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 1-2346
SOUTHWESTERN BELL TELEPHONE COMPANY
Incorporated under the laws of the State of Missouri
I.R.S. Employer Identification Number 43-0529710
530 McCullough, San Antonio, Texas 78215
Telephone Number: (210) 821-4105
THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF SBC COMMUNICATIONS INC., MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION H(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
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
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STATEMENTS OF INCOME
Dollars in millions
(Unaudited)
<CAPTION>
- ------------------------------------------------------------------------------------
Three months ended Nine months ended
September 30, September 30,
----------------------------------------------
1998 1997 1998 1997
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<S> <C> <C> <C> <C>
Operating Revenues
Local service $ 1,412 $ 1,337 $ 4,192 $ 3,898
Network access
Interstate 600 548 1,779 1,631
Intrastate 280 273 832 813
Long-distance service 201 204 582 620
Other 325 266 882 743
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Total operating revenues 2,818 2,628 8,267 7,705
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Operating Expenses
Cost of services and products 1,097 1,002 3,188 2,910
Selling, general and administrative 472 485 1,386 1,525
Depreciation and amortization 513 475 1,489 1,440
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Total operating expenses 2,082 1,962 6,063 5,875
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Operating Income 736 666 2,204 1,830
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Other Income (Expense)
Interest expense (94) (85) (276) (254)
Other income (expense) - net (3) 11 (11) 12
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Total other income (expense) (97) (74) (287) (242)
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Income Before Income Taxes 639 592 1,917 1,588
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Income Taxes 236 218 710 591
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Net Income $ 403 $ 374 $ 1,207 $ 997
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See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
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BALANCE SHEETS
Dollars in millions
<CAPTION>
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September 30, December 31,
-------------- -------------
1998 1997
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<S> <C> <C>
Assets (Unaudited)
Current Assets
Cash and cash equivalents $ 64 $ 79
Accounts receivable - net of allowances for
uncollectibles of $47 and $33 1,860 1,819
Prepaid expenses 315 156
Deferred charges 40 39
Deferred income taxes 178 192
Other current assets 182 167
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Total current assets 2,639 2,452
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Property, Plant and Equipment - at cost 32,373 31,011
Accumulated depreciation and amortization 19,345 18,460
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Property, Plant and Equipment - Net 13,028 12,551
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Other Assets 16 11
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Total Assets $ 15,683 $ 15,014
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Liabilities and Shareowner's Equity
Current Liabilities
Intercompany loans $ 1,828 $ 473
Current portion of long-term obligations 112 172
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Debt maturing within one year 1,940 645
Accrued taxes 548 442
Accounts payable and accrued liabilities 2,079 2,599
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Total current liabilities 4,567 3,686
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Long-Term Debt 4,358 4,824
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Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 529 383
Postemployment benefit obligation 2,542 2,574
Unamortized investment tax credits 201 224
Other noncurrent liabilities 259 305
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Total deferred credits and other noncurrent liabilities 3,531 3,486
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Shareowner's Equity
Common stock - one share, no par value 1 1
Paid-in surplus 2,545 2,745
Retained earnings 681 272
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Total shareowner's equity 3,227 3,018
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Total Liabilities and Shareowner's Equity $ 15,683 $ 15,014
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See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
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STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash
and cash equivalents
(Unaudited)
<CAPTION>
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Nine months ended
September 30,
---------------------
1998 1997
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<S> <C> <C>
Operating Activities
Net income $ 1,207 $ 997
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,489 1,440
Provision for uncollectible accounts 97 87
Amortization of investment tax credits (23) (24)
Deferred income tax expense 161 109
Other - net (879) (220)
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Total adjustments 845 1,392
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Net Cash Provided by Operating Activities 2,052 2,389
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Investing Activities
Construction and capital expenditures (1,885) (1,890)
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Net Cash Used in Investing Activities (1,885) (1,890)
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Financing Activities
Net change in short-term borrowings with original
maturities of three months or less 1,356 238
Issuance of other short-term borrowings - 120
Repayment of other short-term borrowings - (195)
Issuance of long-term debt 196 487
Repayment of long-term debt (736) (101)
Dividends paid (1,098) (1,175)
Equity received from parent 100 155
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Net Cash Used in Financing Activities (182) (471)
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Net increase (decrease) in cash and cash equivalents (15) 28
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Cash and cash equivalents beginning of year 79 69
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Cash and Cash Equivalents End of Period $ 64 $ 97
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Cash paid during the nine months ended September 30 for:
Interest $ 287 $ 237
Income taxes $ 495 $ 370
See Notes to Financial Statements.
</TABLE>
<PAGE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
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STATEMENT OF SHAREOWNER'S EQUITY
Dollars in millions
(Unaudited)
<CAPTION>
- ----------------------------------------------------------------------------
Common Paid-in Retained
Stock Surplus Earnings
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<S> <C> <C> <C>
Balance, December 31, 1997 $ 1 $ 2,745 $ 272
Net income - - 1,207
Dividend to shareowner - (300) (798)
Equity received from parent - 100 -
- ----------------------------------------------------------------------------
Balance, September 30, 1998 $ 1 $ 2,545 $ 681
- ----------------------------------------------------------------------------
See Notes to Financial Statements.
</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........................................ 66.12% 66.70%
Network access lines in service (000)............. 16,335 15,556
Access minutes of use (000,000)................... 47,011 44,229
Resold lines (000)................................ 460 154
Number of employees............................... 50,640 50,870
</TABLE>
<PAGE>
SOUTHWESTERN BELL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions
1. BASIS OF PRESENTATION Southwestern Bell Telephone Company (SWBell) is a
wholly-owned subsidiary of SBC Communications Inc. (SBC). The financial
statements have been prepared by SWBell 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 financial statements contained herein should be read in
conjunction with the financial statements and notes thereto included in
SWBell's 1997 Annual Report on Form 10-K filed with the SEC. Comprehensive
income for SWBell is the same as net income for all periods presented.
2. COMPLETION OF MERGER On April 1, 1997, SBC and Pacific Telesis Group (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 of a
share 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 was accounted for as a pooling of interests and a tax-free
reorganization.
Post-merger initiatives
During the second quarter of 1997, SBC announced several strategic decisions
resulting from the merger integration process that began with the April 1,
1997 closing of its merger with PAC. 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. In connection with these initiatives, SWBell recognized
several charges during the second quarter. The charges related to these
initiatives totaled $141 ($87 after tax). At September 30, 1998 and December
31, 1997, remaining accruals for anticipated cash expenditures related to
these items were approximately $39 and $78. Following is a discussion of the
most significant of these charges.
Reorganization SBC is centralizing several key functions that will support
the operations of SWBell, Pacific Bell (PacBell, which also includes its
subsidiary Pacific Bell Information Services) and Nevada Bell, 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. SWBell, PacBell, and Nevada Bell 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.
<PAGE>
SOUTHWESTERN BELL TELEPHONE COMPANY
NOTES TO FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions
SWBell recognized a charge of approximately $57 ($36 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.
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 $5 ($4 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, SWBell
reviewed the carrying value of related long-lived assets. This review
included estimating remaining useful lives and cash flows. Where this review
indicated impairment, discounted cash flows related to those assets were
analyzed to determine the amount of the impairment. As a result of these
reviews, in the second quarter of 1997 SWBell wrote off some assets and
recognized impairments to the value of other assets with a combined charge of
$84 ($51 after tax), including the write off of voice dial equipment which
will be discontinued.
3. SOFTWARE COSTS SWBell 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 requires capitalization of
certain computer software expenditures beginning in 1999, with earlier
adoption permitted.
SWBell did not elect to early adopt the provisions of the SOP. Management is
currently evaluating the impact of the change in accounting required by the
SOP and anticipates it will be less than $100. With comparable levels of
software expenditures, the SOP would tend to increase net income in
comparison with SWBell'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.
<PAGE>
SOUTHWESTERN BELL TELEPHONE COMPANY
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
RESULTS OF OPERATIONS
Overview Financial results for Southwestern Bell Telephone Company (SWBell) for
the first nine months of 1998 and 1997 are summarized as follows:
- ---------------------------------------------------------------------------
Nine-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Operating revenues $ 8,267 $ 7,705 7.3%
Operating expenses $ 6,063 $ 5,875 3.2%
Net income $ 1,207 $ 997 21.1%
===========================================================================
SWBell's net income for the first nine months of 1997 includes after-tax charges
of $143 reflecting strategic initiatives resulting from SBC Communications
Inc.'s (SBC) comprehensive review of operations of the merged company, the
impact of several regulatory rulings and ongoing merger initiatives during the
first nine months of 1997. Excluding these 1997 charges, SWBell reported net
income of $1,207 for the first nine months of 1998, 5.9% higher than the first
nine months of 1997 net income of $1,140.
Excluding these charges, the primary factor contributing to the increase in net
income during the first nine months of 1998 was growth in demand for services
and products.
Operating Revenues SWBell's operating revenues for the first nine months of 1997
reflect reductions of $67 related primarily to the impact of several regulatory
rulings during the second quarter of 1997. Excluding these items, SWBell's
operating revenues increased $495, or 6.4%, for the first nine months of 1998.
Components of operating revenues for the first nine months of 1998 and 1997 are
as follows:
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Nine-Month Period
------------------------------
Percent
1998 1997 Change
- ----------------------------------------------------------------------------
Local service $ 4,192 $ 3,898 7.5%
Network access:
Interstate 1,779 1,631 9.1
Intrastate 832 813 2.3
Long-distance service 582 620 (6.1)
Other 882 743 18.7
- -------------------------------------------------------------------
Total $ 8,267 $ 7,705 7.3%
============================================================================
<PAGE>
SOUTHWESTERN BELL TELEPHONE COMPANY
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
RESULTS OF OPERATIONS - Continued
Local service revenues increased in the first nine months of 1998 due
primarily to increases in demand totaling more than $261, including
increases in access lines, vertical services, and data-related services
revenues. The number of access lines increased by 5.0% since September 30,
1997, of which nearly 70% was due to growth in Texas. Approximately 30% of
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 14% totaling more than $700 for the first nine months of
1998. Local service revenues also increased with the introduction and
deployment of extended local area service plans in 1998 by approximately
$27, resulting in a shift of revenue from long-distance service. The
overall increase to total operating revenues resulting from introduction
of the plans was approximately $19. Additionally, Federal payphone
deregulation implemented in April 1997 caused local service revenues to
increase by approximately $50 and interstate network access to decrease by
approximately $12; the overall impact was an increase of nearly $39 in
total operating revenues. This payphone-related increase included a third
quarter 1998 decrease of approximately $21 to recognize revenues based
upon actual volumes compared to previously estimated volumes. These
increases were partially offset by a reduction of approximately $58 due to
cellular interconnection rates in the third quarter of 1997; the lower
interconnection rate reductions were in effect for all of 1998.
Network access Interstate network access revenues for 1997 reflect charges
of $52 due to the adverse impacts of several regulatory issues. These
issues include among other items, recovery of certain employee-related
expenses and the productivity factor adjustment in the Federal price cap
filing. Without these impacts, total interstate network access revenues
increased $96, or 5.7% 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 totaling approximately
$163. Also contributing to the increase was the absence of approximately
$35 of the 1997 revenue offset required for net payments for long-term
support which were designed to subsidize universal service, discussed
further in operations and support below. Partially offsetting these
increases were the effects of the annual rate reduction of approximately
$85 related to the Federal productivity factor adjustment, as discussed in
SWBell's 1997 Annual Report on Form 10-K and payphone deregulation of
approximately $12 referred to above in local service.
Intrastate network access revenues increased slightly in the first nine
months of 1998 as increases in demand totaling approximately $29,
including usage by alternative intraLATA toll carriers, were partially
offset by net price decreases of approximately $9 resulting from 1997
state regulatory rate orders.
Long-distance service revenues decreased in the first nine months of 1998
due to the effect of price competition from alternative intraLATA toll
carriers and regulatory rate orders totaling approximately $29.
Additionally, the introduction and deployment of extended area local
service plans reduced long-distance service revenues by approximately $8;
the amount of increase is somewhat greater than the reduction in
long-distance revenue.
Other operating revenues for 1997 reflect charges of $11 due to the impact
of several regulatory issues. Excluding these impacts, other operating
revenues increased $128, or 16.9% in the first nine months of 1998.
Approximately 67% of this increase was due to increased demand for
nonregulated services and products, including consumer equipment and
network integration services. Also contributing by approximately 14% to
the overall increase was the repricing of maintenance and trouble
diagnosis services related to inside wire located on the customers'
premises, effective June of 1998.
<PAGE>
Operating Expenses Components of operating expenses for the first nine months of
1998 and 1997 are as follows:
- ---------------------------------------------------------------------------
Nine-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Operations and support $ 4,574 $ 4,435 3.1%
Depreciation and amortization 1,489 1,440 3.4
- ------------------------------------------------------------------
Total $ 6,063 $ 5,875 3.2%
===========================================================================
SWBell 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 2 to the financial statements, SWBell's
operating expenses in the first nine months of 1997 reflect $152 of adjustments
for charges related to SBC's strategic initiatives, a comprehensive review of
operations of the merged company, the impact of several regulatory rulings and
ongoing merger integration costs. Excluding these 1997 adjustments, SWBell's
normalized operating expenses increased $340, or 5.9%, for the first nine months
of 1998.
Operations and Support Components of operations and support and
normalizing adjustments for the first nine months of 1998 and 1997 are as
follows:
- ---------------------------------------------------------------------------
Nine-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Cost of services and products $ 3,188 $ 2,910 9.6%
Selling, general and administrative 1,386 1,525 (9.1)
- ---------------------------------------------------------------------------
Total operations and support 4,574 4,435 3.1%
Adjustments - (115) -
- ---------------------------------------------------------------------------
Normalized operations and support $ 4,574 $ 4,320 5.9%
===========================================================================
Operations and support consists of all operating expenses except
depreciation and amortization. Operations and support expenses for the
first nine months of 1997 reflect $115 of the adjustments referred to
above.
Excluding these adjustments, normalized operations and support increased
$254, or 5.9%, in the first nine months of 1998 due primarily to increases
in merger implementation costs in 1998 of approximately $121, increased
costs associated with reciprocal compensation for the termination of
Internet traffic of approximately $60, and increases in universal service
fund (USF) charges of approximately $64 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. Also contributing to
the increase in operations and support were increases in wages and
salaries of approximately $23, operating taxes of approximately $27, and
materials of approximately $35. Additionally increases totaling
approximately $33 in uncollectible expense and costs associated with the
Texas and Oklahoma USFs contributed to the increase. These increases were
partially offset by reductions in use of contract labor of approximately
$67 and net reductions to benefits, agent commissions and research and
development costs totaling approximately $66. Costs incurred for local
number portability were comparable for the first nine months of each year.
Depreciation and amortization Summarization of depreciation and
amortization expense and normalizing adjustments for the first nine months
of 1998 and 1997 is as follows:
- ---------------------------------------------------------------------------
Nine-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Depreciation and amortization $ 1,489 $ 1,440 3.4%
Adjustments - (37) -
- ---------------------------------------------------------------------------
Normalized depreciation and amortization $ 1,489 $ 1,403 6.1%
===========================================================================
Depreciation and amortization for the first nine months of 1997 reflects
one-time charges of $37 for the write off of voice dial equipment which
was discontinued. Excluding these adjustments, depreciation and
amortization increased $86 for the first nine months of 1998 due primarily
to increased depreciation expense of $64 resulting from growth in plant
levels. The remainder of the increase was due to rate variances related to
the net impact of revised composite rates.
Interest expense increased $22, or 8.7%, for the first nine months of 1998,
primarily due to increased average long-term borrowings.
Other income (expense) - net was a net expense of $11 for the first nine months
of 1998 which included $15 of call premiums and unamortized discount on the
early extinguishment of $600 of debentures and notes. Other income (expense) -
net was a net income of $12 for the first nine months of 1997 and reflected
royalty payments received from a software affiliate.
Income Taxes for the first nine months of 1997 reflect the tax effect of charges
for strategic initiatives resulting from SBC's comprehensive review of
operations of the merged company and the impact of several regulatory rulings.
Excluding these items, income taxes for the first nine months of 1997 would have
been $668. Income taxes for the first nine months of 1998 were higher due
primarily to higher income before income taxes.
<PAGE>
SOUTHWESTERN BELL TELEPHONE COMPANY
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
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 SWBell by imposing restrictions that prohibit SWBell 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 SWBell 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 SWBell's 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 not likely be until 1999.
Interconnection Reciprocal compensation is billed to SWBell 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 have taken the position
that Internet communications is intrastate or local traffic and have ordered
SWBell 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.
SWBell has 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 1998,
the Texas Public Utility Commission (TPUC) released a status report on SWBell's
checklist compliance efforts. The TPUC reported that SWBell has settled nearly
half of the issues raised, but more collaboration is needed to settle the
remaining recommendations. Additional collaborative sessions are scheduled, with
a proposed decision and vote by the TPUC on whether to recommend SWBell's
in-region interLATA long-distance application to the FCC expected by early 1999.
OTHER BUSINESS MATTERS
New Accounting Standards In June 1998, the Financial Accounting Standards Board
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.
See Note 3 to the Financial Statements for a discussion of the new accounting
standard on software costs.
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.
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.
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>
SOUTHWESTERN BELL TELEPHONE COMPANY
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 12 Computation of Ratios of Earnings to Fixed Charges.
Exhibit 27 Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the third quarter ended
September 30, 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.
Southwestern Bell Telephone Company
November 4, 1998 /s/ Richard G. Lindner
-------------------------
Richard G. Lindner
Vice President and Chief Financial
Officer
<TABLE>
EXHIBIT 12
SOUTHWESTERN BELL TELEPHONE COMPANY
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 $ 1,917 $ 1,588 $ 1,888 $ 2,168 $ 1,688 $ 1,586 $ 1,424
Add:Interest Expense 276 254 343 327 340 358 385
1/3 Rental Expense 31 29 41 33 26 25 23
--------- --------- ---------- ---------- ---------- ----------- -----------
Adjusted Earnings $ 2,224 $ 1,871 $ 2,272 $ 2,528 $ 2,054 $ 1,969 $ 1,832
========= ========= ========== ========== ========== =========== ===========
Total Interest Charges $ 294 $ 275 $ 370 $ 348 $ 340 $ 358 $ 385
1/3 Rental Expense 31 29 41 33 26 25 23
--------- --------- ---------- ---------- ---------- ----------- -----------
Adjusted Fixed Charges $ 325 $ 304 $ 411 $ 381 $ 366 $ 383 $ 408
========= ========= ========== ========== ========== =========== ===========
Ratio of Earnings to Fixed Charges 6.84 6.15 5.53 6.64 5.61 5.14 4.49
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM SOUTHWESTERN
BELL TELEPHONE COMPANY'S SEPTEMBER 30, 1998 FINANCIAL STATEMENTS ON FORM 10-Q
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> 64
<SECURITIES> 0
<RECEIVABLES> 1,907
<ALLOWANCES> 47
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 2,639
<PP&E> 32,373
<DEPRECIATION> 19,345
<TOTAL-ASSETS> 15,683
<CURRENT-LIABILITIES> 4,567
<BONDS> 4,358
0
0
<COMMON> 1
<OTHER-SE> 3,226
<TOTAL-LIABILITY-AND-EQUITY> 15,683
<SALES> 0<F2>
<TOTAL-REVENUES> 8,267
<CGS> 0<F3>
<TOTAL-COSTS> 3,188
<OTHER-EXPENSES> 1,489
<LOSS-PROVISION> 97
<INTEREST-EXPENSE> 276
<INCOME-PRETAX> 1,917
<INCOME-TAX> 710
<INCOME-CONTINUING> 1,207
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,207
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1> THIS AMOUNT IS IMMATERIAL.
<F2> NET SALES OF TANGIBLE PRODUCTS IS NOT MORE THAN 10% OF TOTAL OPERATING
REVENUES AND THEREFORE HAS NOT BEEN STATED SEPARATELY IN THE FINANCIAL
STATEMENTS PURSUANT TO REGULATION S-X, RULE 5-03(B). THIS AMOUNT IS
INCLUDED IN THE "TOTAL REVENUES" TAG.
<F3> COST OF TANGIBLE GOODS SOLD IS INCLUDED IN COST OF SERVICES AND PRODUCTS
IN THE FINANCIAL STATEMENTS AND THE "TOTAL-COST" TAG, PURSUANT TO
REGULATION S-X,RULE 5-03(B).
</FN>
</TABLE>
