
from others in the local telephone and intraLATA toll service markets.
17
<PAGE>
New England Telephone and Telegraph Company
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
For background concerning the Company's contingent liabilities under
the Plan of Reorganization governing the divestiture by AT&T Corp.
(formerly American Telephone and Telegraph Company) of certain assets
of the former Bell System Operating Companies with respect to private
actions relating to pre-divestiture events, see Item 3 of the
Company's Annual Report on Form 10-K for the year ended December 31,
1996.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Number
27 Financial Data Schedule.
(b) Report on Form 8-K filed during the quarter ended September 30,
1997:
A Current Report on Form 8-K, dated August 14, 1997, was filed
regarding the consummation of the merger of a wholly owned
subsidiary of Bell Atlantic Corporation with and into NYNEX
Corporation.
18
<PAGE>
New England Telephone and Telegraph Company
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
NEW ENGLAND TELEPHONE AND TELEGRAPH COMPANY
Date: November 13, 1997 By /s/ Edwin F. Hall
----------------------------
Edwin F. Hall
Controller
UNLESS OTHERWISE INDICATED, ALL INFORMATION IS AS OF NOVEMBER 10, 1997.
19
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THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
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SHEET AS OF SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO
SUCH FINANCIAL STATEMENTS.
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