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, 1998
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 30, 1998, 1,956,015,899 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)
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<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-----------------------------------------------
1998 1997 1998 1997
- -------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Operating Revenues
Local service:
Landline $ 2,612 $ 2,442 $ 7,658 $ 7,092
Wireless 856 789 2,476 2,237
Network access:
Interstate 1,094 1,019 3,310 2,928
Intrastate 468 463 1,392 1,408
Long-distance service 577 541 1,662 1,612
Directory advertising 447 503 1,328 1,345
Other 722 572 1,965 1,601
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Total operating revenues 6,776 6,329 19,791 18,223
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Operating Expenses
Cost of services and products 2,403 2,364 7,039 6,760
Selling, general and administrative 1,432 1,407 4,198 5,538
Depreciation and amortization 1,151 1,086 3,396 3,800
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Total operating expenses 4,986 4,857 14,633 16,098
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Operating Income 1,790 1,472 5,158 2,125
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Other Income (Expense)
Interest expense (222) (240) (693) (693)
Equity in net income of affiliates 55 61 181 143
Other income (expense) - net 288 (25) 211 (109)
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Total other income (expense) 121 (204) (301) (659)
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Income Before Income Taxes 1,911 1,268 4,857 1,466
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Income Taxes 704 452 1,772 580
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Net Income $ 1,207 $ 816 $ 3,085 $ 886
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Earnings Per Common Share $ 0.66 $ 0.45 $ 1.68 $ 0.48
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Earnings Per Common Share - Assuming
Dilution $ 0.65 $ 0.44 $ 1.66 $ 0.48
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Weighted Average Number of Common
Shares Outstanding (in millions) 1,835 1,829 1,837 1,826
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Dividends Declared Per Common Share $ 0.23375 $ 0.22375 $ 0.70125 $ 0.67125
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SBC COMMUNICATIONS INC.
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CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
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<CAPTION>
September 30, December 31,
-------------- -------------
1998 1997
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<S> <C> <C>
Assets (Unaudited)
Current Assets
Cash and cash equivalents $ 779 $ 398
Short-term cash investments 37 320
Accounts receivable - net of allowances for
uncollectibles of $412 and $395 4,895 5,015
Prepaid expenses 551 349
Deferred income taxes 504 622
Deferred charges 112 82
Other current assets 280 276
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Total current assets 7,158 7,062
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Property, Plant and Equipment - at cost 67,919 65,286
Less: Accumulated depreciation and amortization 39,999 37,947
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Property, Plant and Equipment - Net 27,920 27,339
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Intangible Assets - Net of Accumulated
Amortization of $905 and $1,002 2,742 3,269
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Investments in Equity Affiliates 2,545 2,740
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Other Assets 2,164 1,722
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Total Assets $ 42,529 $ 42,132
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Liabilities and Shareowners' Equity
Current Liabilities
Debt maturing within one year $ 1,630 $ 1,953
Accounts payable and accrued liabilities 5,889 6,780
Accrued taxes 1,611 1,108
Dividends payable 429 411
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Total current liabilities 9,559 10,252
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Long-Term Debt 11,217 12,019
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Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 1,982 1,639
Postemployment benefit obligation 4,864 4,929
Unamortized investment tax credits 364 417
Other noncurrent liabilities 2,012 1,984
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Total deferred credits and other noncurrent liabilities 9,222 8,969
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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) 1,867 934
Capital in excess of par value 8,514 9,418
Retained earnings 2,947 1,146
Guaranteed obligations of employee stock
ownership plans (137) (183)
Deferred compensation - LESOP (84) (119)
Treasury shares (at cost) (1,023) (730)
Accumulated other comprehensive income (553) (574)
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Total shareowners' equity 11,531 9,892
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Total Liabilities and Shareowners' Equity $ 42,529 $ 42,132
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<FN>
* The trusts contain $1,030 in principal amount of the Subordinated Debentures
of Pacific Telesis Group.
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
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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<CAPTION>
Nine months ended
September 30,
------------------------
1998 1997
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<S> <C> <C>
Operating Activities
Net income $ 3,085 $ 886
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,396 3,800
Undistributed earnings from investments in
equity affiliates (26) (70)
Provision for uncollectible accounts 341 388
Amortization of investment tax credits (53) (58)
Deferred income tax expense 319 (391)
Other - net (1,421) (25)
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Total adjustments 2,556 3,644
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Net Cash Provided by Operating Activities 5,641 4,530
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Investing Activities
Construction and capital expenditures (3,860) (4,127)
Investments in affiliates (54) (22)
Purchase of short-term investments (41) (728)
Proceeds from short-term investments 324 656
Dispositions 733 427
Acquisitions - (1,049)
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Net Cash Used in Investing Activities (2,898) (4,843)
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Financing Activities
Net change in short-term borrowings with original
maturities of three months or less (146) 668
Issuance of other short-term borrowings 2 730
Repayment of other short-term borrowings (8) (195)
Issuance of long-term debt 394 953
Repayment of long-term debt (1,011) (284)
Purchase of fractional shares - (15)
Purchase of treasury shares (497) (80)
Issuance of treasury shares 176 144
Dividends paid (1,272) (1,210)
Other - (7)
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Net Cash Provided by (Used in) Financing Activities (2,362) 704
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Net increase in cash and cash equivalents 381 391
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Cash and cash equivalents beginning of year 398 314
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Cash and Cash Equivalents End of Period $ 779 $ 705
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Cash paid during the nine months ended September 30 for:
Interest $ 791 $ 709
Income taxes, net of refunds $ 1,057 $ 268
<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SBC COMMUNICATIONS INC.
CONSOLIDATED STATEMENT OF SHAREOWNERS' EQUITY
Dollars in millions
(Unaudited)
<CAPTION>
Guaranteed
Capital Obligations
in of Employee Accumulated
Excess Stock Deferred Other
Common of Par Retained Ownership Compensation Treasury Comprehensive
Shares Value Earnings Plans - LESOP Shares Income
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1997 $934 $9,418 $1,146 $(183) $(119) $(730) $(574)
Comprehensive income:
Net income - - 3,085 - - - -
Other comprehensive income, net of tax:
Foreign currency translation adjustment - - - - - - (61)
Unrealized gain on available for sale
securities, net of reclassification
adjustment - - - - - - 82
Dividends to shareowners - - (1,288) - - - -
Two-for-one stock split 933 (933) - - - - -
Reduction of debt associated with
Employee Stock Ownership Plans - - - 46 - - -
Cost of LESOP trust shares allocated
to employee accounts - - - - 35 - -
Purchase of treasury shares - - - - - (497) -
Issuance of treasury shares - (24) - - - 204 -
Other - 53 4 - - - -
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Balance, September 30, 1998 $1,867 $8,514 $2,947 $(137) $ (84) $(1,023) $(553)
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<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: 1998 1997
-------------------------------
<S> <C> <C>
Debt ratio............................................... 50.62% 58.88%
Network access lines in service (000).................... 34,598 33,050
Resold lines (000)....................................... 714 328
Access minutes of use (000,000)*.........................102,913 96,229
Cellular customers (000)................................. 5,982 5,228
Number of employees......................................118,570 118,440
<FN>
*Amounts have been restated.
</FN>
</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 1997 consolidated financial statements to conform with the 1998
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 1997
Annual Report to Shareowners.
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 Pacific
Telesis Group (PAC), providing telecommunications services in California and
Nevada. PAC's subsidiaries include Pacific Bell (PacBell, which also includes
its subsidiary, Pacific Bell Information Services) 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. COMPREHENSIVE INCOME Effective with the first quarter of 1998, SBC is
reporting comprehensive income for the third quarter and nine months ended
September 30, 1998 and 1997. The components of SBC's comprehensive income for
each period presented include net income and the adjustments to shareowners'
equity for foreign currency translation adjustment and net unrealized gains
on securities.
Following is SBC's comprehensive income:
----------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
-----------------------------------------
1998 1997 1998 1997
----------------------------------------------------------------------------
Net income $ 1,207 $ 816 $ 3,085 $ 886
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Other comprehensive income, net of tax:
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Foreign currency translation
adjustment 15 4 (61) 86
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Net unrealized gain on securities:
Unrealized gain on available
for sale securities 83 - 83 -
Less: reclassification
adjustment for gains included
in net income (1) - (1) -
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Net unrealized gain on securities 82 - 82 -
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Other comprehensive income 97 4 21 86
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Comprehensive income $ 1,304 $ 820 $ 3,106 $ 972
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<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
Dollars in millions except per share amounts
4. MERGER AGREEMENT WITH AMERITECH CORPORATION As disclosed in the Form 8-K
filed on May 11, 1998, SBC announced a definitive agreement to merge an SBC
subsidiary with Ameritech Corporation (Ameritech) in a transaction in which
each share of Ameritech common stock will be converted into and exchanged for
1.316 shares of SBC common stock. After the merger, Ameritech will be a
wholly-owned subsidiary of SBC. The transaction, which has been approved by
the board of directors of each company, is intended to be accounted for as a
pooling of interests and to be a tax-free reorganization. The merger is
subject to certain regulatory approvals as well as approval by the
shareowners of each company. Both SBC and Ameritech have special meetings of
their respective shareowners scheduled for December 1998 for the purpose of
voting on the proposed merger.
5. MERGER WITH SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION (SNET) On
October 26, 1998, SBC and SNET completed the merger of an SBC subsidiary with
SNET, in a transaction in which each share of SNET common stock was exchanged
for 1.7568 shares of SBC common stock (equivalent to approximately 120
million shares, or 6.5% of SBC's outstanding shares at December 31, 1997).
SNET became a wholly-owned subsidiary of SBC effective with the merger and
the transaction will be accounted for as a pooling of interests and a
tax-free reorganization. Effective with the merger, the financial statements
for all periods will be restated to include the accounts of SNET.
The following tables present summarized financial information for SNET that
will be included in SBC's financial statements effective with the merger.
This information does not include the effect of any conforming accounting
changes, primarily related to pension and postemployment benefits:
--------------------------------------------------------------------
September December
30, 1998 31, 1997
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Balance Sheets
Current assets $ 491 $ 455
Noncurrent assets 2,351 2,316
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Total assets $ 2,842 $ 2,771
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Current liabilities $ 581 $ 658
Noncurrent liabilities 1,477 1,516
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Total liabilities $ 2,058 $ 2,174
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--------------------------------------------------------------------
Nine Months Ended September 30, 1998 1997
--------------------------------------------------------------------
Income Statements
Operating revenues $ 1,606 $ 1,494
Operating expenses 1,274 1,200
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Operating income 332 294
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Other income (expense), net (70) (62)
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Income before income taxes $ 262 $ 232
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Effective with the merger, SBC has begun a complete review of all operations,
primarily those of SNET. Review teams are examining operational functions 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
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
Dollars in millions except per share amounts
reevaluating strategies that SBC will incur; however, significant changes
in strategic initiatives or combinations of common functions could result
in material charges to SBC's 1998 results of operations. SBC anticipates
the review teams will complete the evaluation phase by the end of 1998.
6. MERGER WITH PAC 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 1.4629 shares of SBC common stock (equivalent
to approximately 626 million shares; both the exchange ratio and shares
issued have been restated to reflect SBC's first quarter 1998 two-for-one
stock split effected in the form of a stock dividend). 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.
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
total, $287 ($180 net of tax) is included in expenses in the first nine
months of 1997. The amounts are to be returned to ratepayers over five years,
from 1998 to 2002.
Post-merger initiatives
During the second quarter of 1997, SBC announced after-tax charges of $1.6
billion related to several strategic decisions resulting from the merger
integration process that began with the April 1, 1997 closing of its merger
with PAC, which included $165 ($101 after tax) of charges related to several
regulatory rulings during the second quarter of 1997 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. The charges related to the strategic decisions totaled $2
billion ($1.3 billion after tax). At September 30, 1998 and December 31,
1997, remaining accruals for anticipated cash expenditures related to these
decisions were approximately $253 and $432. Following is a discussion of the
most significant of these charges.
Reorganization SBC is centralizing 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 are resulting 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. These charges
totaled $16 ($10 net of tax) in the third quarter of 1997.
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
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
Dollars in millions except per share amounts
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 was scaling back
its limited direct investment in video services. As a result of this
curtailment, SBC halted construction on the Advanced Communications Network
(ACN) in California. As part of an agreement with the ACN vendor, SBC paid
the liabilities of the ACN trust that owned and financed ACN construction,
incurred costs to shut down all construction previously conducted under the
trust and received 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. Additionally, SBC curtailed 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 and withdrawing from the
Americast venture. Americast partners are disputing the withdrawal in
arbitration and litigation, the outcome of which cannot be predicted, but is
not expected to have a material impact on SBC's financial condition or
results of operations. The collective impact of these decisions resulted in a
charge of $145 ($92 after tax) in the second quarter of 1997.
7. PACIFIC TELESIS GROUP FINANCIAL INFORMATION
The following tables present summarized financial information for PAC:
--------------------------------------------------------------------
September 30, December 31,
1998 1997
--------------------------------------------------------------------
Balance Sheets
Current assets $ 2,990 $ 2,835
Noncurrent assets 15,245 14,041
Current liabilities 4,572 4,513
Noncurrent liabilities 10,983 10,305
--------------------------------------------------------------------
--------------------------------------------------------------------
Nine Months Ended September 30, 1998 1997
--------------------------------------------------------------------
Income Statements
Operating revenues $ 8,433 $ 7,463
Operating income (loss) 2,019 (326)
Income (loss) before cumulative effect of
accounting changes 984 (545)
Net income (loss) 984 (223)
--------------------------------------------------------------------
SBC has not provided separate financial statements and other disclosures for
PAC as management has determined that such information is not material to the
holders of the Trust Originated Preferred Securities, which have been
guaranteed by SBC.
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
Dollars in millions except per share amounts
8. EARNINGS PER SHARE
A reconciliation of the numerators and denominators of basic earnings per
share and diluted earnings per share for net income for the third quarter and
nine months ended September 30, 1998 and 1997 are shown in the table below.
<TABLE>
-------------------------------------------------------------------------------
<CAPTION>
Three months ended Nine months ended
September 30, September 30,
-------------------------------------------
1998 1997 1998 1997
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Numerators
Numerator for basic earnings
per share:
Net income $ 1,207 $ 816 $ 3,085 $ 886
-------------------------------------------------------------------------------
Dilutive potential common
shares:
Other stock-based compensation 1 1 3 2
-------------------------------------------------------------------------------
Numerator for diluted
earnings per share $ 1,208 $ 817 $ 3,088 $ 888
-------------------------------------------------------------------------------
Denominators
Denominator for basic earnings per share:
Weighted average number of
common shares
outstanding (000) 1,834,556 1,828,520 1,837,269 1,826,338
-------------------------------------------------------------------------------
Dilutive potential common shares (000):
Stock options 18,955 11,224 19,525 10,107
Other stock-based compensation 5,638 4,456 5,483 4,157
-------------------------------------------------------------------------------
Denominator for diluted
earnings per share 1,859,149 1,844,200 1,862,277 1,840,602
-------------------------------------------------------------------------------
Basic earnings per share $ 0.66 $ 0.45 $ 1.68 $ 0.48
-------------------------------------------------------------------------------
Diluted earnings per share $ 0.65 $ 0.44 $ 1.66 $ 0.48
-------------------------------------------------------------------------------
</TABLE>
9. SOFTWARE COSTS SBC currently expenses costs as incurred for software
purchased or developed for internal use, except for initial operating
software costs, which are capitalized and amortized over the lives of the
associated hardware. The American Institute of Certified Public Accountants
has issued a Statement of Position (SOP) that will require capitalization of
certain computer software expenditures beginning in 1999, with earlier
adoption permitted.
SBC did not elect to early adopt the provisions of the SOP. Management
continues to evaluate the impact of the change in accounting required by the
SOP and anticipates that it will be less than $200. With comparable levels of
software expenditures, the SOP would tend to increase net income in
comparison with SBC's current method of accounting for software costs.
However, the increases would be largest in the year of adoption with
diminishing levels of increases compared with current accounting throughout
the amortization period. Consequently, given otherwise comparable income
levels excluding software, and otherwise comparable software expenditures,
the effect of the SOP would be to increase income in the first year and
decrease income in each subsequent year until the number of years affected by
the SOP equals the amortization period
10.INVESTMENT IN TELEWEST COMMUNICATIONS PLC SBC owns approximately 10% of
Telewest Communications plc (Telewest), the largest cable television operator
in the United Kingdom. Due to restrictions existing on the sale of SBC's
interest in Telewest, SBC accounted for its investment using the cost method
of accounting. During the third quarter of 1998, as a result of Telewest's
merger with General Cable, Telewest entered into a new agreement with its key
shareholders, including SBC, which lifted those restrictions. SBC is now
required to account for its
<PAGE>
SBC COMMUNICATIONS INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)-CONTINUED
Dollars in millions except per share amounts
investment in Telewest as available for sale securities pursuant to
Financial Accounting Standards Board Statement No. 115, "Accounting for
Certain Investments in Debt and Equity Securities" (FAS 115). Under FAS
115, available for sale securities are measured at fair value in the
statement of financial position and unrealized holding gains and losses are
excluded from earnings and reported as a net amount in a separate component
of shareowners' equity until realized. At September 30, 1998 the fair value
of SBC's investment in Telewest was $463. SBC has entered into an agreement
to sell approximately 85% of its Telewest investment. The transaction is
expected to close in the fourth quarter.
11.DISPOSITION OF MTN During the third quarter of 1998, SBC sold its interest
in MTN, a South African national cellular company, to the remaining
shareholders of MTN for $337. The sale fulfilled SBC's obligation to divest
MTN as part of the acquisition of Telkom SA Limited. The effect on other
income (expense) - net and net income from the sale of MTN was $250 and $162.
<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
quarter and first nine months of 1998 and 1997 are summarized as follows:
<TABLE>
- -----------------------------------------------------------------------------------
<CAPTION>
Third Quarter Nine-Month Period
----------------------------- -------------------------------
Percent Percent
1998 1997 Change 1998 1997 Change
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Operating revenues $ 6,776 $ 6,329 7.1% $ 19,791 $ 18,223 8.6%
Operating expenses $ 4,986 $ 4,857 2.7% $ 14,633 $ 16,098 (9.1)%
Net income $ 1,207 $ 816 47.9% $ 3,085 $ 886 -
===================================================================================
</TABLE>
SBC reported net income for the third quarter of 1998 of $1,207, or $.65 per
share assuming dilution, and $3,085, or $1.66 per share assuming dilution, for
the first nine months of 1998. SBC's results for the third quarter and first
nine months of 1998 included after-tax gains of $219, or $.12 per share, for
gains on sales of certain non-core businesses, principally the required
disposition of SBC's MTN investment in South Africa (MTN). SBC's first nine
months of 1997 net income of $886, or $.48 per share, include after-tax charges
of $1.6 billion related to strategic initiatives resulting from the merger
integration process with Pacific Telesis Group (PAC) and the impact of several
second quarter 1997 regulatory rulings. The first nine months of 1997 also
include the first quarter 1997 settlement gain at PAC associated with lump-sum
pension payments that exceeded the projected service and interest costs for 1996
retirements. Excluding the 1998 gains, SBC reported net income of $988, or $.53
per share assuming dilution, and $2,866, or $1.54 per share assuming dilution,
for the third quarter and first nine months of 1998. Excluding the 1997 items,
SBC reported net income of $826, or $.45 per share assuming dilution, and
$2,401, or $1.31 per share assuming dilution, for the third quarter and first
nine months of 1997.
Excluding the 1998 gains and 1997 items, SBC's net income for the third quarter
of 1998 increased by $162, or 19.6%, and increased by $465, or 19.4%, for the
first nine months of 1998. The primary factors contributing to this increase
were growth in demand for services and products at Southwestern Bell Telephone
Company (SWBell), Pacific Bell (PacBell, which also includes its subsidiary,
Pacific Bell Information Services) and Nevada Bell (collectively referred to as
the Telephone Companies), increased contribution from Southwestern Bell Mobile
Systems (Mobile Systems) and reduced dilution from Personal Communications
Services (PCS) operations at Pacific Bell Mobile Services (PBMS). These
increases were partially offset by higher merger related costs.
<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
Operating 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. Excluding these items, SBC's
operating revenues increased $1,380, or 7.5%, for the first nine months of 1998.
Components of operating revenues for the third quarter and first nine months of
1998 and 1997 are as follows:
- --------------------------------------------------------------------------------
Third Quarter Nine-Month Period
----------------------------- -------------------------------
Percent Percent
1998 1997 Change 1998 1997 Change
- --------------------------------------------------------------------------------
Local service:
Landline $ 2,612 $ 2,442 7.0% $ 7,658 $ 7,092 8.0%
Wireless 856 789 8.5 2,476 2,237 10.7
Network access:
Interstate 1,094 1,019 7.4 3,310 2,928 13.0
Intrastate 468 463 1.1 1,392 1,408 (1.1)
Long-distance service 577 541 6.7 1,662 1,612 3.1
Directory advertising 447 503 (11.1) 1,328 1,345 (1.3)
Other 722 572 26.2 1,965 1,601 22.7
- ----------------------------------------- --------------------
Total $ 6,776 $ 6,329 7.1% $ 19,791 $ 18,223 8.6%
================================================================================
Local service Landline local service revenues increased in the third
quarter and first nine months of 1998 due primarily to increases in demand
which total approximately $172 and $486 for the third quarter and first
nine months of 1998, including increases in access lines, vertical
services and data revenues. The number of access lines increased by 4.7%
since September 30, 1997, of which 48% was due to growth in California and
35% was due to growth in Texas. Approximately 36% of SBC's access line
growth was due to sales of additional access lines to existing residential
customers. Vertical services revenues, which include custom calling
services, call control options, Caller ID and other services, increased by
more than 19% and totaled approximately $1.1 billion for the first nine
months of 1998. Additionally, Federal payphone deregulation implemented in
April 1997 caused local service to increase by approximately $96 for the
first nine months of 1998. Local service decreased by approximately $14
for the third quarter as a result of an adjustment related to Federal
payphone deregulation. Federal payphone deregulation also resulted in
decreases in long-distance service of approximately $9 for the first nine
months of 1998, interstate network access of approximately $19 for the
first nine months of 1998 and other operating revenues of approximately $7
for the first nine months of 1998. Partially offsetting the increases in
local service revenues were decreases in local service revenues of $13 and
$58 in the third quarter and first nine months of 1998 due to cellular
interconnection rate reductions in the third quarter of 1997.
Wireless local service revenues increased $67, or 8.5% in the third
quarter and $239, or 10.7% in the first nine months of 1998 due primarily
to growth in the number of customers of 14.4%. These increases were
partially offset by declines in average revenue per customer for Mobile
Systems. Substantially all of the third quarter and approximately 80% of
the year-to-date increase in wireless local service revenues was due to
the expansion of PCS operations in California, Nevada and Oklahoma. At
September 30, 1998, SBC had 5,234,000 traditional cellular customers,
78,000 resale customers and 670,000 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 The increase in interstate network access revenues for the
first nine months of 1998 reflects June 1997 one-time charges of $187.
These one-time charges included billing claim settlements related to the
effect of 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 in the Federal price cap filing. While the
1997 change in the PIU factor, which is used to allocate network access
revenues between interstate and intrastate jurisdictions, also had the
effect of increasing intrastate network access usage, it resulted in a
slight decline in total network access revenues due to rate differences
between the two jurisdictions.
Without these impacts, interstate access revenues increased $75 in the
third quarter and $195 in the first nine months of 1998 due largely to
increases in demand for access services by interexchange carriers,
including special access, and growth in revenues from end-user charges
attributable to an increasing access line base, which collectively
resulted in an increase of approximately $90 and $281 for the third
quarter and first nine months of 1998. Also contributing to the increase
was the absence of the 1997 revenue offset required for net payments for
long-term support, which were designed to subsidize universal service,
totaling approximately $25 and $71 for the third quarter and first nine
months of 1998. This change is discussed further in Operations and support
below. Partially offsetting these increases were the effects of annual
rate reductions related to the Federal productivity factor adjustment, as
discussed in SBC's 1997 Annual Report to Shareowners, totaling
approximately $37 and $144 for the third quarter and first nine months of
1998 and payphone deregulation of approximately $19 for the first nine
months of 1998 referred to above in Local service.
Intrastate network access revenues decreased in the first nine months of
1998 due to the PIU settlements totaling approximately $32 described
above. Excluding this impact, intrastate network access revenues increased
by $5 and $16 in the third quarter and first nine months of 1998 due
largely to increases in demand totaling approximately $11 and $36 for the
third quarter and first nine months of 1998, including usage by
alternative intraLATA toll carriers. These increases were partially offset
by 1997 state regulatory rate orders and implementation of the February
1997 California high cost fund collectively totaling $4 and $14 for the
third quarter and first nine months of 1998.
Long-distance service revenues increased in the third quarter and first
nine months of 1998 due to growth in wireless long-distance revenues of
approximately $21 and $56 for the third quarter and first nine months of
1998 and increased toll messages and demand at PacBell totaling
approximately $6 and $29 for the third quarter and first nine months of
1998, resulting from the growing California economy. These increases were
partially offset by the effect of price competition from alternative
intraLATA toll carriers of approximately $5 and $26 for the third quarter
and first nine months of 1998 at SWBell, Federal payphone deregulation of
approximately $9 for the first nine months of 1998 (referred to in Local
service) and the introduction and deployment of extended area local
service plans at SWBell of approximately $2 and $8 for the third quarter
and first nine months of 1998. Extended area plans also have the effect of
increasing local service revenue; the amount of increase is somewhat
greater than the reduction in long-distance revenue.
<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
Directory advertising revenues decreased $56, or 11.1% in the third
quarter and $17, or 1.3% in the first nine months of 1998. These net
decreases were due primarily to a net $76 effect of directory rescheduling
from the third quarter into the fourth quarter partially offset by 1998
extensions. The year-to-date variance was also affected by a $41 increase
in directory advertising revenues at Pacific Bell Directory in 1998.
Other operating revenues for 1997 reflect June 1997 one-time charges of
$17 due to the impact of several regulatory rulings. Excluding these
impacts on the first nine months of 1997, other operating revenues
increased $150, or 26.2% in the third quarter and $347, or 21.4% in the
first nine months of 1998. Other operating revenues increased
approximately $49 and $119 in the third quarter and first nine months of
1998 due to increased demand for the Telephone Companies' nonregulated
services and products. Also contributing to the increase in other
operating revenues were increased PCS wireless equipment sales and other
equipment sales at PacBell and SWBell of approximately $24 and $96 in the
third quarter and first nine months of 1998 and increased revenues from
other business initiatives of approximately $34 and $82, primarily voice
messaging services and Internet services. These increases were slightly
offset by payphone deregulation of approximately $7 in the third quarter
and first nine months of 1998 referred to in Local service.
Operating Expenses Components of operating expenses for the third quarter and
first nine months of 1998 and 1997 are as follows:
- --------------------------------------------------------------------------------
Third Quarter Nine-Month Period
------------------------- --------------------------
Percent Percent
1998 1997 Change 1998 1997 Change
- -------------------------------------------------------------------------------
Operations and support $ 3,835 $ 3,771 1.7% $ 11,237 $ 12,298 (8.6)%
Depreciation and amortization 1,151 1,086 6.0 3,396 3,800 (10.6)
- --------------------------------------------- ------------------
Total $ 4,986 $ 4,857 2.7% $ 14,633 $ 16,098 (9.1)%
===============================================================================
SBC manages its financial and business operations excluding special one-time or
unusual charges and refers to these adjusted results as normalized operations.
As discussed in Note 6 of Notes to Consolidated Financial Statements, SBC's
operating expenses in the third quarter and first nine months of 1997 reflect
$16 and $2,221 of adjustments for charges related to SBC's strategic
initiatives, a comprehensive review of operations of the merged company and the
impact of several regulatory rulings and ongoing merger integration costs. In
addition, the first nine months of 1997 include a first quarter settlement gain
of $152 associated with lump-sum pension payments that exceeded the projected
service and interest costs for 1996 retirements. Excluding these 1997
adjustments, SBC's normalized operating expenses increased $145, or 3.0%, for
the third quarter and $604, or 4.3%, for the first nine months of 1998.
<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
Operations and support Components of operations and support and
normalizing adjustments for the third quarter and first nine months of
1998 and 1997 are as follows:
<TABLE>
- ----------------------------------------------------------------------------------
<CAPTION>
Third Quarter Nine-Month Period
------------------------ --------------------------
Percent Percent
1998 1997 Change 1998 1997 Change
- ----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Cost of services and products $ 2,403 $ 2,364 1.6% $ 7,039 $ 6,760 4.1%
Selling, general and
administrative 1,432 1,407 1.8 4,198 5,538 (24.2)
- ----------------------------------------------- ------------------
Total operations and support 3,835 3,771 1.7 11,237 12,298 (8.6)
Adjustments - (16) - - (1,477) -
- ------------------------------------------------ ------------------
Normalized operations and
support $ 3,835 $ 3,755 2.1% $ 11,237 $ 10,821 3.8%
==================================================================================
</TABLE>
Operations and support consists of all operating expenses except
depreciation and amortization. Operations and support expenses for the
third quarter and first nine months of 1997 reflect $16 and $1,629 of the
adjustments referred to above partially offset by the $152 settlement gain
described above.
Excluding these adjustments, normalized operations and support increased
$80, or 2.1% in the third quarter of 1998 and $416, or 3.8%, in the first
nine months of 1998. The relatively low level of expense increase has
resulted from merger initiatives that have already been implemented with
many of these expense decreases occurring at PacBell. One of the primary
factors for the nine month increase was higher levels of expenses
associated with PCS operations totaling $176 for the first nine months of
1998, which were partially offset by a decrease of $34 for the first nine
months of 1998 related to declines in customer acquisition costs for
cellular operations. Customer acquisition costs for wireless operations as
a whole declined approximately $25 for the third quarter of 1998. Other
significant factors include increases in merger implementation costs of
approximately $74 and $159 for the third quarter and first nine months of
1998, increased costs associated with reciprocal compensation for the
termination of Internet traffic of approximately $43 and $109 for the
third quarter and first nine months of 1998 and increases in universal
service fund (USF) charges of approximately $43 and $127 for the third
quarter and first nine months of 1998 that were previously reported as an
offset against network access revenues. The current USF system assesses
charges, recorded as expense, and any amounts to be received separately.
Previously, a net payment or receipt for long-term support would be
recorded as an offset to (or increase in) revenue.
1997 pension settlement gains relating to 1997 retirees totaling
approximately $33 and $96 for the third quarter and first nine months of
1997 contributed to the increase when compared to 1998. In addition, wages
and salaries increased approximately $16 and $43 for the third quarter and
first nine months of 1998 and materials increased approximately $20 and
$54 for the third quarter and first nine months of 1998. These increases
were partially offset by reductions in use of contract labor of
approximately $81 and $203 for the third quarter and first nine months of
1998 and net reductions to benefits, research and development costs
totaling approximately $34 and $119 for the third quarter and first nine
months of 1998. Although costs incurred for local number portability (LNP)
were comparable for the first nine months of each year, LNP costs for the
third quarter were approximately $19 lower than 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
Depreciation and amortization Summarization of depreciation and
amortization expense and normalizing adjustments for the third quarter and
first nine months of 1998 and 1997 is as follows:
<TABLE>
- -----------------------------------------------------------------------------------
<CAPTION>
Third Quarter Nine-Month Period
------------------------- ---------------------------
Percent Percent
1998 1997 Change 1998 1997 Change
- -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Depreciation and amortization $ 1,151 $ 1,086 6.0% $ 3,396 $ 3,800 (10.6)%
Adjustments - - - - (592) -
- ----------------------------------------------- ------------------
Normalized depreciation
and amortization $ 1,151 $ 1,086 6.0% $ 3,396 $ 3,208 5.9%
===================================================================================
</TABLE>
Depreciation and amortization for the third quarter of 1998 increased $65,
or 6%, due to overall higher plant levels at the Telephone Companies and
Mobile Systems. Depreciation and amortization for the first nine months of
1997 reflects charges totaling $592 to record impairment of plant and
intangibles (see Note 6 of Notes to Consolidated Financial Statements).
Excluding these adjustments, depreciation and amortization increased $188,
or 5.9% in the first nine months of 1998. The increase was due to
increased depreciation expense of $166 resulting from overall higher plant
levels at the Telephone Companies and Mobile Systems. Also contributing to
the year-to-date increase was the launch of PCS services in California and
Nevada that resulted in higher plant levels and the amortization of PCS
licenses and slight changes in effective composite rate of depreciation at
SWBell, which totaled $66. The increase in depreciation and amortization
for the first nine months of 1998 was partially offset by reduced
depreciation at PacBell related to analog switching equipment of $42.
Interest expense for 1997 includes $27 associated with the second quarter 1997
one-time charges, primarily interest on the merger-approval costs. Excluding
these charges, interest expense increased $27 or 4.1% in the first nine months
of 1998. This increase was due primarily to lower capitalization of interest
during construction partially offset by reduced interest expense resulting from
lower debt levels. The lower debt levels also contributed to the interest
expense decrease of $18 in the third quarter of 1998.
Equity in net income of affiliates decreased $6, or 9.8% in the third quarter of
1998 due primarily to expenses in long-distance and wireless activities by SBC's
investments in Switzerland. Equity in net income of affiliates increased $38, or
26.6% in the first nine months of 1998 due to increased equity in net income of
$59 from SBC's May 1997 investment in Telkom SA Limited (Telkom) of South Africa
and SBC's investment in Telefonos de Mexico, S.A. de C.V. (Telmex). Also
contributing to the increase were lower losses resulting from reduced
involvement in Tele-TV. These increases were partially offset by expenses of $29
in international investments including Switzerland as discussed above and
long-distance in France and Israel.
Other income (expense) - net for the third quarter and first nine months of 1998
included $358 for gains on sales of certain non-core businesses, principally the
required disposition of SBC's MTN investment in South Africa. Expenses for the
first nine months of 1997 included $27 in expenses related to SBC's strategic
initiatives, primarily writeoffs of nonoperating plant. Excluding these 1998
gains and 1997 expenses, other income (expense) - net for the third quarter of
1998 and 1997 was a net expense of $70 and $25, and for the first nine months of
1998 and 1997 was a net expense of $147 and $82. During the first nine months of
1998, various offsetting transactions impacted other income and expense. SBC
<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
recognized other expense related to an impairment of an international investment
and a video investment of $143, call premiums and unamortized discount on early
redemption of debt at SWBell and PacBell. These were offset by income related to
a special dividend of $158 received in 1998 from a software affiliate and gains
on sales of Telmex L shares. The additional increase in net other expense
resulted primarily from higher minority interest expenses and lower interest
income.
Income taxes for the third quarter 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. Income taxes
for the first nine months of 1997 also included taxes on the pension settlement
gain discussed in Operations and support. The net 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 which may not be utilized
due to restrictions associated with the merger. Income taxes for the third
quarter and first nine months of 1998 include amounts related to the sale of
certain non-core businesses discussed in other income. Excluding these items,
income taxes for the third quarter of 1998 and 1997 would have been $565 and
$458 and for the first nine months of 1998 and 1997 would have been $1,633 and
$1,376. Income taxes for 1998 were higher due primarily to higher income before
income taxes.
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
Overview The telecommunications industry in the United States is in a period of
dynamic change in response to regulatory and technological developments.
Consolidation of companies is occurring both within the marketplace for local
telephone service and across other telecommunications services, such as long
distance, cellular, cable television and Internet and other data transmission
services. Companies operating in some of these markets are also expanding into
others, such as the provision of local service by long-distance companies.
The telecommunications industry is also changing internationally, as
government-owned telephone monopolies are being privatized in many countries and
competitive entrants are authorized. U.S.-controlled companies may acquire or
form investment, joint venture or strategic relationships with these newly
privatized companies or their new competitors involving any or all of the range
of telecommunications services. Foreign-controlled companies may also acquire or
form such relationships with U.S. companies.
SBC has participated in many of the types of transactions described above, both
within the United States and internationally, and expects to continue to do so.
As a result of the industry changes described above, SBC faces not only some
greater opportunities than in the past but also more challenges. Its business
success will be affected by how well it anticipates industry changes and
addresses the opportunities and challenges they present.
California Regulation In October 1998, the California Public Utilities
Commission (CPUC) issued a final decision modifying the current regulatory
framework for PacBell effective January 1, 1999. The decision adopted PacBell's
proposal that the current cap on basic residential rates be continued for three
more years, through 2001, with the CPUC itself having the ability to adjust
basic telephone rates. The
<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
final decision also suspended earnings sharing, rate of return reviews and the
use of earnings caps and floors until the next review in 2001. The decision also
adopted PacBell's proposal to eliminate depreciation reviews and granted PacBell
the freedom to set its own depreciation rates and methodology. It also continued
the suspension of the productivity factor adjustment. In addition, the CPUC
decision eliminated most future exogenous cost adjustments, including the
recovery of future costs related to a 1993 accounting change for postretirement
benefits other than pensions. Management currently estimates the items embodied
within the new regulatory framework will have the net effect of reducing revenue
by approximately $100 in 1999.
Telecommunications Act of 1996 In July 1997, SBC brought suit in the United
States District Court for the Northern District of Texas (U.S. District Court),
seeking a declaration that parts of the Telecommunications Act of 1996 (Telecom
Act) are unconstitutional on the grounds that they improperly discriminate
against the Telephone Companies by imposing restrictions that prohibit the
Telephone Companies by name from offering interLATA long-distance and other
services that other Local Exchange Carriers (LECs) are free to provide. The suit
challenged only those portions of the Telecom Act that exclude the Telephone
Companies from competing in certain lines of business. On December 31, 1997, the
U.S. District Court ruled in favor of SBC and declared certain sections of the
Telecom Act unconstitutional, thereby allowing SBC to enter interLATA
long-distance in the Telephone Companies' operating areas. On September 4, 1998,
the United States Court of Appeals for the Fifth Circuit (5th Circuit) reversed
this decision and ruled that the challenged provisions of the Telecom Act are
constitutional. In October 1998, SBC asked the United States Supreme Court
(Supreme Court) to hear an appeal of the 5th Circuit decision. The Supreme Court
has not yet determined if it will hear this appeal. If it decides to accept the
case, a decision would likely not occur until 1999.
Interconnection Reciprocal compensation is billed to SBC by Competitive Local
Exchange Carriers (CLECs) for the termination of certain local exchange traffic
to CLEC customers. SBC believes that under the Telecom Act the state commissions
only have authority to order reciprocal compensation for intrastate or local
traffic, while only the Federal Communications Commission (FCC) has authority
over interstate and interexchange traffic, which is where SBC believes most
Internet traffic terminates. Several state commissions, including the CPUC in an
October 1998 order, have taken the position that Internet communications is
intrastate or local traffic and ordered SBC to pay reciprocal compensation to
certain CLECs. The question whether Internet communications should be classified
as local/intrastate or interstate traffic for reciprocal compensation purposes
is the subject of a pending FCC proceeding and the FCC is expected to rule on
this issue in the near future. SBC's subsidiaries have been recording amounts
sought by certain CLECs for the termination of Internet traffic to Internet
Service Providers as they have been billed.
Long-distance Application SBC continues to seek entry into interLATA
long-distance by requesting favorable recommendation from state commissions and
approval from the FCC, and as necessary through the courts. In September and
October 1998, respectively, the Texas Public Utility Commission (TPUC) and the
CPUC staff released status reports on SBC's checklist compliance efforts. The
TPUC reported that SBC has met over half of the FCC's 14-point checklist items
required for entry into in-region interLATA long-distance and has scheduled
additional collaborative sessions to settle the remaining recommendations. The
CPUC staff also concluded that SBC has not met all items of the FCC's 14-point
checklist and made a series of recommendations as to how SBC can meet the
remaining items. SBC is working with the CPUC to address these remaining items.
Proposed decisions and votes by both the
<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
TPUC and the CPUC on whether to recommend SBC's applications to the FCC are
expected in either late 1998 or early 1999.
OTHER BUSINESS MATTERS
New Accounting Standards In June 1998, the Financial Accounting Standards Board
(FASB) issued Statement No. 133, "Accounting for Derivative Instruments and
Hedging Activities" (FAS 133), which will require all derivatives to be recorded
on the balance sheet at fair value, and will require changes in the fair value
of the derivatives to be recorded in net income or comprehensive income. FAS 133
must be adopted for years beginning after June 15, 1999, with earlier adoption
permitted. Management is currently evaluating the impact of the change in
accounting required by FAS 133, but is not able to quantify the effect at this
time.
In June 1997, the FASB issued Statement No. 131, "Disclosures About Segments of
an Enterprise and Related Information" (FAS 131), which establishes standards
for the way that public business enterprises report information about operating
segments in annual financial statements and requires that those enterprises
report selected information about operating segments in interim financial
reports issued to shareholders. FAS 131 is effective for financial statements
for periods beginning after December 15, 1997, but need not be applied to
interim financial statements in the initial year of its application. SBC will
adopt FAS 131 in the fourth quarter of 1998.
See Note 9 of Notes to Consolidated Financial Statements for a discussion of the
new accounting standard on software costs.
Acquisitions and Dispositions During the third quarter of 1998, SBC sold its
interest in MTN, a South African national cellular company, to the remaining
shareholders of MTN. See Note 11 of Notes to Consolidated Financial Statements.
SBC also sold SBC Media Ventures (Media Ventures), its cable television
properties in Montgomery County, Maryland and Arlington, Virginia and shares in
a software affiliate.
Mergers See Notes 4 and 5 of Notes to Consolidated Financial Statements for
discussions of the merger agreement with Ameritech Corporation and the merger
with Southern New England Telecommunications Corporation.
SBC's Year 2000 Project SBC operates numerous date-sensitive computer
applications and systems throughout its businesses. Since 1996, SBC has been
working to upgrade its networks and computer systems to properly recognize the
Year 2000 and continue to process critical operational and financial
information. Companywide teams are in place to address and resolve Year 2000
issues and processes are underway to evaluate and manage the risks and costs
associated with preparing SBC's date-impacted systems and networks for the new
millennium.
SBC is using a four-step methodology to address the issue. The methodology
consists of inventory and assessment, hardware and software fixes, testing and
deployment. SBC measures its progress by tracking the number of completed
hardware and software applications, network components, personal computers and
building facilities that can correctly process Year 2000 dates.
<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
Inventory and assessment is estimated to require 20% of the overall effort and
includes the identification of items (i.e., line-by-line review of software
code, switch generics, vendor products, etc.) that could be impacted by the Year
2000 and the determination of the work effort required to get them ready. The
inventory and assessment phase has been completed. This process involved
reviewing over 300 million lines of software code, 1,100 central office
switches, 6,800 company buildings, conducting an inventory and assessment of
100,000 personal computers, and coordinating with 1,200 suppliers of 12,000
products to obtain adequate assurance they will be compliant with the Year 2000
or determine and address any appropriate contingency plans or back-up systems.
Making the hardware and software fixes is the second phase of the process and is
estimated to require 25% of the overall effort. This activity involves modifying
program code, upgrading computer software and upgrading or replacing hardware.
As of September 30, 1998, more than half of the hardware and software fixes were
accomplished.
Testing involves ensuring that hardware and software fixes will work properly in
1999 and beyond and occurs both before and after deployment. Testing is
estimated to comprise 45% of the overall effort. Testing began early in 1998, is
approximately one-third complete, and will continue through 1999 to allow for
thorough testing before the Year 2000. Any need for contingency plans or back-up
systems are being determined and addressed during the testing phase.
Deployment involves placing the "fixed" systems into a live environment to
ensure they are working properly. Additional testing is done after deployment as
well. Deployment is estimated to require 10% of the overall effort. Nearly half
of the deployment phase was completed as of September 30, 1998.
SBC expects to spend less than $250 million on the entire project, with
approximately $89 million spent through September 30, 1998. As testing and
hardware and software fixes are estimated to require most of the expenditures,
there is not a strict correlation between expenditures and project completion.
The activities involved in SBC's Year 2000 project necessarily involve estimates
and projections, as describe above, of activities and resources that will be
required in the future. These estimates and projections could change as work
progresses on the project.
LIQUIDITY AND CAPITAL RESOURCES
During the first nine months of 1998, as in 1997, SBC's primary source of funds
continued to be cash provided by operating activities. Additionally, SBC had
$779 in cash and cash equivalents available at September 30, 1998. SBC has
entered into agreements with several banks for lines of credit totaling $2,475,
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, 1998.
Commercial paper borrowings as of September 30, 1998 totaled $1,121.
SBC's investing activities during the first nine months of 1998 consist of
$3,860 in construction and capital expenditures, primarily in the Telephone
Companies and its wireless operations. SBC expects capital expenditures to
approach $5,800 in 1998. Investing activities during the first nine months of
1998 also include asset dispositions of $733, principally the required
disposition of MTN due to SBC's investment in Telkom and the sale of Media
Ventures. In addition, 1997 investing activities primarily reflect the May 1997
investment in Telkom and an additional investment in French operations.
<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
In February 1998, SBC called $630 of long-term debt for retirement, including
$175 at PacBell and $425 at SWBell, and issued approximately $200 in debentures
at PacBell due February 2008 and approximately $200 in debentures at SWBell due
March 2048. In September 1998, SBC called $175 of long-term debt for retirement,
all at SWBell. Cash paid for dividends in the first nine months of 1998 was
$1,272, or 5.1% higher than the first nine months of 1997.
On October 29, 1998, PacBell issued an offer to repurchase up to $925 in
debentures. SBC at this time is unable to predict the amount of debt that will
be redeemed by this offer.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the reported market risks of financial
instruments since the end of the most recent fiscal year.
<PAGE>
SBC COMMUNICATIONS INC.
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
During the third quarter of 1998, the Company sold shares of common stock to
non-employee directors pursuant to the Company's Non-Employee Director Stock and
Deferral Plan. Under the plan, a director may make an annual election to receive
all or part of his annual retainer or fees in the form of SBC shares or deferred
stock units (DSUs) that are convertible into SBC shares. During this period, an
aggregate of 3,965 SBC shares and DSUs were purchased by non-employee directors
at prices ranging from $39.625 to $41.75, in each case the fair market value of
the shares on the date of purchase. The issuances of shares and DSUs were exempt
from registration pursuant to Section 4(2) of the Securities Act.
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, 1998.
<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.
November 4, 1998 /s/ Donald E. Kiernan
------------------------
Donald E. Kiernan
Senior Vice President, Treasurer
and Chief Financial Officer
<TABLE>
SBC COMMUNICATIONS INC. EXHIBIT 12
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
Dollars in Millions
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
---------------------- ----------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---------- --------- -------- --------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Income Before Income Taxes, Extraordinary Loss
and Cumulative Effect of Accounting Changes* $ 4,831 $ 1,396 $ 2,237 $ 4,975 $ 4,383 $ 4,091 $ 2,070
Add: Interest Expense 693 693 947 812 957 935 1,005
Dividends on Preferred Securities 60 60 80 60 - - -
1/3 Rental Expense 96 106 130 108 77 85 81
---------- --------- --------- --------- -------- --------- ---------
Adjusted Earnings $ 5,680 $ 2,255 $ 3,394 $ 5,955 $ 5,417 $ 5,111 $ 3,156
========== ========= ========= ========= ======== ========= =========
Total Interest Charges $ 740 $ 786 $ 1,067 $ 947 $ 957 $ 935 $ 1,005
Dividends on Preferred Securities 60 60 80 60 - - -
1/3 Rental Expense 96 106 130 108 77 85 81
---------- --------- --------- --------- -------- --------- ---------
Adjusted Fixed Charges $ 896 $ 952 $ 1,277 $ 1,115 $ 1,034 $ 1,020 $ 1,086
========== ========= ========= ========= ======== ========= =========
Ratio of Earnings to Fixed Charges 6.34 2.37 2.66 5.34 5.24 5.01 2.91
<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 FINANCIAL INFORMATION EXTRACTED FROM SBC
COMMUNICATIONS INC.'S SEPTEMBER 30, 1998 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-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 779
<SECURITIES> 37
<RECEIVABLES> 5,307
<ALLOWANCES> 412
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 7,158
<PP&E> 67,919
<DEPRECIATION> 39,999
<TOTAL-ASSETS> 42,529
<CURRENT-LIABILITIES> 9,559
<BONDS> 11,217
0
0
<COMMON> 1,867
<OTHER-SE> 9,664
<TOTAL-LIABILITY-AND-EQUITY> 42,529
<SALES> 0<F2>
<TOTAL-REVENUES> 19,791
<CGS> 0<F3>
<TOTAL-COSTS> 7,039
<OTHER-EXPENSES> 3,396
<LOSS-PROVISION> 341
<INTEREST-EXPENSE> 693
<INCOME-PRETAX> 4,857
<INCOME-TAX> 1,772
<INCOME-CONTINUING> 3,085
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,085
<EPS-PRIMARY> 1.68
<EPS-DILUTED> 1.66
<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>
