FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For fiscal year ended December 31, 1996
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 (No Fee Required)
For the transition period from to
Commission File Number: 1-2346
SOUTHWESTERN BELL TELEPHONE COMPANY
Incorporated under the laws of the State of Missouri
I.R.S. Employer Identification Number 43-0529710
One Bell Center, St. Louis, Missouri 63101-3099
Telephone Number 314-235-9800
Securities registered pursuant to Section 12(b) of the Act: (See attached
Schedule A)
Securities registered pursuant to Section 12(g) of the Act: None.
THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF SBC COMMUNICATIONS INC., MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION J(1)(a) AND (b) OF FORM 10-K AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION J(2).
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [Not Applicable]
<TABLE>
<CAPTION>
SCHEDULE A
Securities Registered Pursuant To Section 12(b) Of The Act:
Name of each exchange
Title of each Class on which registered
<S> <C>
Seven Year 6-1/8% Notes, New York Stock Exchange
due March 1, 2000
Eight Year 6-3/8% Notes, New York Stock Exchange
due April 1, 2001
Twelve Year 6-5/8% Notes, New York Stock Exchange
due April 1, 2005
Thirty-Eight Year 7-3/4% Debentures, American Stock Exchange
due September 1, 2009
Forty Year 6-7/8% Debentures, American Stock Exchange
due February 1, 2011
Forty Year 7-3/8% Debentures, American Stock Exchange
due May 1, 2012
Forty Year 7-5/8% Debentures, American Stock Exchange
due October 1, 2013
Twenty-Two Year 7% Debentures, New York Stock Exchange
due July 1, 2015
Thirty Year 7-5/8% Debentures, New York Stock Exchange
due March 1, 2023
Thirty-Two Year 7-1/4% Debentures, New York Stock Exchange
due July 15, 2025
</TABLE>
TABLE OF CONTENTS
Item Page
PART I
1. Business
2. Properties
3. Legal Proceedings
4. Submission of Matters to a Vote of Security Holders *
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters
6. Selected Financial and Operating Data
7. Management's Discussion and Analysis of Results of Operations
(Abbreviated pursuant to General Instruction J(2))
8. Financial Statements and Supplementary Data
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure
PART III
10. Directors and Executive Officers of the Registrant *
11. Executive Compensation *
12. Security Ownership of Certain Beneficial Owners and
Management *
13. Certain Relationships and Related Transactions *
PART IV
14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
*Omitted pursuant to General Instruction J(2).
PART I
ITEM 1. BUSINESS
GENERAL
Southwestern Bell Telephone Company (Telephone Company) was incorporated in 1882
under the laws of the State of Missouri, and has its principal executive offices
at One Bell Center, St. Louis, Missouri 63101-3099 (telephone number 314-235-
9800). The Telephone Company is a wholly-owned subsidiary of SBC Communications
Inc. (SBC), which was incorporated under the laws of the State of Delaware in
1983 by AT&T Corp. (AT&T) as one of seven regional holding companies (RHCs)
formed to hold AT&T's local telephone companies. AT&T divested SBC by means of
a spin-off of stock to its shareowners on January 1, 1984 (divestiture). The
divestiture was made pursuant to a consent decree, referred to as the
Modification of Final Judgment (MFJ), issued by the United States District Court
for the District of Columbia (District Court).
FEDERAL LEGISLATION AND THE MFJ
On February 8, 1996, the Federal Government enacted the Telecommunications Act
of 1996 (the Telecom Act), a major, wide-ranging amendment to the Communications
Act of 1934.
By its specific terms, the Telecom Act supersedes the jurisdiction of the
District Court with regard to activities occurring after the date of enactment.
The Federal Communications Commission (FCC) is given authority for all post-
enactment conduct, with the District Court retaining jurisdiction of pre-
enactment conduct for a five-year period. As a result of these provisions, on
April 11, 1996 the District Court issued its Opinion and Order terminating the
MFJ and dismissing all pending motions as moot, thereby effectively ending 13
years of RHCs regulation under the MFJ.
Among other things, the Telecom Act defines the conditions which must be met
before SBC will be authorized to provide landline interLATA long-distance
service throughout the five-state area. Additional information relating to the
Telecom Act is contained in Item 7, Management's Discussion and Analysis of
Results of Operations of this report under the heading "Competition" beginning
on page 14 of this report.
BUSINESS OPERATIONS
The Telephone Company's principal services include local, long-distance and
network access services, which are provided in the states of Texas, Missouri,
Oklahoma, Kansas and Arkansas (five-state area). Local services involve the
transport of telecommunications traffic between telephones and other customer
premises equipment (CPE) located within the same local service calling area.
Local services include: basic local exchange service, certain extended area
service, dedicated private line services for voice and special services,
directory assistance and various custom calling services. Long-distance
services involve the transport of telecommunications traffic between local
calling areas within the same LATA (intraLATA). Long-distance services also
include other services such as Wide Area Telecommunications Service
(WATS or 800 services) and other special services. Network access services
connect a subscriber's telephone or other equipment to the transmission
facilities of other carriers which provide long-distance (principally interLATA)
and other communications services. Network access services are either switched,
which use a switched communications path between the carrier and the customer,
or special, which use a direct nonswitched path.
During the latter half of 1996 and over the course of 1997, the Telephone
Company has and will be offering certain services on a "wholesale" basis to
competitors, as well as providing elements of the Telephone Company's network on
an "unbundled" basis for local competition. These services are being offered as
specified by the Telecom Act and state actions and agreements. That legislation
and the regulations promulgated by state and federal agencies to implement it
will result in the Telephone Company facing increased competition in significant
portions of its business. Such increased competition is a prerequisite to SBC's
permitted entry into the long-distance business and markets from which it is
currently excluded. The precise impact to the Telephone Company's business in
1997 from local exchange competition is impossible to quantify due to the fact
state and federal regulations governing such competition are not yet finalized.
The following table sets forth the percentage of total operating revenues by any
class of service which accounted for 10% or more of total operating revenues in
any of the last three fiscal years.
<TABLE>
<CAPTION>
Percentage of Total
Operating Revenues
1996 1995 1994
<S> <C> <C> <C>
Local service 48% 48% 48%
Network access 33% 34% 34%
Long-distance service 9% 9% 11%
</TABLE>
The Telephone Company provides its services over approximately 9.8 million
residential and 4.9 million business access lines in the five-state area.
During 1996, nearly two-thirds of the Telephone Company's access line growth
occurred in Texas.
During 1996, the Telephone Company continued to expand its offering of vertical
services throughout its five-state area. Some of these services include
Caller ID, a feature which displays the telephone number of the person calling
and the caller's name in certain markets; Call Return, a feature that redials
the number of the last incoming call; and Call Blocker, a feature which allows
customers to automatically reject calls from a designated list of telephone
numbers.
The FCC has certain rules that impact the manner in which the Telephone Company
may offer network services for enhanced service providers. Enhanced services
are certain services other than basic transmission services. Under these rules,
the Telephone Company is permitted to offer enhanced services either on its own
or jointly with its affiliates, subject to nonstructural safeguards designed to
permit the Telephone Company's competitors to acquire needed network services on
a comparably efficient, non-discriminatory basis and to reduce the risk of
cross-subsidization. These safeguards include accounting and reporting
procedures and Open Network Architecture (ONA) requirements, which represent the
Telephone Company's plan to provide equal access to its network to all enhanced
service providers. Enhanced services are deregulated at the federal level, and
none of the state commissions to which the Telephone Company is subject has
asserted jurisdiction over intrastate enhanced services. The nonstructural
safeguards are currently being reviewed by the FCC as a result of an
October 1994 judicial remand which ruled that the FCC had not adequately
explained how ONA would prevent discrimination against competitors. While the
outcome cannot be predicted with certainty, it is anticipated that the FCC
will reaffirm the nonstructural safeguards.
In December 1996, Southwestern Bell Telecommunications Inc., a wholly-owned
subsidiary of SBC which markets business and residential communications
equipment, was merged into the Telephone Company. The merger did not and is not
expected to have a significant impact on the Telephone Company's results of
operations.
GOVERNMENT REGULATION
In the five-state area, the Telephone Company is subject to regulation by
state commissions which have the power to regulate, in varying degrees,
intrastate rates and services, including local, long-distance and network
access (both intraLATA and interLATA access within the state) services. The
Telephone Company is also subject to the jurisdiction of the FCC with respect
to foreign and interstate rates and services, including interstate access
charges. Access charges are designed to compensate the Telephone Company for
the use of its facilities for the origination or termination of long-distance
and other communications by other carriers. There are currently no access
charges for access to the Internet.
Additional information relating to federal and state regulation of the Telephone
Company is contained in Item 7, Management's Discussion and Analysis of Results
of Operations of this report under the heading "Regulatory Environment"
beginning on page 12 of this report.
MAJOR CUSTOMER
Approximately 11% in 1996, 13% in 1995 and 14% in 1994 of the Telephone
Company's revenues were from services provided to AT&T. No other customer
accounted for more than 10% of total revenues.
COMPETITION
Information relating to competition in the telecommunications industry is
contained in Item 7, Management's Discussion and Analysis of Results of
Operations of this report under the heading "Competition" beginning on page 14
of this report.
RESEARCH AND DEVELOPMENT
The majority of company-sponsored basic and applied research is conducted at
Bell Communications Research, Inc. (Bellcore). The Telephone Company owns a
one-seventh interest in Bellcore along with the other six RHCs. In November
1996, SBC and the other RHCs announced their agreement to sell their interests
in Bellcore to Science Applications International Corporation. Regulatory
approvals of the transaction are pending, and if they are received it is
expected to close in late 1997. The RHCs will retain the portion of
Bellcore that coordinates the Federal Government's telecommunications
requirements for national security and emergency preparedness.
Basic and applied research is also conducted at Southwestern Bell Technology
Resources, Inc. (TRI), a subsidiary of SBC. TRI provides technology
planning and evaluation services to SBC and its subsidiaries, including the
Telephone Company.
EMPLOYEES
As of December 31, 1996, the Telephone Company employed 49,470 persons.
Approximately 76% of the employees are represented by the Communications
Workers of America (CWA). A three-year contract and a 20-month contract were
negotiated between the CWA and the Telephone Company, effective in August 1995
and December 1996. These contracts will be subject to renegotiation in
mid-1998.
ITEM 2. PROPERTIES
The properties of the Telephone Company do not lend themselves to description by
character and location of principal units. At December 31, 1996, network access
lines represented 44% of the Telephone Company's investment in telephone plant;
central office equipment represented 39%; land and buildings represented 9%;
other miscellaneous property, comprised principally of furniture and office
equipment and vehicles and other work equipment, represented 6%; and information
origination/termination equipment represented 2%.
ITEM 3. LEGAL PROCEEDINGS
Six putative class action lawsuits are now pending against the Telephone
Company in state and federal courts in Texas, Missouri, Oklahoma and Kansas
involving the provision by the Telephone Company of maintenance and trouble
diagnosis services relating to telephone inside wire located on customer
premises in these states and in Arkansas. The actions allege that the
Telephone Company's sales practices in connection with these services
violated antitrust, fraud and/or deceptive trade practices statutes and seek
unspecified damages together with punitive damages and attorney's fees. The
Telephone Company believes it has several meritorious defenses to these claims
and is vigorously contesting the allegations. Although the outcomes of these
cases are uncertain, management believes that this litigation will not have a
material adverse impact on the Telephone Company's results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted pursuant to General Instruction J(2).
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
<TABLE>
<CAPTION>
At December 31, or for
the year ended
1996 1995
<S> <C> <C>
Return on Weighted Average 20.99% 14.95%
Total Capital *
Debt Ratio (debt, including 64.24% 65.06%
current maturities, as a
percentage of total capital)
Network access lines in 14,955 14,223
service (000)
Access minutes of use (000,000) 58,668 53,681
Long-distance messages billed (000,000) 998 988
Number of employees 49,470 48,180
<FN>
* Calculated using income before extraordinary loss. The impact of
this charge is included in shareowner's equity.
</TABLE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
Dollars in millions
This discussion should be read in conjunction with the financial statements and
the accompanying notes.
RESULTS OF OPERATIONS
Summary
Financial results, including percentage changes from the prior year, are
summarized as follows:
<TABLE>
<CAPTION>
Percent Change
1996 1995 1996 vs. 1995
<S> <C> <C> <C>
Operating revenues $ 9,733 $ 8,938 8.9%
Operating expenses $ 7,243 $ 6,903 4.9%
Income before extraordinary loss $ 1,369 $ 1,120 22.1%
Extraordinary loss - $ (2,819) -
Net income (loss) $ 1,369 $ (1,699) -
</TABLE>
The Telephone Company recognized an extraordinary loss in 1995 from the
discontinuance of regulatory accounting.
The primary factor contributing to the increase in income before extraordinary
loss in 1996 was the growth in demand for services and products, partially
offset by increases in operating expenses and income taxes.
Items affecting the comparison of the operating results between 1996 and 1995
are discussed in the following sections.
Operating Revenues
Total operating revenues increased $795, or 8.9%, in 1996. Components of total
operating revenues, including percentage changes from the prior year, are as
follows:
<TABLE>
<CAPTION>
Percent Change
1996 1995 1996 vs. 1995
<S> <C> <C> <C>
Local service $ 4,718 $ 4,302 9.7%
Network access
Interstate 2,145 2,035 5.4
Intrastate 1,099 1,032 6.5
Long-distance service 883 822 7.4
Other 888 747 18.9
$ 9,733 $ 8,938 8.9%
</TABLE>
Local Service revenues increased in 1996 due to increases in demand,
primarily increases in residential and business access lines and vertical
services revenues. Total access lines increased 5.1% in 1996. Nearly two-
thirds of the access line growth occurred in Texas, which now has
approximately 59% of total access lines. Approximately 29% of access line
growth was due to the sales of additional access lines to existing
residential customers. Vertical services revenues, which include custom
calling options, Caller ID and other enhanced services, increased by
approximately 22%.
Network Access Interstate network access revenues increased in 1996 due
largely to increases in demand for access services by interexchange
carriers. Growth in revenues from end user charges, attributable to an
increasing access line base, also contributed to the increase. Net rate
reductions under the FCC's revised price cap plan, which was effective
August 1, 1995, partially offset the increase by approximately $65.
Intrastate network access revenues increased in 1996 due primarily to
increases in demand, including usage by alternative intraLATA toll carriers.
Long-Distance Service revenues increased in 1996 due to the inclusion in
1995 of intraLATA toll pool settlement payments and accruals for rate
reductions relating to an appealed 1992 rate order in Oklahoma. The
settlement of the appeals in October 1995 eliminated the need to continue
these accruals. Absent these accruals and settlements, long-distance
service revenues would have decreased slightly due to the continuing impact
of price competition from alternative intraLATA toll carriers. Competition
had less impact on message volumes due to the Telephone Company's deployment
and promotion of optional long-distance calling plans, which generally
result in higher message volumes but lower average revenue per message.
This message volume trend is not expected to continue, because the Telephone
Company plans to emphasize promotions of extended area local service plans.
Other operating revenues consist of the Telephone Company's non-regulated
network services and products, billing and collection services performed
for interexchange carriers and other miscellaneous revenues. The
increase in 1996 was due primarily to increases in demand for the
Telephone Company's nonregulated services and products, including
Caller ID equipment, computer network services, contract programming and
videoconferencing services. In December 1996, Southwestern Bell
Telecommunications Inc., a wholly-owned subsidiary of SBC which markets
business and residential communications equipment, was merged into the
Telephone Company. The inclusion of these equipment sales in other
operating revenues subsequent to the merger also contributed to the
increase.
Operating Expenses
Total operating expenses increased $340, or 4.9%, in 1996. Components of total
operating expenses, including percentage changes from the prior year, are as
follows:
<TABLE>
<CAPTION>
Percent Change
1996 1995 1996 vs. 1995
<S> <C> <C> <C>
Cost of services and products $ 3,069 $ 2,845 7.9%
Selling, general and administrative 2,379 2,304 3.3
Depreciation and amortization 1,795 1,754 2.3
$ 7,243 $ 6,903 4.9%
</TABLE>
Cost of Services and Products increased in 1996 due to increases for network
expansion and maintenance, employee-related expenses, including compensation
and training, and demand-related increases, primarily increases in switching
system software license fees.
Selling, General and Administrative expenses increased in 1996 primarily due
to growth-related increases, including increases in operating taxes, which
include the Texas Infrastructure Fund assessments, contracted services,
employee compensation, advertising and uncollectibles. The comparison of
1996 and 1995 expenses is affected by the inclusion in 1995 of a $93 charge
for costs associated with the strategic realignment discussed in Other
Business Matters.
Depreciation and Amortization increased in 1996 due primarily to growth in
plant levels and changes in plant composition.
Interest Expense decreased $13, or 3.8%, in 1996 due to lower interest rates on
short-term debt and capitalization of interest during construction required by
the discontinuance of regulatory accounting in the third quarter of 1995. Under
regulatory accounting, the Telephone Company accounted for a capitalization of
both interest and equity costs during periods of construction as other income.
Federal Income Tax expense increased $200, or 39.1%, in 1996 primarily due to
higher income before income taxes. The elimination of excess deferred taxes and
the reduction in the amortization of investment tax credits resulting from the
discontinuance of regulatory accounting, as described in Note 2 of the financial
statements, also contributed to the increase.
Extraordinary Loss In 1995, the Telephone Company recorded an extraordinary
loss of $2.8 billion from the discontinuance of regulatory accounting. The
loss included a reduction in the net carrying value of telephone plant
partially offset by the elimination of net regulatory liabilities (see Note 2
to the financial statements).
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
Regulatory Environment
The Telephone Company's telecommunications operations are subject to regulation
by each of the five states in which it operates for intrastate services and by
the FCC for interstate services. Through the end of 1996, the Telephone Company
operated under incentive regulation or price caps for various services provided
by the Telephone Company. In early 1997, Arkansas enacted legislation
establishing incentive regulation for electing companies, replacing a settlement
which had expired on December 31, 1996. Under price cap regulation, the
Telephone Company is permitted to establish and modify prices, not to exceed the
price caps, subject to expedited approval by the governing jurisdiction. Prices
for some other services not specifically covered by price caps are also subject
to regulatory approval.
The states set intrastate price caps for various periods, depending upon the
state. Price caps set by the FCC are adjusted annually for inflation, a
productivity offset and certain other changes in costs. The productivity offset
is a fixed percentage used to reduce price caps and is designed to encourage
increased productivity.
Under the original FCC plan adopted in 1991, the Telephone Company applied a
productivity offset of 3.3%, with sharing at various rates of return on
investment. The FCC adopted revised price cap rules effective August 1, 1995.
The new rules allowed a choice of three new productivity offsets, two of which
provide for a sharing of profits with consumers above certain earnings levels.
The Telephone Company elected a 5.3% productivity offset with no sharing.
The revised FCC price cap plan was intended to be an interim plan that would be
revised in 1996. However, with the passage of the Telecom Act, the FCC is
conducting further proceedings to address various pricing and productivity
issues, and is performing a broader review of price cap regulation in a
competitive environment. Additionally, the FCC will also examine universal
service and access charge rules during 1997. The Telecom Act and FCC actions
taken to implement provisions of the Telecom Act are discussed further under the
heading "Competition".
Following is a summary of significant state regulatory developments.
Texas The Public Utility Regulatory Act, which became effective in May 1995
(PURA), allows the Telephone Company and other Local Exchange Carriers (LECs) to
elect to move from rate of return regulation to price regulation with
elimination of earnings sharing. In September 1995, the Telephone Company
notified the Texas Public Utility Commission (TPUC) that it elected incentive
regulation under the new law. Basic local service rates are capped at existing
levels for four years following the election. The TPUC is prohibited from
reducing switched access rates charged by LECs to interexchange carriers for the
four-year election period.
LECs electing price regulation must commit to network and infrastructure
improvement goals, including expansion of digital switching and advanced
high-speed services to qualifying public institutions, such as schools,
libraries and hospitals, requesting the services. PURA also established an
infrastructure grant fund for use by public institutions in upgrading their
communications and computer technology. PURA provided for a total fund
assessment of $150 annually on all telecommunications providers in Texas for a
ten-year period, half of which would be paid by the cellular and wireless
industry. The provisions establishing different assessment rates for landline
and cellular and wireless service providers were ruled unconstitutional under
the Texas constitution in January 1996, and the lower rate was ordered to be
applied to both categories of service providers, resulting in less than a $150
annual assessment. Based on this order, the Telephone Company's total annual
payment is estimated to be approximately $31 to $35. The 1997 Texas legislative
session is considering this issue with the goal of restoring the assessment to
its original $150 annual amount. As a result, the Telephone Company's annual
payment could increase.
PURA establishes local exchange competition by allowing other companies who
desire to provide local exchange services to apply for certification by the
TPUC, subject to certain build-out requirements, resale restrictions and minimum
service requirements. PURA provides that the Telephone Company will remain the
default carrier of "1 plus" intraLATA toll traffic until all LECs are allowed to
carry interLATA long-distance.
In 1996, MCI Communications Corporation (MCI) and AT&T Corp. (AT&T) sued the
state of Texas, alleging that PURA violates the Texas state constitution,
claiming PURA establishes anticompetitive barriers designed to prevent MCI, AT&T
and Sprint Corporation (Sprint) from providing local services within Texas.
Management is unable to predict the outcome of this proceeding. During 1996,
the TPUC approved the application of Sprint to be granted a certificate of
authority to provide local service, waiving the build-out requirements specified
under state law for facilities-based certificates of authority. AT&T and MCI
have also filed petitions with the FCC arguing the build-out requirements should
be preempted; they have also requested TPUC grant them similar treatment as
Sprint. TPUC has also requested the FCC issue an expedited ruling on whether
PURA's build-out requirements are lawful under the Telecom Act.
More than 80 applications to provide competitive local service certification
have been approved by the TPUC, with over 30 more applications pending approval.
As a result, the Telephone Company expects competition to continue to develop
for local service, but the specific financial impacts of this competition cannot
be reasonably estimated until all required tariff filings are approved by the
TPUC for the Telephone Company and other companies intending to provide local
service.
Missouri During 1996, the 1995 Cole County Circuit Court ruling which
overturned the August 1994 settlement agreement reached among the Telephone
Company, the Missouri Public Service Commission (MPSC) and the Office of Public
Counsel (OPC) was upheld on appeal. The practical effect of this decision is to
eliminate the prospective commitments under the settlement agreement, including
a rate review moratorium and capital investment commitments. The decision has
no immediate impact on the Telephone Company's current rates because they were
approved by the MPSC in separate proceedings, which were not appealed.
Oklahoma On October 30, 1995, the Oklahoma Corporation Commission (OCC)
approved a settlement that resolved pending court appeals of a 1992 rate order.
Under the terms of the settlement, the Telephone Company paid a cash settlement
of $170 to business and residential customers, and offered discounts with a
retail value of $268 for certain Telephone Company services. Previously ordered
rate reductions of $100 were lowered to $84, of which $57 had already been
implemented. The settlement allowed the remaining $27 in rate reductions to be
deferred, with approximately $9 becoming effective in 1996 and the remainder
during 1997. The settlement also provides that no overearnings complaint can be
filed against the Telephone Company until January 1, 1998. The Telephone
Company began accruing for the order in 1992, and the settlement and associated
costs had been fully accrued as of the end of the third quarter of 1995.
Competition
Competition continues to expand in the telecommunications industry. Legislation
and regulation have increased the opportunities for alternative service
providers offering telecommunications services. Technological advances have
expanded the types and uses of services and products available. Accordingly,
the Telephone Company faces increasing competition in significant portions of
its business.
On February 8, 1996, the Telecom Act was enacted into law. The Telecom Act is
intended to address various aspects of competition within, and regulation of,
the telecommunications industry. The Telecom Act provides that all
post-enactment conduct or activities which were subject to the consent decree,
referred to as the MFJ, issued at the time of AT&T's divestiture of the Regional
Holding Companies (RHCs) are now subject to the provisions of the Telecom Act.
Among other things, the Telecom Act also defines conditions SBC must comply with
before being permitted to offer interLATA long-distance service within the five-
state area and establishes certain terms and conditions intended to promote
competition for the Telephone Company's local exchange services. Under terms of
the Telecom Act, SBC may immediately offer interLATA long-distance outside the
five-state area and over its wireless network both inside and outside the five-
state area. Before being permitted to offer landline interLATA long-distance
service in any state within the Telephone Company's five-state region, SBC must
apply for and obtain state-specific approval from the FCC. The FCC's approval,
which involves consultation with the United States Department of Justice,
requires favorable determinations that the Telephone Company has entered into
interconnection agreement(s) that satisfy a 14-point "competitive checklist"
with predominantly facilities based carrier(s) that serve residential and
business customers or, alternatively, that the Telephone Company has a statement
of terms and conditions effective in that state under which it offers the
"competitive checklist" items. The FCC must also make favorable public interest
and structural separation determinations. The Telecom Act directed the FCC to
establish rules and regulations to implement the Telecom Act, and to preempt
specific state law provisions under certain circumstances. The Telecom Act also
allows RHCs to provide cable services over their own networks, but sets limits
on RHCs acquiring interests in cable television operations in their telephone
service areas. It is anticipated that many of the new services and products
that SBC is allowed to offer under the Telecom Act will be provided by
subsidiaries of SBC other than the Telephone Company.
In April 1996, the United States District Court for the District of Columbia
issued its Opinion and Order terminating the MFJ and dismissing all pending
motions related to the MFJ as moot. This ruling effectively ended 13 years of
RHC regulation under the MFJ.
In August 1996, the FCC issued rules by which competitors could connect with
LECs' networks, including those of the Telephone Company. Among other things,
the rules addressed unbundling of network elements, pricing for interconnection
and unbundled elements (Pricing Provisions), and resale of network services.
The FCC rules were appealed by numerous parties, including SBC, other LECs,
various state regulatory commissions and the National Association of Regulatory
Utility Commissioners.
On October 15, 1996, the United States Court of Appeals for the Eighth Circuit
(Eighth Circuit) issued an order to stay the FCC's Pricing Provisions and its
rules permitting new entrants to "pick and choose" among the terms and
conditions of approved interconnection agreements. The stay provides that it
will remain in effect while the Eighth Circuit considers the validity of the
rules. Other provisions of rules adopted by the FCC to implement the Telecom
Act remain in effect.
The effects of the FCC rules are dependent on many factors including, but not
limited to: the ultimate resolution of the pending appeals; the number and
nature of competitors requesting interconnection, unbundling or resale; and the
results of the state regulatory commissions' review and handling of related
matters within their jurisdictions. Accordingly, the Telephone Company is not
able to assess the impact of the FCC rules.
Recently enacted and pending state laws and regulations also allow increased
competition for local exchange services. Companies wishing to provide
competitive local service have filed numerous applications with state
commissions throughout the Telephone Company's five-state area, and the
commissions of each state have begun approving these applications. Under the
Telecom Act, companies seeking to interconnect to the Telephone Company's
network and exchange local calls must enter into interconnection agreements with
the Telephone Company, which are then subject to approval by the appropriate
state commission. Numerous interconnection agreements have been entered into
and approved in the Telephone Company's five-state area. Several companies who
have failed to agree on all interconnection terms have filed for arbitration
before the state commissions.
In October 1996, the TPUC announced its ruling in a consolidated arbitration
hearing between the Telephone Company and AT&T, MCI, MFS Communications Company,
Inc. (MFS), Teleport Communications Group, and American Communications Services,
Inc. The TPUC approved interim interconnection rates to be charged by the
Telephone Company as well as certain other terms of interconnection between the
parties. Some agreements containing the arbitrated rates and terms have been
approved by the TPUC. The Telephone Company also filed revised cost support for
the establishment of permanent rates with the TPUC, with an anticipated
effective date of April 1997. The Telephone Company has filed suit in state
and federal court maintaining that, for various reasons, the arbitration award
is unlawful.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing with
AT&T and MCI and on selected items with MFS. Among other terms, the orders
established discount rates for resale of Telephone Company services and prices
for unbundled network elements. The Telephone Company has filed suit in federal
court appealing the orders as unlawful.
As a result of the Telecom Act and conforming interconnection agreements, the
Telephone Company expects in 1997 it will experience local exchange competition
from multiple providers in various markets. SBC intends to use approved
agreements in support of its application to the FCC to provide interLATA long-
distance service in the Telephone Company's five-state area.
The Telephone Company also faces competition from various local service
providers that bypass the local exchange network. Some of these providers have
built fiber optic "rings" throughout large metropolitan areas to provide
transport services (generally high-speed data) for large business customers and
interexchange carriers. Others provide high-usage customers, particularly large
businesses, alternative telecommunications links for voice and data, such as
private network systems, shared tenant services or private branch exchange (PBX)
systems (which are customer-owned and provide internal switching functions
without using Telephone Company central office facilities). The extent of the
economic incentive to bypass the local exchange network depends upon local
exchange prices, access charges, regulatory policy and other factors. End user
charges ordered by the FCC are designed in part to mitigate the effect of system
bypass.
Competition continues to intensify in the Telephone Company's intraLATA toll
markets. Principal competitors are interexchange carriers, which are assigned
an access code (e.g., "10XXX") used by their customers to route intraLATA calls
through the interexchange carrier's network, and resellers, which sell toll
services obtained at bulk rates.
In the future, it is likely that additional competitors will emerge in the
telecommunications industry. Cable television companies and electric utilities
have expressed an interest in, or already are, providing telecommunications
services. As a result of recent and prospective mergers and acquisitions within
the industry, SBC may face competition from entities offering both cable TV and
telephone services in the Telephone Company's operating territory.
Interexchange carriers have been certified to provide local service, and a
number of other major carriers have publicly announced their intent to provide
local service in certain markets, some of which are in the Telephone Company's
five-state area.
SBC is aggressively representing its interests regarding competition before
federal and state regulatory bodies, courts, Congress and state legislatures.
SBC will continue to evaluate the increasingly competitive nature of its
business to develop appropriate competitive, legislative and regulatory
responses.
OTHER BUSINESS MATTERS
Strategic Realignment In July 1995, SBC announced a strategic realignment which
positions the company to be a single-source provider of telecommunications
services. All of SBC's operations within the five-state area report to one
management group, while international operations and domestic operations outside
the five-state area report to a separate management group.
In connection with this realignment of functions, in 1995 the Telephone Company
recognized $93 in selling, general and administrative expenses. These expenses
include postemployment benefits for approximately 2,400 employees throughout SBC
arising from the future consolidation of operations within the five-state area,
streamlining support and administrative functions and integrating financial
systems. Implementation of the realignment has been delayed due to the pending
merger of an SBC subsidiary with Pacific Telesis Group. The charge reduced the
Telephone Company's net income for 1995 by approximately $58.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Auditors
The Board of Directors
Southwestern Bell Telephone Company
We have audited the accompanying balance sheets of Southwestern Bell Telephone
Company as of December 31, 1996 and 1995, and the related statements of income,
shareowner's equity and cash flows for each of the three years in the period
ended December 31, 1996. Our audits also included the financial statement
schedules listed in the Index at Item 14 (a). These financial statements and
schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Southwestern Bell Telephone
Company at December 31, 1996 and 1995, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1996, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedules, when considered in relation to the
basic financial statements taken as a whole, present fairly in all material
respects the information set forth therein.
As discussed in Note 2 to the financial statements, the Company discontinued its
application of Statement of Financial Accounting Standards No. 71, "Accounting
for the Effects of Certain Types of Regulation" in 1995.
ERNST & YOUNG LLP
San Antonio, Texas
February 14, 1997
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
STATEMENTS OF INCOME
Dollars in millions
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Operating Revenues
Local service $ 4,718 $ 4,302 $ 4,022
Network access 3,244 3,067 2,857
Long-distance service 883 822 904
Other 888 747 665
Total operating revenues 9,733 8,938 8,448
Operating Expenses
Cost of services and products 3,069 2,845 2,761
Selling, general and administrative 2,379 2,304 2,048
Depreciation and amortization 1,795 1,754 1,692
Total operating expenses 7,243 6,903 6,501
Operating Income 2,490 2,035 1,947
Other Income (Expense)
Interest expense (327) (340) (358)
Other income (expense) - net 5 (7) (3)
Total other income (expense) (322) (347) (361)
Income Before Income Taxes and
Extraordinary Loss 2,168 1,688 1,586
Income Taxes
Federal 711 511 456
State and local 88 57 58
Total income taxes 799 568 514
Income Before Extraordinary Loss 1,369 1,120 1,072
Extraordinary Loss from Discontinuance
of Regulatory Accounting, net of tax - (2,819) -
Net Income (Loss) $ 1,369 $ (1,699) $ 1,072
<FN>
The accompanying notes are an integral part of the financial statements.
</TABLE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
BALANCE SHEETS
Dollars in millions
<CAPTION>
December 31,
1996 1995
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents $ 69 $ 43
Accounts receivable - net of allowances for uncollectibles of
$23 and $15 1,674 1,509
Material and supplies 116 131
Deferred charges 35 32
Deferred income taxes 96 143
Prepaid expenses and other current assets 189 81
Total current assets 2,179 1,939
Property, Plant and Equipment - Net 11,759 11,127
Other Assets 30 76
Total Assets $ 13,968 $ 13,142
Liabilities and Shareowner's Equity
Current Liabilities
Debt maturing within one year $ 921 $ 750
Accounts payable and accrued liabilities 2,517 2,290
Total current liabilities 3,438 3,040
Long-Term Debt 4,265 4,217
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 209 174
Postemployment benefit obligation 2,646 2,657
Unamortized investment tax credits 255 286
Other noncurrent liabilities 269 100
Total deferred credits and other noncurrent liabilities 3,379 3,217
Shareowner's Equity
Common stock - one share, no par value 1 1
Paid-in surplus 3,687 4,838
Retained earnings (deficit) (802) (2,171)
Total shareowner's equity 2,886 2,668
Total Liabilities and Shareowner's Equity $ 13,968 $ 13,142
<FN>
The accompanying notes are an integral part of the financial statements.
</TABLE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Operating Activities
Net income (loss) $ 1,369 $ (1,699) $ 1,072
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization 1,795 1,754 1,692
Provision for uncollectible accounts 102 76 71
Amortization of investment tax credits (31) (42) (61)
Pensions and other postemployment expenses 194 106 176
Deferred income taxes 95 125 (112)
Extraordinary loss, net of tax - 2,819 -
Changes in operating assets and liabilities:
Accounts receivable (267) (195) (80)
Other current assets (96) 6 (75)
Accounts payable and accrued liabilities 228 (163) 285
Other - net (123) (22) (192)
Total adjustments 1,897 4,464 1,704
Net Cash Provided by Operating Activities 3,266 2,765 2,776
Investing Activities
Construction and capital expenditures (2,305) (1,734) (1,656)
Net Cash Used in Investing Activities (2,305) (1,734) (1,656)
Financing Activities
Net change in short-term borrowings with original
maturities of three months or less 176 6 173
Issuance of other short-term borrowings 209 91 36
Repayment of other short-term borrowings (134) (91) (41)
Issuance of long-term debt 166 596 1
Repayment of long-term debt (201) (117) (288)
Early extinguishment of debt and related call premiums - (465) -
Dividends paid (1,350) (1,139) (1,065)
Net equity received from parent 199 85 72
Net Cash Used in Financing Activities (935) (1,034) (1,112)
Net increase (decrease) in cash and cash equivalents 26 (3) 8
Cash and cash equivalents beginning of year 43 46 38
Cash and Cash Equivalents End of Year $ 69 $ 43 $ 46
<FN>
The accompanying notes are an integral part of the financial statements.
</TABLE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
STATEMENTS OF SHAREOWNER'S EQUITY
Dollars in millions
<CAPTION>
Retained
Common Paid-in Earnings
Stock Surplus (Deficit)
<S> <C> <C> <C>
Balance, December 31, 1993 $ 1 $ 5,707 $ (366)
Net income - - 1,072
Dividend to shareowner - (389) (683)
Equity from parent - 72 -
Balance, December 31, 1994 1 5,390 23
Net income (loss) - - (1,699)
Dividend to shareowner - (637) (495)
Equity from parent - 85 -
Balance, December 31, 1995 1 4,838 (2,171)
Net income - - 1,369
Dividend to shareowner - (1,350) -
Equity from parent - 199 -
Balance, December 31, 1996 $ 1 $ 3,687 $ (802)
<FN>
The accompanying notes are an integral part of the financial statements.
</TABLE>
NOTES TO FINANCIAL STATEMENTS
Dollars in millions
1. Summary of Significant Accounting Policies
Southwestern Bell Telephone Company (Telephone Company) provides
telecommunications services in Texas, Missouri, Oklahoma, Kansas and
Arkansas. The Telephone Company is a wholly-owned subsidiary of SBC
Communications Inc. (SBC).
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
Income Taxes - The Telephone Company is included in SBC's consolidated
federal income tax return. Federal income taxes are provided for in
accordance with the provisions of the Tax Allocation Agreement (Agreement)
between the Telephone Company and SBC. In general, the Telephone Company's
income tax provision under the Agreement reflects the financial
consequences of income, deductions and credits which can be utilized on a
separate return basis or in consolidation with SBC and which are assured of
realization.
Deferred income taxes are provided for temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes
and the amounts used for tax purposes.
Investment tax credits resulted from federal tax law provisions that
allowed for a reduction in income tax liability based on certain
construction and capital expenditures. Corresponding income tax expense
reductions were deferred and are being amortized as reductions in income
tax expense over the life of the property, plant and equipment that gave
rise to the credits.
Cash Equivalents - Cash equivalents include all highly liquid investments
with original maturities of three months or less.
Material and Supplies - New and reusable materials are carried principally
at average original cost. Specific costs are used for large individual
items. Nonreusable material is carried at estimated salvage value.
Property, Plant and Equipment - Property, plant and equipment is stated at
cost. The cost of additions and substantial betterments of property, plant
and equipment is capitalized. The cost of maintenance and repairs of
property, plant and equipment is charged to operating expenses.
Property, plant and equipment is depreciated using straight-line methods
over their estimated useful lives, generally ranging from 3 to 50 years.
Prior to September 1995, the Telephone Company computed depreciation using
certain straight-line methods and rates as prescribed by regulators. In
accordance with composite group depreciation methodology, when a portion of
the Telephone Company's depreciable property, plant and equipment is
retired in the ordinary course of business, the gross book value is charged
to accumulated depreciation.
2. Discontinuance of Regulatory Accounting
In September 1995, the Telephone Company discontinued its application of
Statement of Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation," (FAS 71). FAS 71 requires
depreciation of telephone plant using lives set by regulators which are
generally longer than those established by unregulated companies, and
deferral of certain costs and obligations based on regulatory actions
(regulatory assets and liabilities). As a result of the adoption of price-
based regulation for most of the Telephone Company's revenues and the
acceleration of competition in the telecommunications market, management
determined that the Telephone Company no longer met the criteria for
application of FAS 71.
Upon discontinuance of FAS 71, the Telephone Company recorded a non-cash,
extraordinary charge to net income of $2,819 (after a net deferred tax
benefit of $1,764). This charge is comprised of an after-tax charge of
$2,897 to reduce the net carrying value of telephone plant, partially
offset by an after-tax benefit of $78 for the elimination of net
regulatory liabilities. The components of the charge are as follows:
<TABLE>
<CAPTION>
Pre-tax After-tax
<S> <C> <C>
Increase telephone plant accumulated depreciation $ 4,657 $ 2,897
Adjust unamortized investment tax credits (41) (25)
Eliminate tax-related regulatory assets and liabilities (88) (88)
Eliminate other regulatory assets 55 35
Total $ 4,583 $ 2,819
</TABLE>
The increase in accumulated depreciation of $4,657 reflects the effects of
adopting depreciable lives for many of the Telephone Company's plant
categories which more closely reflect the economic and technological lives
of the plant. The adjustment was supported by a discounted cash flow
analysis which estimated amounts of telephone plant that may not be
recoverable from future discounted cash flows. This analysis included
consideration of the effects of anticipated competition and technological
changes on plant lives and revenues. The adjustment also included
elimination of accumulated depreciation deficiencies recognized by
regulators and amortized as part of depreciation expense.
Following is a comparison of new lives to those prescribed by regulators
for selected plant categories:
<TABLE>
<CAPTION>
Average Lives (in Years)
Regulator- Estimated
Prescribed Economic
<S> <C> <C>
Digital switch 17 11
Digital circuit 12 7
Copper cable 24 18
Fiber cable 27 20
Conduit 57 50
</TABLE>
The increase in accumulated depreciation also includes an adjustment of
approximately $450 to fully depreciate analog switching equipment scheduled
for replacement. Remaining analog switching equipment is being depreciated
using an average remaining life of four years.
Investment tax credits have historically been deferred and amortized over
the estimated lives of the related plant. The adjustment to unamortized
investment tax credits reflects the shortening of those plant lives
discussed above. Regulatory assets and liabilities are related primarily
to accounting policies used by regulators in the ratemaking process which
are different from those used by non-regulated companies, predominantly in
the accounting for income taxes and deferred compensated absences. These
items are required to be eliminated with the discontinuance of accounting
under FAS 71.
Additionally, in September 1995, the Telephone Company began accounting for
interest on funds borrowed to finance construction as an increase in
property, plant and equipment and a reduction of interest expense. Under
the provisions of FAS 71, the Telephone Company accounted for a
capitalization of both interest and equity costs allowed by regulators
during periods of construction as other income and as an addition to the
cost of plant constructed.
3. Property, Plant and Equipment
Property, plant and equipment, which is stated at cost, is summarized as
follows at December 31:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Property, plant and equipment
In service $ 29,035 $ 27,763
Under construction 312 245
29,347 28,008
Accumulated depreciation and amortization (17,588) (16,881)
Property, plant and equipment--net $ 11,759 $ 11,127
</TABLE>
The Telephone Company's depreciation expense as a percentage of average
depreciable plant was 6.4% for 1996, and 6.5% for 1995 and 1994.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1996, 1995 and
1994 were $99, $78 and $77. At December 31, 1996, the future minimum
rental payments under noncancelable operating leases for the years 1997
through 2001 were $38, $31, $40, $13 and $1, and $8 thereafter. Capital
leases were not significant.
4. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Debentures
4.50%-5.88% 1997-2006 $ 600 $ 600
6.12%-6.88% 2000-2024 1,200 1,200
7.00%-7.75% 2009-2026 1,500 1,500
8.30% 1996 - 200
3,300 3,500
Unamortized discount--net of premium (29) (31)
Total debentures 3,271 3,469
Notes
5.04%-7.67% 1997-2010 1,118 950
Unamortized discount (6) (5)
Total notes 1,112 945
Capitalized leases 3 4
Total long-term debt, including current maturities 4,386 4,418
Current maturities (121) (201)
Total long-term debt $ 4,265 $ 4,217
</TABLE>
During 1995, the Telephone Company refinanced long-term debentures. Costs
of $18 associated with refinancing are included in other income (expense) -
net, with related income tax benefits of $7 included in income taxes, in
the Telephone Company's Statements of Income.
At December 31, 1996, the aggregate principal amounts of long-term debt
scheduled for repayment for the years 1997 through 2001 were $121, $172,
$64, $150 and $237. As of December 31, 1996, the Telephone Company was in
compliance with all covenants and conditions of instruments governing its
debt.
Debt maturing within one year consists of the following at December 31:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Commercial paper $ 800 $ 549
Current maturities of long-term debt 121 201
Total $ 921 $ 750
</TABLE>
The weighted average interest rate on commercial paper debt at December 31,
1996 and 1995 was 5.5% and 5.7%. The Telephone Company has entered into
agreements with several banks for lines of credit totaling $750. All of
these agreements may be used to support commercial paper borrowings and
are on a negotiated fee basis with interest rates negotiable at time of
borrowing. There were no borrowings outstanding under these lines of
credit at December 31, 1996.
5. Financial Instruments
The carrying amounts and estimated fair values of the Telephone Company's
long-term debt, including current maturities, are summarized as follows at
December 31:
<TABLE>
<CAPTION>
1996 1995
Carrying Fair Carrying Fair
Amount Value Amount Value
<S> <C> <C> <C> <C>
Debentures $3,271 $3,208 $3,469 $3,553
Notes 1,112 1,115 945 965
</TABLE>
The fair values of the debentures were estimated based on quoted market
prices. The fair values of the notes were based on discounted cash flows
using current interest rates. The carrying amounts of cash and cash
equivalents and commercial paper debt approximate fair values.
The Telephone Company does not hold or issue any financial instruments for
trading purposes.
6. Income Taxes
Significant components of the Telephone Company's deferred tax liabilities
and assets are as follows at December 31:
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
Depreciation $ 1,516 $ 1,411
Other 107 81
Gross deferred tax liabilities 1,623 1,492
Employee benefits 1,232 1,151
Unamortized investment tax credits 97 108
Other 181 202
Gross deferred tax assets 1,510 1,461
Net deferred tax liabilities $ 113 $ 31
</TABLE>
As a result of implementing Statement of Accounting Standards No. 109,
"Accounting for Income Taxes" in 1993, the Telephone Company recorded a net
reduction in its deferred tax liability. This reduction was substantially
offset by the establishment of a net regulatory liability, which was
eliminated with the discontinued application of FAS 71 in September 1995
(see Note 2).
The components of income tax expense are as follows:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Federal
Current $ 665 $ 447 $ 619
Deferred--net 77 106 (102)
Amortization of investment tax credits (31) (42) (61)
711 511 456
State and local
Current 70 38 68
Deferred--net 18 19 (10)
88 57 58
Total $ 799 $ 568 $ 514
</TABLE>
A reconciliation of income tax expense and the amount computed by applying
the statutory federal income tax rate (35%) to income before income taxes,
extraordinary loss and cumulative effect of changes in accounting
principles is as follows:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Taxes computed at federal statutory rate $ 759 $ 591 $ 555
Increases (decreases) in taxes resulting from:
Amortization of investment tax credits over the life of
the plant that gave rise to the credits--1996 and 1995
net of deferred tax (20) (39) (60)
Excess deferred taxes due to rate change - (24) (35)
Depreciation of telephone plant construction costs
previously deducted for tax purposes--net - 14 18
State and local income taxes--net of federal tax benefit 57 37 38
Other--net 3 (11) (2)
Total $ 799 $ 568 $ 514
</TABLE>
7. Employee Benefits
Pensions - Substantially all employees of the Telephone Company are
covered by noncontributory pension and death benefit plans sponsored by
SBC. The pension benefit formula used in the determination of pension
cost is based on a flat dollar amount per year of service according to
job classification for nonmanagement employees and a stated percentage of
adjusted career income for management employees.
SBC's objective in funding the plans, in combination with the standards of
the Employee Retirement Income Security Act of 1974 (as amended), is to
accumulate funds sufficient to meet its benefit obligations to employees
upon their retirement. Contributions to the plans are made to a trust for
the benefit of plan participants. Plan assets consist primarily of stocks,
U.S. government and domestic corporate bonds and real estate.
Significant assumptions used by SBC in developing pension information
include:
<TABLE>
<CAPTION>
1996 1995 1994
<S> <C> <C> <C>
Discount rate for determining projected benefit obligation 7.5% 7.25% 7.5%
Long-term rate of return on plan assets 8.0% 8.0% 8.0%
Composite rate of compensation increase 4.6% 4.6% 4.6%
</TABLE>
Generally Accepted Accounting Principles (GAAP) require certain disclosures
to be made of components of net periodic pension cost for the period and a
reconciliation of the funded status of the plans with amounts reported in
the balance sheets. Since the funded status of plan assets and obligations
relates to the plans as a whole, which are sponsored by SBC, this
information is not presented for the Telephone Company. The Telephone
Company recognized pension cost for 1996, 1995 and 1994 of $104, $104 and
$80. As of December 31, 1996 and 1995, the amount of the Telephone
Company's cumulative amount of pension cost recognized in excess of its
cumulative contributions made to the trust was $227 and $53.
Postretirement Benefits - Under its benefit plans, the Telephone Company
provides certain medical, dental and life insurance benefits to
substantially all retired employees and accrues actuarially determined
postretirement benefit costs as active employees earn these benefits.
SBC maintains collectively bargained Voluntary Employee Beneficiary
Association (CBVEBA) trusts to fund postretirement benefits. During 1996
and 1995, the Telephone Company contributed $57 and $147, into the CBVEBA
trusts to be ultimately used for the payment of postretirement benefits.
The Telephone Company also funds postretirement life insurance
benefits at an actuarially determined rate. Assets consist principally
of stocks and U.S. Government and corporate bonds.
GAAP require certain disclosures to be made of components of net periodic
postretirement benefit cost and a reconciliation of the funded status of
the plans to amounts reported in the balance sheets. Since the funded
status of assets and obligations relates to the plans as a whole, this
information is not presented for the Telephone Company. The Telephone
Company recognized postretirement benefit cost for 1996, 1995 and
1994 of $211, $209 and $224. At December 31, 1996 and 1995, the amount
included in the Balance Sheets for accrued postretirement benefit
obligation was $2,666 and $2,633. Significant assumptions for the
discount rate, long-term rate of return on plan assets and composite rate
of compensation increase used by SBC in developing the accumulated
postretirement benefit were the same as those used in developing
the pension information.
The assumed medical cost trend rate in 1997 is 8.0%, decreasing gradually
to 5.5% in 2002 prior to adjustment for cost-sharing provisions of the
plan for active and certain recently retired employees. The assumed
dental cost trend rate in 1997 is 6.25%, reducing to 5.0% in 2002.
Raising the annual medical and dental cost trend rates by one percentage
point increases the net periodic postretirement benefit cost for the year
ended December 31, 1996 by approximately 7.0%.
Postemployment Benefits - Under its benefit plans, the Telephone Company
provides employees varying levels of severance pay, disability pay,
workers' compensation and medical benefits under specified circumstances
and accrues these postemployment benefits at the occurrence of an event
that renders an employee inactive or, if the benefits ratably vest, over
the vesting period.
Savings Plans - Substantially all employees are eligible to participate in
contributory savings plans sponsored by SBC. Under the savings plans, the
Telephone Company matches a stated percentage of eligible employee
contributions, subject to a specified ceiling.
The Telephone Company's match of employee contributions to the savings
plans is fulfilled with SBC's shares of stock allocated from two Employee
Stock Ownership Plans and with purchases of SBC's stock in the open market.
The costs relating to these savings plans were $29, $32 and $37 in 1996,
1995 and 1994.
8. Stock Option Plans
Management employees of the Telephone Company participate in various stock
option plans sponsored by SBC. These SBC plans authorize the issuance of
stock options to senior and other management employees to purchase up to 69
million shares of SBC common stock, of which 32 million have been issued.
Options issued through December 31, 1996 carry exercise prices equal to the
market price of the stock at the date of grant and have maximum terms
ranging from five to ten years. Depending upon the plan, vesting of
options occurs one to three years from the date of grant.
In 1996 the Telephone Company elected to continue measuring compensation
cost for these plans using the intrinsic value based method of accounting
prescribed in the Statement of Financial Accounting Standards Board
No. 123, "Accounting for Stock Based Compensation" (FAS 123). Accordingly,
no compensation cost has been recognized for the stock option plans. Had
compensation cost for stock option plans been recognized using the fair
value based method of accounting at the date of grant for awards in 1996
and 1995 as defined by FAS 123, the Telephone Company's net income (loss)
would have been $1,354 and $(1,704).
For purposes of these pro forma disclosures, the estimated fair value of
the options granted after 1994 is amortized to expense over the options'
vesting period. Because most employee options vest over a two to three
year period, these disclosures will not be indicative of future pro forma
amounts until the FAS 123 rules are applied to all outstanding non-vested
awards. The fair value for these options was estimated at the date of
grant, using a Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1996 and 1995: risk-free
interest rate of 6.37% and 6.31%; dividend yield of 3.45% and 3.45%;
expected volatility factor of 16% and 18%; and expected option life of 4.5
and 4.6 years.
FAS 123 requires certain disclosures to be made about the outstanding and
exercisable options, option activity, weighted average exercise price per
option and option exercise price range for each income statement period.
Since the stock option activity relates only to SBC's shareowners' equity,
this information in not presented for the Telephone Company.
9. Additional Financial Information
<TABLE>
<CAPTION>
December 31,
Balance Sheets 1996 1995
<S> <C> <C> <C>
Accounts payable and accrued liabilities
Accounts payable $ 839 $ 829
Accrued taxes 418 258
Advance billing and customer deposits 279 249
Compensated future absences 185 178
Accrued interest 80 81
Accrued payroll 133 88
Other 583 607
Total $ 2,517 $ 2,290
Statements of Income 1996 1995 1994
Interest expense incurred $ 348 $ 344 $ 358
Capitalized interest (21) (4) -
Total interest expense $ 327 $ 340 $ 358
Allowance for funds used $ - $ 11 $ 19
during construction
Statements of Cash Flows 1996 1995 1994
Cash paid during the year for:
Interest $ 327 $ 344 $ 360
Income taxes $ 721 $ 510 $ 741
</TABLE>
Approximately 11% in 1996, 13% in 1995 and 14% in 1994 of the Telephone
Company's revenues were from services provided to AT&T Corp. No other
customer accounted for more than 10% of total revenues.
Approximately 76% of the Telephone Company's employees are represented by
the Communications Workers of America (CWA). A three-year contract and a
20 month contract were negotiated between the CWA and the Telephone
Company, effective in August 1995 and December 1996. These contracts will
be subject to renegotiation in mid-1998.
10. Quarterly Financial Information (Unaudited)
<TABLE>
<CAPTION>
Calendar Total Operating
Quarter Revenues Operating Income Net Income (Loss)
1996 1995 1996 1995 1996 1995
<S> <C> <C> <C> <C> <C> <C>
First $ 2,345 $ 2,163 $ 641 $ 539 $ 351 $ 300
Second 2,410 2,226 634 545 348 307
Third (1) 2,456 2,263 639 551 354 (2,514)
Fourth (2) 2,522 2,286 576 400 316 208
Annual (1) $ 9,733 $ 8,938 $ 2,490 $ 2,035 $ 1,369 $(1,699)
<FN>
(1) 1995 Net Loss reflects an extraordinary loss of $2,819 from discontinuance of regulatory
accounting.
(2) 1995 Operating Income reflects $93 in selling, general and administrative expenses
associated with a strategic realignment of functions. These expenses include
postemployment benefits for employees arising from the consolidation of operations within
the five-state area, streamlining support and administrative functions and integrating
financial systems.
1995 Net Income reflects after-tax charges of $58 for the strategic realignment of
functions and $11 for refinancing of debt.
</TABLE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
No changes in accountants or disagreements with accountants on any accounting or
financial disclosure matters occurred during the period covered by this report.
PART III
ITEMS 10 THROUGH 13.
Omitted pursuant to General Instruction J(2).
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents filed as a part of the report: Page
(1) Report of Independent Auditors..........................
Financial Statements Covered by Report of Independent Auditors:
Statements of Income....................................
Balance Sheets..........................................
Statements of Cash Flows................................
Statements of Shareowner's Equity.......................
(2) Financial Statement Schedules Covered by Report of Independent
Auditors:
II - Valuation and Qualifying Accounts..................
Financial statement schedules other than those listed above have been
omitted because the required information is contained in the financial
statements and notes thereto, or because such schedules are not required
or applicable.
(3) Exhibits:
Exhibit
Number......................................................
4 Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument
which defines the rights of holders of long-term debt of the
registrant is filed herewith. Pursuant to this regulation, the
registrant hereby agrees to furnish a copy of any such instrument to
the SEC upon request.
12 Computation of Ratios of Earnings to Fixed Charges.
23 Consent of Ernst & Young LLP.
24 Powers of Attorney.
27 Financial Data Schedule.
(b) Reports on Form 8-K:
No report on Form 8-K was filed by the Registrant during the last quarter
of the year covered by this report.
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Allowance for Uncollectibles
Dollars in Millions
<CAPTION>
COL. A COL. B COL. C COL. D COL. E
--------- Additions---------
(1) (2)
Charged
Balance at Charged to Other Balance
Beginning of to Costs and Accounts Deductions at End of
Description Period Expenses -Note (a) -Note (b) Period
<S> <C> <C> <C> <C> <C>
Year 1996................................... $ 15 102 27 121 $ 23
Year 1995................................... $ 15 83 25 108 $ 15
Year 1994................................... $ 14 84 31 114 $ 15
<FN>
(a) Amounts previously written off which were credited directly to this account when recovered.
(b) Amounts written off as uncollectible.
</TABLE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on the 11th day of March,
1997.
SOUTHWESTERN BELL TELEPHONE COMPANY
By /s/ Richard G. Lindner
(Richard G. Lindner
Vice President and Chief Financial
Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the date indicated.
Principal Executive Officer:
Edward A. Mueller*
President and Chief
Executive Officer
Principal Financial and
Accounting Officer:
Richard G. Lindner
Vice President and Chief Financial
Officer
/s/ Richard G. Lindner
Directors: (Richard G. Lindner, as attorney-in-fact
and on his own behalf as Principal
Royce S. Caldwell* Financial Officer and Principal
Cassandra C. Carr* Accounting Officer)
William E. Dreyer*
James D. Ellis* March 11, 1997
Donald E. Kiernan*
Edward A. Mueller*
* by power of attorney
EXHIBIT INDEX
Exhibit
Number......................................................
4 Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument
which defines the rights of holders of long-term debt of the
registrant is filed herewith. Pursuant to this regulation, the
registrant hereby agrees to furnish a copy of any such instrument to
the SEC upon request.
12 Computation of Ratios of Earnings to Fixed Charges.
23 Consent of Ernst & Young LLP.
24 Powers of Attorney.
27 Financial Data Schedule.
<TABLE>
EXHIBIT 12
SOUTHWESTERN BELL TELEPHONE COMPANY
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
Dollars in Millions
<CAPTION>
YEAR ENDED DECEMBER 31,
1996 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
Income Before Income Taxes,
Extraordinary Loss and Cumulative
Effect of Changes in Accounting
Principles $ 2,168 $ 1,688 $ 1,586 $ 1,424 $ 1,325
Add: Interest Expense 327 340 358 385 409
1/3 Rental Expense 33 26 25 23 27
Adjusted Earnings $ 2,528 $ 2,054 $ 1,969 $ 1,832 $ 1,761
Total Interest Charges $ 348 $ 340 $ 358 $ 385 $ 409
1/3 Rental Expense 33 26 25 23 27
Adjusted Fixed Charges $ 381 $ 366 $ 383 $ 408 $ 436
Ratio of Earnings to Fixed Charges 6.64 5.61 5.14 4.49 4.04
</TABLE>
EXHIBIT 23
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration
Statement (Form S-3 No. 33-49967) of Southwestern Bell Telephone
Company and in the related Prospectus of our report dated
February 14, 1997, with respect to the financial statements and schedules
of Southwestern Bell Telephone Company included in this Annual Report
(Form 10-K) for the year ended December 31, 1996.
ERNST & YOUNG LLP
San Antonio, Texas
March 7, 1997
EXHIBIT 24
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
SOUTHWESTERN BELL TELEPHONE COMPANY, a Missouri corporation,
hereinafter referred to as the "Company," proposes to file with
the Securities and Exchange Commission, under the provisions of
the Securities Exchange Act of 1934, as amended, an annual report
on Form 10-K, and
WHEREAS, each of the undersigned is a director of the
Company;
NOW, THEREFORE, each of the undersigned hereby constitutes
and appoints T. Michael Payne and Richard G. Lindner, or either
one of them, his or her attorneys for him or her and in his or
her name, place and stead, and in his or her office and capacity
in the Company, to execute and file such annual report, and
thereafter to execute and file any amendment or amendments
thereto, hereby giving and granting to said attorneys full power
and authority to do and perform each and every act and thing
whatsoever requisite or necessary to be done in and concerning
the premises, as fully to all intents and purposes as he might or
could do if personally present at the doing thereof, hereby
ratifying and confirming all that said attorneys may or shall
lawfully do, or cause to be done, by virtue hereof.
IN WITNESS WHEREOF, each of the undersigned has hereunto set
his or her hand on the date set forth opposite his or her
signature.
/s/ Royce S. Caldwell 2/24/97
Royce S. Caldwell Date
Chairman of the
Board
/s/ Cassandra C. Carr 2/26/97
Cassandra C. Carr Date
Director
/s/ William E. Dreyer 2/27/97
William E. Dreyer Date
Director
/s/ James D. Ellis 2/24/97
James D. Ellis Date
Director
/s/ Donald E. Kiernan 2/24/97
Donald E. Kiernan Date
Director and
Treasurer
/s/ Edward A. Mueller 3/6/97
Edward A. Mueller Date
Director and
President and
Chief Executive
Officer
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM
SOUTHWESTERN BELL TELEPHONE COMPANY'S DECEMBER 31, 1996 FINANCIAL
STATEMENTS AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 69,000
<SECURITIES> 0
<RECEIVABLES> 1,697,000
<ALLOWANCES> 23,000
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 2,179,000
<PP&E> 29,347,000
<DEPRECIATION> 17,588,000
<TOTAL-ASSETS> 13,968,000
<CURRENT-LIABILITIES> 3,438,000
<BONDS> 4,265,000
0
0
<COMMON> 1,000
<OTHER-SE> 2,885,000
<TOTAL-LIABILITY-AND-EQUITY> 13,968,000
<SALES> 0<F2>
<TOTAL-REVENUES> 9,733,000
<CGS> 0<F3>
<TOTAL-COSTS> 3,069,000
<OTHER-EXPENSES> 1,795,000
<LOSS-PROVISION> 102,000
<INTEREST-EXPENSE> 327,000
<INCOME-PRETAX> 2,168,000
<INCOME-TAX> 799,000
<INCOME-CONTINUING> 1,369,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,369,000
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1>THIS AMOUNT IS IMMATERIAL.
<F2>NET SALES OF TANGIBLE PRODUCTS IN 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>
