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
For fiscal year ended December 31, 1997
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-2346
SOUTHWESTERN BELL TELEPHONE COMPANY
Incorporated under the laws of the State of Missouri
I.R.S. Employer Identification Number 43-0529710
175 E. Houston, San Antonio, Texas 78205-2233
Telephone Number 210-821-4105
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 I(1)(a) AND (b) OF FORM 10-K AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION I(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]
<PAGE>
8
SCHEDULE A
Securities Registered Pursuant To Section 12(b) Of The Act:
Name of each
Title of each Class exchange
on which registered
------------- ---------------
Seven Year 6-1/8% Notes, New York Stock
due March 1, 2000 Exchange
Eight Year 6-3/8% Notes, New York Stock
due April 1, 2001 Exchange
Twelve Year 6-5/8% Notes, New York Stock
due April 1, 2005 Exchange
Thirty-Eight Year 7-3/4% American Stock
Debentures, Exchange
due September 1, 2009
Forty Year 6-7/8% Debentures, American Stock
due February 1, 2011 Exchange
Forty Year 7-3/8% Debentures, American Stock
due May 1, 2012 Exchange
Forty Year 7-5/8% Debentures, American Stock
due October 1, 2013 Exchange
Twenty-Two Year 7% Debentures, New York Stock
due July 1, 2015 Exchange
Thirty Year 7-5/8% New York Stock
Debentures, Exchange
due March 1, 2023
Thirty-Two Year 7-1/4% New York Stock
Debentures, Exchange
due July 15, 2025
<PAGE>
TABLE OF CONTENTS
Item Page
- ----- ----
PART I
1. Business....................................................... 4
2. Properties..................................................... 7
3. Legal Proceedings.............................................. 7
4. Submission of Matters to a Vote of Security Holders............ *
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................... 8
6. Selected Financial and Operating Data.......................... 8
7. Management's Discussion and Analysis of Results of Operations
(Abbreviated pursuant to General Instruction I(2))............. 9
7A. Quantitative and Qualitative Disclosures about Market Risk..... 17
8. Financial Statements and Supplementary Data.................... 19
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 35
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 35
- ----------
*Omitted pursuant to General Instruction I(2).
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
Southwestern Bell Telephone Company (SWBell) was incorporated in 1882 under the
laws of the State of Missouri, and has its principal executive offices at 175 E.
Houston, San Antonio, Texas 78205-2233 (telephone number 210-821-4105). SWBell
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 the original 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). With the mergers of SBC and Pacific Telesis Group
(PAC), and Bell Atlantic Corporation and NYNEX Corporation, there are now five
RHCs.
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 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.
In July 1997, SBC brought suit in the U.S. District Court for the Northern
District of Texas (U.S. District Court), seeking a declaration that parts of the
Telecom Act are unconstitutional on the grounds that they improperly
discriminate against SWBell by imposing restrictions that prohibit SWBell by
name from offering interLATA (Local Access Transport Area) 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 issued a ruling declaring unconstitutional, among other things,
the prohibitions on SBC providing interLATA long-distance in SWBell operating
areas. If upheld, this ruling is expected to speed competition in the interLATA
long-distance markets in SWBell's regulated operating areas. The FCC and
competitor intervenors have sought and received a stay of the decision by the
U.S. District Court. 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 "Competitive Environment" beginning
on page 14 of this report.
BUSINESS OPERATIONS
SBC is centralizing several key functions that will support the wireline
operations of SWBell, and two subsidiaries of PAC, Pacific Bell and Nevada Bell,
including network planning, strategic marketing and procurement. SBC is also
consolidating a number of corporate-wide support activities, including research
and development, information technology, financial transaction processing and
real estate management. SWBell, Pacific Bell and Nevada Bell will continue as
separate legal entities. These initiatives will result in the creation of some
jobs and the elimination and realignment of others, with many of the affected
employees changing job responsibilities and in some cases assuming positions in
other locations.
SWBell recognized charges during 1997 in connection with these initiatives. The
charges were comprised mainly of postemployment benefits, primarily related to
severance, and costs associated with closing down duplicate operations,
primarily contract cancellations. Other charges arising out of the merger
relating to relocation, retraining and other effects of consolidating certain
operations are being recognized in the periods those charges are incurred.
Additional information on these charges is contained in Note 3 of the Financial
Statements.
SWBell serves the nation's second most populous state, Texas, and sections of
the nation's Midwest region, including 2 of the country's 10 largest
metropolitan areas and 7 of the country's 50 largest metropolitan areas.
SWBell'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.
SWBell offers certain services on a "wholesale" basis to competitors, as well as
provides elements of SWBell'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 have resulted in
SWBell facing increased competition in significant portions of its business. At
December 31, 1997, SWBell provided wholesale services to more than 250 thousand
access lines. Management cannot quantify the impact to SWBell's business in 1998
from local exchange competition, as uncertainty exists as to the breadth and
scope of competitors' offering of local exchange services to all portions of the
market in-region, and as certain regulations, tariffs and negotiations governing
such competition are not yet finalized.
The following table sets forth the percentage for SWBell 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.
- -------------------------------------------------- ----------------------------
Percentage of Total
Operating Revenues
- -------------------------------------------------- ----------------------------
1997 1996 1995
- ------------------------------------------- ----------- ----------- -----------
Local service 51% 48% 48%
Network access 32% 33% 34%
- ------------------------------------------- ----------- ----------- -----------
SWBell provides its services over approximately 10.2 million residential and 5.3
million business access lines in the five-state area. During 1997, over
two-thirds of SWBell's access line growth occurred in Texas.
During 1997, SWBell 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.
In December 1996, substantially all of the operations of Southwestern Bell
Telecommunications, Inc., a wholly-owned subsidiary of SBC were moved into the
operations of SWBell. The move did not and is not expected to have a significant
impact on SWBell's results of operations.
GOVERNMENT REGULATION
In the five-state area, SWBell 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. SWBell is also subject to the
jurisdiction of the FCC with respect to international and interstate rates and
services, including interstate access charges. Access charges are designed to
compensate SWBell 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 to the Internet.
Additional information relating to federal and state regulation of SWBell 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 1997, 11% in 1996 and 13% in 1995 of SWBell'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 "Competitive Environment" beginning
on page 14 of this report.
RESEARCH AND DEVELOPMENT
Certain company-sponsored basic and applied research was conducted at Bell
Communications Research, Inc. (Bellcore). SWBell owned a one-seventh interest in
Bellcore with the remainder owned by SBC, through PAC, and the other four
remaining RHCs. In November 1997, the sale of Bellcore was completed. The RHCs
retained the activities of Bellcore that coordinate the Federal Government's
telecommunications requirements for national security and emergency
preparedness.
Applied research is also conducted at SBC Technology Resources, Inc. (TRI), a
subsidiary of SBC. TRI provides research, technology planning and evaluation
services to SBC and its subsidiaries, including SWBell.
<PAGE>
EMPLOYEES
As of December 31, 1997, SWBell employed 50,500 persons. Approximately 77% of
the employees are represented by the Communications Workers of America (CWA). A
contract covering an estimated 39,000 employees between the CWA and SWBell ends
in August 1998. A new contract is scheduled to be negotiated in 1998.
ITEM 2. PROPERTIES
The properties of SWBell do not lend themselves to description by character and
location of principal units. At December 31, 1997, network access lines
represented 44% of SWBell'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 actions in Texas, Missouri, Oklahoma, and Kansas that
involved the provision by SWBell of maintenance and trouble diagnosis services
relating to telephone inside wire located on customer premises have been
settled. These actions alleged that SWBell's sales practices in connection with
these services violated antitrust, fraud and/or deceptive trade practices
statutes. The trial court has approved the settlement, which is not expected to
materially affect the financial results of SWBell.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted pursuant to General Instruction I(2).
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Not applicable.
ITEM 6. SELECTED FINANCIAL AND OPERATING DATA
-----------------------------------------------------------------------------
At December 31, or for the year ended
1997 1996
------------------------------------------------------------------------------
Return on Weighted Average 17.82% 20.99%
Total Capital
Debt Ratio (debt, including 64.44% 64.24%
current maturities, as a
percentage of total capital)
Network access lines in service 15,741 14,943
(000)
Access minutes of use (000,000) 59,395 55,112
Number of employees 50,500 49,470
------------------------------------------------------------------------------
Operating data may be periodically revised to reflect the most current
information available.
<PAGE>
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:
- --------------------------------------------------------------------------------
Percent
1997 1996 Change
1997 vs.
1996
- --------------------------------------------------------------------------------
Operating revenues $ 10,313 $ 9,733 6.0 %
Operating expenses $ 8,121 $ 7,243 12.1 %
Net income $ 1,187 $ 1,369 (13.3) %
- --------------------------------------------------------------------------------
SWBell's net income for 1997 includes after-tax charges of $296 reflecting
strategic initiatives resulting from SBC Communications Inc.'s (SBC)
comprehensive review of operations of the merged company, the impact of several
regulatory rulings during the second quarter of 1997, costs incurred for
customer number portability since the merger and charges for ongoing merger
integration costs, primarily related to the movement of employees. Excluding
these charges and the favorable impact of SWBell's after-tax gain from the sale
of its interest in Bell Communications Research, Inc. (Bellcore), SWBell
reported net income of $1,468, 7.2% higher than 1996 net income of $1,369.
Excluding these items, the primary factor contributing to the increase in net
income in 1997 was growth in demand for services and products.
Items affecting the comparison of the operating results between 1997 and 1996
are discussed in the following sections
Operating Revenues
SWBell's operating revenues for 1997 reflect reductions of $66 related primarily
to the impact of several regulatory rulings during the second quarter of 1997.
Excluding these reductions, SWBell's operating revenues increased $646, or 6.6%.
Components of operating revenues for 1997, including percentage changes from the
prior year, are as follows:
- -------------------------------------------------------------------------------
Percent
1997 1996 Change
1997 vs.
1996
- -------------------------------------------------------------------------------
Local service $ 5,237 $ 4,718 11.0%
Network access
Interstate 2,176 2,145 1.4
Intrastate 1,078 1,099 (1.9)
Long-distance service 803 883 (9.1)
Other 1,019 888 14.8
================================================================
Total $ 10,313 $ 9,733 6.0%
===============================================================================
<PAGE>
Management's Discussion and Analysis, continued
Dollars in millions
Local Service revenues increased in 1997 due to increases in demand,
including increases in residential and business access lines and vertical
services revenues. Total access lines increased 5.3% in 1997, of which
approximately 68% was due to growth in Texas. Access lines in Texas account
for approximately 59% of SWBell's access lines. Approximately 32% of access
line growth in 1997 was due to sales of additional access lines to existing
residential customers. Vertical services revenues, which include custom
calling options, Caller ID and other services, increased by approximately
23% in 1997. Additionally, Federal payphone deregulation in 1997 increased
local service revenues and decreased long-distance service revenues and
interstate network access revenues; the overall impact was a slight
increase in total operating revenues.
Network Access Interstate network access revenues reflect charges of $52
due to the adverse impacts of several regulatory issues during the second
quarter of 1997, including recovery of certain employee-related expenses
and the retroactive effect of the productivity factor adjustment mandated
in the July 1, 1997 Federal price cap filing. Without these impacts,
interstate network access revenues increased in 1997 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. Partially offsetting these
increases were the effects of rate reductions of approximately $80 in 1997
related to the FCC's productivity factor adjustment.
Intrastate network access revenues decreased slightly in 1997 as modest
increases in demand, including usage by alternative intraLATA toll
carriers, were more than offset by net price decreases resulting from state
regulatory rate orders.
Long-Distance Service revenues decreased in 1997 due primarily to the
impact of price competition from alternative intraLATA toll carriers and
the introduction and deployment of extended area local service plans. The
decrease in long-distance service revenues also reflects impacts of state
regulatory rate orders.
Other operating revenues increased in 1997 due primarily to sales of
business systems communications equipment attributable to the December 1996
movement of substantially all the business of Southwestern Bell
Telecommunications Inc. (Telecom), a wholly-owned subsidiary of SBC which
marketed business and residential communications equipment, into SWBell.
Results also reflect increases in demand for SWBell's nonregulated services
and products.
Operating Expenses
SWBell's operating expenses for 1997 reflect $398 of charges related to
strategic initiatives resulting from a comprehensive review of operations (see
Note 3 to the Financial Statements), costs incurred for customer number
portability since the merger and charges for ongoing merger integration costs.
Excluding these charges, operating expenses increased $480, or 6.6%. Components
of operating expenses, including percentage changes from the prior year, are as
follows:
- -------------------------------------------------------------------------------
Percent
1997 1996 Change
1997 vs.
1996
- -------------------------------------------------------------------------------
Cost of services and products $ 4,048 $ 3,609 12.2%
Selling, general and administrative 2,146 1,839 16.7
Depreciation and amortization 1,927 1,795 7.4
- ----------------------------------------------------------------
Total $ 8,121 $ 7,243 12.1%
===============================================================================
Cost of Services and Products reflects charges of $149 in 1997 relating to
strategic initiatives, including charges for customer number portability
since the merger of SBC and PAC. Excluding these charges, cost of services
and products increased $290, or 8.0%, in 1997 due primarily to increases in
employee compensation, network expansion and maintenance and
interconnection. Results also reflect increased expenses for business
systems communications equipment now sold by SWBell (formerly sold by
Telecom as described above).
Selling, General and Administrative expense for 1997 reflects $209 of
charges relating to strategic initiatives and ongoing merger integration
costs. Excluding these charges, selling, general and administrative expense
increased $98, or 5.3%, in 1997 due primarily to increases in sales agents
commissions, employee compensation, and uncollectibles.
Depreciation and Amortization for 1997 reflects one-time charges of $37 for
the write off of voice dial equipment which will be discontinued (see Note
3 to the Financial Statements). Excluding this charge, depreciation and
amortization increased $95, or 5.3%, in 1997 due primarily to growth in
plant levels. Depreciation and amortization for 1997 also reflects a $92
decrease caused by an increase in copper cable life, which can be
attributed to the emergence of new technologies, such as asymmetrical
digital subscriber line equipment that expands the bandwidth of copper
cable. This technological advancement resulted in a change in strategy,
reflective of the rest of the industry to continue the wide-spread use of
copper cable rather than fiber optic cable for distribution of residential
applications. This decrease was mostly offset by a change in the effective
composite rate for other plant categories.
Interest Expense increased $16, or 4.9%, in 1997 due to increased debt levels.
Income Tax expense decreased $98, or 12.3%, in 1997 due primarily to lower
income before income taxes.
<PAGE>
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
Regulatory Environment
The telecommunications industry is in transition from a tightly regulated
industry overseen by multiple regulatory bodies, to a more incentive-based,
market driven industry monitored by state and federal agencies. SWBell's
wireline telecommunications operations remain subject to regulation by the five
states in which it operates for intrastate services and by the FCC for
interstate services. In 1997, a new price cap regulatory plan was implemented
for SWBell in Missouri, and in Oklahoma, legislation passed allowing alternative
regulation. SWBell under price cap regulation has the freedom to establish and
modify prices for some services as long as they do not exceed the price caps, as
well as the freedom to change prices for some services without regulatory
approval.
Federal Regulation
During 1997, the FCC issued an Access Reform Order restructuring access charges
paid for interexchange carrier access to SWBell's networks. The order raises the
flat monthly end user charge for primary business lines, and additional
residence and business lines, and lowers the price caps on per minute access
charges for interstate long distance carriers. These changes, which took effect
in 1997 and January 1998, are supposed to shift sources of revenue from carriers
to end users without changing the total amount of revenue received by the Local
Exchange Carriers (LECs).
The FCC's price cap plan for the LECs provides for changes to be made annually
to the price caps for inflation, productivity and changes in other costs. In
1997 SWBell was ordered to begin using a 6.5% productivity offset, with no
sharing. Prior to 1997, there were three productivity offsets, two of which
provided for a sharing of profits above a specified earnings level with SWBell's
customers and a higher productivity offset which did not include sharing. SWBell
had elected the higher 5.3% productivity offset without sharing.
With the passage of the Telecom Act, the FCC has been conducting further
proceedings in conjunction with access reform to address a number of pricing and
productivity issues, and is performing a broader review of price cap regulation
in the context of the increasingly more competitive telecommunications
environment. The Chairman of the FCC has indicated that the FCC intends to act
on these proceedings in 1998. The Telecom Act and FCC actions taken to implement
provisions of the Telecom Act are discussed further under the heading
"Competitive Environment."
Pursuant to the Telecom Act, the local coin rate in the payphone industry was
deregulated by the FCC on October 7, 1997, and LECs were required to remove any
direct or indirect subsidy of payphone service from their regulated
telecommunications operations. Removal of the subsidy caused SWBell to raise the
local coin rates throughout its operating territory in 1997.
State Regulation
Through the end of 1997, SWBell operated in the five-state area under price caps
or alternative regulation for its various services. Following is a listing of
certain regulatory developments:
Texas The Public Utility Regulatory Act, which became effective in May 1995
(PURA), allows SWBell and other LECs to elect to move from rate of return
regulation to price regulation with elimination of earnings sharing. In
September 1995, SWBell notified the Texas Public Utility Commission (TPUC) that
it elected incentive regulation under PURA. Basic local service rates were
capped at existing levels for four years following the election. The TPUC is
prohibited from reducing switched access rates charged by LECs to interexchange
carriers while rates are capped.
LECs electing price regulation must commit to network and infrastructure
improvement goals, including expansion of digital switching and advanced
high-speed services to qualifying public institutions, such as schools,
libraries and hospitals, requesting the services. PURA also established an
infrastructure grant fund for use by public institutions in upgrading their
communications and computer technology. PURA provided for a total fund
assessment of $150 annually on all telecommunications providers in Texas for a
ten-year period. The 1997 Texas legislative session changed the funding for the
infrastructure grant from annually collecting $150 for ten years to a flat rate
(1.25%) applied to all telecommunications providers' sales taxable revenues. The
law also provides a cap of $1,500 for the life of the fund. SWBell's annual
payments will increase from the approximate current level in 1997 of $36 per
year to approximately $50 for each of the next three years. Due to the industry
growth in revenues, the fund should be completely funded before the original ten
years.
PURA establishes local exchange competition by allowing other companies that
desire to provide local exchange services to apply for certification by the
TPUC, subject to certain build-out requirements, resale restrictions and minimum
service requirements. PURA provides that SWBell will remain the default carrier
of "1 plus" intraLATA long-distance traffic until SWBell is allowed to carry
interLATA long-distance. In 1996, MCI Communications Corporation (MCI) and AT&T
Corp. (AT&T) sued the state of Texas, alleging that PURA violates the Texas
state constitution, and claiming that PURA establishes anticompetitive barriers
designed to prevent MCI, AT&T and Sprint Corporation (Sprint) from providing
local services within Texas. The FCC, also in response to petitions filed by
AT&T and MCI preempted and voided portions of PURA that required certain new
entrants to build telephone networks to cover a 27 square-mile area in any
market they entered. Furthermore, the FCC also pre-empted rules that excluded
competitors from entering markets with fewer than 31,000 access lines and which
made resale of Centrex phone services subject to a limited property restriction.
AT&T and MCI have dismissed their suits regarding this matter. In October 1997,
SWBell filed with the FCC a Petition for Reconsideration regarding the
preemption of the property restriction for Centrex services.
More than 170 applications for certification to provide competitive local
service have been approved by the TPUC, with over 25 more applications pending
approval. As a result, SWBell expects competition to continue to develop for
local service, but the financial impacts of this competition cannot be
reasonably estimated at this time.
Missouri Effective September 26, 1997, the Missouri Public Service Commission
(MPSC) determined that SWBell is subject to price cap regulation. Prices in
effect as of December 31, 1996 are the initial maximum allowable rates for
services and cannot be adjusted until January 1, 2000 for basic and access
services and until January 1, 1999 for non-basic services. On an exchange basis
where a competitor begins operations, the January 1, 1999 freeze on maximum
allowable rates for non-basic services is removed. After those dates, caps for
basic and access services may be adjusted based on one of two government indices
while caps for non-basic services may be increased up to 8% per year. In an
exchange where competition for basic local service exists for five years,
services will be declared competitive and subject to market pricing unless the
MPSC finds effective competition does not exist. The Office of Public Counsel
and MCI have sought judicial review of the MPSC determination.
Oklahoma Oklahoma enacted legislation, effective July 1, 1997, which allows for
alternative regulation in Oklahoma for telecommunications providers. Key
provisions of the new law allow SWBell to apply for alternative regulation at
any time, impose a restriction against the Oklahoma Corporation Commission (OCC)
initiating a rate case until February 5, 2001, establish a Universal Service
Fund (USF), and require SWBell to keep intrastate access rates at parity with
interstate rates. SWBell is allowed to seek partial recovery of the access rate
reductions from the USF. In addition, the new law allows for streamlined tariff
processing procedures and establishes a framework to have services declared
competitive and eventually deregulated.
Competitive Environment
Competition continues to increase for telecommunication and information
services. Recent changes in legislation and regulation have increased the
opportunities for alternative service providers offering telecommunications
services. Technological advances have expanded the types and uses of services
and products available. As a result, SWBell 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
issued at the time of AT&T divestiture of the Regional Holding Companies (RHCs),
referred to as the Modification of Final Judgment (MFJ), are now subject to the
provisions of the Telecom Act. In April 1996, the United States District Court
for the District of Columbia issued its Opinion and Order terminating the MFJ
and dismissing all pending motions related to the MFJ as moot. This ruling
effectively ended 13 years of RHC regulation under the MFJ. Among other things,
the Telecom Act also defines conditions SBC must comply with before being
permitted to offer interLATA long-distance service within the five-state area
and establishes certain terms and conditions intended to promote competition for
SWBell's local exchange services.
Under the Telecom Act, SBC may immediately offer interLATA long-distance outside
the regulated operating areas and over its wireless network both inside and
outside the regulated operating areas. Before being permitted to offer landline
interLATA long-distance service in any state within the five-state area, 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 and appropriate state commissions, requires favorable determinations
that SWBell 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 SWBell 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 in connection with such
applications.
In July 1997, SBC brought suit in the U.S. District Court for the Northern
District of Texas (U.S. District Court), seeking a declaration that parts of the
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 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 issued a ruling declaring unconstitutional, among
other things, the prohibitions on SBC providing interLATA long-distance in
SWBell operating areas. If upheld, this ruling is expected to speed competition
in the interLATA long-distance markets in SWBell's regulated operating areas.
The FCC and competitor intervenors have sought and received a stay of the
decision by the U.S. District Court.
In August 1996, the FCC issued rules by which competitors could connect with
LECs' networks, including those of SWBell. Among other things, the rules
addressed unbundling of network elements, pricing for interconnection and
unbundled elements (Pricing Provisions), and resale of retail telecommunications
services. The FCC rules were appealed by numerous parties, including SBC.
In July 1997, the United States Court of Appeals for the Eighth Circuit in St.
Louis (8th Circuit) held that the FCC did not have authority to promulgate rules
related to the pricing of local intrastate telecommunications and that its rules
in that regard were invalid. The 8th Circuit also overturned the FCC's rules
which allowed competitors to "pick and choose" among the terms and conditions of
approved interconnection agreements. In October 1997, the 8th Circuit issued a
subsequent decision clarifying that the Telecom Act does not require the
incumbent LECs to deliver network elements to competitors in anything other than
completely unbundled form.
In September 1997, a number of parties including SBC, filed petitions to enforce
the July 1997 ruling of the 8th Circuit that the right to set local exchange
prices, including the pricing methodology used, is reserved exclusively to the
states. The petitions responded to the FCC's rejection of Ameritech
Corporation's interLATA long-distance application in Michigan in which the FCC
stated it intended to apply its own pricing standards to RHC interLATA
applications. The petitioners asserted the FCC was violating state authority. On
January 22, 1998 the 8th Circuit ordered the FCC to abide by the July 1997
ruling and reiterated that the FCC cannot use interLATA long-distance
applications made by SBC and other RHC wireline subsidiaries wishing to provide
interLATA long-distance to attempt to re-impose the pricing standards ruled
invalid in July 1997 by the 8th Circuit. On January 26, 1998, the U.S. Supreme
Court agreed to hear all appeals of the July 1997 8th Circuit decision.
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, SWBell is not able to assess
the impact of the FCC rules at this time.
Landline Local Service
Recent state legislative and regulatory developments also allow increased
competition for local exchange services. Companies wishing to provide
competitive local service have filed numerous applications with state
commissions throughout SWBell's five-state area, and the commissions of each
state have been approving these applications since late 1996. Under the Telecom
Act, companies seeking to interconnect to SWBell's networks and exchange local
calls must enter into interconnection agreements with SWBell. These agreements
are then subject to approval by the appropriate state commissions. SWBell has
reached more than 200 interconnection and resale agreements with competitive
local service providers, and most have been approved by the relevant state
commissions. AT&T and other competitors are reselling SWBell's local exchange
services, and as of December 31, 1997, there were more than 250,000 SWBell
access lines supporting services being sold by resale competitors throughout
SWBell's five-state area, most of them in Texas. Many competitors have placed
facilities in service, and have begun advertising campaigns and offering
services. Beginning in 1996, SWBell was also granted facilities-based and resale
operating authority in territories served by other LECs. SWBell began local
exchange service offerings to these areas during 1997.
In December 1997, the TPUC set rates that SWBell may charge for access and
interconnection to its telephone network. The TPUC decision sets pricing for
dozens of network components and completes a consolidated arbitration between
SWBell and six of its competitors, including AT&T and MCI. SWBell has
TPUC-approved resale and interconnection agreements with approximately 80 local
service providers, with approximately 15 pending approval.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing with
AT&T and MCI and on selected items with Metropolitan Fiber Systems (MFS). Among
other terms, the orders established discount rates for resale of SWBell services
and prices for unbundled network elements. SWBell appealed the interconnection
agreement resulting from the first arbitration proceeding on November 5, 1997; a
decision is still pending. A second arbitration process to address other
interconnection issues with AT&T has concluded, and the MPSC issued an order on
December 23, 1997. SWBell has sought reconsideration of this order. A contract
consistent with the order was submitted to the MPSC on March 4, 1998.
As a result of the Telecom Act and conforming interconnection agreements, SWBell
expects increased competitive pressure in 1998 and beyond from multiple
providers in various markets including facilities-based Competitive Local
Exchange Carriers (CLECs), interexchange carriers (IXCs) and resellers. At this
time, management is unable to assess the effect of competition on the industry
as a whole, or financially on SWBell, but expects both losses of market share in
local service and gains resulting from new business initiatives, vertical
services and new service areas.
Long-distance
Competition continues to intensify in SWBell's intraLATA long-distance markets.
Long-distance service revenues decreased in 1997 due primarily to the impact of
price competition from alternative intraLATA toll carriers and the introduction
and deployment of extended area local service plans.
The OCC recommended that SBC be allowed to offer interLATA long-distance in
Oklahoma. Notwithstanding that recommendation, the FCC denied SBC such authority
and SBC has appealed the decision to the D.C. Court of Appeals, where the case
is pending.
Other
In the future, it is likely that additional competitors will emerge in the
telecommunications industry. Cable television companies and electric utilities
have expressed an interest in, or already are, providing telecommunications
services. As a result of recent and prospective mergers and acquisitions within
the industry, SWBell may face competition from entities offering both cable TV
and telephone services in SWBell five-state area. 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 SWBell's five-state area. Public communications
services such as public payphone services will also face increased competition
as a result of federal deregulation of the payphone industry. In addition,
telecommunications equipment sales face significant competition from numerous
companies.
SWBell is aggressively representing its interests regarding competition before
federal and state regulatory bodies, courts, Congress and state legislatures.
SWBell will continue to evaluate the increasingly competitive nature of its
business, and develop appropriate competitive, legislative and regulatory
strategies.
OTHER BUSINESS MATTERS
Local Number Portability/Interconnection Over the next few years, SWBell expects
to incur significant capital and software expenditures for customer number
portability, which allows customers to switch to local competitors and keep the
same phone number, and interconnection. SWBell expects capital costs and
expenses associated with customer number portability to total up to $600 on a
pre-tax basis over the next four years. Full recovery of customer number
portability costs is required under the Telecom Act; however, the FCC has not
yet determined when or how those significant costs will be recovered. SWBell has
filed a tariff for recovery of these costs. No action has been taken by the FCC
on this tariff, pending the issuance of its order on customer number
portability. SWBell is unable to predict the likelihood of the FCC permitting
the tariff to become effective. Capital costs and expenses associated with
interconnection will vary based on the number of competitors seeking
interconnection, the particular markets entered and the number of customers
served by those competitors. Accordingly, SWBell is currently unable to
reasonably estimate the future costs that will be incurred associated with
interconnection.
Year 2000 Costs SWBell currently operates numerous date-sensitive computer
applications and systems throughout its business. As the century change
approaches, it will be essential for SWBell to ensure that these systems
properly recognize the year 2000 and continue to process critical operational
and financial information. SWBell has established processes for evaluating and
managing the risks and costs associated with preparing its systems and
applications for the year 2000 change. Total expenses for this project have been
estimated to be less than $100 over the next three years. SWBell expects to
substantially complete modifications and incur most of these costs during 1998
to allow for thorough testing before the year 2000.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
<TABLE>
Quantitative Information about Market Risk
- ----------------------------------------------------------------------------------------
Interest Rate Risk Related to Debt Derivatives
Table Presentation
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
<CAPTION>
Interest Exposure Exposure Exposure Exposure Exposure Exposure There- Fair Market
Rate Swaps 1997 1998 1999 2000 2001 2002 after Value as
of
12/31/97
(millions
of $)
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Receive -0- -0- -0- -0- -0- -0- $10.2* $.4
Variable/Pay
Fix
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Fixed Rate 6.705% 6.705% 6.705% 6.705% 6.705% 6.705% 6.705%
Payable
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Variable 5.9375% One One One One One One
Rate Month Month Month Month Month Month
Receivable LIBOR LIBOR LIBOR LIBOR LIBOR LIBOR
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Receive -0- -0- -0- -0- -0- -0- $2.9* $.1
Variable/Pay
Fix
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Fixed Rate 6.555% 6.555% 6.555% 6.555% 6.555% 6.555% 6.555%
Payable
- ----------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------
Variable 5.9375% One One One One One One
Rate Month Month Month Month Month Month
Receivable LIBOR LIBOR LIBOR LIBOR LIBOR LIBOR
- ----------------------------------------------------------------------------------------
<FN>
* Both swaps mature on April 30, 2004
</FN>
</TABLE>
The above table describes the results of entering an interest rate swap for the
purpose of providing variable rate payment streams to pay a floating rate note
or lease obligation, in exchange for fixed rate payments.
Qualitative Information about Market Risk
Interest Rate Risk
SWBell follows SBC's policy on interest rate risk. SBC issues debt and enters
lease obligations that have fixed and floating rate terms. Interest rate swaps
are used for the purpose of controlling the interest expense by fixing the
interest rate of the floating rate debt or lease obligation. When market
conditions favor issuing debt or engaging in lease obligations tied to floating
rate instruments, and SBC prefers not to take the risk of floating rates, SBC
will enter interest rate swap contracts to provide floating rate payments to
service the debt or lease obligation in exchange for paying a fixed rate. SBC
does not seek to make a profit from changes in interest rates. In order to
maintain flexibility in funding amounts, it is necessary to accept exposure to
volatile interest rates. SBC manages interest rate sensitivity by measuring
potential increases in interest expense that would result from a probable change
in interest rates. When the potential increase in interest expense exceeds an
acceptable limit, SBC reduces risk through fixed rate instruments and
derivatives.
<PAGE>
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 (a wholly-owned subsidiary of SBC Communications Inc.) as of December
31, 1997 and 1996, and the related statements of income, shareowner's equity and
cash flows for each of the three years in the period ended December 31, 1997.
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, 1997 and 1996, and the results of its operations and its
cash flows for each of the three years in the period ended December 31, 1997, 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 20, 1998
<PAGE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
- -----------------------------------------------------------------------------------
STATEMENTS OF INCOME
Dollars in millions
<CAPTION>
- -----------------------------------------------------------------------------------
1997 1996 1995
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Revenues
Local service $ 5,237 $ 4,718 $ 4,302
Network access:
Interstate 2,176 2,145 2,035
Intrastate 1,078 1,099 1,032
Long-distance service 803 883 822
Other 1,019 888 747
- -----------------------------------------------------------------------------------
Total operating revenues 10,313 9,733 8,938
- -----------------------------------------------------------------------------------
Operating Expenses
Cost of services and products 4,048 3,609 3,419
Selling, general and administrative 2,146 1,839 1,730
Depreciation and amortization 1,927 1,795 1,754
- -----------------------------------------------------------------------------------
Total operating expenses 8,121 7,243 6,903
- -----------------------------------------------------------------------------------
Operating Income 2,192 2,490 2,035
- -----------------------------------------------------------------------------------
Other Income (Expense)
Interest expense (343) (327) (340)
Other income (expense) - net 39 5 (7)
- -----------------------------------------------------------------------------------
Total other income (expense) (304) (322) (347)
- -----------------------------------------------------------------------------------
Income Before Income Taxes and
Extraordinary Loss 1,888 2,168 1,688
- -----------------------------------------------------------------------------------
- -----------------------------------------------------------------------------------
Income Taxes 701 799 568
- -----------------------------------------------------------------------------------
Income Before Extraordinary Loss 1,187 1,369 1,120
- -----------------------------------------------------------------------------------
Extraordinary Loss from Discontinuance
of Regulatory Accounting, net of tax - - (2,819)
- -----------------------------------------------------------------------------------
Net Income (Loss) $ 1,187 $ 1,369 $ (1,699)
- -----------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
- -------------------------------------------------------------------------------------
BALANCE SHEETS
Dollars in millions
<CAPTION>
- -------------------------------------------------------------------------------------
December 31, December 31,
---------------------------
1997 1996
- -------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents $ 79 $ 69
Accounts receivable - net of allowances for
uncollectibles of $33 and $23 1,819 1,674
Prepaid Expenses 156 168
Deferred charges 39 35
Deferred income taxes 192 96
Other current assets 167 137
- -------------------------------------------------------------------------------------
Total current assets 2,452 2,179
- -------------------------------------------------------------------------------------
Property, Plant and Equipment - at cost 31,011 29,347
Less: Accumulated depreciation and amortization 18,460 17,588
- -------------------------------------------------------------------------------------
Property, Plant and Equipment - Net 12,551 11,759
- -------------------------------------------------------------------------------------
Other Assets 11 30
- -------------------------------------------------------------------------------------
Total Assets $ 15,014 $ 13,968
- -------------------------------------------------------------------------------------
Liabilities and Shareowner's Equity
Current Liabilities
Debt maturing within one year $ 645 $ 921
Accounts payable and accrued liabilities 3,041 2,517
- -------------------------------------------------------------------------------------
Total current liabilities 3,686 3,438
- -------------------------------------------------------------------------------------
Long-Term Debt 4,824 4,265
- -------------------------------------------------------------------------------------
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 383 209
Postemployment benefit obligation 2,574 2,646
Unamortized investment tax credits 224 255
Other noncurrent liabilities 305 269
- -------------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities 3,486 3,379
- -------------------------------------------------------------------------------------
Shareowner's Equity
Common stock - one share, no par value 1 1
Paid-in surplus 2,745 3,687
Retained earnings (deficit) 272 (802)
- -------------------------------------------------------------------------------------
Total shareowner's equity 3,018 2,886
- -------------------------------------------------------------------------------------
Total Liabilities and Shareowner's Equity $ 15,014 $ 13,968
- -------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the financial statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
SOUTHWESTERN BELL TELEPHONE COMPANY
- ---------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
<CAPTION>
- ---------------------------------------------------------------------------------------
1997 1996 1995
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Activities
Net income (loss) $ 1,187 $ 1,369 $ (1,699)
Adjustments to reconcile net income (loss) to
net cash
provided by operating activities
Depreciation and amortization 1,927 1,795 1,754
Provision for uncollectible accounts 123 102 76
Amortization of investment tax credits (31) (31) (42)
Deferred income taxes 81 95 125
Extraordinary loss, net of tax - - 2,819
Changes in operating assets and liabilities:
Accounts receivable (268) (267) (195)
Other current assets (22) (96) 6
Accounts payable and accrued liabilities 523 228 (163)
Other - net (127) 71 84
- ---------------------------------------------------------------------------------------
Total adjustments 2,206 1,897 4,464
- ---------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 3,393 3,266 2,765
- ---------------------------------------------------------------------------------------
Investing Activities
Construction and capital expenditures (2,649) (2,305) (1,734)
Dispositions 65 - -
Other (25) - -
- ---------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (2,609) (2,305) (1,734)
- ---------------------------------------------------------------------------------------
Financing Activities
Net change in short-term borrowings with original (252) 176 6
maturities of three months or less
Issuance of other short-term borrowings 120 209 91
Repayment of other short-term borrowings (195) (134) (91)
Issuance of long-term debt 729 166 596
Repayment of long-term debt (121) (201) (117)
Early extinguishment of debt and related - - (465)
call premiums
Dividends paid (1,395) (1,350) (1,139)
Net equity received from parent 340 199 85
- ---------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (774) (935) (1,034)
- ---------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash 10 26 (3)
equivalents
- ---------------------------------------------------------------------------------------
Cash and cash equivalents beginning of year 69 43 46
- ---------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Year $ 79 $ 69 $ 43
- ---------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the financial statements.
</FN>
</TABLE>
<PAGE>
<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, 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)
- ---------------------------------------------------------------------------------------
Net income - - 1,187
Dividend to shareowner - (1,282) (113)
Equity from parent - 340 -
- ---------------------------------------------------------------------------------------
Balance, December 31, 1997 $ 1 $ 2,745 $ 272
- ---------------------------------------------------------------------------------------
<FN>
The accompanying notes are an integral part of the financial statements.
</FN>
</TABLE>
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Dollars in millions
1. Summary of Significant Accounting Policies
Southwestern Bell Telephone Company (SWBell) provides telecommunications
services in Texas, Missouri, Oklahoma, Kansas and Arkansas. SWBell 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.
Certain reclassifications have been made to the 1996 financial statements
to conform with the 1997 presentation.
Income Taxes - SWBell 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 SWBell and
SBC. In general, SWBell'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.
Property, Plant and Equipment - Property, plant and equipment are 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, SWBell computed depreciation using certain
straight-line methods and rates as prescribed by regulators. In accordance
with composite group depreciation methodology, when a portion of SWBell's
depreciable property, plant and equipment is retired in the ordinary
course of business, the gross book value is charged to accumulated
depreciation.
Software Costs - The costs of computer software purchased or developed for
internal use are expensed as incurred. However, initial operating system
software costs are capitalized and amortized over the lives of the
associated hardware.
Advertising Costs - Costs for advertising products and services or
corporate image are expensed as incurred.
Derivative Financial Instruments - SWBell does not invest in any
derivatives for trading purposes. From time to time SWBell invests in
immaterial amounts of interest rate swaps in order to manage exposure to
interest rate risk. Amounts related to derivative contracts are recorded
by SWBell using the hedge accounting approach. SWBell currently does not
recognize the fair values of these derivative financial investments or
their changes in fair value in its financial statements.
2. Discontinuance of Regulatory Accounting
In September 1995, SWBell 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 SWBell's revenues and the acceleration of competition in the
telecommunications market, management determined that SWBell no longer met
the criteria for application of FAS 71.
Upon discontinuance of FAS 71, SWBell 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:
-----------------------------------------------------------------------
Pre-tax After-tax
-----------------------------------------------------------------------
Increase telephone plant accumulated $ 4,657 $ 2,897
depreciation
Adjust unamortized investment tax credits (41) (25)
Eliminate tax-related regulatory assets and (88) (88)
liabilities
Eliminate other regulatory assets 55 35
-----------------------------------------------------------------------
Total $ 4,583 $ 2,819
=======================================================================
The increase in accumulated depreciation of $4,657 reflects the effects of
adopting depreciable lives for many of SWBell'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.
<PAGE>
Following is a comparison of new lives to those prescribed by regulators
for selected plant categories:
------------------------------------------------------------------------
Average Lives (in Years)
------------------------------------------------------------------------
Regulator- Estimated
Prescribed Economic
-------------------------------------------------------------------------
Digital switch 17 11
Digital circuit 12 7
Copper cable 24 18
Fiber cable 27 20
Conduit 57 50
-------------------------------------------------------------------------
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, SWBell 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, SWBell 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. Completion of Merger 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 the
two-for-one stock split, effected in the form of a stock dividend,
declared January 30, 1998 with a record date of February 20, 1998 and
payable March 19, 1998). 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 1997, SBC announced several strategic decisions
resulting from the merger integration process that began with the April 1
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. Following is a discussion of
the most significant of these charges.
Reorganization - SBC will centralize several key functions that will
support the operations of SWBell, Pacific Bell (PacBell, which also
includes its subsidiaries) 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 will result in the creation of some jobs
and the elimination and realignment of others, with many of the affected
employees changing job responsibilities and in some cases assuming
positions in other locations.
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.
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.
4. Property, Plant and Equipment
Property, plant and equipment, which is stated at cost, is summarized as
follows at December 31:
- -------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------
Property, plant and equipment
In service $ 30,670 $ 29,035
Under construction 341 312
- -------------------------------------------------------------------------------
31,011 29,347
Accumulated depreciation and amortization (18,460) (17,588)
- -------------------------------------------------------------------------------
Property, plant and equipment--net $ 12,551 $ 11,759
===============================================================================
SWBell's depreciation expense as a percentage of average depreciable plant
was 6.5% for 1997, and 6.4% for 1996, and 6.5% for 1995.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1997, 1996 and
1995 were $122, $99 and $78. At December 31, 1997, the future minimum
rental payments under noncancelable operating leases for the years 1998
through 2002 were $43, $54, $15, $2 and $1, and $8 thereafter. Capital
leases were not significant.
<PAGE>
5. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
- -------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------
Debentures
4.50%-5.88% 1997-2006 $ 500 $600
6.13%-6.88% 2000-2024 1,550 1,200
7.00%-7.75% 2009-2026 1,750 1,500
- -------------------------------------------------------------------------------
3,800 3,300
Unamortized discount--net of premium (36) (29)
- -------------------------------------------------------------------------------
Total debentures 3,764 3,271
- -------------------------------------------------------------------------------
Notes 5.04%-7.67% 1997-2010 1,236 1,118
Unamortized discount (6) (6)
- -------------------------------------------------------------------------------
Total notes 1,230 1,112
- -------------------------------------------------------------------------------
Capitalized leases 2 3
- -------------------------------------------------------------------------------
Total long-term debt, including current maturities 4,996 4,386
Current maturities (172) (121)
- -------------------------------------------------------------------------------
Total long-term debt $ 4,824 4,265
===============================================================================
In February 1998, SWBell called $425 of debentures and notes. Estimated
net income impact from unamortized discounts and call premiums is $(5).
During 1995, SWBell 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
SWBell's Statements of Income.
At December 31, 1997, the aggregate principal amounts of long-term debt
scheduled for repayment for the years 1998 through 2002 were $172, $64,
$150, $237 and $325. As of December 31, 1997, SWBell 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:
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Commercial paper $ - $ 800
Current maturities of long-term debt 172 121
Intercompany loans 473 -
- --------------------------------------------------------------------------------
Total $ 645 $ 921
================================================================================
During the third quarter of 1997, SWBell's commercial paper was replaced
by intercompany loans from SBC. Intercompany loans as of December 31, 1997
totaled $473. The weighted average interest rate on debt maturing within
one year, excluding current maturities of long-term debt, at December 31,
1997 and 1996 was 6.0% and 5.5%.
6. Financial Instruments
The carrying amounts and estimated fair values of SWBell's long-term debt,
including current maturities, are summarized as follows at December 31:
- --------------------------------------------------------------------------------
1997 1996
- --------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- -------------------------------------------------------------------------------
Debentures $3,764 $3,828 $3,271 $3,208
Notes 1,230 1,271 1,112 1,115
- -------------------------------------------------------------------------------
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.
SWBell does not hold or issue any financial instruments for trading
purposes.
7. Income Taxes
Significant components of SWBell's deferred tax liabilities and assets are
as follows at December 31:
- -------------------------------------------------------------------------------
1997 1996
- -------------------------------------------------------------------------------
Depreciation $ 1,580 $ 1,516
Other 158 107
- -------------------------------------------------------------------------------
Gross deferred tax liabilities 1,738 1,623
- -------------------------------------------------------------------------------
Employee benefits 1,235 1,232
Unamortized investment tax credits 85 97
Other 227 181
- -------------------------------------------------------------------------------
Gross deferred tax assets 1,547 1,510
- -------------------------------------------------------------------------------
===============================================================================
Net deferred tax liabilities $ 191 $ 113
===============================================================================
As a result of implementing Statement of Accounting Standards No. 109,
"Accounting for Income Taxes" in 1993, SWBell 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).
<PAGE>
The components of income tax expense are as follows:
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Federal
Current $ 593 $ 665 $ 447
Deferred--net 64 77 106
Amortization of investment tax credits (31) (31) (42)
- --------------------------------------------------------------------------------
626 711 511
- --------------------------------------------------------------------------------
State and local
Current 58 70 38
Deferred--net 17 18 19
- --------------------------------------------------------------------------------
75 88 57
================================================================================
Total $ 701 $ 799 $ 568
================================================================================
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:
- -------------------------------------------------------------------------------
1997 1996 1995
- -------------------------------------------------------------------------------
Taxes computed at federal statutory rate $ 661 $ 759 $ 591
Increases (decreases) in taxes resulting from:
Amortization of investment tax credits
over the life of the plant that gave rise
to the credits--1997 to 1995
net of deferred tax (20) (20) (39)
Excess deferred taxes due to rate change - - (24)
Depreciation of telephone plant
construction costs - - 14
previously deducted for tax purposes--net
State and local income taxes--net of 49 57 37
federal tax benefit
Other--net 11 3 (11)
===============================================================================
Total $ 701 $ 799 $ 568
===============================================================================
8. Employee Benefits
Pensions - Substantially all employees of SWBell 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. For management employees,
benefits accrue in separate account balances based on a fixed percentage
of each employee's monthly salary plus interest or are determined based
upon a stated percentage of adjusted career income.
SBC's objective in funding the plans, in combination with the standards of
the Employee Retirement Income Security Act of 1974 (as amended), is to
accumulate funds sufficient to meet its benefit obligations to employees
upon their retirement. Contributions to the plans are made to a trust for
the benefit of plan participants. Plan assets consist primarily of stocks,
U.S. government and domestic corporate bonds and real estate.
Significant assumptions used by SBC in developing pension information
include:
- --------------------------------------------------------------------------------
1997 1996 1995
- --------------------------------------------------------------------------------
Discount rate for determining projected 7.25% 7.5% 7.25%
benefit obligation
Long-term rate of return on plan assets 8.5% 8.0% 8.0%
Composite rate of compensation increase 4.3% 4.6% 4.6%
- --------------------------------------------------------------------------------
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 SWBell. SWBell recognized pension
cost for 1997, 1996 and 1995 of $43, $104, and $104. As of December 31,
1997 and 1996, the amount of SWBell's cumulative amount of pension cost
recognized in excess of its cumulative contributions made to the trust was
$269 and $227.
Postretirement Benefits - Under SBC's benefit plans, SWBell 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 1997
and 1996, SWBell contributed $111 and $57, into the CBVEBA trusts to be
ultimately used for the payment of postretirement benefits. SWBell 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 SWBell. SWBell recognized
postretirement benefit cost for 1997, 1996 and 1995 of $176, $211 and
$209. At December 31, 1997 and 1996, the amount included in the Balance
Sheets for accrued postretirement benefit obligation was $2,599 and
$2,666. 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 1998 is 7.5%, 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 1998 is 6.00%, 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, 1997 by approximately 12.5%.
Postemployment Benefits - Under SBC's benefit plans, SWBell 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,
SWBell matches a stated percentage of eligible employee contributions,
subject to a specified ceiling.
SWBell'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. SWBell's costs
relating to these savings plans were $26, $29 and $32 in 1997, 1996 and
1995.
9. Stock Option Plans
Management employees of SWBell participate in various stock option plans
sponsored by SBC. Options issued through December 31, 1997 carry exercise
prices equal to the market price of the stock at the date of grant and
have maximum terms ranging from five to ten years. Depending upon the
plan, vesting of options occurs up to four years from the date of grant.
Up to 156 million shares may be issued to SBC employees under these plans.
In 1997 SWBell 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 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 1997 and 1996 as defined by
FAS 123, SWBell's net income (loss) would have been $1,154 and $1,354.
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. SBC estimates the fair value of stock options at the date of
grant, using a Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1997 and 1996: risk-free
interest rate of 6.57% and 6.26%; dividend yield of 2.99% and 4.92%;
expected volatility factor of 15% and 18%; and expected option life of 5.8
and 4.7 years. As options are exercisable in SBC common stock, separate
assumptions are not developed for subsidiaries of SBC.
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 SWBell.
<PAGE>
10. Additional Financial Information
- -------------------------------------------------------------------------------
December 31,
---------------------
Balance Sheets 1997 1996
- -------------------------------------------------------------------------------
Accounts payable and accrued liabilities
Accounts payable $ 956 $ 839
Accrued taxes 442 418
Advance billing and customer deposits 302 279
Compensated future absences 193 185
Accrued interest 93 80
Accrued payroll 184 133
Other 871 583
- -------------------------------------------------------------------------------
Total $ 3,041 $ 2,517
===============================================================================
- -------------------------------------------------------------------------------
Statements of Income 1997 1996 1995
- -------------------------------------------------------------------------------
Interest expense incurred $ 370 $ 348 $ 344
Capitalized interest (27) (21) (4)
- -------------------------------------------------------------------------------
Total interest expense $ 343 $ 327 $ 340
===============================================================================
Allowance for funds used
during construction $ - $ - $ 11
===============================================================================
- -------------------------------------------------------------------------------
Statements of Cash Flows 1997 1996 1995
- -------------------------------------------------------------------------------
Cash paid during the year for:
Interest $ 330 $ 327 $ 344
Income taxes $ 629 $ 721 $ 510
- -------------------------------------------------------------------------------
Approximately 11% in 1997, 11% in 1996 and 13% in 1995 of SWBell's
revenues were from services provided to AT&T Corp. No other customer
accounted for more than 10% of total revenues.
Approximately 77% of SWBell's employees are represented by the
Communications Workers of America (CWA). Contracts covering an estimated
39,000 employees between the CWA and SWBell end in 1998. New contracts are
scheduled to be negotiated in 1998.
<PAGE>
11. Quarterly Financial Information (Unaudited)
- -------------------------------------------------------------------------------
Calendar Total Operating
Quarter Revenues Operating Income Net Income
- -------------------------------------------------------------------------------
1997 1996 1997 1996 1997 1996
- -------------------------------------------------------------------------------
First $ 2,535 $ 2,345 $ 710 $ 641 $ 395 $ 351
Second 2,542 2,410 454 634 228 348
Third 2,628 2,456 666 639 374 354
Fourth 2,608 2,522 362 576 190 316
===============================================================================
Annual $ 10,313 $ 9,733 $ 2,192 $ 2,490 $ 1,187 $ 1,369
===============================================================================
Net income includes $149 million second quarter charges related to post-merger
initiatives (See Note 3) and customer number portability, $19 and $128 of
third and fourth quarter merger integration costs and customer number
portability expenses and $15 fourth quarter gain on sale of SWBell's interest
in Bell Communications Research, Inc.
<PAGE>
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 I(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........................... 19
Financial Statements Covered by Report of Independent Auditors:
Statements of Income.................................... 20
Balance Sheets.......................................... 21
Statements of Cash Flows................................ 22
Statements of Shareowner's Equity....................... 23
Notes to the Financial Statements....................... 24
(2) Financial Statement Schedules:
II - Valuation and Qualifying Accounts.................. 37
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.
<PAGE>
(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:
On November 21, 1997, SWBell filed a Current Report on Form 8-K, reporting on
Item 7. Financial Statements and Exhibits. In the report, SWBell filed exhibits
relating to the issuance of its 6 3/8% Notes due November 15, 2007 and 7%
Debentures due November 15, 2027.
On October 23, 1997, SWBell filed a Current Report on Form 8-K, reporting on
Item 7. Financial Statements and Exhibits. In the report, SWBell filed exhibits
relating to up to $1,750,000,000 Medium-Term Notes, Series D, Due Nine Months or
More from Date of Issue.
On October 22, 1997, SWBell filed a Current Report on Form 8-K, reporting on
Item 5. Other Events. In the report, SWBell filed information related to its
third quarter earnings release.
<PAGE>
<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 1997.............................. $ 23 123 29 142 $ 33
Year 1996.............................. $ 15 102 27 121 $ 23
Year 1995.............................. $ 15 83 25 108 $ 15
<FN>
(a) Amounts previously written off which were credited directly to this account when recovered.
(b) Amounts written off as uncollectible.
</FN>
</TABLE>
<PAGE>
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,
1998.
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:
J. Cliff Eason*
President and Chief
Executive Officer
and Chairman of the Board
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*
J. Cliff Eason*
Charles E. Foster* March 11, 1998
Donald E. Kiernan*
Richard G. Lindner*
Alfred G. Richter, Jr.*
* by power of attorney
<PAGE>
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
YEAR ENDED DECEMBER 31,
<CAPTION>
-------------------------------------------------------------------------
1997 1996 1995 1994 1993
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income Before Income Taxes,
Extraordinary Loss and Cumulative $ 1,888 $ 2,168 $ 1,688 $ 1,586 $ 1,424
Effect of Accounting Change
Add: Interest Expense 343 327 340 358 385
1/3 Rental Expense 41 33 26 25 23
------------- ------------- ------------- ------------- -------------
Adjusted Earnings $ 2,272 $ 2,528 $ 2,054 $ 1,969 $ 1,832
============= ============= ============= ============= =============
Total Interest Charges $ 370 $ 348 $ 340 $ 358 $ 385
1/3 Rental Expense 41 33 26 25 23
------------- ------------- ------------- ------------- -------------
Adjusted Fixed Charges $ 411 $ 381 $ 366 $ 383 $ 408
============= ============= ============= ============= =============
Ratio of Earnings to Fixed Charges 5.53 6.64 5.61 5.14 4.49
</TABLE>
EXHIBIT 23
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form
S-3 No. 333-37515) of Southwestern Bell Telephone Company and in the related
Prospectus of our report dated February 20, 1998, 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, 1997.
ERNST & YOUNG LLP
San Antonio, Texas
March 10, 1998
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 Harlie D. Frost 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 3-11-98
Royce S. Caldwell Date
/s/ Cassandra C. Carr 3-11-98
Cassandra C. Carr Date
<PAGE>
Exhibit 24
Page 3 of 2
EXHIBIT 24
Page 2 of 2
/s/ William E. Dreyer 3-11-98
William E. Dreyer Date
/s/ J. Cliff Eason 3-10-98
J. Cliff Eason Date
/s/ Donald E. Kiernan 3-11-98
Donald E. Kiernan Date
/s/ Charles E. Foster 3-11-98
Charles E. Foster Date
/s/ Richard G. Lindner 3-11-98
Richard G. Lindner Date
/s/ Alfred G. Richer, Jr. 3-9-98
Alfred G. Richter, Jr. Date
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANACIAL INFORMATION EXTRACTED FROM
SOUTHWESTERN BELL TELEPHONE COMPANY'S DECEMBER 31, 1997 FINANCIAL STATEMENTS ON
FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-END> DEC-31-1997
<CASH> 79
<SECURITIES> 0
<RECEIVABLES> 1,852
<ALLOWANCES> 33
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 2,452
<PP&E> 31,011
<DEPRECIATION> 18,460
<TOTAL-ASSETS> 15,014
<CURRENT-LIABILITIES> 3,686
<BONDS> 4,824
0
0
<COMMON> 1
<OTHER-SE> 2,745
<TOTAL-LIABILITY-AND-EQUITY> 15,014
<SALES> 0<F2>
<TOTAL-REVENUES> 10,313
<CGS> 0<F3>
<TOTAL-COSTS> 4,048
<OTHER-EXPENSES> 1,927
<LOSS-PROVISION> 123
<INTEREST-EXPENSE> 343
<INCOME-PRETAX> 1,888
<INCOME-TAX> 701
<INCOME-CONTINUING> 1,187
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,187
<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>
