SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K
CURRENT REPORT
Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
Date of Report: May 8, 1997
SBC COMMUNICATIONS INC.
A Delaware Corporation
Commission File No. 1-8610
IRS Employer No. 43-1301883
175 E. Houston, San Antonio, Texas 78205
Telephone Number (210) 821-4105
<PAGE>
Item 7. Financial Statements and Exhibits
On April 1, 1997, SBC Communications Inc. (SBC) and Pacific Telesis Group (PAC)
completed the merger of an SBC subsidiary with PAC, in a transaction in which
each share of PAC common stock was exchanged for 0.73145 of a share of SBC
common stock (equivalent to approximately 313 million shares). With the merger,
PAC became a wholly-owned subsidiary of SBC. The transaction has been accounted
for as a pooling of interests and a tax-free reorganization.
SBC presents herein audited consolidated financial statements of SBC to reflect
the business combination of SBC and PAC. This report includes the consolidated
balance sheets of SBC Communications Inc. (SBC) as of December 31, 1996 and
1995, and the related consolidated statements of income, shareowners' equity and
cash flows for each of the three years in the period ended December 31, 1996
(a) SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS OF SBC COMMUNICATIONS INC.
AND PACIFIC TELESIS GROUP
The following audited supplemental consolidated financial statements and
notes thereto are presented with the merger accounted for as a "pooling of
interests." Under this method of accounting, SBC restates its consolidated
financial statements to include the assets, liabilities, shareowners'
equity and results of operations of PAC. These are supplemental
consolidated financial statements which will become the historical
consolidated financial statements of SBC upon issuance of financial
statements for the quarter ending June 30, 1997.
The following audited supplemental consolidated financial statements have
been prepared using the exchange ratio of 0.73145:
<PAGE>
<TABLE>
Selected Financial and Operating Data
Dollars in millions except per
share amounts
<CAPTION>
- ---------------------------------------------------------------------------------
At December 31 or for the year 1996 1995 1994 1993 1992
ended:
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Financial Data
- ---------------------------------------------------------------------------------
Operating revenues $ 23,486$ 21,712 $ 21,006 $ 20,084$ 19,258
- ---------------------------------------------------------------------------------
Operating expenses $ 17,650$ 16,592 $ 16,056 $ 17,077$ 15,014
- ---------------------------------------------------------------------------------
Operating income $ 5,836 $ 5,120 $ 4,950 $ 3,007 $ 4,244
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Interest expense $ 812 $ 957 $ 935 $ 1,005 $ 1,036
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Equity in net income of affiliates $ 207 $ 120 $ 226 $ 250 $ 208
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Income taxes $ 1,960 $ 1,519 $ 1,448 $ 658 $ 1,161
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Income from continuing operations
before extraordinary loss and
cumulative effect of
accounting changes 1 $ 3,189 $ 2,958 $ 2,777 $ 1,589 $ 2,455
- ---------------------------------------------------------------------------------
Net income (loss) $ 3,279 $ (3,064) $ 2,800 $(2,474)$ 2,424
- ---------------------------------------------------------------------------------
Earnings per common share:
Income from continuing operations
before extraordinary loss and
cumulative effect of
accounting changes 1 $ 3.46 $ 3.22 $ 3.04 $ 1.76 $ 2.74
- ---------------------------------------------------------------------------------
Net income (loss) $ 3.56 $ (3.33) $ 3.07 $ (2.74)$ 2.71
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Total assets $ 39,485$ 37,112 $ 46,113 $ 47,695$ 45,588
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Long-term debt $ 10,930$ 10,409 $ 10,746 $ 10,588$ 10,923
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Construction and capital $ 5,481 $ 4,338 $ 3,981 $ 4,021 $ 3,969
expenditures
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Free cash flow 2 $ 1,935 $ 2,452 $ 2,952 $ 2,147 $ 2,452
- ---------------------------------------------------------------------------------
Dividends declared per common $ 1.72 $ 1.65 $ 1.58 $ 1.51 $ 1.46
share 3
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Book value per common share 4 $ 10.56 $ 9.15 $ 14.58 $ 16.69 $ 19.51
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Ratio of earnings to fixed 5.34 5.24 5.01 2.91 4.06
charges
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Return on weighted average 33.73% 23.97% 24.97% 21.23% 14.24%
shareowners' equity 5
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Debt ratio 4 55.49% 61.73% 48.57% 45.30% 43.32%
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Operating Data*
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EBITDA 6 $ 9,945 $ 9,154 $ 8,774 $ 6,750 $ 7,796
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Network access lines in service 31,370 29,989 28,918 28,018 27,275
(000)
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Access minutes of use (000,000) 123,303 112,874 100,800 93,877 88,035
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Wireless customers (000) 4,433 3,672 2,992 2,049 1,413
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Number of employees 109,870 108,189 110,390 113,755 116,523
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<FN>
*Operating data may be periodically revised to reflect the most current information
available.
1 1996, Change in directory accounting; 1995, Discontinuance of
Regulatory Accounting; 1994-1992, Income (loss) from spun-off
operations; and1993, Early Extinguishment of Debt and Cumulative
Effect of Changes in Accounting Principles.
2 Free cash flow is net cash provided by operating activities less
construction and capital expenditures.
3 Dividends declared by SBC's Board of Directors; these amounts do not
include dividends declared and paid by PAC prior to the merger.
4 Shareowners' equity used in book value per common share and debt ratio
calculations includes extraordinary loss and changes in accounting
principles.
5 Calculated using income before extraordinary loss and changes in
accounting principles. These impacts are included in shareowners'
equity.
6 EBITDA is earnings before interest, taxes, depreciation and
amortization (operating income plus depreciation and amortization).
SBC considers EBITDA an important component in our economic value
added systems as an indicator of the operational strength and
performance of our businesses. It is provided as supplemental
information and is not intended to be a substitute for operating
income, net income or net cash provided by operating activities as a
measure of financial performance or liquidity.
</FN>
</TABLE>
<PAGE>
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Dollars in millions except per share amounts
SBC Communications Inc. (SBC) is a holding company whose subsidiaries and
affiliates operate predominantly in the communications services industry. SBC's
subsidiaries and affiliates provide landline and wireless telecommunications
services and equipment, directory advertising and cable television services.
On April 1, 1997, SBC completed a merger which resulted in Pacific Telesis Group
(PAC) becoming a wholly-owned subsidiary of SBC. Among PAC's subsidiaries are
Pacific Bell (PacBell) and Nevada Bell. The merger was accounted for as a
pooling of interests and a tax-free reorganization. Accordingly, the financial
statements for the periods presented have been restated to include the accounts
of PAC (see Note 3 to the financial statements).
SBC's largest subsidiaries are Southwestern Bell Telephone Company (SWBell),
providing telecommunications services over approximately 15 million access lines
in Texas, Missouri, Oklahoma, Kansas and Arkansas (five-state area), and PacBell
providing telecommunications services over approximately 16 million access lines
in California. SBC also provides telecommunications services through its Nevada
Bell subsidiary over approximately 300 thousand access lines in Nevada. (SWBell,
PacBell and Nevada Bell are collectively referred to as the Telephone
Companies.) The Telephone Companies are subject to regulation by each of the
states in which they operate and by the Federal Communications Commission (FCC).
This discussion should be read in conjunction with the consolidated financial
statements and the accompanying notes.
Results of Operations
Summary
Financial results, including percentage changes from the prior year, are
summarized as follows:
Percent Change
-----------------
1996 1995
1996 1995 1994 vs. vs.
1995 1994
- -------------------------------------------------------------------------------
Operating revenues $ 23,486 $ 21,712 $ 21,006 8.2% 3.4%
Operating expenses $ 17,650 $ 16,592 $ 16,056 6.4% 3.3%
Income before $ 3,189 $ 2,958 $ 2,800 7.8% 5.6%
extraordinary loss and
cumulative effect of
accounting change
Extraordinary loss - $ (6,022) - - -
Cumulative effect of $ 90 - - - -
accounting change
Net income (loss) $ 3,279 $ (3,064) $ 2,800 - -
===============================================================================
SBC recognized an extraordinary loss in 1995 from the discontinuance of
regulatory accounting at SWBell and PacBell.
The primary factors contributing to the increase in income before extraordinary
loss and cumulative effect of accounting change in 1996 were growth in demand
for services and products at the Telephone Companies and Southwestern Bell
Mobile Systems, Inc. (Mobile Systems).
<PAGE>
Management's Discussion and Analysis, continued
Dollars in millions except per share amounts
The primary factors contributing to the increase in income before extraordinary
loss and cumulative effect of accounting change in 1995 were growth in demand
for services and products at the Telephone Companies and Mobile Systems, and an
after-tax gain of $111 associated with the merger of SBC's United Kingdom cable
television operations into TeleWest P.L.C. (TeleWest). These factors were
partially offset by an after-tax charge of $88 recorded in connection with SBC's
strategic functional realignment and revenue shortfalls due to the introduction
of intraLATA long-distance competition in California.
Items affecting the comparison of the operating results between 1996 and 1995,
and between 1995 and 1994, are discussed in the following sections.
Operating Revenues
Total operating revenues increased $1,774, or 8.2%, in 1996 and $706, or
3.4%, in 1995. Components of total operating revenues, including percentage
changes from the prior year, are as follows:
- -------------------------------------------------------------------------------
Percent Change
----------------
1996 1995
1996 1995 1994 vs. vs.
1995 1994
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Local service
Landline $ 8,754 $ 8,118 $ 7,494 7.8% 8.3%
Wireless 2,676 2,247 1,749 19.1 28.5
Network access
Interstate 4,008 3,770 3,525 6.3 7.0
Intrastate 1,823 1,744 1,679 4.6 3.8
Long-distance service 2,240 2,072 2,923 8.1 (29.1)
Directory advertising 1,985 1,984 1,950 0.1 1.7
Other 2,000 1,777 1,686 12.5 5.4
===============================================================
$ 23,486 $ 21,712 $ 21,006 8.2% 3.4%
===============================================================================
Local Service Landline revenues increased in 1996 due to increases in
demand, primarily increases in residential and business access lines and
vertical services revenues. Total access lines increased 4.6% in 1996, of
which 34% was due to growth in Texas and 46% to growth in California.
Access lines in Texas and California account for approximately 80% of the
Telephone Companies' access lines. Approximately 34% of access line growth
in 1996 was due to sales of additional access lines to existing residential
customers. Vertical services revenues, which include custom calling
options, Caller ID and other enhanced services, also increased in 1996.
Effective January 1, 1995, the California Public Utilities Commission
(CPUC) authorized interexchange carriers and others to compete with PacBell
in providing intraLATA long-distance service in California. That decision
also rebalanced prices for most of PacBell's regulated services, which
increased landline local service prices, so that PacBell could remain
competitive in the new environment. Landline local service revenues
increased in 1995 due to price rebalancing in California, which increased
revenue by $379, and increases in demand at the Telephone Companies,
primarily increases in residential and business access lines and vertical
services revenues. These increases were somewhat offset by price cap
revenue reductions ordered by the CPUC. The increased local service
revenues resulting from price rebalancing were more than offset by a
related $616 decrease in long-distance revenues. Total access lines
increased 3.7% in 1995, of which 37% was due to growth in Texas and 43% to
growth in California. Approximately 32% of access line growth in 1995 was
due to the sales of additional access lines to existing residential
customers. Vertical services revenues also increased in 1995.
Wireless revenues relate to Mobile Systems operations and increased in 1996
and 1995 due primarily to the growth in the number of Mobile Systems'
cellular customers of 20.7% and 22.7%. These increases were partially
offset by slight declines in average revenue per customer. Beginning in
1997, wireless revenues will also reflect personal communications services
(PCS) operations in California and Nevada.
Mobile Systems had 4,398,000 customers in areas in which they were one of
the two incumbent providers and 35,000 resale customers at December 31,
1996. These customer amounts were 3,659,000 and 13,000, respectively, at
December 31, 1995.
Network Access Interstate network access revenues increased in 1996 and
1995 due largely to increases in demand for access services by
interexchange carriers. Growth in revenues from end user charges,
attributable to an increasing access line base, also contributed to the
increases in both years. Net rate reductions under the FCC's revised price
cap plan, which were effective August 1, 1995, partially offset these
increases by approximately $115 in both 1996 and 1995.
Intrastate network access revenues increased in 1996 and 1995 due primarily
to increases in demand, including usage by alternative intraLATA toll
carriers. The increase in 1995 was partially offset by the decrease in
prices due to the introduction of competition for long-distance services in
California.
Long-Distance Service In 1996 and 1995 PAC provided approximately 55% - 60%
of SBC's long-distance revenues. Overall, long-distance revenues increased
in 1996 due principally to increases in demand resulting from California's
growing economy and growth in Mobile Systems' long-distance revenues,
including interLATA service that began in February 1996. Additionally,
long-distance service revenues increased due to the inclusion in 1995 of
SWBell intraLATA toll pool settlement payments and accruals for rate
reductions relating to an appealed 1992 rate order in Oklahoma. The
settlement of the appeals in October 1995 eliminated the need to continue
these accruals. Absent these accruals and settlements, SWBell long-distance
service revenues in 1996 would have decreased slightly due to the
continuing impact of price competition from alternative intraLATA toll
carriers. Long-distance service revenues decreased in 1995 primarily due to
an approximate 40% reduction in intraLATA long-distance prices in
California resulting from the introduction of competition for those
services and the related regulatory price rebalancing. Additionally, SWBell
long-distance services revenues experienced decreases, reflecting
competition-related decreases in residential message volumes and the impact
of optional calling plans and extended area service plans.
Directory Advertising revenues were relatively unchanged in 1996 as
increased yellow pages revenues from Southwestern Bell Yellow Pages, Inc.
(Yellow Pages) and Pacific Bell Directory (PBDirectory) were offset by the
decrease resulting from the January 1996 sale of SBC's publishing contracts
for GTE Corporation's service areas to GTE Directories. Excluding the
impact of this sale, revenues increased 5.1% in 1996. Results for 1995
reflect growth in yellow pages revenues, partially offset by the impact of
increased competition.
Other operating revenues in 1996 and 1995 reflect the increased demand for
voice-messaging services, Caller ID equipment, computer network services,
computer programming services and videoconferencing services. Other
increases in 1996 were attributable to revenues from new business
initiatives, such as wireless cable and internet services. The increase in
1995 was partially offset by the decrease in equipment sales revenues at
Mobile Systems resulting primarily from declining equipment prices.
Operating Expenses
Total operating expenses increased $1,058, or 6.4%, in 1996 and $536, or
3.3%, in 1995. Components of total operating expenses, including percentage
changes from the prior year, are as follows:
- -------------------------------------------------------------------------------
Percent Change
---------------
1996 1995
1996 1995 1994 vs. vs.
1995 1994
- -------------------------------------------------------------------------------
Cost of services and $ 8,220 $ 7,864 $ 7,917 4.5% 0.7%
products
Selling, general and 5,321 4,694 4,315 13.4 8.8
administrative
Depreciation and 4,109 4,034 3,824 1.9 5.5
amortization
- ----------------------------------------------------------------
$ 17,650 $ 16,592 $ 16,056 6.4% 3.3%
===============================================================================
Cost of Services and Products increased in 1996 due to increases at the
Telephone Companies for network expansion and maintenance, employee
compensation and demand-related increases. Other increases in 1996 reflect
growth at Mobile Systems, costs incurred to prepare for local competition
and PAC's new business initiatives, such as PCS, Internet access and
network integration. These increases were partially offset by PAC's
decreased employee benefits expenses due to changes in employee benefit
plans and benefit plan assumptions (see Note 9 to the financial
statements). In 1995, expenses decreased primarily due to decreased
California pool settlements with other local exchange carriers, force
reductions at PacBell, and decreased equipment costs at Mobile Systems. The
absence of expenses associated with SBC's United Kingdom cable television
operations (discussed in Other Business Matters) also contributed to the
decrease in 1995. These decreases were mostly offset by increases at the
Telephone Companies for network expansion and maintenance, demand-related
increases for enhanced services, and employee compensation at SWBell.
Selling, General and Administrative expenses increased in 1996 primarily
due to growth-related increases at Mobile Systems and the Telephone
Companies, including contracted services, employee compensation and
software costs. The increase in 1996 also reflects PAC's expenses incurred
to prepare support systems for local competition and for new business
initiatives, including long-distance. In 1995, expenses increased primarily
due to growth-related increases at Mobile Systems and SWBell, including
contracted services and advertising, the $139 charge for costs associated
with the strategic realignment discussed in Other Business Matters, and
software costs at PAC. These increases were somewhat offset by force
reductions at PacBell. Also contributing to the increases in both 1996 and
1995 were increases in operating taxes at SWBell, which include the Texas
Infrastructure Fund assessments.
Depreciation and Amortization increased in 1996 and 1995 due primarily to
growth in plant levels and changes in plant composition, primarily at the
Telephone Companies and Mobile Systems. The increase in 1995 also reflects
the effect of regulatory depreciation represcription at the Telephone
Companies.
<PAGE>
Interest Expense decreased $145, or 15.2%, in 1996 due to a change in PAC's
capital structure which replaced a portion of interest expense with amounts
recorded as Other Income (Expense) (see Note 7 to the financial statements),
lower long-term debt levels in SBC subsidiaries other than PAC, and
capitalization of interest during construction required by the discontinuance of
regulatory accounting in the third quarter of 1995. Under regulatory accounting,
the Telephone Companies accounted for capitalization of both interest and equity
costs during periods of construction as other income.
Equity in Net Income of Affiliates increased $87 in 1996 and decreased $106 in
1995. The 1996 increase reflects: increased income from Telefonos de Mexico,
S.A. de C.V. (Telmex), Mexico's national telecommunications company, due to the
relative stabilization of the peso; net gains on international affiliate
transactions; and improved results from SBC's investment in French cellular
operations, reflecting lower level of losses in its second year. Results for
1995 include losses on SBC's United Kingdom cable television operations, which
were accounted for under the equity method prior to October 1995, and exchange
losses on the non-peso denominated debt of Telmex. Results for 1996 and 1995
also reflect reductions in the translated amount of U.S. dollar earnings from
Telmex's operations. Operational growth at Telmex in both years somewhat offset
these declines. The 1995 decrease was also attributable to SBC's investment in
French cellular operations and PAC's video-related joint venture.
SBC's future earnings from Telmex will continue to be sensitive to changes in
the value of the peso. SBC's investment in Telmex has been recorded under U.S.
generally accepted accounting principles (GAAP), which exclude inflation
adjustments and include adjustments for the purchase method of accounting.
Beginning in 1997, SBC will use the U.S. dollar, instead of the peso, as the
functional currency for its investment in Telmex due to the Mexican economy
becoming highly inflationary as defined by GAAP. Earnings in 1997 will reflect
SBC's reduced ownership percentage in Telmex as discussed in Note 5 to the
financial statements. These changes are each expected to have a slightly
negative impact on Equity in Net Income from Telmex.
Other Income (Expense) - Net decreased $276 in 1996 and increased $210 in 1995.
In 1995, SBC recognized a gain from the merger of SBC's United Kingdom cable
television operations into TeleWest (see Note 13 to the financial statements)
and interest income from tax refunds. The increase was somewhat offset by
expenses associated with the refinancing of long-term debt by the Telephone
Companies (see Note 6 to the financial statements). Results for 1996 reflect the
inclusion in 1995 of these items and decreases due to the reclassification of
interest during construction required by the discontinuance of regulatory
accounting in the third quarter of 1995 as well as distributions paid on Trust
Originated Preferred Securities (TOPrS), as noted in the discussion of Interest
Expense. (see Note 7 to the financial statements).
Income Tax expense increased $441, or 29.0%, in 1996 and $71, or 4.9%, in 1995,
primarily due to higher income before income taxes. In 1995, tax refunds
received at PAC somewhat offset the increase. The elimination of excess deferred
taxes and the reduction in the amortization of investment tax credits resulting
from the discontinuance of regulatory accounting, as described in Note 2 to the
financial statements, also contributed to the increases in both years.
Extraordinary Loss In 1995, SBC recorded an extraordinary loss of $6 billion
from the discontinuance of regulatory accounting. The loss included a reduction
in the net carrying value of telephone plant and the elimination of net
regulatory assets of SWBell and PacBell (see Note 2 to the financial
statements).
<PAGE>
Cumulative Effect of Accounting Change As discussed in note 1 to the financial
statements, PBDirectory changed its method of recognizing directory publishing
revenues and related expenses effective January 1, 1996. The cumulative
after-tax effect of applying the new method to prior years is recognized as of
January 1, 1996 as a one-time, non-cash gain applicable to continuing operations
of $90, or $0.10 per share. The gain is net of deferred taxes of $53. Management
believes this change to the issue basis method is preferable because it is the
method generally followed in the publishing industry, including Yellow Pages,
and better reflects the operating activity of the business. This accounting
change is not expected to have a significant net income effect on future
periods.
Operating Environment and Trends of the Business
Regulatory Environment
The Telephone Companies' telecommunications operations are subject to regulation
by each of the seven states in which they operate for intrastate services and by
the FCC for interstate services. The Telephone Companies operate under incentive
regulation, or price caps, for various services provided by the Telephone
Companies. Under price cap regulation, the Telephone Companies are permitted to
establish and modify prices, not to exceed the price caps, subject to expedited
approval by the governing jurisdiction. Prices for some other services not
specifically covered by price caps are also subject to regulatory approval.
The FCC adopted revised interim price cap rules effective August 1, 1995 that
govern the prices that the larger Local Exchange Carriers (LECs), including the
Telephone Companies, charge interexchange carriers for access to local telephone
networks. Price caps set by the FCC are adjusted annually for inflation, a
productivity offset and certain other changes in costs. The productivity offset
is a fixed percentage used to reduce price caps and is designed to encourage
increased productivity. The revised rules allow a choice of three productivity
offsets, two of which provide for a sharing of profits with consumers above
certain earnings levels and the third of which has no sharing. Through 1996, the
Telephone Companies elected the 5.3% productivity offset with no sharing.
The revised FCC price cap plan was intended to be an interim plan that would be
revised in 1996. However, with the passage of the Telecommunications Act of 1996
(the Telecom Act), the FCC is conducting further proceedings to address various
pricing and productivity issues, and is performing a broader review of price cap
regulation in a competitive environment. Additionally, the FCC has stated it
will examine universal service and access charge rules during 1997. The Telecom
Act and FCC actions taken to implement provisions of the Telecom Act are
discussed further under the heading "Competition."
The states' regulatory bodies set intrastate price caps on various services for
various periods, depending upon the state. The price cap plans in California and
Nevada included sharing mechanisms; however, beginning in 1997, Nevada
implemented a new price cap plan which eliminated the sharing mechanism.
Following is a summary of significant state regulatory developments.
California The CPUC's form of price caps requires PacBell to submit an annual
price cap filing to determine prices for categories of services for each new
year. The price cap plan includes a sharing mechanism that requires PacBell to
share its earnings with customers at certain earnings levels. Price adjustments
reflect the effects of any change in inflation less productivity as well as
adjustments for certain exogenous cost changes. In December 1995, the CPUC
issued an order in its review of the regulatory framework in California that
suspended use of the "inflation minus productivity" component of the price cap
formula for 1996 through 1998. This action freezes the price caps on most of
PacBell's regulated services for the years 1996 through 1998 except for
adjustments due to exogenous costs or price changes approved through the CPUC's
price cap filing process. In December 1996, the CPUC adjusted PacBell's rates
due to various exogenous cost changes by an annual revenue reduction of
approximately $66 annually, effective January 1, 1997.
The CPUC issued its final decision on universal service on October 25, 1996,
establishing an annual California universal service fund of approximately $352
that will subsidize high cost service. Customers of all telecommunications
providers will contribute to the universal service fund via a 2.87% surcharge on
all bills for telecommunications services provided in California. Effective
February 1, 1997, the universal service fund will subsidize the provision of
service in high cost areas. In order to ensure revenue neutrality, PacBell must
reduce its rates dollar for dollar for amounts received from the fund via an
across the board surcredit on all products and services (except residential
basic exchange services) or permanent price reductions for those services that
previously subsidized universal service. The fund was intended to allow PacBell
to eliminate high cost subsidies from its prices, positioning PacBell for
competition. Initially, PacBell expects to receive $305 annually from the fund
based on CPUC estimates of the cost of providing universal service. Management
believes the new program underestimates the cost of providing universal service.
PacBell estimates that the average cost of providing service is up to 33% higher
per line per month than the CPUC estimate, which could result in high cost area
subsidies remaining in prices for competitive services. If this continues, it
would place PacBell at a competitive disadvantage.
In 1992, the CPUC issued a decision adopting, with modification, Statement of
Financial Accounting Standards No. 106, "Employers' Accounting for
Postretirement Benefits Other than Pensions" (FAS 106), for regulatory
accounting purposes. Annual price cap decisions by the CPUC granted PacBell
approximately $100 in each of the years 1993-1996 for partial recovery of higher
costs under FAS 106. In October 1994 the CPUC reopened the proceeding to
determine the criteria for exogenous cost treatment and whether PacBell should
continue to recover these costs. The CPUC's order also held that related
revenues collected after October 12, 1994, were subject to refund plus interest
pending further proceedings. On April 9, 1997, the CPUC completed these
proceedings and reaffirmed that postretirement benefits costs are appropriately
recoverable in PacBell's price cap filings.
The FCC adopted new separations rules effective May 1, 1997 that shift recovery
of substantial other billing and collections costs to the interstate
jurisdiction. This rule change could reduce PacBell's revenues by about $30 in
1997 and about $45 in each subsequent year. Management is evaluating options to
mitigate this effect on net income.
In 1992, a settlement agreement was reached between the State Board of
Equalization, all California counties, the State Attorney General, and 28
utilities, including PacBell, on a specific methodology for valuing utility
property for property tax purposes for a period of eight years. The CPUC opened
an investigation to determine if any resulting property tax savings should be
returned to customers. Intervenors have asserted that as much as $20 of annual
property tax savings should be treated as an exogenous cost reduction in
PacBell's annual price cap filings. These intervenors have also asserted that
past property tax savings totaling as much as approximately $70 as of December
31, 1996, plus interest should be returned to customers. Management believes
that, under the CPUC's regulatory framework, any property tax savings should be
treated only as a component of the calculation of shareable earnings and not as
an exogenous cost. In an Interim Opinion issued in June 1995, the CPUC decided
to defer a final decision on this matter pending resolution of the criteria for
exogenous cost treatment under its regulatory framework.
Texas The Public Utility Regulatory Act, which became effective in May 1995
(PURA), allows SWBell and other LECs to elect to move from rate of return
regulation to price regulation with elimination of earnings sharing. In
September 1995, SWBell notified the Texas Public Utility Commission (TPUC) that
it elected incentive regulation under the new law. Basic local service rates are
capped at existing levels for four years following the election. The TPUC is
prohibited from reducing switched access rates charged by LECs to interexchange
carriers while rates are capped.
LECs electing price regulation must commit to network and infrastructure
improvement goals, including expansion of digital switching and advanced
high-speed services to qualifying public institutions, such as schools,
libraries and hospitals, requesting the services. PURA also established an
infrastructure grant fund for use by public institutions in upgrading their
communications and computer technology. PURA provided for a total fund
assessment of $150 annually on all telecommunications providers in Texas for a
ten-year period, half of which would be paid by the cellular and wireless
industry. The provisions establishing different assessment rates for landline
and cellular and wireless service providers were ruled unconstitutional under
the Texas constitution in January 1996, and the lower rate was ordered to be
applied to both categories of service providers, resulting in less than a $150
annual assessment. Based on this order, SBC's total annual payment is estimated
to be approximately $35 to $45. The 1997 Texas legislative session is
considering this issue with the stated goal of restoring the assessment to its
original $150 annual amount. As a result, SBC's annual payment could increase.
PURA establishes local exchange competition by allowing other companies that
desire to provide local exchange services to apply for certification by the
TPUC, subject to certain build-out requirements, resale restrictions and minimum
service requirements. PURA provides that SWBell will remain the default carrier
of "1 plus" intraLATA long-distance traffic until SWBell is allowed to carry
interLATA long-distance.
In 1996, MCI Communications Corporation (MCI) and AT&T Corp. (AT&T) sued the
state of Texas, alleging that PURA violates the Texas state constitution, and
claiming that PURA establishes anticompetitive barriers designed to prevent MCI,
AT&T and Sprint Corporation (Sprint) from providing local services within Texas.
SBC is unable to predict the outcome of this proceeding. During 1996, the TPUC
approved the application of Sprint for a certificate of authority to provide
local service, waiving the build-out requirements specified under state law for
facilities-based certificates of authority. TPUC has also requested the FCC
issue an expedited ruling on whether PURA's build-out requirements are lawful
under the Telecom Act. AT&T and MCI have also filed petitions with the FCC
arguing the build-out requirements should be preempted; they have also requested
TPUC grant them similar treatment as Sprint. In a preliminary ruling, the TPUC
has waived build-out requirements for them.
More than 100 applications to provide competitive local service certification
have been approved by the TPUC, with over 30 more applications pending approval.
As a result, SWBell expects competition to continue to develop for local
service, but the specific financial impacts of this competition cannot be
reasonably estimated until all required tariff filings are approved by the TPUC
for SWBell and other companies intending to provide local service.
Missouri During 1996, the 1995 Cole County Circuit Court ruling which overturned
the August 1994 settlement agreement reached among SWBell, the Missouri Public
Service Commission (MPSC) and the Office of Public Counsel (OPC) was upheld on
appeal. The practical effect of this decision is to eliminate the prospective
commitments under the settlement agreement, including a rate review moratorium
and capital investment commitments. The decision has no immediate impact on
SWBell's current rates because they were approved by the MPSC in separate
proceedings, which were not appealed.
Oklahoma On October 30, 1995, the Oklahoma Corporation Commission (OCC) approved
a settlement that resolved pending court appeals of a 1992 rate order. Under the
terms of the settlement, SWBell paid a cash settlement of $170 to business and
residential customers, and offered discounts with a retail value of $268 for
certain SWBell services. Previously ordered rate reductions of $100 were lowered
to $84, of which $57 had already been implemented. The settlement allowed the
remaining $27 in rate reductions to be deferred, with approximately $9 becoming
effective in 1996 and the remainder during 1997. The settlement also provides
that no overearnings complaint can be filed against SWBell until January 1,
1998. SWBell began accruing for the order in 1992, and the settlement and
associated costs had been fully accrued as of the end of the third quarter of
1995.
Competitive Environment
Competition continues to increase in the telecommunications industry. Recent
changes in legislation and regulation have increased the opportunities for
alternative service providers offering telecommunications services.
Technological advances have expanded the types and uses of services and products
available. Accordingly, SBC faces increasing competition in significant portions
of its business.
Domestic
On February 8, 1996, the Telecom Act was enacted into law. The Telecom Act is
intended to address various aspects of competition within, and regulation of,
the telecommunications industry. The Telecom Act provides that all
post-enactment conduct or activities which were subject to the consent decree,
referred to as the Modification of Final Judgment (MFJ), issued at the time of
AT&T's divestiture of the Regional Holding Companies (RHCs) are now subject to
the provisions of the Telecom Act. In April 1996, the United States District
Court for the District of Columbia issued its Opinion and Order terminating the
MFJ and dismissing all pending motions related to the MFJ as moot. This ruling
effectively ended 13 years of RHC regulation under the MFJ. Among other things,
the Telecom Act also defines conditions SBC must comply with before being
permitted to offer interLATA long-distance service within California, Texas,
Missouri, Kansas, Oklahoma, Arkansas, and Nevada (regulated operating areas) and
establishes certain terms and conditions intended to promote competition for the
Telephone Companies' local exchange services.
Under terms of the Telecom Act, SBC may immediately offer interLATA
long-distance outside the regulated operating areas and over its wireless
network both inside and outside the regulated operating areas. Before being
permitted to offer landline interLATA long-distance service in any state within
the regulated operating areas, SBC must apply for and obtain state-specific
approval from the FCC. The FCC's approval, which involves consultation with the
United States Department of Justice, requires favorable determinations that the
Telephone Companies have entered into interconnection agreement(s) that satisfy
a 14-point "competitive checklist" with predominantly facilities based
carrier(s) that serve residential and business customers or, alternatively, that
the Telephone Companies have a statement of terms and conditions effective in
that state under which it offers the "competitive checklist" items. The FCC must
also make favorable public interest and structural separation determinations.
The Telecom Act directed the FCC to establish rules and regulations to implement
the Telecom Act, and to preempt specific state law provisions under certain
circumstances. The Telecom Act also allows RHCs to provide cable services over
their own networks, but sets limits on RHCs acquiring interests in cable
television operations in their regulated operating areas.
In August 1996, the FCC issued rules by which competitors could connect with
LECs' networks, including those of the Telephone Companies. Among other things,
the rules addressed unbundling of network elements, pricing for interconnection
and unbundled elements (Pricing Provisions), and resale of network services. The
FCC rules were appealed by numerous parties, including SBC, other LECs, various
state regulatory commissions and the National Association of Regulatory Utility
Commissioners.
On October 15, 1996, the United States Court of Appeals for the Eighth Circuit
(Eighth Circuit) issued an order to stay the FCC's Pricing Provisions and its
rules permitting new entrants to "pick and choose" among the terms and
conditions of approved interconnection agreements. The stay provides that it
will remain in effect while the Eighth Circuit considers the validity of the
rules. Other provisions of rules adopted by the FCC to implement the Telecom Act
remain in effect.
The effects of the FCC rules are dependent on many factors including, but not
limited to: the ultimate resolution of the pending appeals; the number and
nature of competitors requesting interconnection, unbundling or resale; and the
results of the state regulatory commissions' review and handling of related
matters within their jurisdictions. Accordingly, SBC is not able to assess the
impact of the FCC rules.
Landline Local Service
Recent state legislative and regulatory developmentsalso allow increased
competition for local exchange services. Companies wishing to provide
competitive local service have filed numerous applications with state
commissions throughout the Telephone Companies' regulated operating areas, and
the commissions of each state have begun approving these applications. Under the
Telecom Act, companies seeking to interconnect to the Telephone Companies'
network and exchange local calls must enter into interconnection agreements with
the Telephone Companies, which are then subject to approval by the appropriate
state commission. There have been approximately 190 companies approved by state
commissions to provide local telephone service throughout the Telephone
Companies' regulated operating areas, most of them in Texas and California.
There are approximately 70 more applications pending approval before the state
commissions. Several companies who have failed to agree on all interconnection
terms have filed for arbitration before the state commissions.
The CPUC authorized facilities-based local services competition effective
January 1996 and resale competition effective March 1996. Several issues still
need to be resolved before the CPUC issues final rules for local competition.
These issues include final rates for resale, presubscription, implementation of
number portability and LEC provisioning and pricing of essential network
functions to competitors. In order to provide services to resellers, PacBell
uses established operating support systems, and has implemented electronic
ordering systems and a customer care/billing center. Costs to implement local
competition, especially number portability, will be material and it is uncertain
whether regulators will allow for recovery of these costs. The CPUC expects to
issue final rules on presubscription in early 1997 and final rates and rules for
all other issues in late 1997. It is anticipated that competition will be
targeted mainly to high-density areas, where higher margins may be achieved.
Many of these competitors have placed facilities in service and begun extensive
advertising campaigns.
In October 1996, in a consolidated arbitration hearing between SWBell and AT&T,
MCI, MFS Communications Company, Inc. (MFS), Teleport Communications Group, and
American Communications Services, Inc., the TPUC approved interconnection rates
to be charged by SWBell as well as certain other terms of interconnection
between the parties. SWBell also filed revised cost support for the
establishment of rates with the TPUC which may be subject to further hearings.
SWBell, AT&T and MCI filed suit in state and federal court maintaining that, for
various reasons, the arbitration award is unlawful. SWBell has TPUC-approved
interconnection agreements with 26 local service providers, with 17 pending
approvals as of April 15.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing with
AT&T and MCI and on selected items with MFS. Among other terms, the orders
established discount rates for resale of SWBell services and prices for
unbundled network elements. SWBell has filed suit in federal court appealing the
orders as unlawful.
As a result of the Telecom Act and conforming interconnection agreements, the
Telephone Companies expect in 1997 they will experience local exchange
competition from multiple providers in various markets. Management is unable to
assess the effect of competition on the industry as a whole, or financially on
SBC, but expects both losses of market share in local service and gains
resulting from new business initiatives, vertical services and new service
areas. SBC intends to use approved agreements in support of its application to
the FCC to provide interLATA long-distance service in the Telephone Companies'
regulated operating areas.
The Telephone Companies also face competition from various local service
providers that bypass the local exchange network. Some of these providers have
built fiber optic "rings" throughout large metropolitan areas to provide
transport services (generally high-speed data) for large business customers and
interexchange carriers. Others provide high-usage customers, particularly large
businesses, alternative telecommunications links for voice and data, such as
private network systems, shared tenant services or private branch exchange (PBX)
systems (which are customer-owned and provide internal switching functions
without using a telephone company's central office facilities). The extent of
the economic incentive to bypass the local exchange network depends upon local
exchange prices, access charges, regulatory policy and other factors. End user
charges previously ordered by the FCC are designed in part to mitigate the
effect of system bypass.
Wireless Local Service
In 1993, the FCC adopted an order allocating radio spectrum and licenses for
PCS. PCS utilizes wireless telecommunications digital technology at a higher
frequency radio spectrum than cellular. Like cellular, it is designed to permit
access to a variety of communications services regardless of subscriber
location. In an FCC auction, which concluded in March 1995, PCS licenses were
awarded in 51 major markets. SBC acquired PCS licenses in the Major Trading
Areas (MTAs) of Los Angeles-San Diego, California; San Francisco-Oakland-San
Jose, California; Memphis, Tennessee; Little Rock, Arkansas; and Tulsa,
Oklahoma. The California licenses cover all of California and Nevada. SBC is
currently in the build out phase of PCS in most of its California-Nevada markets
and Tulsa, Oklahoma. During 1996, SBC received several AT&T cellular networks in
Arkansas in exchange for SBC's PCS licenses in Memphis, Tennessee and Little
Rock, Arkansas and other consideration.
In November 1996, Pacific Bell Mobile Services (PBMS) conducted an extensive PCS
trial in San Diego, California. Service was formally launched in San Diego in
January 1997, in February 1997 in Las Vegas, Nevada, and in March 1997 in
Sacramento, California. The network will incorporate the Global System for
Mobile Communications ("GSM") standard which is widely used in Europe. PBMS is
selling PCS as an off-the-shelf product in approximately 100 retail stores
across San Diego County, about 60 retail stores in Las Vegas and about 80 retail
stores in Sacramento. PBMS plans to offer PCS service in San Francisco and Los
Angeles in the second quarter of 1997. Management expects a widespread offering
of PCS service in most of California and Nevada by mid-1997. Management
anticipates significant competition, particularly from the two established
cellular companies in each market. However, a high quality product with
PacBell's service reputation should enable PBMS to establish a significant
presence in these markets.
In an FCC auction which concluded January 1997, SBC acquired eight additional
PCS licenses for Basic Trading Areas (BTAs) that are within the five-state area.
SBC plans to build out the new BTAs as part of its strategy to be a full service
telecommunications provider (expected completion 1999). Including these new BTAs
with existing cellular and PCS services, SBC will be able to offer wireless
services to approximately 85% of its landline local service customers in the
five-state area.
Companies granted licenses in MTAs and BTAs where SBC also provides service
include subsidiaries and affiliates of AT&T, Sprint and other RHCs. The degree
of competition which SBC will encounter in its cellular markets will depend, in
part, on the timing and extent of the build out of PCS services.
Long-distance
Competition continues to intensify in the Telephone Companies' intraLATA
long-distance markets. Principal competitors are interexchange carriers, bypass
service interexchange carriers which are assigned an access code (e.g., "10XXX")
used by their customers to route intraLATA calls through the interexchange
carrier's network, and resellers, which sell long-distance services obtained at
bulk rates. Effective January 1, 1995, the CPUC authorized intraLATA
long-distance services competition in California. In April 1995, the CPUC also
ordered PacBell to offer expanded interconnection to competitive access
providers. These competitors are allowed to carry the intrastate portion of
long-distance and intraLATA long-distance calls between PacBell's central
offices and long distance carriers. Competitors may choose to locate their
transmission facilities within or near PacBell's central offices. It is
estimated that PacBell now serves less than 50% of the business intraLATA
long-distance customers in its service areas. On April 11, 1997, SBC filed an
application with the FCC for the provision of interLATA long-distance services
in Oklahoma under the provisions of the Telecom Act. The OCC has approved SBC's
application.
Other
In the future, it is likely that additional competitors will emerge in the
telecommunications industry. Cable television companies and electric utilities
have expressed an interest in, or already are, providing telecommunications
services. As a result of recent and prospective mergers and acquisitions within
the industry, SBC may face competition from entities offering both cable TV and
telephone services in the Telephone Companies' regulated operating areas.
Interexchange carriers have been certified to provide local service, and a
number of other major carriers have publicly announced their intent to provide
local service in certain markets, some of which are in the Telephone Companies'
regulated operating areas.
SBC is aggressively representing its interests regarding competition before
federal and state regulatory bodies, courts, Congress and state legislatures.
SBC will continue to evaluate the increasingly competitive nature of its
business, and to develop appropriate competitive, legislative and regulatory
strategies.
International
Telmex was granted a concession in 1990, which expired in August 1996, as the
sole provider of long-distance services in Mexico. In 1995, the Mexican Senate
and Chamber of Deputies passed legislation encompassing a series of rules for
the introduction of competition into the Mexican long-distance market previously
issued by the Mexican Secretary of Communication and Transportation. Those rules
specified that there would be an unlimited number of long-distance concessions
and that Telmex was required to provide 60 interconnection points by January 1,
1997, and more than 200 interconnection points by the year 2000. Several large
competitors have received licenses to compete with Telmex and begun operations,
including a joint venture between AT&T and Alfa, a Mexican consortium, and
Avantel, S.A., a joint venture between MCI and Grupo Financiero Banamex-Accival,
Mexico's largest financial group. Balloting for presubscription of long-distance
service is currently occuring among Telmex's customers in selected areas.
Other Business Matters
Merger Agreement On April 1, 1997, SBC and PAC completed the merger of an SBC
subsidiary with PAC, in a transaction in which each share of PAC common stock
was exchanged for 0.73145 of a share of SBC common stock. With the merger, PAC
became a wholly-owned subsidiary of SBC. The transaction has been accounted for
as a pooling of interests and a tax-free reorganization. Accordingly, the
financial statements for the periods presented have been restated to include the
accounts of PAC (see Note 3 to the financial statements for more information).
Restructuring Reserve In December 1993, a reserve was established to record the
incremental cost of force reductions associated with restructuring PacBell's
business processes through 1997. This restructuring was expected to allow
PacBell to eliminate approximately 10,000 employee positions through 1997, net
of approximately 4,000 new positions expected to be created. Net force
reductions were 1,926 for 1996 and 9,168 for the three-year period 1994 through
1996. The pace of net force loss moderated in 1996 due to strong volume growth
at PacBell.
This table sets forth the status and activity of this reserve.
- -------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------
Balance - beginning of year $ 228 $ 819 $ 1,097
Additions - - -
Charges: cash outlays (195) (372) (216)
non-cash 64 (219) (62)
- -------------------------------------------------------------------------
Balance - end of year $ 97 $ 228 $ 819
=========================================================================
Charges to the restructuring reserve in 1996 totaled $131, including cash
outlays of $195 and a $64 non-cash charge reversal described below. In 1995,
PacBell charged $219 to the restructuring reserve for the non-cash cost through
1997 of enhanced retirement benefits negotiated in the 1995 union contracts, to
be paid from pension fund assets. Based on its experience, in 1996 PacBell
revised its estimate of these retirement costs. Consequently, $64 of these 1995
non-cash charges were reversed in 1996. There was no effect on net income from
either the 1995 charge or the 1996 change in this estimate. Management expects
to use the remaining reserve balance during 1997.
Effective with the merger, SBC has begun a complete review of all of its
subsidiaries, including subsidiaries of PAC. Approximately 50 review teams are
examining operational functions within the companies and evaluating all
strategic initiatives. The teams will identify synergies between the companies,
establish uniform system requirements and redirect strategic efforts. SBC cannot
currently estimate the amount of future savings to be derived from this process
or the amount of current and future costs associated with reorganizing functions
and reevaluating strategies that SBC will incur; however, significant changes in
strategic initiatives or combinations of common functions would result in
material charges to SBC's 1997 results of operations. SBC anticipates the review
teams will complete the evaluation phase by the end of the second quarter.
Acquisitions and Dispositions In addition to the acquisitions, dispositions and
the merger of SBC's United Kingdom cable television operations discussed in Note
13 to the financial statements, SBC has made several acquisitions and
dispositions since 1994.
In October 1994, SBC sold an additional 25% of its United Kingdom cable
television operations to Cox Cable Communications, accounting for the remaining
investment under the equity method of accounting until the 1995 merger of these
operations.
In 1995, SBC made the following acquisitions: a wireless system serving
Watertown, New York, and 100% of the stock of Cross Country Wireless (CCW), a
wireless cable television operator providing service to 40,000 customers in
Riverside, California and with licenses to provide service in Los Angeles,
Orange County and San Diego. The CCW acquisition involved the exchange of
approximately $120 of stock and assumption of $55 in debt. Additionally, SBC
made the following equity investments in 1995: a $317 investment for 40% of VTR
S.A. (VTR), a privately owned Chilean telecommunications holding company which
is 51% owned by Grupo Luksic, a large Chilean conglomerate and an investment in
a South African wireless company.
In 1996, SBC made the following additional investments: an investment to
maintain its indirect 10% ownership in a French cellular company to offset
dilution of its interest resulting from other equity sales, and an increase in
its holding in VTR to 49% through the purchase of shares from another minority
shareholder. Also in 1996, SBC and the other RHC's reached an agreement to sell
Bell Communications Research (Bellcore) in a transaction expected to close in
1997.
In March 1997, the consortium of SBC and Telekom Malaysia Berhad, which is 60%
owned by SBC, finalized an agreement to purchase 30% of Telkom South Africa
(Telkom), the state-owned telecommunications company of South Africa. Under the
agreement, SBC is committed to invest approximately $750, approximately $600 of
which will remain in Telkom. The transaction is expected to close in the second
quarter of 1997.
None of these transactions had a material effect on SBC's financial results in
1996, 1995 or 1994, nor does management expect them to have a material effect on
SBC's financial position or results of operations in 1997.
Strategic Realignment In July 1995, SBC announced a strategic realignment which
positions the company to be a single-source provider of telecommunications
services. All of SBC's operations within the five-state area report to one
management group, while international operations and domestic operations outside
the five-state area report to a separate management group.
In connection with this realignment of functions, in 1995 SBC recognized $139 in
selling, general and administrative expenses. These expenses include
postemployment benefits for approximately 2,400 employees arising from the
future consolidation of operations within the five-state area, streamlining
support and administrative functions and integrating financial systems.
Implementation of the realignment has been delayed due to the merger with PAC.
The charge reduced net income for 1995 by approximately $88.
<PAGE>
==============================================================================
Liquidity and Capital Resources
==============================================================================
Capital Expenditures and Other Commitments
To provide high-quality communications services to its customers, SBC,
particularly the Telephone Companies, Mobile Systems and SBC's PCS operations
must make significant investments in property, plant and equipment. The amount
of capital investment is influenced by demand for services and products,
continued growth and regulatory commitments.
SBC's capital expenditures totaled $5,481, $4,338 and $3,981 for 1996, 1995 and
1994. The Telephone Companies' capital expenditures increased 29% in 1996 and
11% in 1995 due primarily to demand-related growth, network upgrades,
customer-contracted requirements, ISDN projects, PCS build-out and SWBell's
regulatory commitments. SBC's capital expenditures increase in 1995 was also due
to PAC's expenditures for the PCS network. Mobile Systems expenditures increased
10% in 1996 and 6% in 1995 due to continued growth.
In 1997, management expects total capital spending to increase from 1996, to
between $5,800 and $6,000. Capital expenditures in 1997 will relate primarily to
the continued evolution of the Telephone Companies' networks, including amounts
agreed to under regulation plans at SWBell, and continued build out of Mobile
Systems' markets and PAC's PCS. SBC expects to fund ongoing capital expenditures
with cash provided by operations.
SWBell continues to make additional network and infrastructure improvements over
periods ranging through 2001 to satisfy regulatory commitments. Total capital
expenditures under these commitments will vary based on actual demand of
potential end users. SWBell anticipates spending approximately $150 to $200 in
1997 associated with these commitments.
PacBell has purchase commitments of approximately $208 remaining in connection
with its previously announced program for deploying an all-digital switching
platform with ISDN and SS-7 capabilities.
In December 1994, PacBell contracted for the purchase of up to $2,000 in
Advanced Communications Network (ACN) facilities, which incorporated new
technologies. During 1995, the ability to deploy the facilities outstripped the
ACN vendor's ability to deliver necessary products and software. Accordingly,
management decided to suspend construction at certain sites, which reduced the
expected cost to less than $700. If ACN facilities meet certain quality and
performance criteria (the Network Test), PacBell is committed to purchase the
ACN facilities in 1998. If ACN facilities are acquired, due to competition or
other factors affecting PacBell's ability to recover its investment in these
facilities, their value to PacBell could be materially impaired. If ACN
facilities fail the Network Test, PacBell will not be committed to buy the ACN
facilities but might be liable to reimburse the principal ACN vendor for some
construction costs up to $300, which would also result in a material charge.
As discussed in Other Business Matters, SBC has committed to invest
approximately $750 under its agreement to purchase a stake in Telkom South
Africa. The transaction is expected to be completed in the second quarter of
1997.
Over the next few years, SBC is expecting to incur significant software
expenditures for interconnection and customer number portability. The extent and
timing of these expenditures will vary depending on the timing and nature of
regulatory actions and corresponding or compensating network improvements, but
are likely to be material.
<PAGE>
Dividends Declared
Dividends declared by the Board of Directors of SBC were $1.72 per share in
1996, $1.65 per share in 1995, and $1.58 per share in 1994. These per share
amounts do not include dividends declared and paid by PAC prior to the merger.
Including those PAC dividends, total dividends paid were $1,680 in 1996, $1,933
in 1995 and $1,878 in 1994. Pursuant to the terms of the merger agreement, PAC
reduced its 1996 second, third and fourth quarter dividends. The lower second
and third quarter dividends paid in 1996 improved 1996 cash flow by
approximately $195. Management's dividend policy considers both the expectations
and requirements of shareowners, internal requirements of SBC and long-term
growth opportunities.
Cash, Lines of Credit and Cash Flows
SBC had $314 of cash and cash equivalents available at December 31, 1996.
Commercial paper borrowings as of December 31, 1996, totaled $1,848. SBC has
entered into agreements with several banks for lines of credit totaling $3,550
all of which may be used to support commercial paper borrowings (see Note 6 to
the Financial Statements). SBC had no borrowings outstanding under these lines
of credit as of December 31, 1996.
During 1996, as in 1995 and 1994, SBC's primary source of funds continued to be
cash generated from operations, as shown in the Consolidated Statements of Cash
Flows. Net cash provided by operating activities exceeded SBC's construction and
capital expenditures during 1996, as in 1995 and 1994; this excess is referred
to as free cash flow, a supplemental measure of liquidity. SBC generated free
cash flow of $1,935, $2,452 and $2,952 in 1996, 1995 and 1994.
During 1996 PAC issued $1,000 of TOPrS, $500 at 7.56% in January 1996 and $500
at 8.5% in June 1996 (see Note 7 to the financial statements). The proceeds were
used to retire outstanding short-term debt, primarily commercial paper which had
increased significantly during 1995.
During 1996 and 1995, the Telephone Companies refinanced long-term debt with an
aggregate principal amount of $964.
Total Capital
SBC's total capital consists of debt (long-term debt and debt maturing within
one year), TOPrS and shareowners' equity. Total capital increased $1,844 in 1996
and decreased $4,006 in 1995. The increase in 1996 was due to PAC's increased
financing requirements and the reinvestment of earnings, partially offset by the
acquisition of treasury shares. The decrease in 1995 was due to the effects of
the discontinuance of regulatory accounting. Absent this extraordinary charge,
total capital increased by $2,016 in 1995 due primarily to the reinvestment of
earnings and increased commercial paper borrowings, partially offset by foreign
currency translation adjustments resulting from the decline in the value of the
Mexican peso.
Debt Ratio
SBC's debt ratio was 55.5%, 61.7% and 48.6% at December 31, 1996, 1995 and 1994.
The debt ratio is affected by the same factors that affect total capital. For
1995, the decrease in equity caused by the discontinuance of regulatory
accounting increased the debt ratio by 13.2 percentage points.
Share Repurchases
See Note 12 to the financial statements.
Employee Stock Ownership Plans
See Note 10 to the financial statements.
<PAGE>
Report of Independent Auditors
The Board of Directors and Shareowners
SBC Communications Inc.
We have audited the accompanying supplemental consolidated balance sheets of SBC
Communications Inc. (formed as a result of the consolidation of SBC
Communications Inc. (SBC) and Pacific Telesis Group (PAC)) as of December 31,
1996 and 1995, and the related supplemental consolidated statements of income,
shareowners' equity and cash flows for each of the three years in the period
ended December 31, 1996. The supplemental consolidated financial statements give
retroactive effect to the merger of SBC and PAC on April 1, 1997, which has been
accounted for using the pooling of interests method as described in the notes to
the supplemental consolidated financial statements. These supplemental
consolidated financial statements are the responsibility of SBC's management.
Our responsibility is to express an opinion on these supplemental consolidated
financial statements based on our audits. We did not audit the financial
statements of PAC which statements reflect total assets constituting 42% for
1996 and 43% for 1995 of the related supplemental consolidated financial
statement totals, and which reflect total operating revenues constituting
approximately 41%, 42% and 44% of the related supplemental consolidated
financial statement totals for the years ended December 31, 1996, 1995 and 1994.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to data included for PAC, is based
solely on the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion, based on our audits and the report of other auditors, the
supplemental consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of SBC
Communications Inc. at December 31, 1996 and 1995, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1996, after giving retroactive effect to the merger of PAC,
as described in Note 3 to the supplemental consolidated financial statements, in
conformity with generally accepted accounting principles.
As discussed in Note 3, the supplemental consolidated financial statements
include the effects of changes applied retroactively to conform accounting
methodologies between PAC and SBC. As discussed in Note 1 to the supplemental
consolidated financial statements, Pacific Bell, a subsidiary of PAC, changed
its method of recognizing directory publishing revenues and related expenses
effective January 1, 1996. As discussed in Note 2 to the supplemental
consolidated financial statements, SBC discontinued its application of Statement
of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain
Types of Regulation" in 1995.
ERNST & YOUNG LLP
San Antonio, Texas
February 14, 1997,
except for Note 3, as to which the date is
April 1, 1997
<PAGE>
<TABLE>
SBC Communications Inc.
Consolidated Statements of Income
Dollars in millions except per share amounts
<CAPTION>
- --------------------------------------------------------------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Revenues
Local service $ 11,430 $ 10,365 $ 9,243
Network access 5,831 5,514 5,204
Long-distance service 2,240 2,072 2,923
Directory advertising 1,985 1,984 1,950
Other 2,000 1,777 1,686
- --------------------------------------------------------------------------------------------
Total operating revenues 23,486 21,712 21,006
- --------------------------------------------------------------------------------------------
Operating Expenses
Cost of services and products 8,220 7,864 7,917
Selling, general and administrative 5,321 4,694 4,315
Depreciation and amortization 4,109 4,034 3,824
- --------------------------------------------------------------------------------------------
Total operating expenses 17,650 16,592 16,056
- --------------------------------------------------------------------------------------------
Operating Income 5,836 5,120 4,950
- --------------------------------------------------------------------------------------------
Other Income (Expense)
Interest expense (812) (957) (935)
Equity in net income of affiliates 207 120 226
Other income (expense) - net (82) 194 (16)
- --------------------------------------------------------------------------------------------
Total other income (expense) (687) (643) (725)
- --------------------------------------------------------------------------------------------
Income From Continuing Operations Before Income Taxes,
Extraordinary Loss and Cumulative Effect of
Accounting Change 5,149 4,477 4,225
- --------------------------------------------------------------------------------------------
Income taxes 1,960 1,519 1,448
- --------------------------------------------------------------------------------------------
Income from Continuing Operations 3,189 2,958 2,777
Income from spun-off operations, net of tax - - 23
- --------------------------------------------------------------------------------------------
Income Before Extraordinary Loss and Cumulative Effect
of Accounting Change 3,189 2,958 2,800
- --------------------------------------------------------------------------------------------
Extraordinary Loss from Discontinuance of Regulatory
Accounting, net of tax - (6,022) -
Cumulative Effect of Accounting Change, net of tax 90 - -
- --------------------------------------------------------------------------------------------
Net Income (Loss) $ 3,279 $ (3,064) $ 2,800
- --------------------------------------------------------------------------------------------
Earnings Per Common Share:
Income from Continuing Operations $ 3.46 $ 3.22 $ 3.04
Income from spun-off operations - - .03
- --------------------------------------------------------------------------------------------
Income Before Extraordinary Loss and Cumulative
Effect of Accounting Change 3.46 3.22 3.07
- --------------------------------------------------------------------------------------------
Extraordinary Loss - (6.55) -
Cumulative Effect of Accounting Change .10 - -
- --------------------------------------------------------------------------------------------
Net Income (Loss) $ 3.56 $ (3.33) $ 3.07
- --------------------------------------------------------------------------------------------
Weighted Average Number of Common
Shares Outstanding (in millions) 921 920 912
- --------------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
- ------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------
SBC Communications Inc.
Consolidated Balance Sheets
Dollars in millions except per share amounts
<CAPTION>
- --------------------------------------------------------------------------------------
December 31,
---------------------------
1996 1995
- --------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents $ 314 $ 566
Short-term cash investments 432 243
Accounts receivable - net of allowances for
uncollectibles of
$311 and $266 4,684 3,995
Prepaid expenses 287 198
Deferred charges 102 369
Other current assets 452 666
- --------------------------------------------------------------------------------------
Total current assets 6,271 6,037
- --------------------------------------------------------------------------------------
Property, Plant and Equipment - Net 26,080 24,374
- --------------------------------------------------------------------------------------
Intangible Assets - Net of Accumulated Amortization of
$611 and $543 3,589 3,635
- --------------------------------------------------------------------------------------
Investments in Equity Affiliates 1,964 1,616
- --------------------------------------------------------------------------------------
Other Assets 1,581 1,450
- --------------------------------------------------------------------------------------
Total Assets $ 39,485 $ 37,112
- --------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SBC Communications Inc.
Consolidated Balance Sheets
Dollars in millions except per share amounts
<CAPTION>
- --------------------------------------------------------------------------------------
December 31,
---------------------------
1996 1995
- --------------------------------------------------------------------------------------
<S> <C> <C>
Liabilities and Shareowners' Equity
Current Liabilities
Debt maturing within one year $ 2,335 $ 3,210
Accounts payable and accrued liabilities 6,584 6,026
Dividends payable 393 484
- --------------------------------------------------------------------------------------
Total current liabilities 9,312 9,720
- --------------------------------------------------------------------------------------
Long-Term Debt 10,930 10,409
- --------------------------------------------------------------------------------------
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 853 447
Postemployment benefit obligation 5,070 5,202
Unamortized investment tax credits 498 578
Other noncurrent liabilities 2,181 2,313
- --------------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities 8,602 8,540
- --------------------------------------------------------------------------------------
Commitments and contingencies
- --------------------------------------------------------------------------------------
Corporation-obligated mandatorily redeemable preferred
securities of
subsidiary trusts* 1,000 -
- --------------------------------------------------------------------------------------
Shareowners' Equity
Preferred shares ($1 par value, 10,000,000 authorized: - -
none issued)
Common shares ($1 par value, 2,200,000,000 authorized:
issued 933,772,624 at December 31, 1996 and
933,861,842 at December 31, 1995) 934 934
Capital in excess of par value 9,422 9,398
Retained earnings (deficit) 1,297 (316)
Guaranteed obligations of employee stock ownership plans (229) (272)
Deferred Compensation - LESOP trust (161) (242)
Foreign currency translation adjustment (637) (578)
Treasury shares (20,616,939 at December 31, 1996 and
11,122,981 at December 31, 1995, at cost) (985) (481)
- --------------------------------------------------------------------------------------
Total shareowners' equity 9,641 8,443
- --------------------------------------------------------------------------------------
Total Liabilities and Shareowners' Equity $ 39,485 $ 37,112
- --------------------------------------------------------------------------------------
<FN>
* The trusts contain assets of $1,030 in principal amount of the Subordinated
Debentures of Pacific Telesis Group. The accompanying notes are an integral part
of the consolidated financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SBC Communications Inc.
Consolidated Statements of Cash Flows
Dollars in millions, increase (decrease) in cash and cash
equivalents
- -------------------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Activities
Net income (loss) $ 3,279 $ (3,064) $ 2,800
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 4,109 4,034 3,824
Undistributed earnings from investments in equity (138) (58) (134)
affiliates
Provision for uncollectible accounts 395 346 305
Amortization of investment tax credits (80) (95) (124)
Deferred income tax expense 626 609 (20)
Extraordinary loss, net of tax - 6,022 -
Cumulative effect of accounting change, net of tax (90) - -
Spun-Off Operations - - (23)
Changes in operating assets and liabilities:
Accounts receivable (765) (463) (493)
Other current assets (50) 77 (97)
Accounts payable and accrued liabilities 632 (76) 556
Other - net (502) (542) 321
- -------------------------------------------------------------------------------------------
Total adjustments 4,137 9,854 4,115
- -------------------------------------------------------------------------------------------
Net Cash Provided by Continuing Operations 7,416 6,790 6,915
- -------------------------------------------------------------------------------------------
Net Cash Provided by Spun-off Operations - - 18
- -------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 7,416 6,790 6,933
- -------------------------------------------------------------------------------------------
Investing Activities
Construction and capital expenditures (5,481) (4,338) (3,981)
Investments in affiliates (74) (54) (25)
Purchase of short-term investments (1,005) (704) (325)
Proceeds from short-term investments 816 587 390
Dispositions 96 14 296
Acquisitions (442) (1,186) (1,238)
Net investment in spun-off operations - - 33
- -------------------------------------------------------------------------------------------
Net Cash Used in Continuing Operations (6,090) (5,681) (4,850)
- -------------------------------------------------------------------------------------------
Net Cash used in spun-off operations - - (332)
- -------------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (6,090) (5,681) (5,182)
- -------------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SBC Communications Inc.
Consolidated Statements of Cash Flows
Dollars in millions, increase (decrease) in cash and cash
equivalents
<CAPTION>
- -------------------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Financing Activities
Net change in short-term borrowings with original
maturities of three months or less (977) 1,402 (129)
Issuance of other short-term borrowings 209 91 36
Repayment of other short-term borrowings (134) (91) (41)
Issuance of long-term debt 989 981 355
Repayment of long-term debt (408) (1,086) (462)
Early extinguishment of debt and related call premiums - (465) -
Issuance of trust originated preferred securities 1,000 - -
Issuance of common shares 111 74 180
Purchase of treasury shares (650) (216) (447)
Issuance of treasury shares 52 82 18
Dividends paid (1,664) (1,814) (1,744)
Other (106) - (18)
- -------------------------------------------------------------------------------------------
Net Cash Used in Continuing Operations (1,578) (1,042) (2,252)
- -------------------------------------------------------------------------------------------
Net cash provided by spun-off operations - - 39
- -------------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (1,578) (1,042) (2,213)
- -------------------------------------------------------------------------------------------
Net Cash Provided by (Used in) all Activities (252) 67 (462)
- -------------------------------------------------------------------------------------------
Less spun-off operations - - (275)
- -------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (252) 67 (187)
- -------------------------------------------------------------------------------------------
Cash and cash equivalents beginning of year 566 499 686
- -------------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Year $ 314 $ 566 $ 499
- -------------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the consolidated financial
statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SBC Communications Inc.
Consolidated Statements of Shareowners' Equity
Dollars in millions except per share amounts
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Guaranteed
Obligation
of Deferred
Employee Compensation Foreign
Capital in Stock of Currency
Common Shares Excess of Retained Ownership Employee Stock Translation Treasury Shares
Shares Amount Par Value Earnings Plans Trust Adjustment Shares Amount
(Deficit)
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1993 912,191,021 $912 $11,400 $3,757 $(353) $(386) $(39) (2,510,404) $(110)
Net income for the year
($3.07 per share) - - - 2,800 - - - - -
Dividends to shareowners
($1.58 per share) - - - (1,878) - - - - -
Spun-off stock distribution - - (2,901) - - - - - -
Reduction of debt associated with
Employee Stock Ownership Plans - - - - 38 - - - -
Cost of LESOP trust shares allocated
to
employee accounts - - - - - 80 - - -
Foreign currency translation
adjustment,
net of income tax benefit of $197 - - - - - - (324) - -
Issuance of common shares:
Dividend Reinvestment Plan 3,334,668 4 134 - - - - - -
Other issuances 15,140,077 15 621 - - - - - -
Purchase of treasury shares - - - - - - - (11,301,550) (447)
Issuance of treasury shares - - 4 - - - - 2,410,326 94
Other - - - (14) - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1994 930,665,766 931 9,258 4,665 (315) (306) (363) (11,401,628) (463)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss) for the year
($(3.33) per share) - - - (3,064) - - - - -
Dividends to shareowners
($1.65 per share) - - - (1,933) - - - - -
Reduction of debt associated with
Employee Stock Ownership Plans - - - - 43 - - - -
Cost of LESOP trust shares
allocated to
employee accounts - - - - - 64 - - -
Foreign currency translation -
adjustment,
net of income tax benefit of - - - - - - (215) - -
$116
Issuances of common shares 3,196,076 3 129 - - - - - -
Purchase of treasury shares - - - - - - - (4,610,713) (216)
Issuance of treasury shares:
Dividend Reinvestment Plan - - 19 - - - - 2,730,666 111
Other issuances - - (8) - - - - 2,158,694 87
Other - - - 16 - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1995 933,861,842 934 9,398 (316) (272) (242) (578) (11,122,981) (481)
- ------------------------------------------------------------------------------------------------------------------------------------
Net income for the year
($3.56 per share) - - - 3,279 - - - - -
Dividends to shareowners
($1.72 per share) - - - (1,680) - - - - -
Reduction of debt associated with
Employee Stock Ownership Plans - - - - 43 - - - -
Cost of LESOP trust shares
allocated to
employee accounts - - - - - 81 - - -
Foreign currency translation
adjustment,
net of income tax benefit of $28 - - - - - (59) - -
Purchases of common shares (89,218) - - - - - - - -
Purchase of treasury shares - - - - - - - (13,099,709) (650)
Issuance of treasury shares:
Dividend Reinvestment Plan - - 26 - - - - 2,667,752 109
Other issuances - - (5) - - - - 937,999 37
Other - - 3 14 - - - - -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 1996 933,772,624 $934 $9,422 $1,297 $(229) $(161) $(637) (20,616,939) $(985)
- ------------------------------------------------------------------------------------------------------------------------------------
- ---------
Total
- ---------
<C>
$15,181
- ---------
13,407
- ---------
- ---------
8,443
- ---------
- ---------
$9,641
- ---------
<FN>
The accompanying notes are an integral part of the consolidated financial statements.
</FN>
</TABLE>
<PAGE>
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements
- --------------------------------------------------------------------------------
Dollars in millions except per share amounts
1. Summary of Significant Accounting Policies
Basis of Presentation - The consolidated financial statements include the
accounts of SBC Communications Inc. and its majority-owned subsidiaries
(SBC). SBC's subsidiaries and affiliates operate predominantly in the
communications services industry, providing landline and wireless
telecommunications services and equipment, directory advertising and cable
television services both domestically and worldwide.
SBC's largest subsidiaries are Southwestern Bell Telephone Company
(SWBell) providing telecommunications services in Texas, Missouri,
Oklahoma, Kansas and Arkansas (five-state area), and Pacific Telesis Group
(PAC), providing telecommunications services in California and Nevada.
PAC's subsidiaries include Pacific Bell (PacBell, which also includes its
subsidiaries) and Nevada Bell. (SWBell, PacBell and Nevada Bell are
collectively referred to as the Telephone Companies.)
All significant intercompany transactions are eliminated in the
consolidation process. Investments in partnerships, joint ventures and
less than majority-owned subsidiaries are principally accounted for under
the equity method. Earnings from certain foreign investments accounted for
under the equity method are included for periods ended within three months
of SBC's year end.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
Income Taxes - Deferred income taxes are provided for temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for tax purposes.
Investment tax credits earned prior to their repeal by the Tax Reform Act
of 1986 are amortized as reductions in income tax expense over the lives
of the assets which gave rise to the credits.
Cash Equivalents - Cash equivalents include all highly liquid investments
with original maturities of three months or less.
Deferred Charges - Directory advertising costs are deferred until the
directory is published and advertising revenues related to these costs are
recognized.
Cumulative Effect of Accounting Change - Prior to January 1, 1996, Pacific
Bell Directory (a subsidiary of PacBell) recognized revenues and expenses
related to publishing directories in California using the "amortization"
method, under which revenues and expenses were recognized over the lives
of the directories, generally one year. The change in methodology was made
because it is the method generally followed in the publishing industry,
including Southwestern Bell Yellow Pages, and better reflects the
operating activity of the business.
The cumulative after-tax effect of applying the change in method to prior
years is recognized as of January 1, 1996 as a one-time, non-cash gain
applicable to continuing operations of $90, or $0.10 per share. The gain
is net of deferred taxes of $53. Had the current method been applied
during 1995 and 1994, income before extraordinary loss and accounting
change would not have been materially affected.
<PAGE>
- --------------------------------------------------------------------------------
Notes to Consolidated Financial Statements, continued
- --------------------------------------------------------------------------------
Dollars in millions except per share amounts
<PAGE>
2. Property, Plant and Equipment - Property, plant and equipment is stated at
cost. The cost of additions and substantial betterments of property, plant
and equipment is capitalized. The cost of maintenance and repairs of
property, plant and equipment is charged to operating expenses. Property,
plant and equipment is depreciated using straight-line methods over their
estimated economic lives, generally ranging from 3 to 50 years. Prior to
the discontinuance of regulatory accounting in the third quarter of 1995,
SWBell and PacBell computed depreciation using certain straight-line
methods and rates as prescribed by regulators. In accordance with
composite group depreciation methodology, when a portion of the Telephone
Companies' depreciable property, plant and equipment is retired in the
ordinary course of business, the gross book value is charged to
accumulated depreciation; no gain or loss is recognized on the disposition
of this plant.
Intangible Assets - Intangible assets consist primarily of wireless
cellular, PCS and television licenses, cable television licenses, customer
lists and the excess of consideration paid over net assets acquired in
business combinations. These assets are being amortized using the
straight-line method, over periods generally ranging from 5 to 40 years.
At December 31, 1996 and 1995, amounts included in net intangible assets
for licenses were $2,695 and $2,692. Management periodically reviews the
carrying value and lives of all intangible assets based on expected future
cash flows.
Software Costs - The costs of computer software purchased or developed for
internal use are expensed as incurred. However, initial operating system
software costs are capitalized and amortized over the lives of the
associated hardware.
Advertising Costs - Costs for advertising products and services or
corporate image are expensed as incurred.
Foreign Currency Translation - Local currencies are generally considered
the functional currency for SBC's share of foreign operations, except in
countries considered highly inflationary. SBC translates its share of
foreign assets and liabilities at current exchange rates. Revenues and
expenses are translated using average rates during the year. The ensuing
foreign currency translation adjustments are recorded as a separate
component of Shareowners' Equity. Other transaction gains and losses
resulting from exchange rate changes on transactions denominated in a
currency other than the local currency are included in earnings as
incurred.
Earnings Per Common Share - The earnings per common share computation uses
the weighted average number of common shares outstanding, including shares
held by employee stock ownership plans. Common stock equivalents
outstanding are not considered dilutive.
2. Discontinuance of Regulatory Accounting
In the third quarter of 1995, SWBell and PacBell discontinued their
application of Statement of Financial Accounting Standards No. 71,
"Accounting for the Effects of Certain Types of Regulation" (FAS 71). FAS
71 requires depreciation of telephone plant using lives set by regulators
which are generally longer than those established by unregulated
companies, and deferral of certain costs and obligations based on
regulatory actions (regulatory assets and liabilities). As a result of the
adoption of price-based regulation for most of SWBell's revenues and the
acceleration of competition in the California and five-state area
telecommunications markets, management determined that SWBell and PacBell
no longer met the criteria for application of FAS 71.
<PAGE>
Upon discontinuance of FAS 71 by SWBell and PacBell, SBC recorded a
non-cash, extraordinary charge to net income of $6,022 (after a net
deferred tax benefit of $4,037). This charge was comprised of an after-tax
charge of $5,739 to reduce the net carrying value of telephone plant, and
an after-tax charge of $283 for the elimination of net regulatory assets.
The components of the charge were as follows:
-----------------------------------------------------------------------
Pre-tax After-tax
-----------------------------------------------------------------------
Increase telephone plant accumulated $ 9,476 $ 5,739
depreciation
Elimination of net regulatory assets 583 283
=======================================================================
Total $10,059 $ 6,022
=======================================================================
The increase in accumulated depreciation of $9,476 reflected the effects
of adopting depreciable lives for SWBell's and PacBell's plant categories
which more closely reflect the economic and technological lives of the
plant. The adjustment was supported by discounted cash flow analyses which
estimated amounts of telephone plant that may not be recoverable from
discounted future cash flows. These analyses included consideration of the
effects of anticipated competition and technological changes on plant
lives and revenues.
Following is a comparison of new lives to those prescribed by regulators
for selected plant categories:
------------------------------------------------------------------------
Average Lives (in Years)
------------------------------------------------------------------------
Regulator- Estimated
Prescribed Economic
-------------------------------------------------------------------------
Digital switch 17 10-11
Digital circuit 10-12 7-8
Copper cable 19-26 14-18
Fiber cable 27-30 20
Conduit 57-59 50
=========================================================================
The increase in accumulated depreciation at SWBell also included an
adjustment of approximately $450 to fully depreciate analog switching
equipment scheduled for replacement. Remaining analog switching equipment
is being depreciated using an average remaining life of four years.
The discontinuance of FAS 71 for external financial reporting purposes
also required the elimination of net regulatory assets of $583. Regulatory
assets and liabilities are related primarily to accounting policies used
by regulators in the ratemaking process which are different from those
used by non-regulated companies. The differences arose predominantly in
the accounting for income taxes, deferred compensated absences, and, in
California, pension costs and debt redemption costs. These items are
required to be eliminated with the discontinuance of accounting under FAS
71. SWBell and PacBell accounting and reporting for regulatory purposes
are not affected by the discontinuance of FAS 71 for external financial
reporting purposes.
With the discontinuance of FAS 71, SWBell and PacBell began accounting for
interest on funds borrowed to finance construction as an increase in
property, plant and equipment and a reduction of interest expense. Under
the provisions of FAS 71, both companies capitalized both interest and
equity costs allowed by regulators during periods of construction as other
income and as an addition to the cost of plant constructed. Additionally,
PacBell began accounting for pension costs under Statement of Financial
Accounting Standards No. 87, "Employers' Accounting for Pensions," (FAS
87) and Statement of Financial Accounting Standards No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension
Plans and for Termination Benefits" (FAS 88).
<PAGE>
3. Merger Agreement
On April 1, 1997, SBC and PAC completed the merger of an SBC subsidiary
with PAC, in a transaction in which each share of PAC common stock was
exchanged for 0.73145 of a share of SBC common stock (equivalent to
approximately 313 million shares). With the merger, PAC became a
wholly-owned subsidiary of SBC. The transaction has been accounted for as
a pooling of interests and a tax-free reorganization. Accordingly, the
financial statements for the periods presented have been restated to
include the accounts of PAC. These are supplemental consolidated financial
statements which will become the historical consolidated financial
statements of SBC upon issuance of financial statements for the quarter
ending June 30, 1997.
Operating revenues, income before extraordinary loss and cumulative effect
of accounting change and net income (loss) of the separate companies for
the last three years were as follows:
- -------------------------------------------------------------------------------
Year Ended December 31, 1996 1995 1994
- -------------------------------------------------------------------------------
Operating revenues:
SBC $ 13,898 $ 12,670 11,772
PAC 9,588 9,042 9,234
- -------------------------------------------------------------------------------
Combined $ 23,486 $ 21,712 $ 21,006
- -------------------------------------------------------------------------------
Income before extraordinary loss and
cumulative effect
of accounting change:
SBC $ 2,101 $ 1,889 $ 1,649
PAC 1,057 1,048 1,159
Adjustments 31 21 (8)
- -------------------------------------------------------------------------------
Combined $ 3,189 $ 2,958 $ 2,800
- -------------------------------------------------------------------------------
Net income (loss):
SBC $ 2,101 $ (930) $ 1,649
PAC 1,142 (2,312) 1,159
Adjustments 36 178 (8)
- -------------------------------------------------------------------------------
Combined $ 3,279 $ (3,064) $ 2,800
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
The combined results include the effect of changes applied retroactively
to conform accounting methodologies between PAC and SBC for, among other
items, pensions, postretirement benefits, sales commissions and merger
transaction costs as well as certain deferred tax adjustments resulting
from the merger. In each case, SBC believes the new methods are more
prevelent and better reflect the operations of the business. Transaction
costs and one-time charges relating to the closing of the merger were $359
($215 net of tax) including, among other items, the present value of
amounts to be returned to California ratepayers as a condition of the
merger and expenses for investment banker and professional fees. Of this
amount, $72 is included in expenses in 1996. The remainder will be
reflected in 1997 expenses.
Effective with the merger, SBC has begun a complete review of all of its
subsidiaries, including subsidiaries of PAC. Approximately 50 review teams
are examining operational functions within the companies and evaluating
all strategic initiatives. The teams will identify synergies between the
companies, establish uniform system requirements and redirect strategic
efforts. SBC cannot currently estimate the amount of future savings to be
derived from this process or the amount of current and future costs
associated with reorganizing functions and reevaluating strategies that
SBC will incur; however, significant changes in strategic initiatives or
combinations of common functions would result in material charges to SBC's
1997 results of operations. SBC anticipates the review teams will complete
the evaluation phase by the end of the second quarter.
<PAGE>
4. Property, Plant and Equipment
Property, plant and equipment is summarized as follows at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
Telephone Companies plant
In service $ 56,638 $ 54,152
Under construction 1,614 1,042
- -------------------------------------------------------------------------------
58,252 55,194
Accumulated depreciation and amortization (34,515) (32,698)
- -------------------------------------------------------------------------------
Total Telephone Companies 23,737 22,496
- -------------------------------------------------------------------------------
Other 3,534 2,819
Accumulated depreciation and amortization (1,191) (941)
- -------------------------------------------------------------------------------
Total other 2,343 1,878
- -------------------------------------------------------------------------------
Property, plant and equipment--net $ 26,080 $ 24,374
===============================================================================
SBC's depreciation expense as a percentage of average depreciable plant
was 7.2% for 1996, 7.4% for 1995, and 7.2% for 1994.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1996, 1995 and
1994 were $207, $166 and $159. At December 31, 1996, the future minimum
rental payments under noncancelable operating leases for the years 1997
through 2001 were $124, $109, $103, $57 and $35, and $180 thereafter.
Capital leases were not significant.
<PAGE>
5. Equity Investments
Investments in affiliates accounted for under the equity method consist
principally of SBC's investment in Telefonos de Mexico, S.A. de C.V.
(Telmex), Mexico's national telecommunications company. SBC is a member of
a consortium that holds all of the AA shares of Telmex stock, representing
voting control of the company. The consortium is controlled by a group of
Mexican investors led by an affiliate of Grupo Carso, S.A. de C.V. SBC
also owns L shares which have limited voting rights. In January 1997, SBC
sold a portion of its L shares so that its total equity investment was
below 10% of Telmex's total equity capitalization.
In December 1994 SBC made an equity investment in French cellular
operations (see Note 12). Other equity investments held by SBC include
interests in Australian and Israeli operations which provide directory,
cable television and other services, minority ownership of several
domestic wireless properties and 1995 investments in Chilean
telecommunications and South African wireless operations.
The following table is a reconciliation of SBC's investments in equity
affiliates:
- -------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------
Beginning of year $ 1,616 $ 1,776 $ 1,458
Additional investments 337 447 629
Equity in net income 207 120 224
Dividends received (70) (62) (90)
Currency translation adjustment (94) (268) (560)
Reclassifications and other adjustments (32) (397) 115
===============================================================================
End of year $ 1,964 $ 1,616 $ 1,776
===============================================================================
Currency translation adjustments for 1995 and 1994 primarily reflect the
effect on SBC's investment in Telmex of the decline in the value of the
Mexican peso relative to the U.S. dollar during those years. Beginning in
1997, SBC will use the U.S. dollar, instead of the peso, as the functional
currency for its investment in Telmex due to the Mexican economy becoming
highly inflationary.
Other adjustments for 1995 reflect the change to the cost method of
accounting in October 1995 for SBC's United Kingdom cable television
operations (see Note 13) and the reclassification of a credit deferred in
1994 pending completion of the French cellular investment in 1995. Other
adjustments for 1994 reflect the change to the equity method of accounting
for SBC's previously consolidated United Kingdom cable television
operations.
Undistributed earnings from equity affiliates were $762 and $624 at
December 31, 1996 and 1995.
<PAGE>
6. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
SWBell
Debentures
4.50%-5.88% 1997-2006 $ 600 $600
6.12%-6.88% 2000-2024 1,200 1,200
7.00%-7.75% 2009-2026 1,500 1,500
8.30% 1996 - 200
- -------------------------------------------------------------------------------
3,300 3,500
Unamortized discount--net of premium (29) (31)
- -------------------------------------------------------------------------------
Total debentures 3,271 3,469
- -------------------------------------------------------------------------------
Notes
5.04%-7.67% 1997-2010 1,118 950
Unamortized discount (6) (5)
- -------------------------------------------------------------------------------
Total notes 1,112 945
- -------------------------------------------------------------------------------
PacBell
Debentures
4.62%-5.88% 1999-2006 475 225
6.00%-6.88% 2002-2034 1,194 945
7.12%-7.75% 2008-2043 2,150 2,150
8.50% 2031 225 225
- -------------------------------------------------------------------------------
4,044 3,545
Unamortized discount--net of premium (89) (85)
- -------------------------------------------------------------------------------
Total debentures 3,955 3,460
- -------------------------------------------------------------------------------
Notes
6.25%-8.70% 2001-2005 1,150 1,150
Unamortized discount (18) (20)
- -------------------------------------------------------------------------------
Total notes 1,132 1,130
- -------------------------------------------------------------------------------
Other notes
5.70%-6.98% 1996-2007 310 316
7.00%-9.50% 1996-2020 1,140 1,263
- -------------------------------------------------------------------------------
1,450 1,579
Unamortized discount (14) (21)
- -------------------------------------------------------------------------------
Total other notes 1,436 1,558
- -------------------------------------------------------------------------------
Guaranteed obligations of employee stock
ownership plans (1)
8.41%-9.40% 1996-2000 208 260
- -------------------------------------------------------------------------------
Capitalized leases 303 48
- -------------------------------------------------------------------------------
Total long-term debt, including current maturities 11,417 10,870
Current maturities (487) (461)
===============================================================================
Total long-term debt $ 10,930 10,409
===============================================================================
(1) See Note 9.
During 1995, SBC refinanced long-term debentures of SWBell and PacBell.
Costs of $36 associated with refinancing are included in other income
(expense) - net, with related income tax benefits of $14 included in
income taxes in SBC's Consolidated Statements of Income.
At December 31, 1996, the aggregate principal amounts of long-term debt
scheduled for repayment for the years 1997 through 2001 were $487, $347,
$582, $485 and $509. As of December 31, 1996, SBC was in compliance with
all covenants and conditions of instruments governing its debt.
During 1996, PAC entered into sale and leaseback arrangements to finance
equipment associated with the buildout of its PCS network. As of December
31, 1996 the obligation remaining for this group of leases is $270. These
leases are classified as capitalized leases and the related assets are
classified as property, plant and equipment.
Debt maturing within one year consists of the following at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
Commercial paper $ 1,848 $ 2,749
Current maturities of long-term debt 487 461
===============================================================================
Total $ 2,335 $ 3,210
===============================================================================
The weighted average interest rate on commercial paper debt at December
31, 1996 and 1995 was 6.0% and 5.8%. SBC has entered into agreements with
several banks for lines of credit totaling $750. All of these agreements
may be used to support commercial paper borrowings and are on a negotiated
fee basis with interest rates negotiable at time of borrowing. There were
no borrowings outstanding under these lines of credit at December 31,
1996. Another group of uncommitted lines of credit with banks that do not
require compensating balances or commitment fees, and accordingly are
subject to continued review, amounted to approximately $2,800 at December
31, 1996.
7. Financial Instruments
The carrying amounts and estimated fair values of SBC's long-term debt,
including current maturities and other financial instruments, are
summarized as follows at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- -------------------------------------------------------------------------------
SWBell debentures $3,271 $3,208 $3,469 $3,553
SWBell notes 1,112 1,115 945 965
PacBell debentures 3,955 3,917 3,460 3,651
PacBell notes 1,132 1,171 1,130 1,224
Other notes 1,436 1,478 1,558 1,629
Trust originated preferred securities 1,000 990 - -
(TOPrS) -
Guaranteed obligations of employee
stock ownership plans(1) 208 219 260 280
- -------------------------------------------------------------------------------
(1) See Note 10.
The fair values of SBC's long-term debt were estimated based on quoted
market prices, where available, or on the net present value method of
expected future cash flows using current interest rates. The fair value of
the TOPrS was estimated based on quoted market prices. The carrying
amounts of commercial paper debt approximate fair values.
SBC does not hold or issue any financial instruments for trading purposes.
SBC's cash equivalents and short-term investments are recorded at
amortized cost. The carrying amounts of cash and cash equivalents and
short-term investments and customer deposits approximate fair values.
Pacific Telesis Financing I and II (the Trusts) were formed for the
exclusive purpose of issuing preferred and common securities representing
undivided beneficial interests in the Trusts and investing the proceeds
from the sales of TOPrS in unsecured subordinated debt securities of PAC.
Under certain circumstances, dividends on TOPrS could be deferred for up
to a period of five years. TOPrS are subject to a limited guarantee from
PAC. PAC sold $1 billion of TOPrS, $500 at 7.56% in January 1996 through
Pacific Telesis Financing I and $500 at 8.5% in June 1996 through Pacific
Telesis Financing II. Both issues of TOPrS were priced at $25 per share,
have an original 30-year maturity that may be extended up to 49 years, and
are callable five years after date of sale at par and are included on the
balance sheet as corporation-obligated mandatorily redeemable preferred
securities of subsidiary trusts. The proceeds were used to retire
short-term indebtedness, primarily commercial paper.
As of December 31, 1996, Pacific Telesis Financing I and II held
subordinated debt securities of PAC in principal amounts of $515.5 and
$514.5, respectively, with interest rates of 7.56% and 8.5%, respectively.
PAC has entered into an equity swap contract to hedge exposure to risk of
market changes related to its recorded liability for outstanding employee
stock options for common stock of AirTouch Communications, Inc. (spun-off
operations) and associated SARs. (See Note 11) PAC plans to make open
market purchases of the stock of spun-off operations to satisfy its
obligation for options that are exercised. Off-balance-sheet risk exists
to the extent the market price of the stock of spun-off operations rises
above the market price reflected in the liability's current carrying
value. The equity swap was entered into to hedge this exposure and
minimize the impact of market fluctuations. The contract entitles PAC to
receive settlement payments to the extent the price of the common stock of
spun-off operations rises above the notional value of $23.74 per share,
but imposes an obligation to make payments to the extent the price
declines below this level. The swap also obligates PAC to make a monthly
payment of a fee based on LIBOR. The total notional amount of the
contract, $60 and $77 as of December 31, 1996 and 1995 respectively,
covers the approximate number of the options and SARs outstanding of
spun-off operations on that date. PAC plans to periodically adjust
downward the outstanding notional amount as the options and SARs are
exercised. The equity swap contract expires April 1999.
Both the equity swap and PAC's liability for the stock options and SARs of
spun-off operations are carried in the balance sheet at their market
values, which were immaterial as of December 31, 1996 and 1995. Gains and
losses from quarterly market adjustments of the carrying amounts are
substantially offset in results of operations. As of December 31, 1996 and
1995, the accounting loss that would be incurred from nonperformance by
the counterparty to the equity swap was $4 and $14, respectively. However,
management does not expect to realize any loss from counterparty
nonperformance.
<PAGE>
8. Income Taxes
Significant components of SBC's deferred tax liabilities and assets are as
follows at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
Depreciation and amortization $ 3,283 $ 3,072
Other 1,019 820
- -------------------------------------------------------------------------------
Deferred tax liabilities 4,302 3,892
- -------------------------------------------------------------------------------
Employee benefits 2,221 2,206
Unamortized investment tax credits 195 224
Other 1,328 1,503
- -------------------------------------------------------------------------------
Deferred tax assets 3,744 3,933
- -------------------------------------------------------------------------------
Deferred tax assets valuation allowance 96 110
===============================================================================
Net deferred tax liabilities $ 654 $ 69
===============================================================================
In 1996 the State of California reduced the corporate tax rate from 9.3% to
8.84%, effective for taxable years beginning on or after January 1, 1997. In
accordance with generally accepted accounting principles, net deferred tax
assets at December 31, 1996 were revalued to reflect the lower tax rate. This
revaluation increasing state income tax expense, net of federal income tax, and
decreasing net income was not material in 1996.
The decrease in the valuation allowance is the result of an evaluation of the
uncertainty associated with the realization of certain deferred tax assets. The
valuation allowance is maintained in deferred tax assets for certain unused
federal and state loss carryforwards.
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
1996 1995 1994
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Federal
Current $ 1,242 $ 829 $ 1,347
Deferred--net 468 520 (49)
Amortization of investment tax credits (80) (95) (124)
- ----------------------------------------------------------------------------------
1,630 1,254 1,174
- ----------------------------------------------------------------------------------
State and local
Current 172 176 245
Deferred--net 158 89 29
- ----------------------------------------------------------------------------------
330 265 274
==================================================================================
Total $ 1,960 $ 1,519 $ 1,448
==================================================================================
</TABLE>
<PAGE>
A reconciliation of income tax expense and the amount computed by applying
the statutory federal income tax rate (35%) to income before income taxes
and extraordinary loss is as follows:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
1996 1995 1994
- ----------------------------------------------------------------------------------
<S> <C> <C> <C>
Taxes computed at federal statutory rate $ 1,802 $ 1,567 $ 1,479
Increases (decreases) in income taxes resulting
from:
Amortization of investment tax credits over the
life of the plant (53) (92) (124)
that gave rise to the credits--1996 and
1995, net of deferred income tax
Excess deferred income taxes due to rate change - (24) (35)
Depreciation of telephone plant construction
costs previously - 14 23
deducted for tax purposes--net
State and local income taxes--net of federal 215 172 178
income tax benefit
Other--net (4) (118) (73)
==================================================================================
Total $ 1,960 $ 1,519 $ 1,448
==================================================================================
</TABLE>
9. Employee Benefits
Pensions - Substantially all employees of SBC are covered by one of three
noncontributory pension and death benefit plans. The pension benefit
formula used in the determination of pension cost for nonmanagement
employees is based on a flat dollar amount per year of service according
to job classification. For PAC managers, benefits accrue in separate
account balances based on a fixed percentage of each employee's monthly
salary with interest. For all other managers, employees' benefits are
determined based upon a stated percentage of adjusted career income.
SBC's objective in funding the plans, in combination with the standards of
the Employee Retirement Income Security Act of 1974 (as amended), is to
accumulate funds sufficient to meet its benefit obligations to employees
upon their retirement. Contributions to the plans are made to a trust for
the benefit of plan participants. Plan assets consist primarily of stocks,
U.S. government and domestic corporate bonds, index funds and real estate.
SBC reports pension costs and related obligations under the provisions of
FAS 87 and FAS 88. However, prior to discontinuing application of FAS 71
during 1995, PacBell recognized pension costs consistent with the methods
adopted for ratemaking. Nevada Bell continues to follow the accounting
method prescribed by the Public Service Commission of Nevada. Pension
costs recognized by PacBell under FAS 71 reflected a California Public
Utilities Commission (CPUC) order requiring the continued use of the
aggregate cost method for intrastate operations and a Federal
Communications Commission (FCC) requirement to use FAS 87 and FAS 88 for
interstate operations. (See Note 2)
<TABLE>
Net pension cost is composed of the following:
<CAPTION>
- ---------------------------------------------------------------------------------------
1996 1995 1994
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Service cost--benefits earned during the 297 $ 311 $ 354 $
period
Interest cost on projected benefit 1,131 1,161 1,142
obligation
Actual return on plan assets (2,919) (4,232) (24)
Other--net 1,270 2,813 (1,396)
- ---------------------------------------------------------------------------------------
Net periodic pension cost (benefit)under (221) 53 76
FAS 87
Adjustment to reflect differing - - 18
regulatory treatment
- ---------------------------------------------------------------------------------------
Net pension cost (benefit) (221) $ 53 $ 94 $
- ---------------------------------------------------------------------------------------
</TABLE>
<PAGE>
The following table sets forth the pension plans' funded status and the
amounts included in SBC's Consolidated Balance Sheets at December 31:
- --------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------
Fair value of plan assets $ 20,738 $ 20,019
Less: Actuarial present value of projected benefit 15,006 17,339
obligation
- --------------------------------------------------------------------------------
Plan assets in excess of projected benefit 5,732 2,680
obligation
Unrecognized prior service cost 845 992
Unrecognized net gain (6,072) (3,272)
Unamortized transition asset (973) (1,099)
- --------------------------------------------------------------------------------
Accrued pension cost $ (468) $ (699)
================================================================================
The projected benefit obligation was increased $202 and $407 at December
31, 1996 and 1995, respectively, for the cost of force reductions
anticipated to take place in 1996 and 1997 and recognized in the SBC's
financial statements under FAS 88.
Significant weighted average assumptions used in developing pension
information include:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------
1996 1995 1994
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Discount rate for determining projected benefit 7.5% 7.25% 7.78%
obligation
Long-term rate of return on plan assets 8.55% 8.0% 8.0%
Composite rate of compensation increase 4.3% 4.3% 4.3%
- -----------------------------------------------------------------------------------
</TABLE>
The projected benefit obligation is the actuarial present value of all
benefits attributed by the pension benefit formula to previously rendered
employee service. It is measured based on assumptions concerning future
interest rates and employee compensation levels. Should actual experience
differ from the actuarial assumptions, the benefit obligation will be
affected.
In March 1996, management amended the pension plan for PAC managers from a
final pay plan to a cash balance plan effective July 1, 1996. An enhanced
transition benefit, based on frozen pay and service as of June 30, 1996
was established to preserve benefits already accrued by salaried employees
under the final pay plan and resulted in an increase in earned benefits
for most employees. SBC also updated the actuarial assumptions used in
valuing the PAC plans to reflect changes in market interest rates and
recent experience, including a change in its assumption concerning future
ad hoc increases in pension benefits. Taken together, these changes
increased net income by approximately $125 during 1996.
The actuarial estimate of the accumulated benefit obligation does not
include assumptions about future compensation levels. The accumulated
benefit obligation as of December 31, 1996 was $13,965, of which $12,376
was vested. At December 31, 1995 these amounts were $15,433 and $13,565.
The reduction in the accumulated benefit obligation in 1996 reflects the
changes noted above.
During 1996, 1995 and 1994, special pension benefits and cash incentives
were offered in connection with PacBell restructuring and related force
reduction program. Approximately 4,200, 2,200 and 3,800 employees left
PacBell during 1996, 1995 and 1994, respectively, under retirement or
voluntary and involuntary severance programs. Annual pension cost excludes
$(64), $219 and $62 of additional pension costs charged to PacBell's
restructuring reserve in 1996, 1995 and 1994, respectively.
In December 1996, under the provisions of Section 420 of the Internal
Revenue Code, SBC transferred $73 in pension assets to a health care
benefit account for the reimbursement of retiree health care benefits paid
by SBC.
Supplemental Retirement Plans - SBC also provides senior and middle
management employees with nonqualified, unfunded supplemental retirement
and savings plans. These plans include supplemental defined pension
benefits as well as compensation deferral plans, some of which include a
corresponding match by SBC based on a percentage of the compensation
deferral. Expenses related to these plans were $88, $91 and $94 in 1996,
1995 and 1994. Liabilities of $758 and $701 related to these plans have
been included in other noncurrent liabilities in SBC's Consolidated
Balance Sheets at December 31, 1996 and 1995.
Postretirement Benefits - SBC provides certain medical, dental and life
insurance benefits to substantially all retired employees under various
plans and accrues actuarially determined postretirement benefit costs as
active employees earn these benefits. However, employees retiring after
certain dates will pay a share of the costs of medical coverage that
exceeds a defined dollar medical cap. Such future cost sharing provisions
have been reflected in determining SBC's postretirement benefit costs.
Postretirement benefit cost is composed of the following:
-----------------------------------------------------------------------------
1996 1995 1994
-----------------------------------------------------------------------------
Service cost--benefits earned during the $ 101 99 $ 108
period
Interest cost on accumulated postretirement 475 496 489
benefit obligation
(APBO)
Actual return on assets (375) (452) (19)
Other--net 208 318 (87)
=============================================================================
Postretirement benefit cost $ 409 $ 461 $ 491
=============================================================================
SBC maintains Voluntary Employee Beneficiary Association (VEBA) trusts to
fund postretirement benefits. During 1996 and 1995, SBC contributed $320
and $455 into the VEBA trusts to be ultimately used for the payment of
postretirement benefits. Assets consist principally of stocks and U.S.
government and corporate bonds.
The following table sets forth the plans' funded status and the amount
included in SBC's Consolidated Balance Sheets at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
Retirees $ 4,047 $ 4,200
Fully eligible active plan participants 706 583
Other active plan participants 1,819 1,867
- -------------------------------------------------------------------------------
Total APBO 6,572 6,650
Less: Fair value of plan assets 2,697 2,169
- -------------------------------------------------------------------------------
APBO in excess of plan assets 3,875 4,481
Unrecognized prior service cost (31) (38)
Unrecognized net gain 1,119 616
- -------------------------------------------------------------------------------
Accrued postretirement benefit obligation $ 4,963 $ 5,059
===============================================================================
In December 1995, one of the life insurance benefit plans was merged with
one of the medical plans. Also in December 1995, $109 of postretirement
life insurance assets were transferred to the VEBA trusts. The fair value
of plan assets restricted to the payment of life insurance benefits only
were $746 and $700 at December 31, 1996 and 1995. At December 31, 1996 and
1995, the accrued life insurance benefits included in the accrued
postretirement benefit obligation were $57 and $42.
The assumed medical cost trend rate in 1997 is 8%, decreasing gradually to
5.5% in 2002, prior to adjustment for cost-sharing provisions of the plan
for active and certain recently retired employees. The assumed dental cost
trend rate in 1997 is 6.25%, reducing to 5.0% in 2002. Raising the annual
medical and dental cost trend rates by one percentage point increases the
APBO as of December 31, 1996 by $557 and increases the aggregate service
and interest cost components of the net periodic postretirement benefit
cost for 1996 by approximately $53. Significant assumptions for the
discount rate, long-term rate of return on plan assets and composite rate
of compensation increase used in developing the APBO and related
postretirement benefit costs were the same as those used in developing the
pension information.
10. Other Employee Benefits
Employee Stock Ownership Plans - SBC maintains contributory savings plans
which cover substantially all employees. Under the savings plans, SBC
matches a stated percentage of eligible employee contributions, subject to
a specified ceiling.
SBC has three leveraged Employee Stock Ownership Plans (ESOPs) as part of
the existing savings plans. Two of the ESOPs were funded with notes issued
by the savings plans to various lenders, the proceeds of which were used
to purchase shares of SBC's common stock in the open market. These notes
are unconditionally guaranteed by SBC and therefore recorded as a
liability. They will be repaid with SBC contributions to the savings
plans, dividends paid on SBC shares and interest earned on funds held by
the ESOPs.
The third ESOP purchased PAC treasury shares in exchange for a promissory
note from the plan to PAC. Since PAC is the lender, this note is not
reflected as a liability and the remaining cost of unallocated trust
shares is carried as a reduction of shareowners' equity. Principal and
interest on the note is paid from employer contributions and dividends
received by the trust. All PAC shares were exchanged for SBC shares
effective with the merger April 1, 1997. The provisions of this ESOP were
unaffected by this exchange.
SBC's match of employee contributions to the savings plans is fulfilled
with shares of stock allocated from the ESOPs and with purchases of SBC's
stock in the open market. Shares held by the ESOPs are released for
allocation to the accounts of employees as employer matching contributions
are earned. Benefit cost is based on a combination of the contributions to
the savings plans and the cost of shares allocated to participating
employees' accounts. Both benefit cost and interest expense on the notes
are reduced by dividends on SBC's shares held by the ESOPs and interest
earned on the ESOPs' funds.
Information related to the ESOPs and the savings plans is summarized below:
- -------------------------------------------------------------------------------
1996 1995 1994
- -------------------------------------------------------------------------------
Benefit expense--net of dividends and interest $ 65 $ 66 $ 67
income
Interest expense--net of dividends and 26 37 36
interest income
- -------------------------------------------------------------------------------
Net ESOP expense 91 103 103
Additional savings plans stock purchases - - (1)
- -------------------------------------------------------------------------------
Total expense $ 91 $ 103 $ 102
===============================================================================
Company contributions for ESOPs $ 108 $ 89 $ 118
===============================================================================
Dividends and interest income for debt service $ 62 $ 72 $ 62
===============================================================================
SBC shares held by the ESOPs are summarized as follows at December 31:
- -------------------------------------------------------------------------------
1996 1995
- -------------------------------------------------------------------------------
Unallocated 15,502,896 16,136,159
Committed to be allocated 177,594 274,425
Allocated to participants 15,559,574 16,209,602
===============================================================================
Total 31,240,064 32,620,186
===============================================================================
<PAGE>
11. Stock Based Compensation
Under various SBC plans, senior and other management employees have
received stock options and SARs to purchase 41 million shares of SBC
common stock. As of December 31, 1996, SBC is authorized to issue options
to purchase up to an additional 37 million shares remain authorized for
issuance. Options issued through December 31, 1996 carry exercise prices
equal to the market price of the stock at the date of grant and have
maximum terms ranging from five to ten years. Depending upon the plan,
vesting of options occurs up to three years from the date of grant.
In 1996 SBC elected to continue measuring compensation cost for these
plans using the intrinsic value based method of accounting prescribed in
Statement of Financial Accounting Standards No. 123, "Accounting for Stock
Based Compensation" (FAS 123). Accordingly, no compensation cost for stock
based compensation plans has been recognized other than for restricted
stock and SARs which totaled $2 and $1 for 1996 and 1995, respectively.
Had compensation cost for stock option plans been recognized using the
fair value based method of accounting at the date of grant for awards in
1996 and 1995 as defined by FAS 123, SBC's net income (loss) would have
been $3,250 and $(3,074) and net income (loss) per share would have been
$3.53 and $(3.34).
Options and SARs held by the continuing employees of PAC at the time of
the spin-off (see Note 15) were supplemented with an equal number of
options and SARs for common shares of spun-off operations. The exercise
prices for outstanding options and SARs held by continuing employees of
PAC were adjusted downward to reflect the value of the supplemental
spun-off operations' options and SARs. The balance sheet reflects a
related liability equal to the difference between the current market price
of spun-off operations stock and the exercise prices of the supplemental
options outstanding (see Note 7). As of December 31, 1996, 2,182,369
supplemental spun-off operations options and SARs were outstanding with
expiration dates ranging from 1997 to 2003. Outstanding options and SARs
that were held by employees of the wireless operations at the spin-off
date were replaced by options and SARs for common shares of spun-off
operations. The spun-off operations assumed liability for these
replacement options and SARs.
For purposes of these pro forma disclosures, the estimated fair value of
the options granted after 1994 is amortized to expense over the options'
vesting period. Because most employee options vest over a two to three
year period, these disclosures will not be indicative of future pro forma
amounts until the FAS 123 rules are applied to all outstanding non-vested
awards. The fair value for these options was estimated at the date of
grant, using a Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1996 and 1995: risk-free
interest rate of 6.26% and 6.34%; dividend yield of 4.92% and 3.61%;
expected volatility factor of 18% and 18%; and expected option life of 4.7
and 4.6 years.
<PAGE>
Information related to options and SARs is summarized below:
- --------------------------------------------------------------------------------
Weighted
Average
Number Exercise
Price
- --------------------------------------------------------------------------------
Outstanding at January 1, 1994 14,318,818 $35.25
Granted 10,504,532 42.72
Exercised (1,304,357) 32.14
Forfeited/Expired (505,278) 38.04
Replaced - Spun-off operations (1,019,633) 33.17
- --------------------------------------------------------------------------------
Outstanding at December 31, 1994 21,994,082 39.03
(7,942,775 exercisable at weighted average price
of $34.60)
Granted 8,367,822 46.97
Exercised (2,186,670) 33.79
Forfeited/Expired (754,684) 42.71
- --------------------------------------------------------------------------------
Outstanding at December 31, 1995 27,420,550 41.77
(12,762,259 exercisable at weighted average price
of $38.10)
Granted 12,321,638 45.96
Exercised (1,883,710) 37.45
Forfeited/Expired (759,276) 43.11
- --------------------------------------------------------------------------------
Outstanding at December 31, 1996 37,099,202 $43.35
(17,761,413 exercisable at weighted average price
of $40.25)
================================================================================
Information related to options and SARs outstanding at December 31, 1996:
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------
Exercise Price Range $22.00-26.99$27.00-39.99 $40.00-44.99 $45.00-57.38
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Number of options and SARs:
Outstanding 78,305 8,315,629 12,986,852 15,718,416
Exercisable 78,305 4,501,735 11,653,036 1,528,337
Weighted average exercise price:
Outstanding $24.05 $ 35.26 $ 42.04 $ 48.81
Exercisable $24.05 $ 33.42 $ 42.07 $ 47.35
Weighted average remaining 1.8 years 4.9 years 7.2 years 6.2 years
contractual life
========================================================================================
</TABLE>
The weighted-average grant-date fair value of each option granted during
the year was $6.90 for 1996 and $8.31 for 1995.
Options and SARs outstanding but not exercisable at December 31, 1996
include 3,811,502 held by PAC employees. All options and SARs held by PAC
employees became exercisable effective with the merger.
12. Shareowners' Equity
Share Repurchases - From time to time, SBC has repurchased shares of
common stock for distribution, to offset shares distributed through its
employee benefit plans and SBC's Dividend Reinvestment Plan, in connection
with certain acquisitions or for general purposes. In January 1997, the
Board of Directors of SBC (Board) rescinded all authorizations to
repurchase common stock.
Guaranteed Obligations of Employee Stock Ownership Plans - SBC's guarantee
of certain ESOP notes issued by savings plans (see Note 10) is presented
as a reduction to shareowners' equity and an increase in long-term debt.
The amount of debt guaranteed decreases as the notes are repaid.
Shareowners' Rights Plan - The Shareowners' Rights Plan (Plan) becomes
operative in certain events involving the acquisition of 20% or more of
SBC's common stock by any person or group in a transaction not approved by
the Board, or the designation by the Board of a person or group owning
more than 10% of the outstanding stock as an adverse person, as provided
in the Plan. Upon the occurrence of these events, each right, unless
redeemed by the Board, generally entitles the holder (other than the
holder triggering the right) to purchase an amount of common stock of SBC
(or, in certain circumstances, of the potential acquiror) having a value
equal to two times the exercise price of $160. The rights expire in
January 1999. After giving effect to a stock split in May 1993, effected
in the form of a stock dividend, each share of common stock represents
one-half of a right.
The rights have certain antitakeover effects. The rights will cause
substantial dilution to a person or group that attempts to acquire SBC on
terms not approved by the Board.
The rights should not interfere with any merger or other business
combination approved by the Board since the rights may be redeemed.
13. Acquisitions and Dispositions
In October 1995, SBC combined its United Kingdom cable television
operations with those of TeleWest Communications, P.L.C., a publicly held
joint venture between Telecommunications, Inc. and U S WEST, Inc. The
resulting entity, TeleWest P.L.C. (TeleWest), is the largest cable
television operator in the United Kingdom. SBC owns approximately 15% of
the new entity and accounts for its investment using the cost method of
accounting. Restrictions expiring over the next four years exist on the
sale of SBC's interest in TeleWest. SBC recorded an after-tax gain of $111
associated with the combination.
During 1995, SBC purchased at auction PCS licenses in Los Angeles-San
Diego, California; San Francisco-Oakland-San Jose, California; Memphis,
Tennessee; Little Rock, Arkansas; and Tulsa, Oklahoma for approximately
$769. During 1996, SBC received several AT&T cellular networks in Arkansas
in exchange for SBC's PCS licenses in Memphis and Little Rock and other
consideration.
During 1994, SBC purchased two cable television systems located in
Montgomery County, Maryland, and Arlington County, Virginia, for $650.
Also in 1994, SBC acquired the domestic wireless business of Associated
Communications Corporation (Associated) for $705, including wireless
systems in Buffalo, Rochester, Albany and Glens Falls, New York, and in
two separate transactions purchased smaller wireless systems in Syracuse,
Utica and Ithaca, New York, which are adjacent to the Associated
properties.
In October 1994, SBC formed a strategic alliance with Compagnie Generale
des Eaux (CGE), a French diversified public company. Through this
alliance, SBC acquired an indirect 10% ownership of Societe Francaise du
Radiotelephone S.A. (SFR), a nationwide cellular company in France, and
minority ownership interests in other communications businesses controlled
by CGE, and CGE obtained an effective 10% interest in SBC's wireless
operations in Washington, D.C.-Baltimore and surrounding rural markets.
SBC and CGE both made contributions to the alliance. SBC's effective
contribution was $376. This investment is accounted for under the equity
method of accounting.
In addition to payments shown in the Consolidated Statements of Cash
Flows, the 1994 acquisitions were also financed through the issuance of 16
million new and treasury shares, valued at approximately $660, and the
issuance of approximately $360 of long-term debt. All of the acquisitions
were accounted for under the purchase method of accounting. The purchase
prices in excess of the underlying fair value of identifiable net assets
acquired are being amortized over periods not to exceed 40 years. Results
of operations of the properties acquired have been included in the
consolidated financial statements from their respective dates of
acquisition.
The above developments did not have a significant impact on consolidated
results of operations for 1995 and 1994, nor would they had they occurred
on January 1 of the respective periods.
<PAGE>
14. Additional Financial Information
- -------------------------------------------------------------------------------
December 31,
--------------------
Balance Sheets 1996 1995
- -------------------------------------------------------------------------------
Accounts payable and accrued liabilities
Accounts payable $ 2,741 $ 2,639
Accrued taxes 893 472
Advance billing and customer deposits 611 672
Compensated future absences 479 477
Accrued interest 279 265
Accrued payroll 194 173
Other 1,387 1,328
===============================================================================
Total $ 6,584 $ 6,026
===============================================================================
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
Statements of Income 1996 1995 1994
- -------------------------------------------------------------------------------
Interest expense incurred $ 948 $ 1,000 $ 935
Capitalized interest (136) (43) -
- -------------------------------------------------------------------------------
Total interest expense $ 812 $ 957 $ 935
===============================================================================
Allowance for funds used during - $ 48 $ 48
construction
===============================================================================
- -------------------------------------------------------------------------------
Statements of Cash Flows 1996 1995 1994
- -------------------------------------------------------------------------------
Cash paid during the year for:
Interest $ 908 $ 996 $ 923
Income taxes $ 1,283 $ 1,220 $ 1,665
- -------------------------------------------------------------------------------
No customer accounted for more than 10% of consolidated revenues in 1996
or 1995. Approximately 10% of SBC's consolidated revenues in 1994 were
from services provided to AT&T Corp. No other customer accounted for more
than 10% of consolidated revenues in 1994.
Several subsidiaries of SBC have negotiated contracts with the
Communications Workers of America (CWA), none of which is subject to
renegotiation in 1997. Approximately 66% of SBC's employees are
represented by the CWA.
<PAGE>
15. Spun-Off Operations
Effective April 1, 1994, PAC spun off to shareowners its domestic and
international cellular, paging and other wireless operations in a
one-for-one stock distribution of its 86% interest in AirTouch
Communications, Inc. The stock distribution was recorded as a stock
dividend from paid-in capital at the carrying amount of the net assets of
spun-off operations. As a result, PAC's total assets and shareowners'
equity were each reduced by $2.9 billion in 1994. The stock distribution
itself was a non-cash transaction, which did not affect PAC's cash flow
statement.
Under a separation agreement, any unrecorded non-tax contingent
liabilities that become certain after the spin-off date will be allocated
based on origin of the claim, and acts by, or benefits to, PAC or the
spun-off operations. In addition, PAC's responsibilities have been
terminated in connection with any future obligations under the spun-off
operations' joint venture agreement with Cellular Communications, Inc.,
and under various financial instrument contracts.
PAC's previous interests in the net revenues and expenses of the spun-off
operations prior to April 1, 1994, are classified separately as income
from spun-off operations in the income statement.
The components of income from operations through March 31, 1994 are
summarized below:
------------------------------------------------------------
Operating revenues $ 259
Operating expenses 225
------------------------------------------------------------
Operating income 34
Other income (expense)-net 22
------------------------------------------------------------
Income before income taxes 56
Income taxes 29
------------------------------------------------------------
Income before minority interest 27
Minority interest of other shareowners (4)
------------------------------------------------------------
Income from spun-off operations $ 23
------------------------------------------------------------
PAC's cash flow statement for 1994 includes separately the cash flows of
spun-off operations.
16. Restructuring Reserve
In December 1993 a reserve was established to record the incremental cost
of force reductions associated with restructuring PacBell's business
processes through 1997. This reserve is to cover the incremental severance
costs associated with terminating more than 14,000 employees through 1997.
It is also to cover the incremental costs of consolidating and
streamlining operations and facilities to support this downsizing
initiative. The remaining reserve balance as of December 31, 1996 and
1995, was $97 and $228, respectively.
<PAGE>
17. Commitments And Contingencies
Purchase Commitments - In December 1994, PacBell contracted for the
purchase of up to $2,000 of Advanced Communications Network ("ACN")
facilities, which incorporated new technologies. During 1995, the ability
to deploy the facilities outstripped the ACN vendors' ability to deliver
necessary products and software. Accordingly, management decided to
suspend construction at certain sites, which reduced the expected cost to
less than $700. If ACN facilities meet certain quality and performance
criteria (the Network Test), PacBell is committed to purchase the ACN
facilities in 1998. If ACN facilities are acquired, due to competition or
other factors affecting PacBell's ability to recover its investment in
these facilities, their value to PacBell could be materially impaired. If
ACN facilities fail the Network Test, PacBell will not be committed to buy
the ACN facilities but might be liable to reimburse the principal ACN
vendor for some construction costs up to $300, which would also result in
a material charge
As of December 31, 1996, PacBell had purchase commitments of about $208
remaining in connection with its previously announced program for
deploying an all digital switching platform with ISDN and SS-7
capabilities.
Revenues Subject to Refund - In 1992, the CPUC issued a decision adopting,
with modification, FAS 106, "Employers' Accounting for Postretirement
Benefits Other than Pensions," for regulatory accounting purposes. Annual
price cap decisions by the CPUC granted PacBell approximately $100 in each
of the years 1993-1996 for partial recovery of higher costs under FAS 106.
In October 1994 the CPUC reopened the proceeding to determine the criteria
for exogenous cost treatment and whether PacBell should continue to
recover these costs. The CPUC's order also held that related revenues
collected after October 12, 1994, were subject to refund plus interest
pending this future proceeding. Subsequently, the CPUC reaffirmed that
postretirement benefits costs are appropriately recoverable in PacBell's
price cap filings.
Property Tax Investigation - In 1992, a settlement agreement was reached
between the State Board of Equalization, all California counties, the
State Attorney General, and 28 utilities, including PacBell, on a specific
methodology for valuing utility property for property tax purposes for a
period of eight years. The CPUC opened an investigation to determine if
any resulting property tax savings should be returned to customers.
Intervenors have asserted that as much as $20 of annual property tax
savings should be treated as an exogenous cost reduction in PacBell's
annual price cap filings. These intervenors have also asserted that past
property tax savings totaling as much as approximately $70 as of December
31, 1996, plus interest should be returned to customers. Management
believes that, under the CPUC's regulatory framework, any property tax
savings should be treated only as a component of the calculation of
shareable earnings and not as an exogenous cost. In an Interim Opinion
issued in June 1995, the CPUC decided to defer a final decision on this
matter pending resolution in a separate proceeding of the criteria for
exogenous cost treatment under its regulatory framework.
<PAGE>
18. Quarterly Financial Information (Unaudited)
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
Earnings Stock Price (4)
Total per -----------------------------
Calendar Operating Operating Net Income Common
Quarter Revenues Income (Loss) Share High Low Close
- ----------------------------------------------------------------------------------
1996
<S> <C> <C> <C> <C> <C> <C> <C> <C>
First (1)$ 5,574 $ 1,458 $ 888 $ 0.96$ 60.250$ 49.750 $ 52.625
Second 5,738 1,489 803 0.87 50.750 46.250 49.250
Third 5,957 1,532 867 0.94 51.000 46.000 48.125
Fourth 6,217 1,357 721 0.79 55.250 47.000 51.875
- ------------------------------------------
Annual $ 23,486 $ 5,836 $ 3,279 $ 3.56
(1)
==================================================================================
1995
First $ 5,164 $ 1,233 $ 695 $ 0.76$ 43.875$ 39.625 $ 42.000
Second 5,256 1,301 712 0.78 47.875 41.625 47.625
Third (2) 5,567 1,432 (5,207) (5.64) 55.125 45.500 55.000
Fourth (3) 5,725 1,154 736 0.80 58.500 53.125 57.250
- ------------------------------------------
Annual $ 21,712 $ 5,120 $ (3,064) $ (3.33)
(2)
==================================================================================
<FN>
(1) Net Income and Earnings per Common Share reflect a cumulative effect of
accounting change of $90 or $0.10 per share from change in accounting for
directory operations.
(2) Net Loss and Earnings per Common Share reflect an extraordinary loss of
$6,022, or $6.55 per share, from discontinuance of regulatory accounting.
(3) Operating Income reflects $139 in selling, general and administrative
expenses associated with a strategic realignment of functions. These
expenses include postemployment benefits for approximately 2,400 employees
arising from the consolidation of operations within the five-state area,
streamlining support and administrative functions and integrating financial
systems.
Net Income and Earnings per Common Share reflect after-tax charges of $88
for the strategic realignment of functions and $11 for refinancing of debt
and an after-tax gain of $111 from the merger of SBC's United Kingdom cable
television operations into TeleWest. The net of these transactions was $12,
or $0.01 per share.
(4) Represents historical trading of SBC common stock. Prices have not been
adjusted to reflect the merger with PAC.
</FN>
</TABLE>
<PAGE>
(b) Exhibits
Exhibit 18 Preferability letter on changes in accounting.
Exhibit 23-a Consent of Ernst & Young LLP.
Exhibit 23-b Consent of Coopers & Lybrand L.L.P.
Exhibit 27 Financial Data Schedule.
Exhibit 99 Opinion of Independent Auditors Coopers & Lybrand L.L.P.
<PAGE>
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SBC Communications Inc.
/s/ Donald E. Kiernan
Donald E. Kiernan
Senior Vice President, Treasurer
and Chief Financial Officer
May 8, 1997
<PAGE>
EXHIBIT INDEX
Exhibit
Number......................................................
18 Preferability letter on changes in accounting.
23-a Consent of Ernst & Young LLP.
23-b Consent of Coopers & Lybrand L.L.P.
27 Financial Data Schedule.
99 Opinion of Independent Auditors Coopers & Lybrand L.L.P.
EXHIBIT 18
May 8, 1997
Mr. Donald Kiernan
Senior Vice President, Treasurer and
Chief Financial Officer
SBC Communications Inc.
175 W. Houston Street
San Antonio, Texas 78205
Dear Mr. Kiernan:
Note 3 of Notes to Consolidated Financial Statements of SBC Communications Inc.
(SBC) included in its Form 8-K filed in connection with the merger of SBC and
Pacific Telesis Group (PAC) describes changes in the methods of accounting for
pensions, postretirement benefits, and sales commissions. You have advised us
that you believe that the changes are to conform the accounting methods of SBC
and PAC and that the new methods are preferable because the new methods for
pensions and postretirement benefits are more widely used and the new method for
sales commissions is prevalent industry practice.
We conclude that the changes in the methods of accounting for the items
described above are to acceptable alternative methods which, based on your
business judgment to make these changes for the reasons cited above, are
preferable in your circumstances.
ERNST & YOUNG LLP
EXHIBIT 23-a
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statements
(Forms S-8) pertaining to the SBC Savings Plan and Savings and Security Plan
(Nos. 33-54309 and 333-24295), the Stock Savings Plan, Management Stock Savings
Plan and Stock Based Savings Plan (Nos. 33-37451 and 33-54291), the SBC
Communications Inc. 1992 Stock Option Plan (No. 33-49855) and the SBC
Communications Inc. 1995 Management Stock Option Plan (No. 33-61715), and in the
Registration Statements (Forms S-3) pertaining to the SBC Communications Inc.
Dividend Reinvestment Plan (No. 333-08979), and SBC Communications Capital
Corporation and SBC Communications Inc. (Nos. 33-45490 and 33-56909), and in the
related Prospectuses of our report dated February 14, 1997 (except Note 3, as to
which the date is April 1, 1997), with respect to the supplemental consolidated
financial statements included in this Current Report ( Form 8-K) for the year
ended December 31, 1996.
ERNST & YOUNG LLP
San Antonio, Texas
May 7,1997
EXHIBIT 23-b
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Form 8-K of SBC
Communications Inc. of our report dated February 27, 1997, on our audits of the
consolidated financial statements and financial statement schedule of Pacific
Telesis Group and Subsidiaries as of December 31, 1996 and 1995, and for each of
the three years in the period ended December 31, 1996.
Coopers & Lybrand L.L.P.
San Francisco, California
May 8, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANACIAL INFORMATION EXTRACTED
FROM SBC COMMUNICATIONS INC.'S DECEMBER 31, 1996 SUPPLEMENTAL
CONSOLIDATED FINANCIAL STATEMENTS AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 314,000
<SECURITIES> 432,000
<RECEIVABLES> 4,995,000
<ALLOWANCES> 311,000
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 6,271,000
<PP&E> 61,786,000
<DEPRECIATION> 35,706,000
<TOTAL-ASSETS> 39,485,000
<CURRENT-LIABILITIES> 9,312,000
<BONDS> 10,930,000
0
0
<COMMON> 934,000
<OTHER-SE> 8,707,000
<TOTAL-LIABILITY-AND-EQUITY> 39,485,000
<SALES> 0<F2>
<TOTAL-REVENUES> 23,486,000
<CGS> 0<F3>
<TOTAL-COSTS> 8,220,000
<OTHER-EXPENSES> 4,109,000
<LOSS-PROVISION> 395,000
<INTEREST-EXPENSE> 812,000
<INCOME-PRETAX> 5,149,000
<INCOME-TAX> 1,960,000
<INCOME-CONTINUING> 3,189,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 90,000
<NET-INCOME> 3,279,000
<EPS-PRIMARY> 3.56
<EPS-DILUTED> 0
<FN>
<F1> THIS AMOUNT IS IMMATERIAL.
<F2> NET SALES OF TANGIBLE PRODUCTS IS NOT MORE THAN 10% OF TOTAL OPERATING
REVENUES AND THEREFORE HAS NOT BEEN STATED SEPARATELY IN THE FINANCIAL
STATEMENTS PURSUANT TO REGULATION S-X, RULE 5-03(B). THIS AMOUNT IS
INCLUDED IN THE "TOTAL REVENUES" TAG.
<F3> COST OF TANGIBLE GOODS SOLD IS INCLUDED IN COST OF SERVICES AND PRODUCTS
IN THE FINANCIAL STATEMENTS AND THE "TOTAL-COST" TAG, PURSUANT TO
REGULATION S-X,RULE 5-03(B).
</FN>
</TABLE>
EXHIBIT 99
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowners
of Pacific Telesis Group:
We have audited the accompanying consolidated balance sheets of Pacific Telesis
Group and Subsidiaries as of December 31, 1996 and 1995, and the related
consolidated statements of income, shareowners' equity, and cash flows for each
of the three years in the period ended December 31, 1996. These financial
statements are the responsibility of 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 an 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Pacific Telesis
Group and Subsidiaries as of December 31, 1996 and 1995, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1996, in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basis financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
As discussed in Note A to the Consolidated Financial Statements, Pacific Bell, a
subsidiary of Pacific Telesis Group, changed its method of recognizing directory
publishing revenues and related expenses effective January 1, 1996. Also
discussed in Note A, Pacific Bell discontinued its application of Statement of
Financial Accounting Standards No. 71 during 1995.
Coopers & Lybrand L.L.P.
San Francisco, California
February 27, 1997
