<PAGE>
U. S. Securities And Exchange Commission
Washington, D.C. 20549
Form 8-K
Current Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (date of earliest event reported): February 18, 1999
Commission File Number 1-8612
Ameritech Corporation
A Delaware Corporation
30 South Wacker Drive
Chicago, Illinois 60606
I.R.S. Employer Identification Number
36-3251481
Telephone number (800)257-0902
<PAGE>
Item 5. Other Events
The purpose of this Form 8-K Current Report is to file certain financial
information concerning the registrant and its subsidiaries. Such financial
information is set forth in the exhibits to this Current Report.
Item 7. Financial Statements and Exhibits
(c) Exhibits.
Number Description
12 Computation of ratio of earnings to fixed charges for the five
years ended December 31, 1998
23 Consent of Arthur Andersen LLP
27 Financial Data Schedule
99 Ameritech Corporation and its subsidiaries - Certain financial
information as of and for the year ended December 31, 1998
- Selected Financial and Operating Data
- Management's Discussion and Analysis of Financial Condition
and Results of Operations
- Report of Management
- Report of Independent Public Accountants
- Consolidated Statements of Income
- Consolidated Balance Sheets
- Consolidated Statements of Shareowners' Equity
- Consolidated Statements of Cash Flows
- Notes to Consolidated Financial Statements
2
<PAGE>
Under the requirements of the Securities Exchange Act of 1934, an
authorized company official has signed this report on our behalf.
Dated: February 18, 1999
Ameritech Corporation
By: /s/ Barbara A. Klein
Barbara A. Klein
Vice President and
Comptroller
3
<PAGE>
Exhibit 12
AMERITECH CORPORATION
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
FOR THE FIVE YEARS ENDED DECEMBER 31, 1998
(Dollars in Millions)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
EARNINGS
Income before interest
income taxes, extraordinary
item and undistributed
equity earnings............ $ 6,044 $ 4,116 $ 3,726 $ 3,537 $ 2,162
Preferred dividends
of subsidiaries (3)....... 53 29 13 9 2
Portion of rent expense
representing interest..... 81 73 73 67 64
Michigan Single
Business Tax (2)........... 38 43 43 34 33
------- ------- ------- ------- -------
Total earnings (1)........ $ 6,216 $ 4,261 $ 3,855 $ 3,647 $ 2,261
======= ======= ======= ======= =======
FIXED CHARGES
Interest expense............ $ 611 $ 505 $ 514 $ 469 $ 435
Preferred dividends
of subsidiaries (3)....... 53 29 13 9 2
Capitalized interest........ 27 25 28 20 13
Portion of rent expense
representing interest..... 81 73 73 67 64
------- ------- ------- ------- -------
Total fixed charges....... $ 772 $ 632 $ 628 $ 565 $ 514
======= ======= ======= ======= =======
RATIO OF EARNINGS TO FIXED
CHARGES...................... 8.05 6.74 6.14 6.45 4.40
======= ======= ======= ======= =======
</TABLE>
(1) Results for 1998 include a pretax gain of $1,543 million from the sale of
substantially all of our TCNZ shares, as well as a pretax gain of $170
million from the sale of certain telephone and directory assets in
Wisconsin to Century Telephone Enterprises Inc. A pretax charge of $104
million for restructuring, combined with a pretax charge of $54 million for
a currency-related fair-value adjustment related to our Tele Danmark
investment and a pretax charge of $38 million for the costs of redeeming
long-term debt, partially offset the gains. Several one-time items were
recorded in 1997 and 1996, however the net impact of these items on pretax
income was not significant.
Results for 1995 include a $134 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, as well as a pretax gain of $66 million on the
exchange of cellular minority interests. Results for 1994 include a $728
million pretax charge associated with the nonmanagement work force
restructuring and a $69 million pretax charge related to the reduction of
certain asset values, primarily real estate. Costs of the work force
restructuring program were largely funded from the Ameritech Pension Plan.
(2) Earnings are income before income taxes and fixed charges. Since the
Michigan Single Business Tax ("the Tax") and rental expense have been
deducted, the Tax and the one-third portion of rental expense considered to
be fixed charges are added back.
(3) For purposes of the above computation, the preferred stock dividend
requirements of subsidiaries have been increased to an amount representing
the pretax earnings that would be required to cover the dividend
requirements.
<PAGE>
Exhibit 23
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the incorporation by
reference of our report dated January 21, 1999, which is included as part of
Exhibit 99 to this Form 8-K, into Ameritech Corporation's previously filed
Registration Statement File Nos. 33-34006, 33-49036, 33-51771, 33-51773,
33-00897, 33-02591, 333-29569, 333-29591, 333-37407 and 333-43179.
/s/ Arthur Andersen LLP
ARTHUR ANDERSEN LLP
Chicago, Illinois
February 18, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
AMERITECH CORPORATION'S DECEMBER 31, 1998 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-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 139,000
<SECURITIES> 0<F1>
<RECEIVABLES> 3,390,000
<ALLOWANCES> (338,000)
<INVENTORY> 345,000
<CURRENT-ASSETS> 5,130,000
<PP&E> 36,344,000
<DEPRECIATION> 22,039,000
<TOTAL-ASSETS> 30,299,000
<CURRENT-LIABILITIES> 8,000,000
<BONDS> 5,557,000
0
0
<COMMON> 1,177,000
<OTHER-SE> 9,720,000
<TOTAL-LIABILITY-AND-EQUITY> 30,299,000
<SALES> 0<F2>
<TOTAL-REVENUES> 17,154,000
<CGS> 0<F3>
<TOTAL-COSTS> 12,961,000
<OTHER-EXPENSES> (2,055,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 611,000
<INCOME-PRETAX> 5,637,000
<INCOME-TAX> 2,031,000
<INCOME-CONTINUING> 3,606,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,606,000
<EPS-PRIMARY> 3.27<F4>
<EPS-DILUTED> 3.25<F4>
<FN>
<F1>WE HAVE NOT STATED SECURITIES SEPARATELY IN THE FINANCIAL
STATEMENTS, BECAUSE THEY ARE NOT MATERIAL. WE HAVE INCLUDED THEM
IN THE CASH TAG.
<F2>NET SALES OF TANGIBLE PRODUCTS IS NOT MORE THAN 10% OF TOTAL OPERATING
REVENUES. WE THEREFORE HAVE NOT STATED THESE SALES SEPARATELY IN THE
FINANCIAL STATEMENTS, PER REGULATION S-X, RULE 5-03(B). WE HAVE INCLUDED
THESE SALES IN THE "TOTAL REVENUES" TAG.
<F3>WE HAVE INCLUDED COST OF TANGIBLE GOODS SOLD IN COST OF SERVICE AND
PRODUCTS IN THE FINANCIAL STATEMENTS AND THE "TOTAL COST" TAG, PER
REGULATION S-X, RULE 5-03(B).
<F4>WE HAVE CALCULATED EARNINGS PER SHARE AMOUNTS IN ACCORDANCE WITH FAS 128
"EARNINGS PER SHARE." WE HAVE ENTERED BASIC AND DILUTED AMOUNTS IN PLACE OF
PRIMARY AND FULLY DILUTED, RESPECTIVELY.
</FN>
</TABLE>
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
Ameritech Corporation and Subsidiaries
As of December 31 or for the year ended
(dollars in millions, except per share amounts)
<TABLE>
<CAPTION>
1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues $17,154 $15,998 $14,917 $13,428 $12,569 $11,865 $11,285 $10,983 $10,773 $10,316 $10,014
------------------------------------------------------------------------------------------------
Operating expenses(1) 12,961 12,199 11,412 10,125 10,540 9,307 8,941 9,001 8,584 8,161 7,882
------------------------------------------------------------------------------------------------
Operating income 4,193 3,799 3,505 3,303 2,029 2,558 2,344 1,982 2,189 2,155 2,132
Interest expense 611 505 514 469 435 453 495 545 454 384 366
Other income, net 2,055 390 326 260 147 117 125 219 76 14 52
Income taxes 2,031 1,388 1,183 1,086 571 709 628 491 557 547 581
------------------------------------------------------------------------------------------------
Income before special
accounting items(2) 3,606 2,296 2,134 2,008 1,170 1,513 1,346 1,165 1,254 1,238 1,237
Special accounting items(2) -- -- -- -- (2,234) -- (1,746) -- -- -- --
------------------------------------------------------------------------------------------------
Net income (loss) $3,606 $2,296 $2,134 $2,008 $(1,064) $1,513 $(400) $1,165 $1,254 $1,238 $1,237
------------------------------------------------------------------------------------------------
Earnings (loss) per share(3)
Income before special
accounting items(2)
Basic $3.27 $2.09 $1.93 $1.81 $1.06 $1.39 $1.25 $1.10 $1.18 $1.15 $1.14
Diluted 3.25 2.08 1.92 1.81 1.06 1.39 1.25 1.10 1.18 1.15 1.14
Special accounting items(2)
Basic -- -- -- -- (2.03) -- (1.62) -- -- -- --
Diluted -- -- -- -- (2.03) -- (1.62) -- -- -- --
------------------------------------------------------------------------------------------------
Net income (loss)
Basic $3.27 $2.09 $1.93 $1.81 $(0.97) $1.39 $(0.37) $1.10 $1.18 $1.15 $1.14
Diluted 3.25 2.08 1.92 1.81 (0.97) 1.39 (0.37) 1.10 1.18 1.15 1.14
------------------------------------------------------------------------------------------------
Dividends declared
per share(3) $1.218 $1.148 $1.078 $1.015 $0.97 $0.93 $0.89 $0.86 $0.81 $0.75 $0.69
------------------------------------------------------------------------------------------------
Average common shares
outstanding (millions)(3) 1,101.6 1,098.7 1,103.8 1,107.2 1,098.5 1,088.2 1,073.1 1,062.1 1,061.2 1,078.9 1,088.8
Total assets(4) $30,299 $25,339 $23,707 $21,942 $19,947 $23,428 $22,818 $22,290 $21,715 $19,833 $19,163
Property, plant and
equipment, net(4) $14,305 $13,873 $13,507 $13,457 $13,455 $17,366 $17,335 $16,986 $16,652 $16,296 $16,078
Capital expenditures $2,982 $2,651 $2,476 $2,176 $1,955 $2,108 $2,267 $2,200 $2,154 $2,015 $1,895
Long-term debt $5,557 $4,610 $4,437 $4,513 $4,448 $4,090 $4,586 $4,964 $5,074 $5,069 $4,487
Total debt(6) $8,176 $7,646 $7,592 $6,651 $6,346 $6,692 $6,704 $6,938 $6,769 $5,582 $4,942
Debt ratio 42.9% 47.9% 49.7% 48.7% 51.2% 46.0% 48.9% 46.1% 46.7% 42.1% 38.7%
Return on average equity(5) 36.2% 28.5% 28.7% 29.5% (13.6)% 20.1% (5.9)% 14.5% 16.3% 15.8% 15.8%
Return on average total
capital(5) 22.1% 18.1% 17.1% 18.2% (4.6)% 13.1% 0.2% 10.6% 11.8% 11.9% 12.0%
Market price per common share(3) $63.38 $40.25 $30.31 $29.44 $20.19 $19.19 $17.81 $15.88 $16.69 $17.00 $11.94
Access lines (000s) 20,968 20,502 19,694 19,057 18,239 17,560 17,001 16,584 16,278 15,899 15,469
Cellular subscribers (000s) 3,577 3,177 2,512 1,891 1,299 860 586 483 326 242 146
Employees 70,525 74,359 66,128 65,345 63,594 67,192 71,300 73,967 75,780 77,326 77,334
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Increase in operating expenses in 1994 and 1998 was due to work force
restructuring charges of $728 million and $104 million, respectively, while
operating expenses in 1995 decreased due to a restructuring credit of $134
million.
(2) Special accounting items represent an extraordinary item for the
discontinuance of FAS 71 (accounting in a regulatory environment) in 1994
and the cumulative effect of changes in accounting principles in 1992 for
FAS106 ($1,644 million) and FAS 112 ($102 million).
(3) Gives retroactive effect to all stock splits.
(4) Substantial reduction in total assets and property, plant and equipment, net
in 1994 was due principally to the discontinuance of FAS 71.
(5) Return on average equity and return on average total capital are calculated
using weighted average monthly amounts.
(6) Total debt excludes preferred stock issued by subsidiaries of $325 million
in 1998, $250 million in 1997, $60 million in 1995 and $85 million in 1994.
The 1997 and 1994 issues are subject to mandatory redemption.
22
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL
CONDITION (dollars in millions, except per share amounts)
OVERVIEW
- -------------------------------------------------------------------------------
Ameritech is a diversified, full-service communications company providing
wireline and wireless telephone service, paging, cable TV, security services,
directory advertising and online services. Our five domestic landline
communications subsidiaries provide local telephone service, network access and
public telephone service to more than 12 million customers in Illinois, Indiana,
Michigan, Ohio and Wisconsin. These subsidiaries are subject to regulation by
the respective state utility commissions and by the Federal Communications
Commission (FCC). In addition, we provide cellular service primarily in our
five-state region and Missouri; paging services in our five-state region,
Missouri and Minnesota; cable TV service in Illinois, Michigan and Ohio; and
security services throughout North America.
The communications industry continued to adapt to sweeping regulatory
changes, increased competition and significant new strategic initiatives in
1998. The Telecommunications Act of 1996 established a national policy that
calls for competition and open markets, rather than regulatory management, as
the basic industry business environment. As a result, it opened the nation's
communications markets to competition from new players both within and outside
the industry, potentially enabling them to become either niche or full-service
providers of voice, video, data, local and long-distance services for their
customers. At the same time, many communications markets in other parts of the
world are in the midst of reform, resulting in privatization and deregulation of
many previously nationalized communications companies.
These forces acting together create an environment for tremendous potential
growth in the global communications industry. Ameritech recognized these growth
opportunities several years ago, and we implemented three basic strategies to
compete effectively in this new environment: speed growth in our core business,
introduce new services for customers and connect customers around the world. By
adhering to these strategies, we have positioned ourselves to take advantage of
future market expansion and strategic growth opportunities.
On May 11, 1998, we accelerated the execution of Ameritech's strategy with
the announcement of our agreement to merge with SBC Communications Inc. In the
merger transaction, each share of Ameritech common stock will be converted into
and exchanged for 1.316 shares of SBC common stock. After the merger, Ameritech
will be a wholly owned subsidiary of SBC. The transaction was approved by the
board of directors and shareowners of each company in 1998, but remains subject
to various federal and state regulatory approvals. Ameritech and SBC own
competing cellular licenses in several markets, including Chicago and St. Louis.
Because FCC rules limit cross-ownership of cellular licenses, we expect that the
FCC will require divestiture of one overlapping license in each market before
granting approval of the merger.
RESULTS OF OPERATIONS
- -------------------------------------------------------------------------------
Ameritech's record of strong financial results continued in 1998. We achieved
double-digit earnings growth before one-time items in each quarter of 1998 and
for the year. Results were driven by solid revenue growth and by operating cost
controls initiated in the first quarter of 1998. Income from international
ventures in Belgium, Denmark and Hungary also contributed to earnings growth.
Consolidated results of operations for 1998 compared with the prior year were
as follows:
Results of Operations
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income before
one-time items $2,614 $2,346 $268 11.4
One-time items 992 (50) 1,042 n/m
Net income 3,606 2,296 1,310 57.1
EPS before one-time items
Basic $2.37 $2.14 $0.23 10.7
Diluted 2.35 2.12 0.23 10.8
Earnings per share
Basic $3.27 $2.09 $1.18 56.5
Diluted 3.25 2.08 1.17 56.3
Average common shares
(millions) 1,101.6 1,098.7 2.9 0.3
- -------------------------------------------------------------------------------
</TABLE>
One-time items in 1998 consisted of:
o a pretax charge of $104 million ($64 million after-tax, or $0.05 per share)
for restructuring related to a cost containment program announced in March
1998;
o a pretax gain of $1,543 million ($1,012 million after-tax, or $0.91 per
share) from the sale of substantially all of our shares in Telecom
Corporation of New Zealand Limited (TCNZ);
o a pretax charge of $54 million ($34 million after-tax, or $0.03 per share),
for a currency-related fair-value adjustment related to our Tele Danmark
investment;
o a pretax gain of $170 million ($102 million after-tax, or $0.09 per share)
from the sale of certain Wisconsin telephone and directory assets to Century
Telephone Enterprises, Inc. (Century Telephone); and,
o a pretax charge of $38 million ($24 million after-tax, or $0.02 per share)
for the costs of redeeming $1.3 billion of long-term debt.
One-time items in 1997 included:
o an after-tax charge of $87 million, or $0.08 per share, related to our share
of the costs of a work force restructuring at Belgacom, the national
telecommunications provider in Belgium;
o a pretax gain of $52 million ($37 million after-tax, or $0.03 per share)
resulting from the sale of our 12.5% interest in Sky Network Television
Limited of New Zealand (Sky TV);
23
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
o a pretax charge of $69 million ($42 million after-tax, or $0.04 per share)
resulting from our agreement to settle lawsuits related to our inside wire
maintenance services;
o a pretax gain of $42 million ($25 million after-tax, or $0.03 per share)
resulting from the sale of our 14.3% share of Bell Communications Research
(Bellcore);
o a pretax gain of $43 million ($27 million after-tax, or $0.03 per share)
resulting from the sale in an initial public offering of a portion of our
stake in MATAV, the telecommunications provider in Hungary; and,
o a pretax charge of $16 million ($10 million after-tax, or $0.01 per share)
resulting from a currency-related fair-value adjustment related to our Tele
Danmark investment.
Including the effects of these one-time items, 1998 net income increased
$1,310 million, or 57.1%, and diluted earnings per share increased $1.17, or
56.3%, over the comparable prior year period. Net income before one-time items
increased $230 million, or 10.9%, in 1997, and diluted earnings per share
increased $0.21, or 11.0%, over 1996 results. Results in 1996 included an
after-tax gain of $18 million, or $0.02 per share, resulting from the sale of
our interest in Centertel, a cellular telephone company in Poland.
SEGMENTS The following discussion makes reference to a new segment reporting
concept adopted in 1998. As discussed more fully in Note 14 to the consolidated
financial statements on pages 51 to 53, based on how we manage our business, we
have three reportable segments. Our largest segment is communications, which
provides landline telephone service, cellular telephone and paging services, as
well as call management and data services to business and residential customers.
Our second segment is information and entertainment, which provides printed and
online directories for business and residential users, security and alarm
monitoring services for homes and businesses, and cable TV services. Our third
reportable segment is international, which manages our investments in foreign
ventures. The international segment has no revenues, as all accounting activity
is recorded using the one-line equity method of accounting. We evaluate the
performance of our two revenue-producing segments on a direct margin basis,
which represents total revenues of that segment less direct expenses attributed
to it (excluding corporate allocations, information technology costs, interest
income or expense, income taxes and certain other costs).
Our communications segment is characterized by stable revenue growth and
solid earnings. Revenue growth in the information and entertainment segment is
somewhat higher, in part due to acquisitions, but earnings growth is more modest
due to the start-up nature of our cable TV operation and normal integration
costs being incurred in our security services business. The international
segment continues to contribute to earnings growth.
Total direct margin for reportable segments was $6,593 million in 1998,
$6,049 million in 1997 and $5,332 million in 1996. Direct margin for the
communications segment represented approximately 92% in 1998, 92% in 1997 and
90% in 1996, and margin from the information and entertainment segment
represented the remaining 8%, 8% and 10% for those years.
Direct margin in the communications segment increased in both 1998 and 1997
due to increased profitability in the cellular business, increased revenues from
high-margin call management services and steady growth in the landline
communications business.
Our margins in the information and entertainment segment have been slowed by
acquisitions we have made in our security services business. While these
acquisitions have added to revenues, integration and consolidation of monitoring
centers have impacted our margins. Further, the start-up nature of our cable TV
business, which did not have any revenues until mid-1996 and now has more than
200,000 customers, has affected margins in this segment as well.
REVENUES We derive most of our revenues from the provisioning of landline
telephone service and supporting products, which represents approximately 75% of
total revenues from operating segments. Other significant sources of revenue in
1998 included
[CHART APPEARS HERE]
1993 1994 1995 1996 1997 1998
---------------------------------------------
$11.9 $12.6 $13.4 $14.9 $16.0 $17.2
Revenue Growth
(in billions)
Ameritech's total revenues increased 7.2% in 1998 to
$17.2 billion, fueled by strong customer demand and
new product launches.
cellular and paging, which contributed approximately 11% of total revenues, and
directory advertising, which represents approximately 8% of total revenues.
Revenues increased by 7.2% to $17.2 billion in 1998. Revenue growth resulted
from strong gains in local service and data services revenues, combined with
continued growth in cellular, paging and security services. Rate reductions,
resulting primarily from access charge reform for landline communications
services, and lower revenues from long-distance services in our communications
segment, partially offset the increase. Revenue growth in 1998 was 6.4% in our
communications segment and 26.1% in our information and entertainment segment,
due in part to asset acquisitions in the security services business.
Total revenues increased by 7.2% to $16.0 billion in 1997, driven by
increased demand for a wide array of voice and data
24
<PAGE>
transmission services. Rate reductions partially offset these increases. Revenue
growth in 1997 was 7.6% in our communications segment and was 11.7% in our
information and entertainment segment.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Local service $7,020 $6,572 $448 6.8
- -------------------------------------------------------------------------------
</TABLE>
LOCAL SERVICE Local service revenues include basic monthly service fees and
usage charges, fees for call management services, public phone revenues, and
certain installation and connection charges. Local service rates generally have
been regulated by the state public service commissions. These revenues are
included in the results of our communications segment.
In the local service arena, demand for data services grew strongly in 1998,
as evidenced by a 58% increase in the number of ISDN lines in service and 33%
annual growth in high-capacity circuits. The proliferation of fax machines,
Internet usage and computer communications resulted in data traffic exceeding
voice traffic for the first time in our history. Demand for additional lines and
call management services remained strong as revenues from call management
services subscribed to on a monthly basis, such as Call Waiting and Caller ID,
increased by 17% in 1998. Pay-per-use revenues for such services as automatic
call back and three-way calling grew at a 61% annual rate. Access lines in
service increased by 2.3% to 20,968,000 as of December 31, 1998, or 2.7%
normalized for approximately 89,000 lines sold in November 1998 to Century
Telephone.
Local service revenues increased by $397 million, or 6.4%, in 1997 due
largely to increased sales of call management services. These increases resulted
from growth in both the number of features in service and the number of
pay-per-use activations of call management services. Access line growth, driven
in part by increased demand for second lines by residential and small business
customers, also contributed to the revenue increase. Access line growth in 1997
was 4.1%, including approximately 133,000 lines added on November 1, 1997, from
the acquisition of certain assets from Sprint Corporation (Sprint) in the
Chicago area.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Network access
Interstate access $2,481 $2,485 $(4) (0.2)
Intrastate access 551 619 (68) (11.0)
- -------------------------------------------------------------------------------
</TABLE>
NETWORK ACCESS Network access revenues are fees charged to interexchange
carriers, such as AT&T and MCI WorldCom, that use our local landline
communications network to connect customers to their long-distance networks. In
addition, end users pay flat rate access fees to connect to the long-distance
networks. These revenues are generated from both interstate and intrastate
services and are included in the results of our communications segment.
Total network access revenues decreased in 1998, due primarily to rate
reductions resulting from access charge reform effective July 1, 1997, and
additional reductions that took effect July 1, 1998. In addition, access charge
revenues decreased due to a change in reporting classification of certain pay
phone revenues from interexchange carriers for their customers' use of our pay
phones. This change in classification decreased network access revenues and
increased miscellaneous revenues by approximately $106 million in 1998 compared
with 1997. Approximately $87 million of this decrease related to interstate
network access revenues. Minutes of use increased in 1998 for both interstate
and intrastate access, due primarily to growth in the number of calls handled
for interexchange carriers. Growth in network usage by alternative providers of
intraLATA toll service in Illinois, Michigan and Wisconsin also contributed to
the intrastate access volume increase. Minutes of use increased, over the
comparable prior year period, by 6.0% for interstate and 10.5% for intrastate.
Interstate network access revenues increased by $120 million, or 5.1%, in
1997 due primarily to volume increases. The volume of calls that we handled for
interexchange carriers increased, and demand for dedicated services grew as
Internet service providers and other high-capacity users increased their
utilization of our network. Intrastate network access revenues increased by $46
million, or 8.0%, due to greater use of our network by alternative providers of
intraLATA toll services in Illinois, Michigan and Wisconsin. Rate reductions for
both interstate and intrastate network access, resulting primarily from access
charge reforms that took effect on July 1, 1997, partially offset these
increases. Minutes of use increased, over the comparable period in 1996, by 6.1%
for interstate and 15.4% for intrastate.
[GRAPHIC APPEARS HERE]
Total cellular customers at Belgacom,
one of our major European partnerships,
grew 84% in 1998 to 1.2 million.
25
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Long-distance $1,408 $1,384 $24 1.7
- -------------------------------------------------------------------------------
</TABLE>
LONG-DISTANCE Our current long-distance service revenues are derived from
customer calls to locations outside of the customer's local calling areas but
within the same local access and transport area (LATA). These revenues also are
included in the results of our communications segment.
Long-distance revenues increased in 1998, reflecting growth in dedicated
services and price increases. Volume decreases, resulting from increased
competition in Illinois, Michigan and Wisconsin, partially offset the increase.
Customers now may use an alternative provider of their choice for intraLATA toll
calls in these markets, without dialing a special access code when placing the
call.
Long-distance revenues decreased by $107 million, or 7.2%, in 1997, due to a
decrease in the volume of intraLATA toll calls completed. Implementation of Dial
1 + capability in the Illinois, Michigan and Wisconsin markets was substantially
complete in 1997, resulting in increased competition for these toll calls.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cellular, directory
and other $5,694 $4,938 $756 15.3
- -------------------------------------------------------------------------------
</TABLE>
CELLULAR, DIRECTORY AND OTHER Cellular, directory and other revenues include
revenues derived from cellular communications, paging services, telephone
directory publishing, cable TV, lease financing, billing and collection
services, telephone equipment sales, and security installations and services.
These revenues result from both our communications and information and
entertainment segments, as well as from other business activities, such as lease
financing, not included in the results of reportable segments.
Revenues from cellular, directory and other services increased in 1998,
resulting primarily from solid growth in the number of cellular subscribers and
pagers in service, as well as continued growth in our security and cable TV
businesses. Revenues from Voice Mail and other nonregulated services, as well as
a change in reporting classification of certain pay phone revenues, as
previously discussed, also contributed to the increase. Also in 1998, we revised
a partnership agreement covering the publication of directories in Illinois and
northwest Indiana, resulting in increased directory advertising revenues.
Competition from other cellular providers has intensified in our region,
particularly in the Chicago market. However, the increased price competition and
expanded service offerings have stimulated demand, driving additional subscriber
growth. We continued to introduce our ClearPathSM digital wireless service in
cities throughout our region during 1998, offering customers enhanced call
clarity, longer battery life and better call security.
Revenues from cellular, directory and other services increased by $625
million, or 14.5%, in 1997 due to strong growth in the number of cellular and
paging subscribers. Introduction of ClearPath service in the Chicago and Detroit
markets and successful retention of a high percentage of subscribers contributed
to the revenue increase. Paging services grew at a strong rate due to increased
marketing efforts and continued customer demand for added convenience. Increased
revenues from equipment sales and inside wire installation and maintenance
services also contributed to the increase, as did higher directory revenues,
resulting primarily from volume growth and price increases.
OPERATING EXPENSES Following is a discussion of operating expenses for Ameritech
on a consolidated basis. Total operating expenses increased by 6.2% to $13.0
billion in 1998. Overall business growth and network expansion drove much of the
increase. Higher access charge expenses and a restructuring charge also
contributed to the increase. Total operating expenses increased by 6.9% to $12.2
billion in 1997, due primarily to increased employee-related and other operating
expenses resulting from overall business growth.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Employee-related
expenses $4,169 $3,959 $210 5.3
- -------------------------------------------------------------------------------
</TABLE>
EMPLOYEE-RELATED EXPENSES Employee-related expenses increased in 1998 due
primarily to higher employee levels in the information and entertainment
segment, combined with higher wage rates and overtime expenses in the
communications segment. During 1998, we entered into new collective bargaining
agreements with the International Brotherhood of Electrical Workers (IBEW) and
the Communications Workers of America (CWA). The IBEW contract took effect on
June 28, 1998, for a period of five years. The contract will be re-opened in
2001 to address certain economic wage issues for the final two years of the
agreement. The CWA contract was effective August 9, 1998, and
[GRAPHIC APPEARS HERE]
Our total voice channel equivalents,
which include both switched phone lines and
high-capacity connections, grew 13% in 1998.
26
<PAGE>
expires on March 31, 2001. Both agreements provide for basic wage increases of
11.2% over the contract period (until 2001 for the IBEW) and also address
benefits, pensions, work rules and other wage-related items. The IBEW represents
approximately 12,000 employees in Illinois and northwest Indiana, while the CWA
represents approximately 28,000 employees in all five states of our region.
Employee-related expenses increased by $248 million, or 6.7%, in 1997 due
primarily to growth-related employee increases in the security services,
cellular and cable TV businesses. Higher wage levels at the landline
communications subsidiaries, partially offset by lower work force levels, also
contributed to the overall increase.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Depreciation and
amortization $2,717 $2,521 $196 7.8
- -------------------------------------------------------------------------------
</TABLE>
DEPRECIATION AND AMORTIZATION Continued network expansion for both wireline and
wireless services in the communications segment, combined with increasing
investments in newer technologies that have shorter depreciable lives,
contributed to an increase in depreciation and amortization expense in 1998.
Higher rates resulted from the use of shorter depreciable lives for newer
technologies. Higher asset balances at our security services subsidiary,
combined with higher amortization of intangibles from acquisitions, also
contributed to the increase.
Depreciation and amortization expense increased by $156 million, or 6.6%, in
1997 due to continued network expansion, resulting from greater demand for
network services and an increase in the cellular subscriber base, and to
increased intangible asset amortization.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Other operating
expenses $5,370 $5,140 $230 4.5
- -------------------------------------------------------------------------------
</TABLE>
OTHER OPERATING EXPENSES Other operating expenses increased in 1998 due
primarily to higher access charge expenses resulting from state commission
rulings (which we are contesting) that require local exchange carriers to pay
reciprocal compensation for calls by their customers to the Internet via
Internet service providers (ISPs) who, in turn, are customers of competing local
exchange carriers. Higher cost of sales resulting from growth-related customer
increases at the cellular operation, combined with increased sales of customer
premises equipment, also contributed to the increase. Decreased advertising
expenses, reflecting the timing of promotions and other marketing campaigns,
combined with lower right-to-use fees for switching system software, partially
offset the increase.
Other operating expenses increased by $397 million, or 8.4%, in 1997 due to
customer increases and higher cost of sales resulting from growth in sales of
customer premises equipment. A one-time charge of $69 million resulting from a
litigation settlement also contributed to the increase.
In May 1996, we commenced a 10-year agreement with IBM Global Services (IBM)
to perform certain information technology services previously performed by
Ameritech. As a result of this agreement, contract services expenses have
increased from their 1996 level, while employee-related costs and depreciation
expenses related to computer assets have moderated somewhat.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Restructuring $104 $-- $104 n/m
- -------------------------------------------------------------------------------
</TABLE>
RESTRUCTURING In March 1998, we announced plans to significantly reduce future
operating expenses by the end of 2002. As part of this cost containment program,
we recorded a pretax restructuring charge of $104 million ($64 million
after-tax) to cover the costs of consolidating security monitoring centers and
closing 53 company-owned cellular retail stores. The charge covers
employee-related costs of approximately $54 million for termination of the
employment of approximately 5,000 employees, as well as other costs of
approximately $50 million related to lease terminations and asset write-downs.
Approximately 10% of the charge relates to our information and entertainment
segment, and the balance relates to our communications segment.
Approximately 3,200 employees whose employment relationship is to be severed
work at our security services subsidiary. These employees are being displaced
due primarily to the consolidation of our monitoring centers. Staffing
requirements at new locations will require us to hire a significant number of
new employees.
In 1998, 1,478 employees left Ameritech as part of this restructuring
program.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Taxes other than
income taxes $601 $579 $22 3.8
- -------------------------------------------------------------------------------
</TABLE>
TAXES OTHER THAN INCOME TAXES Taxes other than income taxes consist of property
taxes, gross receipts taxes and other taxes not directly related to earnings.
Taxes other than income taxes increased in 1998 primarily as a result of
higher property taxes, principally in Illinois and Michigan, combined with
higher gross receipts taxes, principally in Ohio and Wisconsin. Lower capital
stock taxes in Illinois, as well as lower property taxes in Ohio, resulting
primarily from tax reforms, partially offset the increase.
Taxes other than income taxes decreased by $14 million, or 2.4%, in 1997
primarily due to property tax decreases in Ohio and Illinois, as well as lower
capital stock taxes in Illinois resulting from tax reforms. Higher gross
receipts taxes resulting from overall business growth partially offset these
decreases.
27
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
OTHER INCOME AND EXPENSE
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest expense $611 $505 $106 21.0
- -------------------------------------------------------------------------------
</TABLE>
INTEREST EXPENSE Interest expense increased in 1998 due primarily to higher
overall debt balances associated with our $3.1 billion investment in Tele
Danmark. We funded this investment in part by issuing $2.5 billion in long-term
debt. Lower interest on short-term debt, resulting primarily from a reduction in
short-term debt balances following the sale of substantially all of our TCNZ
shares, partially offset these increases.
Interest expense decreased by $9 million, or 1.8%, in 1997 due primarily to
increased cash flow from operations, resulting in lower average short-term debt
balances. This decrease was partially offset by the effect of higher short-term
interest rates. Increased interest on long-term debt, resulting from higher
average long-term debt balances, also partially offset the decrease.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Other income, net $2,055 $390 $1,665 426.9
- -------------------------------------------------------------------------------
</TABLE>
OTHER INCOME, NET Other income, net includes earnings related to Ameritech's
investments (when the equity method of accounting is followed), interest income
and other nonoperating items.
Other income increased in 1998 due primarily to the effects of a one-time
pretax gain of $1,543 million ($1,012 million after-tax) resulting from the
public sale of substantially all of our stake in TCNZ, partially offset by a
one-time pretax charge of $54 million ($34 million after-tax) for a
currency-related fair-value adjustment related to our investment in Tele Danmark
A/S, the national communications provider in Denmark. A one-time pretax gain of
$170 million ($102 million after-tax) from the sale of certain telephone and
directory assets to Century Telephone also contributed to the increase. Earnings
from our new investment in Tele Danmark, combined with stronger earnings from
our investments in Belgium and Hungary, contributed to the increase as well.
Partially offsetting these increases were lower equity earnings from TCNZ,
resulting from the sale of substantially all of our stake in this company in
April 1998, as well as a one-time pretax charge of $38 million ($24 million
after-tax) for the costs of redeeming $1.3 billion of long-term debt.
Other income increased by $64 million, or 19.6%, in 1997 primarily as the
result of three one-time gains. We sold our stake in Sky TV, resulting in a
pretax gain of $52 million ($37 million after-tax). We also realized a one-time
pretax gain of $43 million ($27 million after-tax) related to the sale of a
portion of our MATAV shares in an initial public offering, and a one-time pretax
gain of $42 million ($25 million after-tax) related to the sale of our
investment in Bellcore. A one-time after-tax charge of $87 million for our share
of the costs of a work force restructuring at Belgacom partially offset the
increase.
Our investments in international ventures are subject to certain risks
related to fluctuations in foreign currency exchange rates. In 1998 and 1997, we
recognized some foreign exchange transaction gains and losses and currency
translation adjustments related to these investments, due to fluctuations in the
value of the U.S. dollar against the respective local currencies. While future
fluctuations in currency exchange rates could impact future results of
operations, we expect foreign operations to continue to provide strong financial
results and earnings growth.
As previously noted, our international investments represent one of our three
reportable segments. Equity income from these investments after one-time items
described above, was $378 million in 1998, $289 million in 1997 and $233 million
in 1996. This equity income does not require a full provision for additional
U.S. income taxes due to substantial available foreign income tax credits
arising from these same foreign tax jurisdictions. The increase in equity income
in 1998 results primarily from the addition of Tele Danmark to our portfolio,
which more than offset the equity income lost from TCNZ sold in April 1998.
Enhanced profitability at Belgacom and MATAV also contributed to the increase,
as well as the effects of stronger local currencies. The increase in 1997 equity
earnings when compared with 1996 was due to higher equity income from all of our
foreign investments, but moderated due to the strength of the U.S. dollar
against the local currencies.
<TABLE>
<CAPTION>
Increase Percent
1998 1997 (Decrease) Change
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Income taxes $2,031 $1,388 $643 46.3
- -------------------------------------------------------------------------------
</TABLE>
INCOME TAXES Income tax expense increased in 1998 due primarily to the tax
impacts of gains resulting from sales of investments, including our TCNZ shares.
Our effective tax rate was 36.0% in 1998 compared with 37.7% in 1997. The lower
effective rate in 1998 resulted primarily from the tax basis exceeding the book
basis in our TCNZ shares sold.
Income taxes increased by $205 million, or 17.3%, in 1997 due to an increase
in pretax earnings, as well as the effects of a one-time after-tax charge of $87
million related to our share of the costs of a work force restructuring at
Belgacom. A decrease in the amortization of investment tax credits relative to
pretax income and a change in tax law in New Zealand that subjected us to a
withholding tax on dividend distributions also contributed to the increase.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------------------------------------------------------
Ameritech continued to generate strong cash flows from operations during 1998.
These cash flows, combined with capital derived from external sources, enabled
us not only to fund increased capital expenditures, but also to pursue
significant new investment opportunities and to increase dividends paid per
share by 6.2% over the prior year period.
28
<PAGE>
CASH FLOWS FROM OPERATING ACTIVITIES Cash flows from operations increased by
$300 million to $4.8 billion in 1998, due primarily to overall business growth,
combined with working capital improvements. These factors also led to an
increase in cash flows from operations of $767 million to $4.5 billion in 1997.
CASH USED IN INVESTING ACTIVITIES Although capital expenditures increased by
more than $300 million in 1998, reflecting continued investment in the core
communications segment and the infrastructure for new businesses, investments in
other communications ventures represented the single largest use of company
funds in 1998. The largest of these was our $3.1 billion investment in Tele
Danmark. Following our investment and a repurchase of shares by Tele Danmark
from the Kingdom of Denmark, we hold a 41.6% stake in the company. This increase
in cash outflows was partially offset by the proceeds from our sale of
substantially all of our TCNZ shares. This transaction was structured as an
installment sale, with approximately half of the proceeds due at the time of
sale in April 1998 and the other half due by March 31, 1999. The initial
installment resulted in proceeds of approximately $1.1 billion, and the second
installment will result in additional proceeds in 1999 of approximately $1.0
billion. Also in 1998, we received proceeds of approximately $473 million from
the repayment by General Electric Company of the note related to our GEIS
investment and proceeds of approximately $221 million from the sale of assets to
Century Telephone.
Investments in new businesses also increased in 1997, with acquisitions
totaling more than $1 billion for the year. In April and June 1997, we acquired
assets of three companies engaged in security services. Consideration for these
assets consisted of approximately $82 million in cash and the issuance of a
total of 3,009,602 common shares with a dollar value of approximately $100
million. In October 1997, we acquired security assets of Rollins Protective
Services, a division of Rollins, Inc., and security assets of Republic Security
Company Holdings, a subsidiary of Republic Industries, Inc. We used
approximately $800 million in cash to make these purchases.
In November 1997, we acquired from Sprint the assets of its local exchange
business in suburban Chicago, formerly known as Central Telephone Company of
Illinois. We paid $160 million in cash.
Other investing activities in 1997 included proceeds from our sales of
investments, including our stake in Bellcore, our investment in Sky TV and a
portion of our stake in MATAV through an initial public offering. In addition to
these sales, we also received proceeds of approximately $152 million from a
stock repurchase program at TCNZ.
Investing activities in 1996 consisted primarily of our investment with
several partners in Belgacom. A consortium led by Ameritech purchased a 49.9%
stake in Belgacom from the Belgian government for a purchase price of
approximately $2.5 billion. Ameritech invested approximately $865 million for
its 35% consortium share, representing approximately 17.5% of Belgacom.
Investing activities in 1996 also included additional investments in security
services assets.
Capital expenditures increased in all three years due primarily to increased
spending at the landline communications subsidiaries to meet increased demand
for data, custom calling and private line services and to comply with regulatory
requirements. Capital spending also increased due to continued enhancement and
expansion of the cellular network.
We believe that investment in the core communications segment 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. We are deploying capital based on customer demands,
our business plans and regulatory commitments. We place a high priority on
technologies that will enable us to provide customers with new products and
services.
[CHART APPEARS HERE]
1993 1994 1995 1996 1997 1998
---------------------------------------------
$1.49 $1.69 $1.89 $2.12 $2.35 $2.61
Earnings Growth
(in billions, before one-time items)
Ameritech's earnings climbed 11.4% in 1998 to $2.61
billion. This marked our sixth straight year of
double-digit earnings growth.
CASH FLOWS FROM FINANCING ACTIVITIES Financing activities in 1998 included
issuance of $2.5 billion of long-term debt and $325 million of preferred stock
by a wholly owned subsidiary, primarily to finance our investment in Tele
Danmark. In January 1998, we issued $1.75 billion of long-term debt in five
separate tranches through our financing subsidiary, Ameritech Capital Funding
(ACF). In addition, we issued $750 million of Eurodollar notes in February 1998,
due in 2003. Short-term debt decreased by $417 million, primarily reflecting the
application of proceeds from our sale of TCNZ shares. In December 1998, we
redeemed approximately $1.3 billion of long-term debt issued by our landline
communications subsidiaries in Illinois, Michigan, Ohio and Wisconsin to take
advantage of favorable market conditions. We funded these redemptions using
short-term debt. Financing activities also included dividend payments and stock
repurchases, as discussed below.
In 1997, we issued $650 million of long-term debt through our financing
subsidiary, primarily to fund our acquisitions of security assets from Rollins
and Republic, and one of our wholly owned
29
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
subsidiaries issued $250 million of preferred stock in June 1997 in a private
placement.
Financing activities in 1996 consisted primarily of debt issuances by two of
our landline communications subsidiaries in Indiana and Wisconsin aggregating
$275 million.
STOCK REPURCHASE PROGRAM Our board of directors has periodically authorized
management to repurchase shares of Ameritech common stock in the open market or
through private transactions. During 1998, we repurchased in the open market 9.6
million shares of stock for approximately $500 million. During 1997, we
repurchased 19.0 million shares of common stock for an aggregate purchase price
of $602 million, and during 1996, we repurchased in the open market 17.4 million
shares of common stock for an aggregate price of $492 million. As of December
31, 1998, management is authorized to make further repurchases of up to $1.5
billion; however, we have agreed with SBC in conjunction with our merger
agreement to repurchase shares only in connection with share issuance
requirements under certain benefit plans.
DIVIDENDS Ameritech paid dividends of $1,323 million in 1998. This was an
increase of $81 million, or 6.5%, over 1997. In December 1998, Ameritech's board
of directors approved a 5.8% increase in the quarterly dividend payable February
1, 1999. We paid dividends of $1,242 million in 1997, an increase of $71
million, or 6.1%, over 1996. Our dividend policy is consistent with the need to
balance returns to shareowners and investments of capital necessary in a
competitive environment.
FINANCING OPTIONS As of December 31, 1998, we maintained available lines of
credit totaling $1.8 billion, a committed credit facility of $2.0 billion and
shelf registrations for issuance of up to $1.2 billion in unsecured debt
securities.
In October 1998, Moody's Investor Service advised us that it had lowered the
debt ratings of three of our landline communications subsidiaries from Aaa to
Aa1. The change resulted not from any action taken by Ameritech or its
subsidiaries, but from Moody's efforts to bring the ratings of wholly owned
subsidiaries more in line with the parent holding company ratings in the
telecommunications industry. The ratings of our other two landline
communications subsidiaries remained at Aa1. We believe the impact of these
adjustments will not be significant.
Standard & Poor's has advised us that our credit ratings may be downgraded in
the event our merger with SBC is completed. Moody's has, however, reaffirmed our
strong credit ratings irrespective of the merger.
Management believes that we have adequate internal and external resources
available to finance our business development, network expansion, dividends,
acquisitions and investments.
OTHER MATTERS
- ------------------------------------------------------------------------------
REGULATORY CONSIDERATIONS
The Telecommunications Act of 1996 In general, the Telecommunications Act of
1996 (the 1996 Act) includes provisions designed to open local exchange markets
to competition and to afford the Bell operating companies (BOCs) and their
affiliates the competitive opportunity to provide interLATA (long-distance)
services. Under the 1996 Act, the BOCs' ability to provide in-region
long-distance services is dependent upon their satisfaction of, among other
conditions, a 14-point "competitive checklist" of specific requirements for
opening the local market to competition.
In late 1997, a U.S. District Court in Texas ruled that certain
line-of-business restrictions in the 1996 Act, including the requirement in
Section 271 that the BOCs must comply with the competitive checklist before
being permitted to provide long-distance services to local phone customers,
constituted an unconstitutional bill of attainder by virtue of their exclusive
applicability to the BOCs. The U.S. Court of Appeals for the Fifth Circuit
reversed that decision in September 1998, and in January 1999 the U.S. Supreme
Court declined to hear an appeal of the appellate court decision.
In two other cases, similar constitutional challenges were rejected by the
U.S. Court of Appeals for the District of Columbia Circuit (the D.C. Circuit
Court). In May 1998, the D.C. Circuit Court found that Section 274 of the 1996
Act, which covers electronic publishing activities, did not constitute an
unconstitutional bill of attainder. A petition for certiorari, seeking review of
that decision, is pending before the U.S. Supreme Court. In December 1998, the
D.C. Circuit Court ruled against another bill of attainder constitutional
challenge to the long-distance provisions of Section 271 of the 1996 Act.
Local interconnection and unbundled access In January 1999, the U.S. Supreme
Court issued its opinion on various cross-appeals of the 1997 decision of the
U.S. Circuit Court of Appeals for the Eighth Circuit (the Eighth Circuit Court)
relating to the FCC's 1996 order on the local interconnection provisions of the
1996 Act (the Interconnection Order).
The Supreme Court reversed portions of the Eighth Circuit Court's earlier
decision that had vacated several provisions of the Interconnection Order. The
Court decided that the FCC has rulemaking authority to implement the local
competition provisions of the 1996 Act, including pricing methodology. This
overturned the Eighth Circuit Court's ruling that the states were vested with
exclusive jurisdiction over the pricing for local interconnection, unbundled
network elements and local service resale provided by incumbent local exchange
carriers (ILECs) to competitive local exchange carriers (CLECs). The Supreme
Court also reinstated the FCC's "pick and choose" rules allowing CLECs to select
among individual provisions from other existing interconnection agreements.
30
<PAGE>
The Supreme Court upheld the FCC's determination that the definition of a
network element could include items beyond physical facilities and equipment,
such as operational support systems, operator services, directory assistance and
vertical services such as call forwarding and caller identification. It further
ruled that the FCC could bar ILECs from separating already combined network
elements. However, the Supreme Court overturned the FCC's rule identifying and
requiring ILECs to offer specific network elements, finding that the FCC had not
adequately considered, as required by the 1996 Act, whether those specific
unbundled network elements were "necessary" or whether the failure to provide
access to them might "impair" the ability of CLECs to provide competitive
services. We believe that this ruling supports our view that the objectives of
the 1996 Act, including development and deployment of advanced technologies
desired by customers, will best be served by encouraging infrastructure
investments, rather than through unlimited blanket access to all existing ILEC
network elements.
Since the Eighth Circuit Court's 1997 opinion, local interconnection matters
and unbundled network element pricing have been resolved primarily through
negotiated interconnection agreements or state commission arbitration
proceedings. The substantive validity of the FCC's pricing rules, including its
total element long-run incremental cost (TELRIC) pricing methodology, was not
before the Supreme Court, and will be addressed by the Eighth Circuit Court on
remand. Pending judicial resolution of the appropriate pricing methodologies and
a determination by the FCC of which unbundled network elements are "necessary,"
our landline communications subsidiaries expect to continue to negotiate and
enter into interconnection agreements and pursue, through appropriate state or
federal proceedings, timely recovery of their costs.
We also may seek review by the U.S. Supreme Court of the separate Eighth
Circuit Court decision last year regarding shared transport. In 1998, the Eighth
Circuit Court upheld the FCC's determination that "shared transport," which
would include access to all of an ILEC's transport facilities, is a network
[GRAPHIC APPEARS HERE]
Ameritech added 400,000 wireless
customers in 1998 for a growth
rate of 13%.
element that should be made available to competitors on an unbundled basis.
The outcome of future regulatory and judicial developments in this area is
subject to continuing uncertainty. We believe that the pricing rules and
methodologies generally adopted by our in-region state commissions with respect
to our existing interconnection agreements should not differ materially from
those that may be applied under proposed FCC pricing methodologies. We further
expect that future judicial or regulatory decisions will define reasonable
limiting standards, consistent with the purposes of the 1996 Act, as to which of
our existing network elements must be made available to competitors. We can give
no assurance, however, that future regulatory and judicial determinations may
not have a material adverse effect on future revenues and margins in our
communications segment.
Reciprocal compensation A number of CLECs are engaged in regulatory and judicial
proceedings with various ILECs, including our landline communications
subsidiaries, with respect to the payment of reciprocal compensation to the
CLECs for calls originating on the ILECs' networks for dial-up connections to
access the Internet via ISPs served by the CLECs' networks. The CLECs have
asserted that such reciprocal compensation is provided for by interconnection
agreements between the CLECs and the ILECs. Together with other ILECs, we have
maintained that we are not required to make such reciprocal compensation
payments pursuant to those agreements because such traffic is interstate access
service, not local.
A U.S. District Court in Illinois has ruled that our Illinois landline
communications subsidiary is required to make reciprocal compensation payments
in these circumstances under its applicable interconnection agreements. This
order is on appeal to the U.S. Court of Appeals for the Seventh Circuit. Cases
that involve appeals by other subsidiaries of adverse regulatory determinations
are pending in U.S. District Courts in Michigan and Wisconsin. Pending the
outcome of such appeals, our Illinois, Michigan and Wisconsin landline
communications subsidiaries currently are making reciprocal compensation
payments, under protest, to CLECs pursuant to existing interconnection
agreements. The Public Utilities Commission of Ohio also ruled that our Ohio
landline communications subsidiary is required to make reciprocal compensation
payment, but has stayed its order pending rehearing.
On October 30, 1998, the FCC issued a Memorandum Opinion and Order in which
it found that a service offering by another ILEC, permitting ISPs to furnish
their customers with high-speed access to the Internet through a dedicated
connection, is an interstate service that is properly tariffed at the federal
level. In so ruling, the FCC considered the totality of the communication as an
end-to-end transmission between an end user and the Internet Web site accessed
by the end user, and rejected the argument that such a communication should be
separated into two components (consisting of an ILEC-provided intrastate
telecommunications service that terminated at the ISP's local server, and an
interstate
31
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
information service provided by the ISP). The FCC expressly limited its decision
only to the high-speed, dedicated access connection between an end user
subscriber and an ISP as described in the proposed tariff, and made no
determination whether ILECs generally should be required to pay reciprocal
compensation for Internet calls via ISPs. The FCC has indicated its intention to
provide separate guidance in the near future on the jurisdictional nature of
dial-up access via a LEC's local switch.
We believe that this recent FCC Order is consistent with our view that
Internet traffic is appropriately classified as interstate and that reciprocal
compensation is not required for dial-up access in the circumstances described
above. We also believe that our view ultimately should be upheld in pending or
future appellate judicial proceedings or through FCC determination. However,
there can be no assurance as to that outcome or that our landline communications
subsidiaries will not be required to begin or continue to make such reciprocal
compensation payments under existing interconnection agreements. In addition to
reciprocal compensation now being paid by our Illinois, Michigan and Wisconsin
landline communications subsidiaries, we are making periodic accruals of amounts
that may become payable in Ohio and Indiana in the event our view is not
ultimately upheld.
Universal service, access charge reform and price caps In May 1997, the FCC
issued three closely related orders that established rules to implement the
universal service provisions of the 1996 Act (the Universal Service Order) and
to revise both interstate access charge pricing (the Access Reform Order) and
the price cap plan for ILECs (the Price Cap Order).
Universal service The FCC's Universal Service Order provides that all
interstate telecommunications providers will be required to contribute to
universal service funding, based on retail telecommunications revenues. The
Universal Service Order establishes a multi-billion dollar interstate universal
service fund to help link eligible schools and libraries and low-income
consumers and rural health care providers to the global telecommunications
network (including the Internet). The FCC directed the phase-in of these funds
through 1999.
Access charge reform In its Access Reform Order, the FCC restructured
interstate access pricing and adopted changes to its tariff structure that
require ILECs to use rates that reflect the type of costs incurred.
In addition to the changes introduced in connection with the Access Reform
Order, we have implemented state changes that mirror the federal access reform
structure. Various interexchange carriers opposing such changes have filed
complaints before the Illinois, Michigan and Wisconsin state commissions seeking
lower access charges. The state commissions in Illinois (the Illinois Commerce
Commission) and Michigan (the Michigan Public Service Commission or MPSC), in
response to such a complaint, have ordered us to split the intrastate primary
interexchange carrier charge (PICC) into two separate per-line components, with
one-half of the total charge payable by the intraLATA toll carrier and the other
half by the interLATA toll carrier. Accordingly, the revenues we receive from
this charge will decrease to the extent that we are the intraLATA toll carrier.
In addition, the MPSC required that these changes be made retroactive to January
1, 1998, when the initial tariffs for this charge were filed. We have appealed
the MPSC's order.
Price caps Our interstate access services are subject to price cap
regulation, which limits prices rather than profits. The Price Cap Order
effectively reduced access charges by increasing the price cap productivity
offset factor to 6.5% from the previous 5.3% and by applying this factor
uniformly to all access providers. The order also required ILECs subject to
price cap regulation to set their 1997 price cap index assuming that the 6.5%
factor had been in effect since July 1996. Certain parties have sought judicial
review of the Price Cap Order, and a decision by the D.C. Circuit Court with
respect to these matters currently is pending.
We currently cannot predict the precise impact of these regulatory changes on
our business, especially as their nature and timing may evolve in connection
with judicial and FCC consideration of other provisions of the 1996 Act.
Number portability On May 5, 1998, the FCC entered an order to allow
telecommunications carriers, such as our landline communications subsidiaries,
to recover over a five-year period their carrier-specific costs of implementing
long-term number portability. Long-term number portability allows customers to
retain their local telephone numbers in the event they change local exchange
carriers. We are completing implementation of long-term number portability in
compliance with an FCC-mandated schedule. Our number portability surcharge
became effective on February 1, 1999.
Acquisitions of Security Services Assets by SecurityLink
On September 25, 1998, the FCC issued a Memorandum Opinion and Order on Remand
and Order to Show Cause relating to an asset acquisition by our security
services subsidiary (SecurityLink) in 1996. The FCC found that we had gained
"financial control" over the entity from which SecurityLink acquired the
security services assets, in violation of the 1996 Act, and required that,
within 30 days after issuance of the Order, we show cause why the FCC should not
require SecurityLink to divest the assets acquired in this transaction.
Previously, the FCC had ruled that the same transaction was permissible under
the 1996 Act, and the D.C. Circuit Court had vacated and remanded that decision
to the FCC. On October 26, 1998, we filed our response with the FCC, contending
that divestiture would not be an appropriate remedy.
Previously, on July 8, 1998, the FCC issued a Memorandum Opinion and Order
and Order to Show Cause, finding that three separate asset acquisitions by
SecurityLink in 1997 (made after the first FCC ruling on security services
described above and before
32
<PAGE>
the D.C. Circuit Court decision) violated the same provision of the 1996 Act,
and ordering SecurityLink to show cause why the FCC should not require
divestiture of the assets acquired in such transactions. We filed our response
with the FCC on August 7, 1998, contending that divestiture would not be an
appropriate remedy.
The FCC's decision on these Orders to Show Cause is pending.
COMPETITIVE ENVIRONMENT Technological developments, marketplace demand and
legislative, regulatory and judicial actions have expanded the types of services
and products available from an increasing number of companies, creating growth
opportunities in the global communications industry. Our competitive strategy,
including our proposed merger with SBC, is to position ourselves to take
advantage of such growth opportunities by continuing to branch into new services
that are logical extensions of our business and by exporting our expertise to
customers around the world.
These same factors also have resulted in increasing competition in all areas
of our business. In pursuing business opportunities both inside and outside the
United States, we compete against other local service providers, long-distance
service providers, cable TV companies, wireless and Internet service providers
(including companies that provide all or some combination of these services),
and other entrants from a range of industries. As we have expanded our paging
and cellular services, the number and type of competitors have grown. Our
telephone directory publishing business faces competition from not only other
directory publishing businesses and traditional advertising media, such as
television, radio, direct mail, magazines and newspapers, but also providers of
new technologies, such as Internet and other online services. Many of our
competitors have substantial scale and geographic scope, significant capital,
technological and marketing resources, and wide-ranging service offerings.
With the passage of the 1996 Act and other regulatory initiatives, our local
service markets have been more extensively opened to new competitors, many of
which are believed to have initially targeted high-volume business customers in
densely populated areas. Interconnection agreements with competitive service
providers require our landline communications subsidiaries to provide
interconnection or access to unbundled network elements at cost-based rates and
telecommunications services at discounted, wholesale rates. These agreements and
applicable tariffs may result in some downward pressure on local service
revenues, as a portion of our revenue shifts from local service at retail prices
to network access and wholesale services at lower rates and as some competitors
provide services using their own networks, in whole or in part. We cannot
predict with certainty the impact that these and other developments ultimately
may have on our future business, results of operations or financial condition.
YEAR 2000 READINESS The Year 2000 issue exists because many computer systems
and applications, including those embedded in equipment and facilities, use
two-digit rather than four-digit date fields to designate an applicable year. As
a result, the systems and applications may not properly recognize the year 2000
or process data that includes it, potentially causing data miscalculations or
inaccuracies or operational malfunctions or failures.
We have established a centrally managed, companywide initiative to identify,
evaluate and address Year 2000 issues. Begun in May 1996, our Year 2000 effort
covers our network and supporting infrastructure for our provision of local
switched and data telecommunications services, cellular and paging services,
cable
[CHART APPEARS HERE]
1993 1994 1995 1996 1997 1998
--------------------------------------------
$172 $190 $215 $227 $235 $238
Productivity Gains
(revenues per employee in thousands)
Revenues per employee increased to $238,000 in
1998, representing a 38% improvement over the past
five years.
TV service and security services. Also within the scope of this initiative are
our operational and financial information technology (IT) systems and
applications, end-user computing resources and building systems, such as
security, elevator, and heating and cooling systems. In addition, the project
includes a review of the Year 2000 compliance efforts of our key suppliers and
other principal business partners and, as appropriate, the development of joint
business support and continuity plans for Year 2000 issues. While this
initiative is broad in scope, it is structured to identify and prioritize our
efforts for mission-critical systems, network elements and products and key
business partners.
Work is progressing in the following phases: inventory, assessment,
remediation, testing, deployment and monitoring. Although the pace of the work
varies among our business units and the phases often are conducted in parallel,
as of December 31, 1998, the inventory and assessment phases have been
substantially completed, the remediation phase is nearing completion, and the
testing and deployment phases are well under way.
As of December 31, 1998, the majority of our network elements requiring
corrective activity, including substantially all of our core network switches
and other network components that we regard as mission-critical, have been made
Year 2000 ready and deployed back into production. As of December 31, 1998, more
than 90% of our total identified IT applications, including substantially all
that we have determined to be mission-critical, have been remediated, and a
majority of all corrected applications have completed certification testing and
been deployed back into production. We have
33
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
also made substantial progress in Year 2000 readiness preparations for our
remaining infrastructure components (buildings and physical facilities, internal
voice telephone systems, and desktop PCs), and these efforts are scheduled to be
completed in mid-1999. Final integration testing for certain critical systems
and processes is scheduled to be completed by the end of the third quarter of
1999.
With the majority of our various systems remediated and a substantial portion
of those already tested and deployed back into production, we believe we are
well positioned to complete the remediation and deployment of our remaining
systems, any additional testing that may be necessary, and the development of
our business contingency and continuity plans in advance of the Year 2000
transition. However, our ability to meet that goal remains dependent upon a
variety of factors, including the timely provision of necessary upgrades and
modifications by our suppliers and contractors. In some instances, upgrades or
modifications are not expected to be available until mid- or late-1999.
We have sought Year 2000 readiness information from various third-party
suppliers on whom we depend for certain products or essential services (such as
electric utilities, interexchange carriers, etc.), but we have no method of
ensuring that these suppliers will convert their critical systems and processes
in a timely manner. We are developing business contingency and continuity plans
(see discussion below), and are continuing to work with our key suppliers as
part of a supplier compliance program to seek to minimize such risks.
As is the case for other communications services providers, there exists a
worst case scenario possibility that a failure to correct a Year 2000 program in
one or more of our mission-critical network elements or IT applications could
cause a significant disruption of or interruption in certain of our normal
business functions. Based on our assessments and work to date, we believe that
any such material disruption to our operations due to failure of an internal
system is unlikely. However, due to the uncertainty inherent in Year 2000 issues
generally and those that are beyond our control in particular (e.g., the final
Year 2000 readiness of our suppliers, customers, utilities, interconnecting
carriers, and joint venture and investment interests), there can be no assurance
that one or more such failures would not have a material impact on our results
of operations, liquidity or financial condition.
There also may be Year 2000 issues in customer premises equipment (CPE),
including CPE that we have sold or maintained and CPE that is used in connection
with 911 services. Although the customer generally is responsible for CPE,
customers could attribute a Year 2000 disruption in their CPE to a malfunction
of our network service. We have taken steps to encourage many of our customers
potentially at risk to undertake the necessary assessment and remedial
activities to avoid a Year 2000 problem with their equipment and systems.
We currently estimate that we will incur expenses of approximately $250
million through 2001 in connection with our anticipated Year 2000 efforts, of
which approximately $108 million had been incurred through December 31, 1998.
The timing of our expenses may vary and is not necessarily indicative of
readiness efforts or progress to date. We anticipate that a portion of our Year
2000 expenses will not be incremental costs, but rather will represent the
redeployment of existing IT resources. We also expect to incur certain capital
improvement costs (totaling approximately $30 million) to support this project.
Such capital costs ($12 million as of December 31, 1998) are being incurred
sooner than originally planned but, for the most part, would have been required
in the normal course of business.
[CHART APPEARS HERE]
1993 1994 1995 1996 1997 1998
--------------------------------------------
512 632 745 1,140 1,495 1,542
Paging Growth
(pagers in service in thousands)
Ameritech's total number of pagers in service doubled
over the past three years and tripled over the
past five years.
We have significant minority investments in large telecommunications
providers in Belgium, Denmark and Hungary. Each of those companies has plans in
place and activities under way to address Year 2000 issues, and we are offering
advice in these efforts as practical. Based on information reported to us, the
estimated proportionate share of these companies' Year 2000 conversion costs
that will flow through to our earnings is not expected to be material. As is the
case for many companies outside the United States, we believe that the Year 2000
readiness efforts of these carriers has not progressed as far as our own, and we
expect that the Year 2000 readiness conversion and testing activities at some of
these companies will continue into late 1999.
As part of our Year 2000 initiative, we are evaluating scenarios that may
occur as a result of the century change and are in the process of developing
contingency and business continuity plans tailored for Year 2000-related
occurrences. Contingency planning to maintain and restore service in the event
of natural disasters, power failures and software-related problems has been part
of our standard operation for many years, and we are working to leverage this
experience in the development of contingency and continuity plans tailored to
meet Year 2000-related challenges. This work is being performed through
centrally managed, companywide teams organized by critical business functions
(including ordering, provisioning, maintenance, billing and power). Our
contingency and business continuity plans are expected to assess the potential
for business disruption in various scenarios, and to provide for key operational
back-up, recovery and restoration alternatives.
34
<PAGE>
The above information is based on our current best estimates, which were
derived using numerous assumptions of future events, including the availability
and future costs of certain technological and other resources, third-party
modification actions and other factors. Given the complexity of these issues and
possible unidentified risks, actual results may vary materially from those
anticipated and discussed above. Specific factors that might cause such
differences include, among others, the availability and cost of personnel
trained in this area, the ability to locate and correct all affected computer
code, the timing and success of Year 2000 remedial efforts of our customers and
suppliers, and similar uncertainties.
EURO CONVERSION On January 1, 1999, 11 of the 15 member countries of the
European Union formed the Economic and Monetary Union (EMU) and established
fixed conversion rates between their sovereign currencies and the future
European currency unit, the euro. The participating countries agreed to adopt
the euro as their common legal currency on that date. The sovereign "legacy"
currencies of these countries will continue in circulation within the respective
countries until at least January 1, 2002, but not later than July 1, 2002. At
the time of final conversion, new euro-denominated bills and coins will be used
exclusively.
Our international business segment consists of several significant minority
investments in Europe, including Belgacom in Belgium, Tele Danmark in Denmark
and MATAV in Hungary. Of these, only Belgium is among the countries that will
convert to the euro; Tele Danmark, however, has operating affiliates in several
participating countries. Management at these companies must address several
issues related to the conversion, including increased price transparency, the
tax treatment of conversion gain or loss, changes to business processes and
modification of information systems to process euro-denominated transactions
during the transition period.
Management at our European affiliates has informed us that efforts to convert
computer systems and business processes are well under way and are scheduled to
be complete by the time the conversion takes place. Based on information
reported to us, the estimated proportionate share of euro-related costs that
will flow through to our earnings is not expected to be material.
EFFECTS OF FOREIGN CURRENCY FLUCTUATIONS Our foreign operations and investments
in international ventures are subject to certain risks related to fluctuation in
foreign currency exchange rates. For the three years ended December 31, 1998,
due to fluctuations in the U.S. dollar, we recognized some foreign exchange
transaction gains and losses and currency translation adjustments related to
these investments. Foreign exchange transaction gains and losses incurred by
wholly owned subsidiaries affected operating income. Transaction gains and
losses incurred by other international ventures (primarily equity-method
investments) affected other income, net. Translation adjustments resulted in a
change in the investment balance and a corresponding change in accumulated other
comprehensive income on the consolidated balance sheet. While future
fluctuations in currency exchange rates could impact results of operations or
financial position, we expect foreign investments to continue to provide strong
financial results and earnings growth.
DISCLOSURES ABOUT MARKET RISK We are exposed to market risks primarily from
changes in interest rates and foreign currency exchange rates. To manage our
exposure to these fluctuations, we occasionally enter into various hedging
transactions that have been authorized according to documented policies and
procedures. We do not use derivatives for trading purposes, to generate income
or to engage in speculative activity, and we never use leveraged derivatives.
The amounts shown below represent an estimated potential loss that we could
incur from adverse changes in either interest rates or foreign exchange rates,
based upon the value-at-risk estimation model. The value-at-risk model uses
historical foreign exchange rates and interest rates to estimate the volatility
and correlation of these rates in future periods. It estimates a loss in fair
market value using the variance/co-variance statistical modeling technique. The
model addresses numerous market risk exposures, but specifically excludes
equity-method investments, which in our case are significant. The fair value
losses shown in the table below are for a one-day time period with a confidence
level of 95% (signifying our degree of confidence that actual one-day losses
would not exceed such estimated losses, in each case, based on the model). Such
estimated losses have no impact on our results of operations or financial
condition.
<TABLE>
<CAPTION>
December 31
---------------
1998 1997
- ----------------------------------------------------------
<S> <C> <C>
Risk category
Interest rates $39 $25
Foreign exchange -- --
- ----------------------------------------------------------
</TABLE>
The value-at-risk model assumes that all movements in these rates will be
adverse and disregards the possibility that interest rates and foreign currency
exchange rates could move in our favor. Actual experience has shown that gains
and losses tend to offset each other over time, and we believe it is 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 global
financial markets.
The fair value at risk increased in 1998 due primarily to a net increase in
fixed-rate debt, and to an increase in the volatility of interest rates, mostly
resulting from market activity in the third and fourth quarters of 1998. We
issued $2.5 billion of fixed-rate debt in the first quarter of 1998, principally
to fund our investment in Tele Danmark, and in December 1998 we redeemed $1.3
billion of fixed-rate debt issued by four of our landline communications
subsidiaries. Value at risk related to foreign exchange has not changed
significantly since December 31, 1997, but as previously
35
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
(dollars in millions, except per share amounts)
noted, the value-at-risk model does not consider our significant foreign
equity-method investments.
NEW ACCOUNTING PRONOUNCEMENTS
AICPA SOP 98-1 In March 1998, the American Institute of Certified Public
Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use." This SOP
provides authoritative guidance for the capitalization of certain costs related
to computer software developed or obtained for our internal applications, such
as:
o external direct costs of materials and services, such as programming costs;
o payroll costs for employees devoting time to the software project; and,
o 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. We will adopt SOP 98-1 in the
first quarter of 1999 and estimate that the impact of adoption will be to
decrease software-related expenses for Ameritech and all of its subsidiaries by
$200 million to $250 million in the year of adoption. We have historically
expensed most computer software costs as incurred and will be required to
continue to expense all Year 2000 modification costs as incurred.
FAS 133 In June 1998, the Financial Accounting Standards Board (FASB) issued FAS
133, "Accounting for Derivative Instruments and Hedging Activities." This
statement provides standardized accounting and disclosure guidance for
derivative instruments and the derivative portion of certain similar contracts.
It amends FAS 52, "Foreign Currency Translation," and FAS 107, "Disclosures
about Fair Values of Financial Instruments," and it supersedes a number of other
financial accounting standards.
The statement requires entities that use derivative instruments to measure
these instruments at fair value and record them as assets or liabilities on the
balance sheet. It also requires entities to reflect the gains or losses
associated with changes in the fair value of these derivatives, either in
earnings or as a separate component of comprehensive income, depending on the
nature of the underlying contract or transaction.
FAS 133 is effective for all fiscal quarters of fiscal years beginning after
June 15, 1999, and is to be adopted as of the beginning of the fiscal year. At
the time of adoption, all derivative instruments are to be measured at fair
value and recorded on the balance sheet. Any differences between fair value and
carrying amount at that time will be recorded as a cumulative effect of a change
in accounting principle, in either net income or other comprehensive income, as
appropriate. Adoption of this statement may or may not have a material impact on
our results of operations or financial position, depending on the nature and
magnitude of derivative activity in which we engage and the changes in market
conditions with respect to foreign currencies, interest rates or other
underlying values. We have not yet quantified the impacts of the initial
adoption of FAS 133 on our results of operations or financial condition, nor
have we determined when we will implement the new standard.
PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT Some of the
information presented in, or in connection with, this report may constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995 that involve potential risks and uncertainties.
Our future results could differ materially from those discussed here. Some of
the factors that could cause or contribute to such differences include:
o changes in economic and market conditions that impact the demand for our
products and services, or for products and services by companies in which we
have substantial investments;
o the effects of vigorous competition in the local exchange, intraLATA toll,
cellular, data, cable TV, directory advertising or security services markets;
o federal regulatory developments that impact the telecommunications, security
services and cable TV industries, and pending regulatory issues in state
jurisdictions, as well as the outcome of any related judicial reviews;
o the timing of and costs associated with entry into the interLATA
long-distance market;
o the timing of, and potential regulatory or other considerations relating to,
the consummation of our proposed merger with SBC;
o the potential impact of issues related to Year 2000 software compliance;
o risks inherent in international operations, including possible economic,
political or monetary instability, as well as the potential impact of Year
2000 compliance and euro currency conversion issues; and,
o the impact of new technologies and the potential effect of delays in
development or deployment of such technologies.
The words "expect," "believe," "anticipate," "estimate," "project," and
"intend" and similar expressions are intended to identify forward-looking
statements. These forward-looking statements are found at various places
throughout the Management's Discussion and Analysis and elsewhere in this
report.
You should not place undue reliance on these forward-looking statements,
which are applicable only as of the date hereof. We have no obligation to revise
or update these forward-looking statements to reflect events or circumstances
that arise after the date hereof or to reflect the occurrence of unanticipated
events.
36
<PAGE>
REPORT OF MANAGEMENT
Shareowners, Ameritech Corporation
The consolidated financial statements were prepared in accordance with
generally accepted accounting principles, which required the use of estimates
and judgment. Management prepared these statements and other information in the
annual report and is responsible for their integrity and objectivity.
Our consolidated financial statements have been audited by Arthur Andersen
LLP. Management has made available to Arthur Andersen LLP all of our financial
records and related data, as well as the minutes of meetings of shareowners and
directors. We believe that all representations made to Arthur Andersen LLP were
valid and appropriate.
Management maintains a system of internal control over the preparation of our
published financial statements that provides reasonable assurance as to the
integrity and reliability of the consolidated financial statements, the
protection of assets from unauthorized use or disposition, and the prevention
and detection of fraudulent financial reporting. The internal control system
provides appropriate division of responsibility, and written policies and
procedures are communicated to employees and updated as necessary. Management is
responsible for proactively fostering a strong ethical climate so that the
company's affairs are conducted according to the highest standards of personal
and corporate conduct.
The company maintains a strong internal auditing program to assess the
effectiveness of internal controls and recommend possible improvements. As part
of their audit of the consolidated financial statements, Arthur Andersen LLP
considered the internal control system to determine the nature, timing and
extent of necessary audit tests. Management has considered the recommendations
of our internal auditors and Arthur Andersen LLP concerning the company's system
of internal control, and has responded appropriately.
Management assessed the company's internal control system in relation to
criteria for effective internal control. These criteria consist of five
interrelated components, which are: control environment, risk assessment,
control activities, information and communication, and monitoring. Based on its
assessment, management believes that, as of December 31, 1998, our system of
internal control has met these criteria.
The board of directors, through its audit committee which consists solely of
outside directors, serves in an oversight capacity to assure the integrity and
objectivity of the financial reporting process. The role of the committee
includes monitoring accounting and financial controls and assuring the
independence of Arthur Andersen LLP. Both the internal auditors and the
independent public accountants have complete access to the committee and
periodically meet with the committee, with and without management present.
Sincerely,
/s/ Richard C. Notebaert /s/ Oren G. Shaffer
Richard C. Notebaert Oren G. Shaffer
Chairman and Chief Executive Officer Executive Vice President and
January 21, 1999 Chief Financial Officer
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
Board of Directors, Ameritech Corporation
We have audited the accompanying consolidated balance sheets of Ameritech
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998
and 1997, and the related consolidated statements of income, shareowners' equity
and cash flows for each of the three years in the period ended December 31,
1998. These financial statements are the responsibility of the company's
management. Our responsibility is to express an opinion on these financial
statements 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 Ameritech
Corporation and subsidiaries as of December 31, 1998 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.
/s/ Arthur Andersen LLP
Arthur Andersen LLP
Chicago, Illinois
January 21, 1999
37
<PAGE>
CONSOLIDATED STATEMENTS OF INCOME
Ameritech Corporation and Subsidiaries
<TABLE>
<CAPTION>
For the year ended December 31
------------------------------------
(dollars in millions, except per share amounts) 1998 1997 1996
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues
Local service $7,020 $6,572 $6,175
Interstate network access 2,481 2,485 2,365
Intrastate network access 551 619 573
Long-distance service 1,408 1,384 1,491
Cellular, directory and other 5,694 4,938 4,313
-----------------------------------
17,154 15,998 14,917
-----------------------------------
Operating expenses
Employee-related expenses 4,169 3,959 3,711
Depreciation and amortization 2,717 2,521 2,365
Other operating expenses 5,370 5,140 4,743
Restructuring 104 -- --
Taxes other than income taxes 601 579 593
-----------------------------------
12,961 12,199 11,412
-----------------------------------
Operating income 4,193 3,799 3,505
Interest expense 611 505 514
Other income, net 2,055 390 326
-----------------------------------
Income before income taxes 5,637 3,684 3,317
Income taxes 2,031 1,388 1,183
-----------------------------------
Net income $3,606 $2,296 $2,134
-----------------------------------
Earnings per common share
Basic $3.27 $2.09 $1.93
-----------------------------------
Diluted $3.25 $2.08 $1.92
-----------------------------------
Average common shares outstanding (millions) 1,101.6 1,098.7 1,103.8
- ---------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
38
<PAGE>
CONSOLIDATED BALANCE SHEETS
Ameritech Corporation and Subsidiaries
<TABLE>
<CAPTION>
As of December 31
-------------------------
(dollars in millions) 1998 1997
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets
Cash and temporary cash investments $139 $239
Receivables, less allowance for uncollectibles of $338 and $308, respectively 3,052 3,078
Installment receivable from TCNZ share sale 940 --
Material and supplies 345 290
Prepaid and other 654 942
----------------------
5,130 4,549
----------------------
Property, plant and equipment
In service 35,859 34,020
Under construction 485 371
----------------------
36,344 34,391
Less, accumulated depreciation 22,039 20,518
----------------------
14,305 13,873
----------------------
Investments, primarily international 4,938 1,751
----------------------
Other assets and deferred charges 5,926 5,166
----------------------
Total assets $30,299 $25,339
----------------------
Liabilities and shareowners' equity
Current liabilities
Debt maturing within one year $2,619 $3,036
Accounts payable 1,905 1,955
Other 3,476 2,250
----------------------
8,000 7,241
----------------------
Long-term debt 5,557 4,610
----------------------
Deferred credits and other long-term liabilities
Accumulated deferred income taxes 1,502 1,150
Unamortized investment tax credits 115 140
Postretirement benefits other than pensions 2,918 2,965
Other 1,310 925
----------------------
5,845 5,180
----------------------
Shareowners' equity
Common stock, par value $1; 2.4 billion shares authorized;
1,177 million issued in 1998 and 1997 1,177 1,177
Proceeds in excess of par value 5,493 5,313
Reinvested earnings 6,455 4,190
Treasury stock, at cost (78 million shares in 1998 and 79 million shares in 1997) (1,923) (1,645)
Deferred compensation (114) (190)
Accumulated other comprehensive income (191) (537)
----------------------
10,897 8,308
----------------------
Total liabilities and shareowners' equity $30,299 $25,339
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
39
<PAGE>
CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
Ameritech Corporation and Subsidiaries
<TABLE>
<CAPTION>
Shareowners' Equity
------------------------------------------------------------------------------
Accumulated Common Treasury
Proceeds in Other Shares Common
(dollars in millions, Common Excess of Reinvested Treasury Deferred Comprehensive Issued Shares
except per share amounts) Total Stock Par Value Earnings Stock Compensation Income (millions) (millions)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balances, December 31, 1995 $7,015 $1,175 $5,026 $2,209 $(986) $(329) $(80) 1,175 67
Comprehensive income
Net income 2,134 2,134
Unrealized gain (loss)
on securities, net of
reclassifications (1) (1)
Foreign currency
translation adjustments (103) (103)
-------
Comprehensive income 2,030
Dividends ($1.078 per share) (1,189) (1,189)
Stock issued to employees 29 1 28 1
Treasury stock activity
Purchases (492) (492) 17
Issuances 200 66 134 (8)
Reduction of LESOP debt 70 70
Other 24 24
---------------------------------------------------------------------------------------------------
Balances, December 31, 1996 7,687 1,176 5,144 3,154 (1,344) (259) (184) 1,176 76
Comprehensive income
Net income 2,296 2,296
Unrealized gain (loss)
on securities, net of
reclassifications (3) (3)
Foreign currency
translation adjustments (350) (350)
-------
Comprehensive income 1,943
Dividends ($1.148 per share) (1,260) (1,260)
Stock issued to employees 12 1 11 1
Treasury stock activity
Purchases (602) (602) 19
Issuances 318 72 246 (13)
Acquisitions of businesses 98 43 55 (3)
Reduction of LESOP debt 69 69
Other 43 43
---------------------------------------------------------------------------------------------------
Balances, December 31, 1997 8,308 1,177 5,313 4,190 (1,645) (190) (537) 1,177 79
Comprehensive income
Net income 3,606 3,606
Unrealized gain (loss)
on securities, net of
reclassifications 9 9
Foreign currency
translation adjustments 337 337
-------
Comprehensive income 3,952
Dividends ($1.218 per share) (1,341) (1,341)
Treasury stock activity
Purchases (500) (500) 10
Issuances 345 123 222 (11)
Reduction of LESOP debt 76 76
Other 57 57
---------------------------------------------------------------------------------------------------
Balances, December 31, 1998 $10,897 $1,177 $5,493 $6,455 $(1,923) $(114) $(191) 1,177 78
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
40
<PAGE>
CONSOLIDATED STATEMENTS OF CASH FLOWS
Ameritech Corporation and Subsidiaries
<TABLE>
<CAPTION>
For the year ended December 31
---------------------------------------
(dollars in millions) 1998 1997 1996
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income $3,606 $2,296 $2,134
Adjustments to net income
Restructuring, net of tax 64 -- --
Depreciation and amortization 2,717 2,521 2,365
Deferred income taxes, net 305 235 122
Investment tax credits, net (25) (32) (36)
Capitalized interest (27) (25) (28)
Change in accounts receivable, net 26 (8) (296)
Change in material and supplies (95) (97) (61)
Change in other current assets (213) (116) (11)
Change in accounts payable (50) 119 44
Change in certain other current liabilities 1,322 391 86
Change in certain noncurrent assets and liabilities (959) (622) (482)
Gain on sale of TCNZ shares (1,543) -- --
Gain on sale of assets to Century Telephone Enterprises, Inc. (170) -- --
Gain on sale of shares in MATAV -- (43) --
Gain on sale of Bellcore -- (42) --
Gain on sale of Sky Network Television of New Zealand -- (52) --
Other operating activities, net (148) (15) (94)
----------------------------------
Net cash from operating activities 4,810 4,510 3,743
----------------------------------
Cash flows from investing activities
Capital expenditures, net (2,954) (2,641) (2,440)
Additional investments, including acquisition of new companies (3,261) (1,074) (922)
Proceeds from sale of TCNZ shares 1,078 -- --
Proceeds from sale of assets to Century Telephone Enterprises, Inc. 221 -- --
Proceeds from repayment of GEIS note 473 -- --
Proceeds from TCNZ share repurchase -- 152 --
Proceeds from sale of shares in MATAV -- 146 --
Proceeds from sale of Bellcore -- 64 --
Proceeds from sale of Sky Network Television of New Zealand -- 52 --
Other investing activities, net 3 (14) 51
----------------------------------
Net cash from investing activities (4,440) (3,315) (3,311)
----------------------------------
Cash flows from financing activities
Net change in short-term debt (221) (195) 815
Issuance of long-term debt 2,500 650 273
Retirement of long-term debt (1,672) (320) (92)
Dividend payments (1,323) (1,242) (1,171)
Repurchase of common stock (500) (602) (492)
Proceeds from reissuance of treasury stock 401 330 196
Issuance of preferred stock in subsidiaries 322 250 --
Other financing activities, net 23 28 53
----------------------------------
Net cash from financing activities (470) (1,101) (418)
----------------------------------
Net increase (decrease) in cash and temporary cash investments (100) 94 14
Cash and temporary cash investments, beginning of year 239 145 131
----------------------------------
Cash and temporary cash investments, end of year $139 $239 $145
- -------------------------------------------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of the financial statements.
41
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions, except per share amounts)
1. SIGNIFICANT ACCOUNTING POLICIES
- ------------------------------------------------------------------------------
NATURE OF OPERATIONS Ameritech Corporation is one of the world's largest
communications companies, providing a wide array of local phone, data, directory
and other services to more than 12 million customers (primarily in Illinois,
Indiana, Michigan, Ohio and Wisconsin).
We serve more than 3.5 million cellular customers, more than 1.5 million
paging customers and approximately 1.2 million security services customers. The
security services business is conducted throughout the United States and Canada.
We have cellular interests in Norway as well as interests in communications
companies in Belgium, Denmark and Hungary. We also publish business directories
in Germany and other European countries.
See our discussion of regulatory matters and competitive environment in Other
Matters in Management's Discussion and Analysis of Results of Operations and
Financial Condition (MD&A) on pages 30 to 36. See also the discussion of our
pending merger in Note 16 on page 53.
CONSOLIDATION The consolidated financial statements include all of our
majority-owned subsidiaries. We have eliminated all significant intercompany
transactions.
BASIS OF ACCOUNTING We have prepared the consolidated financial statements in
accordance with U.S. generally accepted accounting principles (GAAP). We have
made certain reclassifications to the 1997 and 1996 balances to correspond to
the 1998 presentation.
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.
MATERIAL AND SUPPLIES We have stated 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 We file a consolidated federal income tax return. At the end of
each period, we determine deferred tax assets and liabilities 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 also recognize
deferred income taxes on undistributed equity earnings from foreign investments
when we do not control the dividend flow back to the United States.
PROPERTY, PLANT AND EQUIPMENT We have stated property, plant and equipment
primarily at original cost. The provision for depreciation is based principally
on straight-line remaining life and straight-line equal life group methods of
depreciation applied to individual categories of plant with like
characteristics.
We use average plant lives, generally ranging from three to 30 years
depending upon the type of asset. In general, the lives used for certain
communications assets and office equipment have shortened due to the use of
newer technologies.
Generally, when depreciable assets are retired, the amount at which such
assets are carried in property, plant and equipment is charged to accumulated
depreciation. The cost of maintenance and repair of assets is charged to
expense.
Most of our property, plant and equipment is located in Illinois, Indiana,
Michigan, Ohio and Wisconsin.
TEMPORARY CASH INVESTMENTS We have stated temporary cash investments 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.
DERIVATIVE FINANCIAL INSTRUMENTS We occasionally enter into forward contracts
and swap agreements to hedge exposures to foreign currency exchange and interest
rate risks. We include gains and losses on foreign currency forward contracts
used for hedging purposes in net income in the period in which the gain or loss
arises. We record gains and losses that hedge an investment in a foreign company
as a component of accumulated other comprehensive income until such time as we
reduce our interest in the company. Gains and losses on interest rate swaps or
interest rate "locks" are recorded as adjustments to interest expense.
We use derivatives in a limited way for the following purposes:
o to manage financial risk;
o to hedge assets and obligations that we already hold; and,
o to protect our cash flows.
We do not use derivatives to generate income or engage in speculative
activity, and we never use leveraged derivatives.
ADVERTISING COSTS We charge advertising costs to expense as incurred.
SOFTWARE COSTS We have historically expensed most software and related license
fees as incurred. Beginning in 1999, we are required, because of a change in
GAAP, to capitalize a significant portion of software developed or obtained for
our internal use. See our discussion of new accounting pronouncements in Other
Matters in MD&A on page 36.
COMPREHENSIVE INCOME In 1998, we adopted Statement of Financial Accounting
Standards (FAS) 130, "Reporting Comprehensive Income," issued by the Financial
Accounting Standards Board (FASB). We report accumulated other comprehensive
income as a separate component of shareowners' equity. The deferred tax effects
of the unrealized gain or loss on available-for-sale securities were a $5
million benefit in 1998 and expense
42
<PAGE>
of $2 million in 1997 and $1 million in 1996. We do not recognize deferred
income taxes on foreign currency translation adjustments.
EARNINGS PER SHARE We compute basic earnings per common share by dividing net
income by the weighted average number of common shares outstanding during the
period.
Diluted earnings per share are calculated by including all dilutive potential
common shares such as stock options. Dilutive potential common shares were
9,319,370 in 1998, 5,375,302 in 1997 and 4,448,568 in 1996. No adjustment to
reported net income is required when computing diluted earnings per share.
STOCK OPTIONS We account for our stock option plans in accordance with
Accounting Principles Board (APB) Opinion 25, under which no compensation
expense is recognized in the financial statements unless the plan is determined
to be variable in nature.
REVENUE RECOGNITION We generally recognize revenues as we provide services or
deliver products to customers. We bill certain local telephone and wireless and
security service revenues in advance, resulting in deferred revenues. We account
for our directory advertising revenues generally as billed over the term of the
related directory (usually one year) and amortize production costs, which are
deferred when incurred, to match the related revenues.
INTANGIBLES We amortize intangibles, including goodwill arising from business
combinations, on a straight-line basis over the anticipated period of benefit,
not to exceed 40 years. We periodically review amounts recorded as intangible
assets for impairment using expected undiscounted future cash flows.
TRANSLATION ADJUSTMENTS We translate the assets and liabilities relating to our
share of significant foreign operations to U.S. dollars at year-end exchange
rates. We translate revenues and expenses to U.S. dollars using average exchange
rates for the year. Translation adjustments are accumulated and recorded as a
separate component of accumulated other comprehensive income.
2. INVESTMENTS
- ------------------------------------------------------------------------------
We account for our investments in Tele Danmark, Belgacom and MATAV using the
equity method of accounting.
TELE DANMARK In January 1998, we purchased a 34% interest in Tele Danmark A/S,
the national communications provider in Denmark, from the Kingdom of Denmark for
approximately $3.1 billion. As part of our investment agreement, Tele Danmark
repurchased and retired all remaining shares owned by the Danish government,
effectively increasing our equity ownership to 41.6% of Tele Danmark.
Based on the year-end closing price of individual Tele Danmark shares, the
aggregate market value of our investment was $6.1 billion as of December 31,
1998. We are amortizing goodwill of approximately $1,453 million from this
investment over a period of 40 years.
BELGACOM In March 1996, a consortium led by Ameritech finalized its agreement to
acquire an interest in Belgacom S.A., the national communications provider in
Belgium. The consortium purchased from the Belgian government a 49.9% stake in
Belgacom. The consortium's purchase price was approximately 74 billion Belgian
francs, or $2.5 billion. We have invested approximately $865 million for our 35%
allocable consortium share, which results in about a 17.5% investment in
Belgacom.
After giving effect to Belgacom's unfunded pension obligation and other
adjustments to conform to U.S. GAAP, our share of goodwill from this investment
is approximately $845 million, which we are amortizing on a straight-line basis
over a period of 40 years.
[GRAPH APPEARS HERE]
1993 1994 1995 1996 1997 1998
----------------------------------------------
860 1,299 1,891 2,512 3,177 3,577
Wireless Growth
(wireless customers in thousands)
Ameritech has a strong growth record in wireless. In
1998, we added 400,000 cellular customers, an
increase of 13%.
MATAV We invested a total of $843 million in MATAV, the national communications
provider in Hungary. On November 14, 1997, MATAV completed an initial public
offering (IPO) of its shares. We sold 11.5% of our shares in the IPO and
realized cash proceeds of $146 million. We recorded a pretax gain of $43 million
on the share sale and currently hold 309,029,700 shares, or approximately 30% of
MATAV. Based on the year-end closing price of individual MATAV shares, the
aggregate value of our remaining shares is approximately $1.8 billion. We are
amortizing goodwill of approximately $385 million, adjusted for the share sale,
over a period of 40 years.
TELECOM CORPORATION OF NEW ZEALAND LIMITED In April 1998, we sold substantially
all of our remaining 24.95% interest in Telecom Corporation of New Zealand
Limited (New Zealand Telecom or TCNZ) in a global stock offering. The first of
two installment payments was received in April 1998 with the second
43
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions, except per share amounts)
payment due by March 31, 1999. At the time of the first installment payment, we
irrevocably transferred our shares to a trustee, which is holding the shares in
trust for the purchasers until the final installment is paid. We retained a
security interest in the shares, and each purchaser remains personally liable
until the final installment payment is received. The purchasers will receive all
ordinary dividends in the interim period. The trustee will have one vote for
each share and will vote the shares based on instructions from the purchasers.
[GRAPH APPEARS HERE]
1993 1994 1995 1996 1997 1998
----------------------------------------------
$3,189 $3,430 $3,556 $3,743 $4,510 $4,810
Cash Flow Growth
(cash flow from operations in millions)
Cash flow from operations increased to $4.8
billion in 1998, up 51% over the past
five years.
In accordance with FAS 125, "Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities," we accounted for this
transaction as a sale and recorded an after-tax gain of approximately $1.0
billion. Because the receivable from the second installment payment does not
have a stated interest rate, we are imputing interest at 9%. Net proceeds from
the initial installment were approximately $1.1 billion, and we expect to
receive total net proceeds of approximately $2.1 billion from this transaction.
We have hedged substantially all foreign exchange risk associated with the final
installment. Until April 1998, we used the equity method of accounting for this
investment.
SUMMARY OF NONCONSOLIDATED INVESTMENTS A summary of our investments, which have
not been consolidated, follows:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Tele Danmark $3,401 $ --
Belgacom 892 742
MATAV 534 506
New Zealand Telecom -- 417
Other international investments 4 4
-----------------
Total international investments 4,831 1,669
Domestic investments 107 82
-----------------
Total investments $4,938 $1,751
- -----------------------------------------------------------------------------
</TABLE>
In accordance with the equity method of accounting, we increase our recorded
investment for our allocable share of earnings (adhering to purchase accounting
and U.S. GAAP), reduce the investment for distributions (dividends) received and
give effect to any currency translation adjustments. We received dividends on
such investments of $171 million in 1998, $164 million in 1997 and $152 million
in 1996.
The following tables present summarized financial information of significant
investments accounted for using the equity method of accounting after taking
into account all adjustments necessary to conform to U.S. GAAP, but excluding
Ameritech's purchase adjustments including goodwill:
<TABLE>
<CAPTION>
Year ended December 31 1998 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues $11,344 $8,199 $7,400
Operating income 2,803 1,918 1,918
Net income 1,751 723 1,002
-----------------------------
Weighted average
owned by Ameritech* 27.8% 22.2% 23.3%
- -----------------------------------------------------------------------------
</TABLE>
* Represents Ameritech's weighted average share of revenues.
<TABLE>
<CAPTION>
As of December 31 1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Current assets $4,145 $2,421
Noncurrent assets 13,826 10,851
Current liabilities 5,165 4,565
Noncurrent liabilities 6,864 6,500
Minority interest 69 91
- -----------------------------------------------------------------------------
</TABLE>
OTHER INVESTMENTS In addition to acquiring our Tele Danmark investment in 1998,
we made several smaller investments for approximately $100 million in cash and
assumed debt of approximately $40 million. At various times in 1997, we acquired
assets of several companies engaged in security services through our wholly
owned subsidiary, SecurityLink from Ameritech, Inc., for approximately $1
billion in cash and stock.
We accounted for these transactions using the purchase method of accounting.
We allocated our purchase price to individual assets and liabilities based on
estimates of fair value. Revenues of all of the above-mentioned security
businesses in 1996, prior to our asset acquisitions, were approximately $195
million.
44
<PAGE>
3. PROPERTY, PLANT AND EQUIPMENT
- ------------------------------------------------------------------------------
The components of property, plant and equipment were as follows as of December
31:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Land $ 148 $ 152
Buildings 3,308 3,123
Central office equipment 14,658 13,335
Cable, wiring and conduit 14,605 13,960
Other 3,140 3,450
-------------------
35,859 34,020
Under construction 485 371
-------------------
36,344 34,391
Less, accumulated depreciation 22,039 20,518
-------------------
Total property, net $14,305 $13,873
- -----------------------------------------------------------------------------
</TABLE>
Depreciation expense on property, plant and equipment was $2,475 million in
1998, $2,317 million in 1997 and $2,216 million in 1996.
4. INCOME TAXES
- ------------------------------------------------------------------------------
The components of income tax expense follow:
<TABLE>
<CAPTION>
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal
Current $1,568 $ 994 $ 959
Deferred, net 213 217 115
Investment tax credits, net (25) (32) (36)
-----------------------------
Total 1,756 1,179 1,038
-----------------------------
State, local and foreign
Current 223 191 138
Deferred, net 52 18 7
-----------------------------
Total 275 209 145
-----------------------------
Total income tax expense $2,031 $1,388 $1,183
- ------------------------------------------------------------------------------
</TABLE>
Total income taxes paid were $956 million in 1998, $1,151 million in 1997 and
$1,075 million in 1996.
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):
<TABLE>
<CAPTION>
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Statutory tax rate 35.0% 35.0% 35.0%
State income taxes,
net of federal benefit 3.1 2.9 2.8
Amortization of
investment tax credits (0.3) (0.6) (0.7)
Other, net (1.8) 0.4 (1.4)
----------------------------
Effective tax rate 36.0% 37.7% 35.7%
- ------------------------------------------------------------------------------
</TABLE>
Income tax expense was reduced by $12 million in 1996 as a result of a portion
of the beginning-of-year valuation allowances no longer being required.
As of December 31, 1998 and 1997, the components of long-term accumulated
deferred income taxes were as follows:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets
Postretirement and
postemployment benefits $1,110 $1,127
Other 330 291
------------------
1,440 1,418
------------------
Deferred tax liabilities
Accelerated depreciation
and amortization 1,903 1,737
Prepaid pension cost 627 530
Undistributed equity
earnings from foreign
investments 80 44
Other 332 257
------------------
2,942 2,568
------------------
Net deferred tax liability $1,502 $1,150
- -----------------------------------------------------------------------------
</TABLE>
As of December 31, we had valuation allowances against certain deferred tax
assets aggregating $107 million in 1998 and $72 million in 1997. We do not
separately report deferred income taxes in current assets and liabilities, as
they are not significant.
5. 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:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Notes payable
Commercial paper $2,368 $2,584
Bank loans 4 9
Other 12 38
Long-term debt maturing
within one year 235 405
------------------
Total $2,619 $3,036
------------------
Weighted average interest rate
on notes payable, year-end 5.4% 5.8%
- -----------------------------------------------------------------------------
</TABLE>
We have a committed revolving credit facility of $2.0 billion. The fee for this
facility is 0.035% per annum. No amounts were outstanding under this facility as
of December 31, 1998. In addition, we have entered into uncommitted agreements
with a number of banks for lines of credit totaling $1.8 billion. We had $1
million outstanding under these agreements as of December 31, 1998, and did not
use the agreements during 1997 or 1996. The interest rates on these lines are
negotiable at the time of borrowing. There are no significant commitment fees or
material compensating balance requirements associated with any of these lines of
credit. These lines, as well as the revolving credit facility, are available for
support of commercial paper borrowing and to meet short-term cash needs.
45
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions, except per share amounts)
6. LONG-TERM FINANCING
- -----------------------------------------------------------------------------
Long-term debt consists principally of debt issued by our landline
communications subsidiaries and our financing subsidiary, Ameritech Capital
Funding Corporation (ACF). The following table sets forth interest rates and
other information on long-term debt outstanding as of December 31:
<TABLE>
<CAPTION>
Interest Rates Maturities 1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
4.375%-6.0% 2000-2007* $1,890 $640
6.125%-8.0% 2001-2028 3,517 3,462
8.125%-9.0% 2000-2005 45 326
9.1%-10.0% 2006-2016 96 96
------------------
5,548 4,524
LESOP (Note 8) 37 114
Capital lease obligations 6 9
Other 2 1
Unamortized discount, net (36) (38)
------------------
Total $5,557 $4,610
- -----------------------------------------------------------------------------
</TABLE>
* Includes $250 million ACF 5.9% debentures maturing in 2038 with a put option
by holder in 2005.
Scheduled maturities of long-term debt, including principal payments on LESOP
debt (see Note 8), are $235 million due in 1999, $147 million due in 2000, $606
million due in 2001, $127 million due in 2002 and $977 million due in 2003.
In December 1998, we redeemed approximately $1.3 billion of long-term debt,
including mortgage bonds, issued by our landline communications subsidiaries. We
called this debt in anticipation of refinancing at more favorable interest rates
in 1999. Interest rates on the extinguished debt ranged from 6.25% to 8.5% and
maturities ranged from 2004 to 2026.
In January 1998, we issued $1.75 billion of long-term debt in five separate
tranches through ACF. The notes and debentures bear interest at annual rates
ranging from 5.65% to 6.55% and mature between 2001 and 2038. In February 1998
we issued $750 million of 5.88% unsecured Eurodollar notes, due February 19,
2003, through ACF. We used proceeds from these borrowings primarily to fund our
investment in Tele Danmark.
As of December 31, 1998, we had available for issuance through our landline
communications subsidiaries and ACF $1.2 billion in unsecured debt securities
through shelf registration statements with the Securities and Exchange
Commission (SEC).
PREFERRED STOCK ISSUANCES BY SUBSIDIARIES In April 1998, an Ameritech subsidiary
issued through a private placement 3,250 shares of stated rate auction preferred
stock (STRAPS) in four separate series. Net proceeds from these issuances
totaled $322 million. Dividends accrue on the STRAPS at varying rates, which are
adjusted periodically through separate auctions on each series. Dividends are
cumulative from the date of issuance. The dividend rates for each series ranged
from 4.15% to 4.35% as of December 31, 1998.
In June 1997, one of our wholly owned subsidiaries issued $250 million of
preferred stock in a private placement. The holders of the preferred stock may
require our subsidiary to redeem the shares at any time after May 20, 2004.
Holders receive quarterly dividends based on a rolling three-month London
Interbank Offer Rate (LIBOR). The dividend rate for the December 31, 1998,
payment was 6.05%.
As of December 31, 1998, another wholly owned subsidiary has outstanding $85
million of Series A Preferred Stock (7.04%, subject to mandatory redemption in
2001) and $60 million of Series B Preferred Stock (variable rate, 4.4% as of
December 31, 1998, not subject to mandatory redemption).
All preferred stock issued by subsidiaries is included in Other long-term
liabilities on the consolidated balance sheet.
7. Other assets and deferred charges
- -----------------------------------------------------------------------------
The components of other assets and deferred charges are as follows:
<TABLE>
<CAPTION>
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Goodwill $1,077 $980
Acquired security services
customers 453 512
Other intangibles 544 538
------------------
Total intangibles, net 2,074 2,030
Prepaid pension asset 1,651 1,394
Other 2,201 1,742
------------------
$5,926 $5,166
- -----------------------------------------------------------------------------
</TABLE>
Costs of acquiring security services customers generally are being amortized
over 10 years, the expected life when acquired from a third party. Our goodwill
generally is amortized over 40 years. Accumulated amortization of intangibles
was $366 million in 1998 and $273 million in 1997.
8. EMPLOYEE BENEFIT PLANS
- -----------------------------------------------------------------------------
PENSION AND RETIREE HEALTH AND LIFE PLANS We maintain noncontributory defined
benefit pension plans for substantially all employees, as well as postretirement
health care and life insurance plans for substantially all retirees and their
dependents.
The components of pension cost (credits) are as follows:
<TABLE>
<CAPTION>
Pension Benefits
--------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Benefits earned during the year $210 $183 $167
Interest cost on projected
benefit obligation 551 556 493
Expected return on plan assets (886) (822) (765)
Net amortization and deferral
Transition obligation (110) (110) (112)
Other 10 19 22
-------------------------------
Net pension credits $(225) $(174) $(195)
- ------------------------------------------------------------------------------
</TABLE>
46
<PAGE>
The components of postretirement benefit cost are as follows:
<TABLE>
<CAPTION>
Retiree Health and Life Benefits
---------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Benefits earned during the year $84 $80 $88
Interest cost on accumulated
benefit obligation 367 360 345
Expected return on plan assets (150) (127) (110)
Net (gain) or loss amortization 10 -- 16
---------------------------
Total postretirement
benefit cost $311 $313 $339
- ------------------------------------------------------------------------------
</TABLE>
The following tables set forth pension and postretirement obligations and plan
assets as of December 31:
<TABLE>
<CAPTION>
Pension Benefits Retiree Health and Life
---------------- -----------------------
1998 1997 1998 1997
- ------------------------------------------ ----------------------------------
<S> <C> <C> <C> <C>
Change in benefit
obligation:
Benefit obligation
as of January 1 $7,994 $7,622 $5,454 $5,057
Service cost 210 183 84 80
Interest cost 551 556 367 360
Plan amendment (30) -- -- --
Effect of settlements (34) (35) -- --
Actuarial loss (gain) 760 416 190 228
Benefits paid (766) (748) (293) (271)
---------------- ------------------
Benefit obligation
as of December 31 $8,685 $7,994 $5,802 $5,454
- ------------------------------------------------------------------------------
Change in plan
assets:
Fair value as
of January 1 $13,611 $12,121 $1,755 $1,491
Actual return 1,946 2,268 247 205
Company
contribution -- -- 89 83
Effect of settlements (37) (39) -- --
Benefits paid (758) (739) (23) (24)
---------------- ------------------
Fair value as
of December 31 $14,762 $13,611 $2,068 $1,755
- ------------------------------------------------------------------------------
Funded status:
As of December 31 $6,077 $5,617 $(3,734) $(3,699)
Unrecognized cost:
Actuarial
and investment
(gains)
losses, net (4,246) (3,996) 814 732
Prior service cost 366 431 2 2
Transition
obligation (546) (658) -- --
---------------- ------------------
Prepaid (accrued)
benefit cost $1,651 $1,394 $(2,918) $(2,965)
- ------------------------------------------------------------------------------
</TABLE>
Assumptions as of December 31:
<TABLE>
<CAPTION>
Pension Benefits Retiree Health and Life
---------------- -----------------------
1998 1997 1998 1997
- ----------------------------------------- -----------------------------------
<S> <C> <C> <C> <C>
Discount rate 6.75% 7.0% 6.75% 7.0%
Expected return 8.4% 8.4% 8.4% 8.4%
Compensation
increase rate 4.1% 4.1% 4.1% 4.1%
- -----------------------------------------------------------------------------
</TABLE>
Effective December 31, 1996, we gave effect to increases in future benefits
under the nonmanagement pension plan. The assumed health care cost trend rate
was 7.6% for 1998 and 8.0% for 1997 and is assumed to decrease by 0.4% per year
to 4.0% in 2007 and remain at that level. A one percentage-point change in the
assumed health care cost trend rate would have the following effects:
<TABLE>
<CAPTION>
One Percentage- One Percentage-
Point Increase Point Decrease
- ------------------------------------------------------------------------------
<S> <C> <C>
Effect on total of service and
interest cost components $ 65 $ (52)
Effect on postretirement
benefit obligation $706 $(580)
- ------------------------------------------------------------------------------
</TABLE>
LEVERAGED EMPLOYEE STOCK OWNERSHIP PLANS In 1989, we created leveraged employee
stock ownership plans (LESOPs) within our existing employee savings plans. To
fund the LESOPs, the trustee for the savings plans issued $665 million of debt,
at 8.03% interest, payable in semiannual installments through 2001, which we
guaranteed. The trustee used the proceeds to purchase at fair market value
45,132,552 shares of Ameritech common stock from our treasury. These shares are
considered to be outstanding for earnings per share purposes. The trustee repays
the notes, including interest, with funds from our contributions to the savings
plans, from dividends paid on the shares of our common stock held by the trustee
and with new loans from Ameritech.
As a result of our unconditional guarantee, we have recorded the notes of the
trusts as long-term debt and as deferred compensation in the accompanying
consolidated balance sheets. Deferred compensation represents a reduction of
shareowners' equity.
[GRAPHIC APPEARS HERE]
Revenues from data communications
grew 32% in 1998 to $1.7 billion.
47
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions, except per share amounts)
Debt and deferred compensation decrease as the trustee makes principal payments.
As of December 31, 1998, we had $37 million included in long-term debt and $77
million included in long-term debt maturing within one year with respect to the
LESOPs.
We maintain savings plans that cover substantially all of our employees.
Under these plans, we match a certain percentage of eligible contributions made
by the employees to the plans. The LESOP provisions of the savings plans became
effective January 1, 1990. Under these provisions, our matching contributions
are allocated to employees in company stock from the LESOP trusts. We release
Ameritech stock for allocation to employees in the proportion that principal and
interest paid in a year bears to the total principal and interest due over the
life of debt outstanding in the trusts.
We record our matching contributions to the plans as compensation expense.
Any change in the required contribution as a result of leveraging this
obligation is recorded as a gain or loss in other income. The amount expensed
and contributed to the LESOPs totaled $31 million in 1998, $29 million in 1997
and $34 million in 1996. Interest expense incurred by the savings plans was $9
million in 1998, $15 million in 1997 and $21 million in 1996. Dividends paid on
shares of stock held by the trustee used to partially satisfy debt repayment
requirements were $42 million for 1998 and $41 million for both 1997 and 1996.
As of December 31, 1998, we had allocated or committed 35,256,838 shares to
employee accounts, leaving 9,875,714 shares unallocated. As of December 31,
1997, we had allocated or committed 32,154,838 shares to employee accounts,
leaving 12,977,714 shares unallocated.
We have entered into agreements to lend up to $123 million to one of the
trusts through December 1, 2004. As of December 31, 1998, the trustee borrowed
$94 million from Ameritech at rates ranging from 6.1% to 8.4%. The trustee
borrowed an additional $20 million in January 1999 at 5.6%.
RESTRUCTURING In March 1998, we announced plans to significantly reduce future
operating expenses by the end of 2002. As part of this cost containment program,
we recorded a pretax restructuring charge of $104 million ($64 million
after-tax, or $0.06 per share) in March 1998 principally to cover the costs of
consolidating security monitoring centers and closing 53 company-owned cellular
retail stores. The charge includes employee-related costs (principally
severance) of approximately $54 million for the termination of the employment of
approximately 5,000 employees, as well as other costs of approximately $50
million related to lease terminations and asset write-downs. We accounted for
the employee costs of the restructuring charge in accordance with our existing
severance plans and following FAS 112, "Employers' Accounting for Postemployment
Benefits." We accounted for the other restructuring costs in accordance with
existing accounting literature for restructurings. The charge does not include
approximately 550 employees identified for employment termination when we
acquired certain security services assets in 1997. We included the cost of
terminating the employment of these employees in our purchase price.
Employee reductions under the March 1998 restructuring program were 1,478 in
1998. Termination costs related to these employees were approximately $15
million. We also incurred nonemployee costs of approximately $13 million in 1998
related to this restructuring, resulting in an accrual balance of approximately
$76 million as of December 31, 1998. Settlement gains of approximately $3
million associated with this restructuring were recorded in 1998.
MANAGEMENT WORK FORCE REDUCTIONS Effective January 1, 1995, management employees
who are asked to leave the company under certain conditions will receive a
severance payment under the Management Separation Benefit Plan (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 Ameritech under the MSBP, other than those leaving as part
of the March 1998 restructuring discussed above, was 249 in 1998, 273 in 1997
and 618 in 1996.
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 $18 million in 1998, $20 million in 1997 and $33 million in 1996. We fund
the involuntary plans from our operations and made cash payments of $4 million
in 1998, $5 million in 1997 and $17 million in 1996.
9. COMMITMENTS
- -----------------------------------------------------------------------------
We lease certain facilities and equipment used in our operations under both
operating and capital leases. Rental expense under operating leases was $243
million in 1998, $220 million in 1997 and $219 million in 1996. As of December
31, 1998, the aggregate minimum rental commitments under noncancelable leases
were as follows:
<TABLE>
<CAPTION>
Years Operating Capital
- ------------------------------------------------------------------------------
<S> <C> <C>
1999 $94 $3
2000 82 2
2001 70 3
2002 56 1
2003 51 1
Thereafter 201 1
---------------
Total minimum rental commitments $554 11
----
Less: executory costs 1
interest costs 2
---
Present value of minimum lease payments $8
- ------------------------------------------------------------------------------
</TABLE>
We commenced a 10-year agreement in 1996 with IBM Global Services (IBM), to
perform certain information technology services we previously performed. IBM
also is responsible for the consolidation of our data centers. The terms of the
agreement and subsequent amendments specify payments to IBM that do not exceed
about $200 million in any year. Actual charges from IBM
48
<PAGE>
may increase or decrease based in part on usage, growth or other data processing
requirements. We may terminate the entire agreement upon payment of a
predetermined fee, which varies based on the reason for termination and the year
terminated.
10. FINANCIAL INSTRUMENTS AND DERIVATIVES
- -----------------------------------------------------------------------------
The following table presents the estimated fair value of our financial
instruments as of December 31:
<TABLE>
<CAPTION>
1998 1997
----------------- -----------------
Carrying Fair Carrying Fair
Value Value Value Value
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Cash and temporary
cash investments $139 $139 $239 $239
Debt 8,327 8,644 7,749 8,037
Other assets 1,434 1,421 907 888
Other liabilities 760 789 476 509
- -----------------------------------------------------------------------------
</TABLE>
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 our debt maturing
within one year approximates fair value because of the short-term maturities
involved. We estimated the fair value of our 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
long-term receivables, other investments, financial contracts, customer deposits
and preferred stock of subsidiaries. We based the fair values of these items on
expected cash flows, available market prices or market comparables. Fair value
of other liabilities includes the effect of interest rate swaps and forwards
discussed below.
FINANCIAL CONTRACTS, INCLUDING DERIVATIVES We occasionally enter into foreign
currency forward contracts to hedge exposure to adverse exchange risk. Also, we
use interest rate swaps to manage interest rate exposure. Related gains and
losses are reflected in net income. As of December 31, 1998, we had contracts
giving us the right to deliver foreign currency valued at approximately $1.0
billion ($3.0 billion in 1997). As of December 31, we also had entered into
interest rate swap agreements to change the interest rate on notional amounts of
$395 million in 1998 and $527 million in 1997. We adjust interest expense to
give effect to obligations under the swaps. We are exposed to credit risk in the
unlikely event of nonperformance by counterparties and the fair value of the
swaps exceeds their carrying value. As of December 31, 1998, the fair value of
these interest rate swaps was $25 million less than carrying value. As of
December 31, 1997, the fair value of the interest rate swaps was $15 million
less than carrying value.
11. OTHER INCOME, NET
- -----------------------------------------------------------------------------
The components of other income, net are as follows:
<TABLE>
<CAPTION>
Income (expense) 1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Equity earnings of affiliates* $382 $206 $236
Interest on company-owned
life insurance and
related programs 40 46 55
Gain on LESOP 52 44 35
Gain on sale of TCNZ shares 1,543 -- --
Charge for early redemption
of long-term debt (38) -- --
Gain on sale of assets to
Century Telephone 170 -- --
Gain on sale of Sky Network
Television of New Zealand -- 52 --
Gain on sale of shares in MATAV -- 43 --
Gain on sale of Bellcore -- 42 --
Loss on forward contracts related
to Tele Danmark acquisition (54) (16) --
Other, net (40) (27) --
-----------------------------
Total $2,055 $390 $326
- ------------------------------------------------------------------------------
</TABLE>
* Primarily Tele Danmark, Belgacom and MATAV in 1998 and TCNZ, Belgacom and
MATAV in 1997 and 1996. Results in 1997 include an $87 million restructuring
charge at Belgacom.
12. SHAREOWNERS' EQUITY
- -----------------------------------------------------------------------------
STOCK INFORMATION Our certificate of incorporation authorizes 2.4 billion common
shares. The certificate also allows 30 million shares of preferred stock (par
value $1 per share) and 30 million shares of preference stock (par value $1 per
share).
As of December 31, 1998, we have registered 14,279,340 shares of our common
stock with the SEC for future issuance. We may issue these shares from time to
time for the completion of acquisitions, for the payment of dividends or for
other corporate purposes.
STOCK PLANS In April 1997, shareowners approved a long-term stock incentive
plan. Through our 1989 and 1997 plans, we grant incentive compensation to our
officers and other employees in the form of stock options, stock appreciation
rights, restricted stock and performance awards. The incentives granted are
based upon terms and conditions and are subject to certain limitations,
determined by a committee of the board of directors, which administers the
plans. The plans authorize the issuance of up to 120,000,000 shares of common
stock over a 10-year period. All future grants will be made under the 1997 plan.
We may grant stock options under the 1997 plan as either incentive stock
options or nonqualified stock options. We have not granted any options at less
than fair market value as of the date
49
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions, except per share amounts)
of grant. Under the 1997 plan, stock options and stock appreciation rights may
not be granted at less than the fair market value on the date of grant except in
the case of awards to newly hired or promoted employees when the fair market
value on the date of hire or promotion may be used. Additionally, under the 1997
plan, the per share exercise price may not be repriced or surrendered as
consideration in exchange for a new award with a lower per share exercise price.
The options have a maximum life of 10 years and one day from the date of grant.
We may grant stock appreciation rights independently or together with stock
options. Stock appreciation rights permit the optionee to receive stock, cash or
a combination thereof equal to the amount by which the fair market value on the
exercise date exceeds the option price. Substantially all stock options granted
on or following December 16, 1987, are exercisable after one year in equal
increments over the following three years. Beginning in 1994, we awarded grants
of nonqualified stock options with dividend equivalents to certain employees.
Information regarding options granted under a long-term incentive plan, which
expired in 1994 and under the 1989 and 1997 plans, is as follows:
<TABLE>
<CAPTION>
Incentive Nonqualified
Stock Options Stock Options
------------- ---------------------
Shares Price* Shares Price*
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
December 31, 1995 11,336 $10.29 27,951,434 $19.03
Granted -- -- 13,760,832 $29.15
Exercised (11,336) $10.29 (4,393,874) $18.08
Canceled or expired -- -- (1,666,368) $24.99
- -----------------------------------------------------------------------------
December 31, 1996 -- -- 35,652,024 $22.78
Granted -- -- 17,226,368 $30.15
Exercised -- -- (7,859,530) $19.83
Canceled or expired -- -- (4,369,148) $27.53
- -----------------------------------------------------------------------------
December 31, 1997 -- -- 40,649,714 $25.96
Granted -- -- 9,697,193 $45.09
Exercised -- -- (6,773,262) $23.36
Canceled or expired -- -- (1,638,244) $35.78
- -----------------------------------------------------------------------------
December 31, 1998 -- -- 41,935,401 $30.42
- -----------------------------------------------------------------------------
</TABLE>
* Weighted average
The above stock options have the following characteristics as of December 31,
1998:
<TABLE>
<CAPTION>
Remaining
Shares Life Shares
Grant Year Outstanding Price* (in years)* Exercisable
- ------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1989-93 2,150,083 $16.28 2.4 2,150,083
1994 3,307,615 19.28 5.1 3,307,615
1995 5,576,324 20.84 6.1 5,576,324
1996 8,361,187 29.13 7.1 4,816,787
1997 13,477,031 30.30 8.1 3,671,271
1998 9,063,161 45.09 9.3 2,111
---------- ----------
41,935,401 19,524,191
- ------------------------------------------------------------------------------
</TABLE>
* Weighted average
As of December 31, additional shares available under stock options with dividend
equivalents were 1,144,092 in 1998, 1,006,992 in 1997 and 713,820 in 1996.
All stock appreciation rights granted under the plans have been issued in
tandem with nonqualified stock options. The exercise of a nonqualified option or
a stock appreciation right cancels the related right or option. We have not
issued any stock appreciation rights after December 31, 1990.
As of December 31, 1998, 22,333 shares of nonperformance-based restricted
stock are outstanding under the plans. Shareowners' equity reflects deferred
compensation for the unvested stock awarded. This amount is reduced and charged
against operations (together with any change in market price) as the employees
vest in the stock.
In 1995, the FASB issued FAS 123, "Accounting for Stock-Based Compensation."
This pronouncement requires us to calculate the value of stock options at the
date of grant using an option pricing model. We have elected the "pro forma,
disclosure only" option permitted under FAS 123, instead of recording a charge
to operations, as shown below:
<TABLE>
<CAPTION>
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income As reported $ 3,606 $ 2,296 $ 2,134
Pro forma 3,581 2,262 2,107
Earnings per share As reported basic 3.27 2.09 1.93
As reported diluted 3.25 2.08 1.92
Pro forma basic 3.25 2.06 1.91
Pro forma diluted 3.21 2.05 1.91
- ------------------------------------------------------------------------------
</TABLE>
Because the FAS 123 method of accounting has not been applied to options granted
prior to January 1, 1995, the resulting pro forma compensation cost may not be
representative of that to be expected in future years. We adjusted pro forma net
income for dividend equivalents expensed as a variable plan.
Our weighted-average assumptions used in the pricing model and resulting fair
values were as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Risk-free rate 5.63% 6.22% 5.37%
Expected dividend yield* 2.67% 3.74% 3.50%
Expected option life (in years)
(without dividend equivalents) 4.20 3.25 3.25
Expected option life (in years)
(with dividend equivalents) 5.40 5.00 5.00
Expected stock price volatility 24.43% 23.67% 20.74%
Grant date value
(without dividend equivalents) $10.07 $5.49 $4.48
Grant date value
(with dividend equivalents) $15.95 $10.31 $8.99
- ------------------------------------------------------------------------------
</TABLE>
* The options granted with dividend equivalents (about 27% of total options
granted in 1998, 24% in 1997 and 28% in 1996) were priced assuming the
dividends would accrue to the optionee over the expected life of the option.
50
<PAGE>
13. ADDITIONAL FINANCIAL INFORMATION
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
December 31
--------------------
1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Other current liabilities
Accrued payroll $165 $284
Accrued taxes 1,405 478
Advance billings and customer deposits 370 378
Dividends payable 351 330
Accrued interest 183 127
Other 1,002 653
-----------------
Total $3,476 $2,250
- ------------------------------------------------------------------------------
</TABLE>
Interest paid was $555 million in 1998, $534 million in 1997 and $544 million in
1996. Advertising expense was $283 million in 1998, $354 million in 1997 and
$270 million in 1996.
Net income was reduced by $56 million in 1998 and $24 million in 1997 as a
result of reclassification of currency translation adjustments from other
comprehensive income. This resulted from the sale of our TCNZ and MATAV shares
previously discussed. Reclassifications from other comprehensive income as a
result of sales of securities did not exceed $10 million in any year.
14. SEGMENT INFORMATION
- -----------------------------------------------------------------------------
We have three reportable segments as defined by FAS 131, "Disclosures About
Segments of an Enterprise and Related Information." They are communications,
information and entertainment, and international. The communications segment
provides telecommunications services such as landline telephone service,
cellular telephone and paging services, and call management and data services to
business and residential customers primarily in the states of Illinois, Indiana,
Michigan, Ohio and Wisconsin. Communications services also include network
access and interconnection services for interexchange carriers and competitive
providers of local telephone service. The information and entertainment segment
provides printed and online directories for business and residential users,
security and alarm monitoring services for homes and businesses, and cable TV
services. The international segment manages our investments in foreign ventures,
which we account for using the equity method of accounting. In addition to these
reportable segments, we derive revenues from other nonreportable segments,
including lease financing services.
Our reportable segments are strategic business units or aggregations of
strategic business units that offer different products or services. They are
managed separately based on differences in customer base, strategic objectives
or regulatory environment. With the exception of the international segment,
management evaluates segment performance based upon direct margin, which
represents total revenues less direct expenses attributable to that segment.
Results are normalized for one-time items. Management does not allocate
corporate overhead, centralized information technology (IT) costs, interest
income, interest expense, other nonoperating items or income taxes when
measuring segment results. Corporate overhead and IT costs are shown as a
reconciling item in the reconciliation of segment profit to consolidated
operating income below. The international segment is evaluated based on income
from equity-method investees before one-time items. The accounting policies of
the segments are generally the same as those described in Note 1. Following is a
summary of information about segment profits, assets and capital expenditures
(including business acquisitions).
<TABLE>
<CAPTION>
Communications
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues from
external customers $15,121 $14,208 $13,207
Intersegment revenues 148 154 183
Depreciation and amortization 2,398 2,276 2,207
Net income in
equity-method investees 4 4 3
Segment profit 6,066 5,561 4,811
Segment assets 19,899 19,053 18,014
Expenditures for
segment assets 2,702 2,795 2,181
- ------------------------------------------------------------------------------
</TABLE>
[GRAPHIC APPEARS HERE]
Our total number of high-capacity
circuits grew 33% in 1998, reflecting
surging demand for data communications.
51
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in millions, except per share amounts)
<TABLE>
<CAPTION>
Information and entertainment
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues from
external customers $1,993 $1,581 $1,415
Intersegment revenues 9 2 2
Depreciation and amortization 177 124 74
Segment profit 527 488 521
Segment assets 2,868 2,472 1,168
Expenditures for
segment assets 186 1,086 149
- ------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
International
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Income from equity-
method investees $378 $289 $233
Segment assets 7,438 2,328 2,562
Expenditures for
segment assets 3,143 -- 898
- ------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Other business activities
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues from
external customers $156 $134 $109
Revenues from operating
segments 92 72 36
Depreciation and amortization 130 109 69
Profit 90 77 64
Assets 1,479 1,192 953
Expenditures for
long-lived assets 139 103 87
- ------------------------------------------------------------------------------
</TABLE>
Following are reconciliations of reportable segment information to financial
statement amounts:
<TABLE>
<CAPTION>
Revenues
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Total revenues from
reportable segments $17,271 $15,945 $14,807
Other operating revenues 248 206 145
Corporate revenues
and eliminations (365) (153) (35)
-----------------------------
Total consolidated
revenues $17,154 $15,998 $14,917
- ------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Profit
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Communications and
information and
entertainment margins $6,593 $6,049 $5,332
Margin from other
business activities 90 77 64
Corporate and eliminations (2,386) (2,258) (1,891)
-----------------------------
Operating income before
one-time items 4,297 3,868 3,505
One-time items
in operating income (104) (69) --
-----------------------------
Operating income 4,193 3,799 3,505
Interest expense 611 505 514
Income from international
equity-method investees 378 289 233
Other income (expense) 56 67 75
Other one-time items 1,621 34 18
-----------------------------
Pretax income $5,637 $3,684 $3,317
- ------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Assets
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
Total assets for
reportable segments $30,205 $23,853 $21,744
Other assets 1,479 1,192 953
Corporate assets and
eliminations (1,385) 294 1,010
-----------------------------
Total consolidated
assets $30,299 $25,339 $23,707
- ------------------------------------------------------------------------------
</TABLE>
GEOGRAPHIC INFORMATION We hold investments in entities or conduct operations in
a number of countries outside the United States. Substantially all of our
overseas ventures are accounted for using the equity method of accounting, under
which we do not record the revenues and expenses of the ventures in our
operating results (see Note 2). Specifically, less than 1% of consolidated
revenues for all years presented are from outside the United States. A summary
of our long-lived assets by country is as follows:
<TABLE>
<CAPTION>
Long-lived assets
1998 1997 1996
- ------------------------------------------------------------------------------
<S> <C> <C> <C>
United States $20,309 $19,093 $17,658
Belgium 892 742 890
Denmark 3,401 -- --
Hungary 534 506 655
New Zealand -- 417 670
Other countries 33 32 35
-----------------------------
Total $25,169 $20,790 $19,908
- ------------------------------------------------------------------------------
</TABLE>
52
<PAGE>
PRODUCT INFORMATION Most of our revenues are derived from the provisioning of
landline telephone service and supporting products. Products or services that
contributed more than 5% of our consolidated revenues other than those of our
landline telephone business are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
- -----------------------------------------------------------------------------
<S> <C> <C> <C>
Cellular and paging 11% 11% 9%
Directory advertising 8% 8% 8%
- -----------------------------------------------------------------------------
</TABLE>
15. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
- -----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Diluted
Operating Net Earnings
Revenues Income Income per Share
- -----------------------------------------------------------------------------
<S> <C> <C> <C> <C>
1998
1st Quarter $4,133 $905 $492 $0.44
2nd Quarter 4,289 1,164 1,707 1.54
3rd Quarter 4,290 1,063 645 0.58
4th Quarter 4,442 1,061 762 0.68
------------------------------
Total $17,154 $4,193 $3,606 $3.25
- -----------------------------------------------------------------------------
1997
1st Quarter $3,859 $912 $536 $0.48
2nd Quarter 3,986 1,041 537 0.49
3rd Quarter 4,006 962 613 0.56
4th Quarter 4,147 884 610 0.55
------------------------------
Total $15,998 $3,799 $2,296 $2.08
- -----------------------------------------------------------------------------
</TABLE>
The first quarter of 1998 includes a one-time pretax charge of $104 million ($64
million after-tax) for restructuring related to a cost containment program, as
well as a one-time pretax charge of $54 million ($34 million after-tax) for a
currency-related fair value adjustment in conjunction with our Tele Danmark
investment. The second quarter of 1998 includes a one-time pretax gain of $1.5
billion ($1.0 billion after-tax) related to the sale of substantially all of our
TCNZ shares. The fourth quarter of 1998 includes a one-time pretax charge of $38
million ($24 million after-tax) for the costs of early redemption of long-term
debt, as well as a pretax gain of $170 million ($102 million after-tax) from the
sale of certain telephone and directory assets to Century Telephone Enterprises,
Inc.
The second quarter of 1997 includes a one-time after-tax charge of $87
million related to our share of the costs of a work force restructuring at
Belgacom. The third quarter of 1997 includes a one-time pretax gain of $52
million ($37 million after-tax) resulting from the sale of our interest in Sky
Network Television of New Zealand. Several other significant income and expense
items were reported in the fourth quarter of 1997. However, the net result was
not material to results for the quarter or year.
We calculated earnings per share on a quarter-by-quarter basis in accordance
with GAAP. Quarterly EPS figures may not total EPS for the year due to
fluctuations in the number of shares outstanding.
We have included all adjustments necessary for a fair statement of results
for each period.
16. MERGER AGREEMENT
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On May 11, 1998, we jointly announced with SBC Communications Inc. (SBC) a
definitive agreement to merge an SBC subsidiary with Ameritech in a transaction
in which each outstanding share of Ameritech common stock (other than shares
owned by Ameritech, SBC or their respective subsidiaries) will be converted into
and exchanged for 1.316 shares of SBC common stock. After the merger, Ameritech
will be a wholly owned subsidiary of SBC. The transaction has been approved by
the board of directors and shareowners of each company. It is intended to be
accounted for as a pooling of interests and will qualify for federal income tax
purposes as a tax-free reorganization. The merger is subject to the satisfaction
of certain conditions and regulatory approvals.
The transaction, if approved by regulators and completed, will constitute a
change in control of the company. Stock options granted to employees prior to
initiation of the merger vest fully upon the change in control, and certain
change in control agreements and employee severance plans become operative.
These agreements and plans have been described in our most recent proxy
statement.
We have capitalized direct merger-related costs aggregating approximately $22
million as of December 31, 1998, pending completion of the merger.
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