FORM 10-Q
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1997
or
|_| Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission File Number 1-8610
SBC COMMUNICATIONS INC.
Incorporated under the laws of the State of Delaware
I.R.S. Employer Identification Number 43-1301883
175 E. Houston, San Antonio, Texas 78205
Telephone Number: (210) 821-4105
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
At October 31, 1997, 916,587,974 common shares were outstanding.
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
SBC COMMUNICATIONS INC.
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CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions except per share amounts
(Unaudited)
<CAPTION>
- -------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
-----------------------------------------------
1997 1996 1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating Revenues
Local service:
Landline $ 2,467 $ 2,229 $ 7,142 $ 6,516
Wireless 805 685 2,287 1,968
Network access:
Interstate 1,019 999 2,928 2,982
Intrastate 463 461 1,408 1,370
Long-distance service 541 564 1,612 1,667
Directory advertising 503 517 1,345 1,318
Other 547 502 1,550 1,448
- -------------------------------------------------------------------------------------
Total operating revenues 6,345 5,957 18,272 17,269
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Operating Expenses
Cost of services and products 2,365 2,075 6,760 5,957
Selling, general and administrative 1,422 1,309 5,587 3,763
Depreciation and amortization 1,086 1,041 3,800 3,070
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Total operating expenses 4,873 4,425 16,147 12,790
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Operating Income 1,472 1,532 2,125 4,479
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Other Income (Expense)
Interest expense (240) (193) (693) (618)
Equity in net income of affiliates 62 70 143 170
Other income (expense) - net (26) (22) (109) (39)
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Total other income (expense) (204) (145) (659) (487)
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Income Before Income Taxes and
Cumulative Effect of Accounting 1,268 1,387 1,466 3,992
Change
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Income Taxes 452 520 580 1,524
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Income Before Cumulative Effect
of Accounting Change 816 867 886 2,468
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Cumulative Effect of Accounting
Change, net of tax - - - 90
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Net Income $ 816 $ 867 $ 886 $ 2,558
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Earnings Per Common Share:
Income Before Cumulative Effect of
Accounting Change $ 0.89 $ 0.94 $ 0.97 $ 2.67
Cumulative Effect of Accounting - - - 0.10
Change
- -------------------------------------------------------------------------------------
Net Income $ 0.89 $ 0.94 $ 0.97 $ 2.77
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Weighted Average Number of Common
Shares Outstanding (in millions) 914 922 913 922
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Dividends Declared Per Common Share $ 0.4475 $ 0.43 $ 1.3425 $ 1.29
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
SBC COMMUNICATIONS INC.
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CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
- --------------------------------------------------------------------------------
September 30, December 31,
------------- -------------
1997 1996
- --------------------------------------------------------------------------------
Assets (Unaudited)
Current Assets
Cash and cash equivalents $ 705 $ 314
Short-term cash investments 504 432
Accounts receivable - net of allowances for
uncollectibles of $391 and $311 4,867 4,684
Prepaid expenses 452 287
Deferred income taxes 755 201
Deferred charges 118 102
Other current assets 222 251
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Total current assets 7,623 6,271
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Property, Plant and Equipment - at cost 64,310 61,786
Less: Accumulated depreciation and amortization 37,536 35,706
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Property, Plant and Equipment - Net 26,774 26,080
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Intangible Assets - Net of Accumulated
Amortization of $967 and $611 3,289 3,589
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Investments in Equity Affiliates 2,722 1,964
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Other Assets 1,648 1,581
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Total Assets $ 42,056 $ 39,485
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Liabilities and Shareowners' Equity
Current Liabilities
Debt maturing within one year $ 3,448 $ 2,335
Accounts payable and accrued liabilities 5,874 5,682
Accrued taxes 2,000 902
Dividends payable 411 393
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Total current liabilities 11,733 9,312
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Long-Term Debt 11,636 10,930
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Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 771 853
Postemployment benefit obligation 4,975 5,070
Unamortized investment tax credits 440 498
Other noncurrent liabilities 1,965 2,181
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Total deferred credits and other noncurrent 8,151 8,602
liabilities
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Corporation-obligated mandatorily redeemable
preferred securities of subsidiary trusts* 1,000 1,000
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Shareowners' Equity
Common shares issued ($1 par value) 934 934
Capital in excess of par value 9,416 9,422
Retained earnings 958 1,297
Guaranteed obligations of employee stock (196) (229)
ownership plans
Deferred compensation - LESOP (118) (161)
Foreign currency translation adjustment (551) (637)
Treasury shares (at cost) (907) (985)
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Total shareowners' equity 9,536 9,641
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Total Liabilities and Shareowners' Equity $ 42,056 $ 39,485
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* The trusts contain $1,030 in principal amount of the Subordinated Debentures
of Pacific Telesis Group.
See Notes to Consolidated Financial Statements.
<PAGE>
SBC COMMUNICATIONS INC.
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
(Unaudited)
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Nine months ended
September 30,
------------------------
1997 1996
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Operating Activities
Net income $ 886 $ 2,558
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,800 3,070
Undistributed earnings from investments in (70) (124)
equity affiliates
Provision for uncollectible accounts 388 293
Amortization of investment tax credits (58) (60)
Deferred income tax expense (391) 333
Cumulative effect of accounting change, net of - (90)
tax
Other - net (25) (947)
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Total adjustments 3,644 2,475
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Net Cash Provided by Operating Activities 4,530 5,033
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Investing Activities
Construction and capital expenditures (4,127) (3,694)
Investments in affiliates (22) (57)
Purchase of short-term investments (728) (750)
Proceeds from short-term investments 656 569
Dispositions 427 115
Acquisitions (1,049) (223)
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Net Cash Used in Investing Activities (4,843) (4,040)
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Financing Activities
Net change in short-term borrowings with original
maturities of three months or less 668 (845)
Issuance of other short-term borrowings 730 209
Repayment of other short-term borrowings (195) (89)
Issuance of long-term debt 953 814
Repayment of long-term debt (284) (318)
Issuance of trust originated preferred securities - 1,000
Purchase of fractional shares (15) -
Purchase of treasury shares (80) (338)
Issuance of treasury shares 144 76
Dividends paid (1,210) (1,297)
Other (7) (1)
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Net Cash Provided by (Used in) Financing 704 (789)
Activities
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Net increase in cash and cash equivalents 391 204
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Cash and cash equivalents beginning of year 314 566
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Cash and Cash Equivalents End of Period $ 705 $ 770
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Cash paid during the nine months ended September 30 for:
Interest $ 709 $ 649
Income taxes, net of refunds $ 268 $ 970
See Notes to Consolidated Financial Statements.
<PAGE>
<TABLE>
SBC COMMUNICATIONS INC.
CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
Dollars in millions
(Unaudited)
<CAPTION>
Guaranteed Foreign
Capital in Obligations of Deferred Currency
Common Excess of Retained Employee Stock Compensation Translation Treasury
Shares Par Value Earnings Ownership Plans - LESOP Adjustment Shares
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 934 $ 9,422 $ 1,297 $ (229) $ (161) $ (637) $ (985)
Net income - - 886 - - - -
Dividends to shareowners - - (1,227) - - - -
Reduction of debt associated
with Employee Stock Ownership - - - 33 - - -
Plans
Reduction of debt associated
with Deferred Compensation - LESOP - - - - 43 - -
Foreign currency translation
adjustment - - - - - 86 -
Purchase of treasury shares - - - - - - (80)
Issuance of treasury shares - (8) - - - - 158
Other - 2 2 - - - -
- ------------------------------------------------------------------------------------------------------------------------
Balance, September 30, 1997 $ 934 $ 9,416 $ 958 $ (196) $ (118) $ (551) $ (907)
- --------------------------------------------------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<TABLE>
SELECTED FINANCIAL AND OPERATING DATA
<CAPTION>
At September 30, or for the nine months then ended: 1997 1996
------------------------
<S> <C> <C>
Return on weighted average shareowners' equity........... 11.86% 35.28%
Debt ratio............................................... 58.88% 55.79%
Network access lines in service (000).................... 32,465 31,117
Access minutes of use (000,000).......................... 96,974 89,244
Cellular customers (000)................................. 5,228 4,156
Number of employees......................................118,440 108,940
</TABLE>
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions except per share amounts
1. BASIS OF PRESENTATION The consolidated financial statements have been
prepared by SBC Communications Inc. (SBC) pursuant to the rules and
regulations of the Securities and Exchange Commission (SEC) and, in the
opinion of management, include all adjustments (consisting only of normal
recurring accruals) necessary to present fairly the results for the interim
periods shown. Certain information and footnote disclosures, normally
included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted pursuant to
such SEC rules and regulations. Certain reclassifications have been made to
the 1996 consolidated financial statements to conform with the 1997
presentation. The results for the interim periods are not necessarily
indicative of results for the full year. The consolidated financial
statements contained herein should be read in conjunction with the
consolidated financial statements and notes thereto included in SBC's Current
Report on Form 8-K dated May 8, 1997, which presents the audited consolidated
financial statements of SBC reflecting the business combination of SBC and
Pacific Telesis Group (PAC).
2. CONSOLIDATION The consolidated financial statements include the accounts of
SBC and its majority-owned subsidiaries. SBC's largest subsidiaries are
Southwestern Bell Telephone Company (SWBell), providing telecommunications
services in Texas, Missouri, Oklahoma, Kansas and Arkansas, and 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 foreign investments accounted for under the equity method are included
for periods ended within three months of the date of SBC's Consolidated
Statements of Income.
3. COMPLETION OF MERGER On April 1, 1997, SBC and PAC completed the merger of an
SBC subsidiary with PAC, in a transaction in which each outstanding 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 was accounted for as a
pooling of interests and a tax-free reorganization.
The combined results include the effects 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 and certain deferred tax adjustments resulting from the merger. The
retroactive application of these conforming changes increased SBC's net
income by $15 for the third quarter of 1996 and $49 for the first nine months
of 1996; SBC had reported pre-merger net income of $593 and $1,558, while PAC
reported net income of $259 and $951. The conforming changes did not affect
operating revenues for the third quarter or first nine months of 1996; during
those periods, PAC reported operating revenues of $2,356 and $7,139 and SBC
reported pre-merger revenues of $3,601 and $10,130.
Transaction costs and one-time charges resulting from the merger of $359
($215 net of tax) include, among other items, the present value of amounts to
be returned to California and Nevada ratepayers as a condition of the merger
(merger approval costs) and expenses for investment banker and professional
fees. Of this total, $287 ($180 net of tax) is included in expenses in 1997,
and $72 ($35 net of tax) in 1996.
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
Post-merger initiatives
During the second quarter 1997, SBC announced after-tax charges of $1.6
billion in the second quarter related to several strategic decisions
resulting from the merger integration process that began with the April 1
closing of its merger with PAC, which included $165 ($101 after tax) of
charges related to recent regulatory rulings and $281 ($176 after tax) for
merger approval costs. The decisions resulted from an extensive review of
operations throughout the merged company and include significant integration
of operations and consolidation of some administrative and support functions.
Following is a discussion of the most significant of these charges.
Reorganization SBC will centralize several key functions that will support
the operations of the Telephone Companies, including network planning,
strategic marketing and procurement. It is also consolidating a number of
corporate-wide support activities, including research and development,
information technology, financial transaction processing and real estate
management. The Telephone Companies will continue as separate legal entities.
These initiatives will result in the creation of some jobs and the
elimination and realignment of others, with many of the affected employees
changing job responsibilities and in some cases assuming positions in other
locations.
SBC recognized a charge of approximately $338 ($213 net of tax) during the
second quarter of 1997 in connection with these initiatives. This charge was
comprised mainly of postemployment benefits, primarily related to severance,
and costs associated with closing down duplicate operations, primarily
contract cancellations. Other charges arising out of the merger related to
relocation, retraining and other effects of consolidating certain operations
are being recognized in the periods those charges are incurred.
Impairments/asset valuation As a result of SBC's merger integration plans,
strategic review of domestic operations and organizational alignments, SBC
reviewed the carrying values of related long-lived assets. This review
included estimating remaining useful lives and cash flows and identifying
assets to be abandoned. Where this review indicated impairment, discounted
cash flows related to those assets were analyzed to determine the amount of
the impairment. As a result of these reviews, SBC wrote off some assets and
recognized impairments to the value of other assets with a combined charge of
$965 ($667 after tax) recorded in the second quarter of 1997. These
impairments and writeoffs related to the wireless digital TV operations in
southern California, certain analog switching equipment in California,
certain rural and other telecommunications equipment in Nevada, selected
wireless equipment, duplicate or obsolete equipment, cable within commercial
buildings in California, certain nonoperating plant and other assets.
Video curtailment/purchase commitments SBC also announced it is scaling back
its limited direct investment in video services. As a result of this
curtailment, SBC has halted construction on the Advanced Communications
Network (ACN) in California. As part of an agreement with the ACN vendor, SBC
will pay the liabilities of the ACN trust that owns and finances ACN
construction, incur costs to shut down all construction previously conducted
under the trust and receive certain consideration from the vendor. In the
second quarter of 1997, SBC recognized its net expense of $553 ($346 after
tax) associated with these activities. During the third quarter of 1997, SBC
recorded the corresponding short-term debt of $610 previously incurred by the
ACN trust on its balance sheet.
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions except per share amounts
Additionally, SBC will curtail several other video-related activities
including discontinuing its broadband network video trials in Richardson,
Texas and San Jose, California, substantially scaling back its involvement in
the Tele-TV joint venture, evaluating its option to invest in cable
television operations in Chicago and negotiating with Americast Corporation
to define the appropriate ongoing role for SBC within the Americast venture.
Americast Corporation has filed for arbitration in connection with these
negotiations. The collective impact of these decisions resulted in a charge
of $145 ($92 after tax) in the second quarter of 1997.
4. NEW ACCOUNTING STANDARD Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (FAS 128), requires dual presentation of basic and
diluted earnings per share (EPS). Diluted EPS will be similar to the fully
diluted EPS under current accounting rules. SBC will adopt FAS 128 in its
annual 1997 consolidated financial statements, but does not expect FAS 128 to
have any significant impact.
5. CUMULATIVE EFFECT OF CHANGE IN DIRECTORY ACCOUNTING Prior to January 1, 1996,
Pacific Bell Directory (a subsidiary of PacBell and an indirect subsidiary of
PAC) 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. Under
the new "issue basis" method, revenues and expenses are recognized when the
directories are issued. The change to the issue basis method was made because
it is the method generally followed in the publishing industry, including
Southwestern Bell Yellow Pages, Inc., and better reflects the operating
activity of the business.
The change was adopted during the fourth quarter of 1996. The cumulative
after-tax effect of applying the change in method to prior years was
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.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS
Overview Financial results for SBC Communications Inc. (SBC) for the third
quarters and first nine months of 1997 and 1996 are summarized as follows:
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------
Third Quarter Nine-Month Period
--------------------------- ---------------------------
Percent Percent
1997 1996 Change 1997 1996 Change
- ------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues $ 6,345 $ 5,957 6.5% $ 18,272 $ 17,269 5.8%
Operating expenses $ 4,873 $ 4,425 10.1% $ 16,147 $ 12,790 26.2%
Income before cumulative
effect of accounting change $ 816 $ 867 (5.9)% $ 886 $ 2,468 (64.1)%
Cumulative effect of
accounting change - - - - $ 90 -
Net income $ 816 $ 867 (5.9)% $ 886 $ 2,558 -
====================================================================================
</TABLE>
SBC reported net income for the third quarter of 1997 of $816, or $0.89 per
share, compared to $867, or $ 0.94 per share, in the third quarter of 1996.
SBC's net income for the first nine months of 1997 of $886, or $0.97 per share,
includes after-tax charges of approximately $1.7 billion reflecting strategic
initiatives resulting from a comprehensive review of operations of the merged
company, the impact of several regulatory rulings during the second quarter of
1997, costs incurred for customer number portability since the merger and
charges for ongoing merger integration costs, primarily related to movement of
employees. Excluding these items, SBC reported net income of $2,540 for the
first nine months of 1997, 2.9% higher than 1996 income before cumulative effect
of accounting change of $2,468, and on a per share basis, $2.78 per share, 4.1%
higher than 1996 earnings per share of $2.67. SBC currently anticipates
incurring additional after-tax charges for ongoing merger integration costs,
primarily related to movement of employees, and customer number portability of
$250 to $350 during the remainder of 1997.
Excluding these charges, the primary factors contributing to the increase in
income before cumulative effect of accounting change during the third quarter
and first nine months of 1997 were growth in demand for services and products at
Southwestern Bell Telephone Company (SWBell) and Southwestern Bell Mobile
Systems (Mobile Systems), partially offset by increased expenses at Pacific Bell
(PacBell, which also includes its subsidiaries), including expenses for the
introduction of Personal Communications Services (PCS) operations in California
and Nevada. Third quarter results also reflect charges to net income of $43 for
costs incurred in connection with customer number portability since the merger
and ongoing merger integration costs. Results for the first nine months of 1997
were also favorably affected by a first quarter 1997 $90 after-tax settlement
gain at Pacific Telesis Group (PAC) associated with lump-sum pension payments
that exceeded the projected service and interest costs for 1996 retirements.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Revenues SBC's operating revenues for the first nine months of 1997 reflect
reductions of $188 related primarily to the impact of several regulatory rulings
during the second quarter of 1997. SBC's operating revenues increased $388, or
6.5%, in the third quarter of 1997, and excluding the reductions described
above, $1,191, or 6.9%, in the first nine months of 1997. Components of
operating revenues for the third quarters and first nine months of 1997 and 1996
are as follows:
- --------------------------------------------------------------------------------
Third Quarter Nine-Month Period
----------------------------- -------------------------------
Percent Percent
1997 1996 Change 1997 1996 Change
- --------------------------------------------------------------------------------
Local service:
Landline $ 2,467 $ 2,229 10.7% $ 7,142 $ 6,516 9.6%
Wireless 805 685 17.5 2,287 1,968 16.2
Network access:
Interstate 1,019 999 2.0 2,928 2,982 (1.8)
Intrastate 463 461 0.4 1,408 1,370 2.8
Long-distance 541 564 (4.1) 1,612 1,667 (3.3)
service
Directory 503 517 (2.7) 1,345 1,318 2.0
advertising
Other 547 502 9.0 1,550 1,448 7.0
- ------------------------------------- -------------------
Total $ 6,345 $ 5,957 6.5% $ 18,272 $ 17,269 5.8%
================================================================================
Local Service Landline local service revenues increased in the third
quarter and first nine months of 1997 due primarily to increases in
demand, including increases in access lines and vertical services
revenues. The number of access lines increased by 4.3% since September 30,
1996, of which 43% was due to growth in California and 38% was due to
growth in Texas. Approximately 37% of access line growth was due to sales
of additional access lines to existing residential customers. Vertical
services revenues for the nine month period, which include custom calling
options, Caller ID and other enhanced services, increased by approximately
21%. Local service revenues also reflect the implementation of the
California High Cost Fund (CHCFB) that went into effect February 1, 1997.
The California Public Utilities Commission (CPUC) has stated that the
CHCFB is intended to directly subsidize the provision of service to high
cost areas and allow PacBell to set competitive rates for other services.
The rebalancing provisions of the CHCFB resulted in a minor shift of
equivalent revenues from long-distance and intrastate network access
revenues to local service revenues in the third quarter and first nine
months of 1997. For further information on the operations of the CHCFB,
see the discussion under the heading "Regulatory Environment - California"
on page 10 of SBC's Current Report on Form 8-K dated May 8, 1997.
Additionally, Federal payphone deregulation increased local service and
decreased other operating revenues and, to a lesser extent, long-distance
service and interstate network access; the overall impact was a slight
increase in total operating revenues. Rate reductions due to CPUC price
cap orders partially offset increases in landline local service revenues.
Wireless local service revenues increased in the third quarter and first
nine months of 1997 due primarily to growth in the number of Mobile
Systems' cellular customers of 19.4% (17.4% excluding acquisitions) since
September 30, 1996, partially offset by a decline in average revenue per
customer. 1997 wireless local revenues also include revenues from PCS
operations in California, Nevada and Oklahoma, which contributed to the
increase. At September 30, 1997, SBC had 4,890,000 traditional cellular
customers, 51,000 resale customers and 287,000 PCS customers.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Network Access Interstate network access revenues decreased in the first
nine months of 1997 due to $187 in one-time charges. These one-time
charges include billing claim settlements related to the Percentage
Interstate Usage (PIU) factor in California and several Federal regulatory
issues including end-user charges, recovery of certain employee-related
expenses and the retroactive effect of the productivity factor adjustment
mandated in the July 1, 1997 Federal price cap filing. While the change in
the PIU factor in California, which is used to allocate network access
revenues between interstate and intrastate jurisdictions, also had the
effect of increasing intrastate network access revenues, it resulted in a
slight decline in total network access revenues. Without these impacts,
interstate network access revenues increased in the third quarter and
first nine months of 1997 due to increases in demand for access services
by interexchange carriers and growth in revenues from end-user charges
attributable to an increasing access line base. Partially offsetting these
increases were the effects of the rate reduction related to the
productivity factor adjustment and PacBell's revenue sharing adjustments
made in 1996.
Intrastate network access revenues increased in the first nine months of
1997 due primarily to the PIU settlements described above. Excluding this
impact, intrastate network access revenues were relatively unchanged in
the third quarter and first nine months of 1997 as increases in demand,
including usage by alternative intraLATA toll carriers, were offset by
state regulatory rate orders and the effects of the CHCFB discussed above
in Local Service.
Long-Distance Service revenues decreased in the third quarter and first
nine months of 1997 due to the effect of the CHCFB discussed above,
regulatory rate orders, price competition from alternative intraLATA toll
carriers and the introduction and deployment of extended area local
service plans at SWBell. These decreases were somewhat offset by increases
due to growth in wireless revenues, including revenues from interLATA
service, and demand resulting from California's growing economy.
Directory Advertising revenues increased in the first nine months of 1997
due mainly to the publication of directories not published in 1996 and, to
a lesser extent, increased demand. Directory Advertising revenues
decreased in the third quarter of 1997 due to changes in directory
publication schedules as compared with 1996, which shifted a major
directory into the fourth quarter of 1997.
Other operating revenues increased in the third quarter and first nine
months of 1997 due primarily to increased equipment sales at Pacific Bell
Mobile Services and Mobile Systems and increased demand for PacBell and
SWBell nonregulated products and services. Revenues from new business
initiatives, primarily voice messaging services and Internet services,
also contributed to the increase. For the nine month period, these
increases were somewhat offset by decreases in sales of Caller ID
equipment resulting from outsourcing Caller ID equipment sales to an
external vendor during 1997.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Expenses SBC's operating expenses for the first nine months of 1997 reflect
approximately $2.3 billion of charges related to strategic initiatives resulting
from a comprehensive review of operations of the merged company, the impact of
several regulatory rulings during the second quarter of 1997 (see Note 3 to the
Financial Statements), costs incurred for customer number portability since the
merger and charges for ongoing merger integration costs. SBC's operating
expenses increased $448, or 10.1%, in the third quarter of 1997 and excluding
the charges described above $1,055, or 8.2%, in the first nine months of 1997.
Components of operating expenses for the third quarters and first nine months of
1997 and 1996 are as follows:
- -------------------------------------------------------------------------------
Third Quarter Nine-Month Period
----------------------------- -----------------------------
Percent Percent
1997 1996 Change 1997 1996 Change
- -------------------------------------------------------------------------------
Cost of
services and $ 2,365 $ 2,075 14.0% $ 6,760 $ 5,957 13.5%
products
Selling,
general and 1,422 1,309 8.6 5,587 3,763 48.5
administrative
Depreciation
and amortization 1,086 1,041 4.3 3,800 3,070 23.8
- ----------------------------------------- --------------------
Total $ 4,873 $ 4,425 10.1% $ 16,147 $ 12,790 26.2%
===============================================================================
Cost of services and products reflects charges of $96 in the first nine
months of 1997 relating to SBC's strategic initiatives, operational
reviews, costs incurred for customer number portability since the merger
and ongoing merger integration costs; excluding these charges, expenses
increased $707, or 11.9%, in the first nine months of 1997. The third
quarter and year-to-date increases were significantly impacted by the
introduction of PCS operations during 1997. Additional increases were due
primarily to increases in employee compensation, including increases
related to force additions and contract labor, network expansion and
maintenance, growth at Mobile Systems and interconnection costs. During
the third quarter of 1997, pension settlement gains previously reported as
cost of services and products were reclassified to selling, general and
administrative expense; prior quarters of 1997 were restated to reflect
this reclassification.
Selling, general and administrative expense for the first nine months of
1997 reflects $1,613 of charges relating to SBC's strategic initiatives,
operational reviews and ongoing merger integration costs. As discussed in
Note 3 to the Financial Statements, the most significant of these charges
included shutdown of the Advanced Communications Network (ACN), regulatory
costs related to the approval of the merger with SBC by California and
Nevada regulators, and reorganization initiatives. Excluding these
one-time charges, expenses increased $211, or 5.6%, in the first nine
months of 1997. The third quarter and year-to-date increases were
significantly impacted by the introduction of PCS operations during 1997.
Additional increases were due primarily to growth at Mobile Systems and
increases in employee compensation, contract labor, sales agents
commissions and uncollectibles. For the nine month period, these increases
were partially offset by PAC's first quarter 1997 $152 settlement gain
associated with lump-sum pension payments that exceeded the projected
service and interest costs for 1996 retirements and reduced expenses
resulting from conforming accounting methodologies and assumptions for
pensions and postretirement benefits.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
RESULTS OF OPERATIONS - Continued
Depreciation and amortization for the first nine months of 1997 reflects
charges totaling $592 to record impairment of plant and intangibles. As
discussed in Note 3 to the Financial Statements, the most significant of
these impairments related to the wireless digital TV operations in
southern California, certain analog switching equipment in California,
certain rural and other telecommunications equipment in Nevada, selected
wireless equipment and cable within commercial buildings in California.
Depreciation and amortization increased $138 excluding these charges, or
4.5%, in the first nine months of 1997 and $45, or 4.3% in the third
quarter of 1997. These increases were primarily due to overall higher
plant levels partially offset by reduced depreciation beginning with the
second quarter of 1997 on analog switching equipment in California at
PacBell.
Interest expense increased $47, or 24.4%, and $75, or 12.1%, in the third
quarter and first nine months of 1997 due primarily to increased debt levels.
The year-to-date increase was also due to interest associated with second
quarter 1997 one-time charges.
Equity in net income of affiliates decreased $8 and $27 in the third quarter and
first nine months of 1997 due primarily to decreased income from Telefonos de
Mexico, S.A. de C.V. (Telmex), resulting from SBC's reduced ownership percentage
after the sale of Telmex L shares and the change in the functional currency used
by SBC to record its interest in Telmex from the peso to the U.S. dollar
beginning in 1997. Additionally, results for the third quarter of 1996 reflected
net gains on international affiliate investment transactions. These decreases
were partially offset by income from SBC's May 1997 investment in Telkom SA
Limited (see Other Business Matters), whose results reflected strong growth and
expense management.
SBC's investment in Telmex is recorded in accordance with U.S. generally
accepted accounting principles, which exclude inflation adjustments and include
adjustments for the purchase method of accounting.
Other income (expense) -net was a net expense of $26 and $109 for the third
quarter and first nine months of 1997. Results for the nine month period reflect
$26 in expenses related to SBC's strategic initiatives, primarily writeoffs of
nonoperating plant. Other increases relate primarily to distributions paid on an
additional $500 of Trust Originated Preferred Securities sold by PAC in June
1996 and the market valuation adjustment on the SBC debt redeemable either in
cash or Telmex L shares. Partially offsetting these increased expenses were
royalty payments associated with software developed by an affiliate and the gain
on the sale of Telmex L shares.
Income taxes for the first nine months of 1997 reflect the tax effect of charges
for strategic initiatives resulting from SBC's comprehensive review of
operations of the merged company and the impact of several regulatory rulings in
the second quarter of 1997. The effective tax rate on these items was lower as a
result of non-deductible items included in the charge and valuation adjustments
to certain deferred tax assets. Excluding these items, income taxes for the
third quarter and first nine months of 1997 were lower due to reduced income
before income tax and lower state taxes. Income taxes paid, net of refunds
reflect the impact of reduced tax payments due to merger-related and integration
costs incurred.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
State Interconnection Agreements/ Reselling Developments SBC continues to enter
into interconnection agreements with companies desiring to provide local service
in its operating territory. Approximately 230 interconnection agreements have
been reached, and most have been approved by the relevant state commissions.
AT&T Corp. (AT&T) and other competitors are reselling SBC local exchange
services, and as of September 30, 1997, there were more than 330,000 SBC access
lines supporting services resold by competitors.
Federal Interconnection In September 1997, 28 state commissions, the National
Association of Regulatory Utilities Commissioners and the D.C. Public Service
Commission, along with many companies who have Local Exchange Carriers (LECs)
including SBC, filed petitions to enforce the July 18, 1997 ruling of the U.S.
Court of Appeals for the Eighth Circuit in St. Louis (8th Circuit) that the
right to set local exchange prices, including the pricing methodology used, is
reserved exclusively to the states. The petitions respond to the Federal
Communications Commission's (FCC) rejection of Ameritech Corporation's interLATA
long-distance application in Michigan in which the FCC stated it is applying its
own pricing standards to interLATA applications. The petitioners assert the FCC
is violating state authority. On October 14, 1997, the 8th Circuit granted the
LECs' petitions for rehearing and ruled that they do not have to deliver network
elements to competitors in anything other than completely unbundled form.
Payphone Deregulation/Market Price Adjustments Final price deregulation of the
payphone industry took effect October 7, 1997. SBC raised payphone prices
throughout its operating territories, beginning in October 1997. The new prices
are the result of federal telecommunications deregulation, which prohibits the
subsidy of payphone service directly or indirectly from telephone service
operations and allows payphone providers to determine their own pricing.
Portions of the Telecommunications Act of 1996 (Telecom Act) Challenged In July
1997, SBC brought suit in the U.S. District Court for the Northern District of
Texas, seeking a declaration that a portion of the Telecom Act is
unconstitutional on the grounds that it improperly discriminates against SBC by
imposing restrictions that prohibit SBC from offering interLATA long-distance
and other services that other LECs are free to provide. The suit challenges only
that portion of the Telecom Act that excludes SBC from competing in certain
lines of business. SBC is currently awaiting a decision by the court on its
motion for summary judgement.
California Universal Service Rebalancing Hearings related to the PacBell March
1997 filing to permanently reduce certain toll and access rates and eliminate
universal service surcredits to ratepayers for rebalancing of the CHCFB were
held in October 1997 with a decision expected in the second quarter of 1998.
FCC Pre-empts Portions of Texas Public Utility Regulatory Act (PURA) The FCC
pre-empted and voided portions of PURA that required certain new entrants to
build telephone networks to cover a 27 square-mile area in any market they
entered. Also pre-empted were rules that excluded competitors from entering
markets with fewer than 31,000 access lines and limited resale of Centrex phone
services. Texas regulators have already given AT&T and MCI Communications
Corporation waivers of the build-out requirement that was pre-empted, and SBC
has dismissed all appeals relating to this issue.
<PAGE>
SBC COMMUNICATIONS INC.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions except per share amounts
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS - Continued
OTHER BUSINESS MATTERS
Acquisitions and Dispositions
In May 1997, the consortium of SBC and Telekom Malaysia Berhad, 60% owned by
SBC, completed the purchase of 30% of Telkom SA Limited (Telkom), the
state-owned government telecommunications company of South Africa. SBC invested
approximately $760, approximately $600 of which will remain in Telkom.
During the third quarter of 1997, SBC agreed to sell its cable television
properties in Montgomery County, Maryland and Arlington, Virginia, as well as
its purchase option to invest in cable television operations in Chicago. These
transactions are expected to occur during 1998.
LIQUIDITY AND CAPITAL RESOURCES
During the first nine months of 1997, as in 1996, SBC's primary source of funds
continued to be cash provided by operating activities. Additionally, in March
1997 SBC issued approximately $385 in debt due March 2001 which, at SBC's
option, may be redeemed upon maturity either in cash or Telmex L shares
(equivalent to up to 2.4% of Telmex's equity capitalization at March 31, 1997).
During the third quarter of 1997, SBC recorded short-term debt of $610
previously incurred by the ACN trust on its balance sheet (see Note 3 to the
Financial Statements). SBC had $705 in cash and cash equivalents available at
September 30, 1997. SBC has entered into agreements with several banks for lines
of credit totaling $3,240, all of which may be used to support commercial paper
borrowings. SBC had no borrowings outstanding under these lines of credit as of
September 30, 1997. Commercial paper borrowings as of September 30, 1997 totaled
$2,441.
Over the next few years, SBC is expecting to incur significant capital and
software expenditures for customer number portability and interconnection. SBC
expects capital costs and expenses associated with customer number portability,
which allows customers to switch to new local competitors and keep the same
phone number, to total up to $1.2 billion on a pre-tax basis over the next four
years. Full recovery of customer number portability costs is required under the
Telecom Act; however, the FCC has not yet determined when or how those
significant costs will be recovered. SBC has filed a tariff for recovery of
these costs. No action has been taken by the FCC on this tariff, pending the
issuance of its order on customer number portability. SBC is unable to predict
the likelihood of the FCC permitting the tariffs to become effective. Capital
costs and expenses associated with interconnection will vary based on the number
of competitors seeking interconnection and markets entered and customers served
by those competitors. Accordingly, SBC is currently unable to reasonably
estimate these costs.
<PAGE>
SBC COMMUNICATIONS INC.
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 12 Computation of Ratios of Earnings to Fixed Charges.
Exhibit 27 Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the third quarter ended
September 30, 1997.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SBC Communications Inc.
November 12, 1997 /s/ Donald E. Kiernan
-----------------------
Donald E. Kiernan
Senior Vice President, Treasurer
and Chief Financial Officer
<TABLE>
EXHIBIT 12
SBC COMMUNICATIONS INC.
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
Dollars in Millions
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
<CAPTION>
--------------------- -----------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- -----------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Income Before Income Taxes, Extraordinary Loss
and Cumulative Effect of Accounting Changes* $ 1,396 $ 3,868 $ 4,975 $ 4,383 $ 4,091 $ 2,070 $ 3,447
Add: Interest Expense 693 618 812 957 935 1,005 1,036
Dividends on Preferred Securities 60 40 60 - - - -
1/3 Rental Expense 106 80 108 77 85 81 89
--------- --------- --------- --------- -------- -------- ---------
Adjusted Earnings $ 2,255 $ 4,606 $ 5,955 $ 5,417 $ 5,111 $ 3,156 $ 4,572
========= ========= ========= ========= ======== ======== =========
Total Interest Charges $ 786 $ 711 $ 947 $ 957 $ 935 $ 1,005 $ 1,036
Dividends on Preferred Securities 60 40 60 - - - -
1/3 Rental Expense 106 80 108 77 85 81 89
--------- --------- --------- --------- -------- -------- ---------
Adjusted Fixed Charges $ 952 $ 831 $ 1,115 $ 1,034 $ 1,020 $ 1,086 $ 1,125
========= ========= ========= ========= ======== ======== =========
Ratio of Earnings to Fixed Charges 2.37 5.54 5.34 5.24 5.01 2.91 4.06
<FN>
*Undistributed earnings on investments accounted for under the equity method
have been excluded.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANACIAL INFORMATION EXTRACTED FROM SBC
COMMUNICATIONS INC.'S SEPTEMBER 30,1997 CONSOLIDATED FINANCIAL STATEMENTS AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> SEP-30-1997
<CASH> 705
<SECURITIES> 504
<RECEIVABLES> 5,258
<ALLOWANCES> 391
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 7,623
<PP&E> 64,310
<DEPRECIATION> 37,536
<TOTAL-ASSETS> 42,056
<CURRENT-LIABILITIES> 11,733
<BONDS> 11,636
0
0
<COMMON> 934
<OTHER-SE> 8,602
<TOTAL-LIABILITY-AND-EQUITY> 42,056
<SALES> 0<F2>
<TOTAL-REVENUES> 18,272
<CGS> 0<F3>
<TOTAL-COSTS> 6,760
<OTHER-EXPENSES> 3,800
<LOSS-PROVISION> 388
<INTEREST-EXPENSE> 693
<INCOME-PRETAX> 1,466
<INCOME-TAX> 580
<INCOME-CONTINUING> 886
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 886
<EPS-PRIMARY> 0.97
<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>
