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, 1998
OR
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-2346
SOUTHWESTERN BELL TELEPHONE COMPANY
Incorporated under the laws of the State of Missouri
I.R.S. Employer Identification Number 43-0529710
530 McCullough, San Antonio, Texas 78215
Telephone Number 210-821-4105
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>
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
Forty Year 6 7/8% Debentures, American Stock
Due February 1, 2011 Exchange
Twenty-Two Year 7% Debentures, New York Stock
Due July 1, 2015 Exchange
Thirty Year 7 5/8% Debentures, New York Stock
Due March 1, 2023 Exchange
Thirty-Two Year 7 1/4%, Debentures, New York Stock
Due July 15, 2025 Exchange
Fifty Year 6 7/8% Debentures, New York Stock
Due March 31, 2048 Exchange
<PAGE>
TABLE OF CONTENTS
Item Page
- ----- ----
PART I
1. Business....................................................... 4
2. Properties..................................................... 8
3. Legal Proceedings.............................................. 8
4. Submission of Matters to a Vote of Security Holders............ *
PART II
5. Market for Registrant's Common Equity and Related
Stockholder Matters.......................................... 9
6. Selected Financial and Operating Data.......................... 9
7. Management's Discussion and Analysis of Results of Operations
(Abbreviated pursuant to General Instruction I(2))............. 10
7A. Quantitative and Qualitative Disclosures about Market Risk..... 20
8. Financial Statements and Supplementary Data.................... 22
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure..................................... 37
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 38
- ----------
*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 530
McCullough, San Antonio, Texas 78215 (telephone number 210-821-4105). SWBell is
a wholly-owned subsidiary of SBC Communications Inc. (SBC). SWBell provides
landline telecommunications services over 16 million access lines in Texas,
Missouri, Oklahoma, Kansas and Arkansas (five-state area). SWBell provides local
exchange services and is subject to regulation by the five state commissions and
the Federal Communications Commission (FCC).
SBC was one of the original seven regional holding companies (RHCs) formed to
hold AT&T Corp.'s (AT&T) local telephone companies. AT&T divested SBC, and its
subsidiary SWBell, 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).
On February 8, 1996, the Federal Government enacted the Telecommunications Act
of 1996 (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 regulation of RHCs under the MFJ.
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 "Regulatory Environment" beginning on page 13.
Business Combinations
With the completion of SBC's mergers with Pacific Telesis Group (PAC) in 1997
and with Southern New England Telecommunications Corporation in 1998, SBC began
reviews of operations of SWBell, Pacific Bell, Nevada Bell and The Southern New
England Telephone Company (collectively referred to as the Telephone Companies).
As a result of the review and recommendations of merger teams, SBC is
centralizing several key functions that will support the operations of the
Telephone Companies, including network planning, strategic marketing and
procurement. It is also consolidating a number of corporate-wide support
activities, including research and development, information technology,
financial transaction processing and real estate management. The Telephone
Companies will continue as separate legal entities. These initiatives continue
to 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. Additional information on this
matter is contained in Note 2 of Notes to Financial Statements.
<PAGE>
BUSINESS OPERATIONS
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
offers customers an expansive range of services and products, varying by market,
including: local exchange services, long distance, telecommunications equipment
and enhanced services. These services and products are described more fully
below.
SWBell's revenues are categorized for financial reporting purposes as local
service, network access, long distance service and other.
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
- --------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------- ----------- ----------- -----------
Local service 50% 50% 48%
Network access 32% 32% 34%
- -------------------------------------------- ----------- ----------- -----------
Local services involve the transport of wireline 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 vertical
services, including custom calling services, call control options and Caller ID
services.
Network access services connect a subscriber's telephone or other equipment to
the transmission facilities of other carriers that 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.
Additionally, SWBell also provides long distance services that 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.
SWBell provides its services over approximately 10.7 million residential and 5.6
million business access lines in the five-state area. During 1998, over
two-thirds of SWBell's access line growth occurred in Texas.
Customer Premises Equipment and Other Equipment Sales
Equipment offerings at SWBell range from single-line and cordless telephones to
sophisticated digital business exchange (PBX) systems, all of which can be
offered with SWBell's central office based solutions. PBX is a private telephone
switching system, usually located on a customer's premises, which provides
intra-premise telephone services as well as access to the public switched
network.
<PAGE>
In December 1996, substantially all of the operations of Southwestern Bell
Telecommunications, Inc., a wholly-owned subsidiary of SBC, which offered CPE,
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.
New Products
As part of its continuing strategy to be among the leaders in the communications
services industry, SWBell is constantly developing new services and products. It
currently is introducing several new data products, including Asymmetrical
Digital Subscriber Line (ADSL). ADSL enables customers to transfer over existing
telephone lines, data, graphics, audio and video files at speeds up to 1.5
megabits per second. ADSL allows customers to simultaneously make a phone call
and access information via the Internet or an office local area network. ADSL is
the subject of a pending FCC review. Additional information relating to the
pending FCC review of ADSL is contained in Item 7, Management's Discussion and
Analysis of Results of Operations of this report under "Regulatory Environment"
beginning on page 13.
During 1998, SWBell continued to expand its offering of vertical services
throughout its operating areas. These services include, among other things,
Caller ID, a feature which displays the telephone number of the person calling
and the caller's name in certain markets; Caller ID Call Waiting, a feature
which displays the telephone number and caller's name in certain markets when
the customer is on a call; 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.
Since 1996, SWBell has been offering certain local services on a "wholesale"
basis to competitors, as well as providing elements of its networks on an
"unbundled" basis for local competition. These services are being offered as
specified by the Telecom Act and state actions and interconnection agreements.
The Telecom Act and the regulations promulgated by federal and state agencies to
implement it have resulted in SWBell facing increased competition in significant
portions of its business. At December 31, 1998, SWBell provided wholesale
services to more than 524,000 access lines. Management cannot quantify the
impact to SWBell's business in 1999 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, but expects continued increases in local exchange services
competition.
Operating Segments
In June 1997, the Financial Accounting Standards Board issued Statement No. 131,
"Disclosures About Segments of an Enterprise and Related Information" (FAS 131),
which establishes standards for the way that public business enterprises report
information about operating segments in quarterly and annual financial
statements. FAS 131 changes segment reporting from an industry segment basis to
an operating segment basis defined based on how the business is managed. As
SWBell operates in only one of SBC's segments, wireline telecommunications
services, separate segment reporting does not apply to SWBell.
<PAGE>
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 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.
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 13.
MAJOR CUSTOMER
Approximately 9% in 1998, 11% in 1997 and 12% in 1996 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 "Competition" beginning on page 17.
Customer Premises Equipment and Other Equipment Sales
SWBell faces significant competition from numerous companies in marketing its
telecommunications equipment.
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 and another affiliate of SBC owned a one-seventh interest, with the
remainder owned by the other four remaining RHCs. In November 1997, the RHCs
sold Bellcore to a third party but continue to have a research agreement with
Bellcore. The RHCs have 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.
EMPLOYEES
As of December 31, 1998, SWBell employed approximately 50,700 persons.
Approximately three-fourths of the employees are represented by the
Communications Workers of America (CWA). A new agreement between the CWA and
SWBell was reached on April 7, 1998, covering an estimated 39,000 employees
through April 1, 2001. Among other items, the agreement specifies an 11%
increase in wages over the life of the contract.
<PAGE>
ITEM 2. PROPERTIES
The properties of SWBell do not lend themselves to description by character and
location of principal units. At December 31, 1998, network access lines
represented 44% of SWBell's investment in telephone plant; central office
equipment represented 40%; 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 1%.
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
in 1998. 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 1998 1997
-------------------------------------------------------------------------------
Debt Ratio (debt, including current
maturities, as a percentage of total capital) 65.48% 64.44%
Network access lines in service (000) 16,462 15,741
Access minutes of use (000,000) 62,853 59,395
Resold lines (000) 524 267
Number of employees 50,700 50,500
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<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
1998 1997 Change
1998 vs.
1997
- --------------------------------------------------------------------------------
Operating revenues $ 10,752 $ 10,116 6.3%
Operating expenses $ 7,958 $ 7,924 0.4%
Net income $ 1,527 $ 1,187 28.6%
- --------------------------------------------------------------------------------
SWBell's net income in 1998 includes $13 of an after-tax benefit associated with
an adjustment of a postemployment benefits accrual and in 1997 includes
after-tax charges of $237 reflecting strategic initiatives resulting from SBC's
merger with PAC, the impact of several regulatory rulings and ongoing merger
initiatives during 1997, as well as a gain on the sale of SWBell's interest in
Bellcore (see Note 2 of Notes to Financial Statements for further discussion of
merger integration costs). Excluding these 1998 and 1997 benefit and charges,
SWBell reported normalized net income of $1,514 for 1998, 6.3% higher than 1997
normalized net income of $1,424.
Excluding these items, the primary factor contributing to the increase in net
income in 1998 was growth in demand for services and products.
Items affecting the comparison of the operating results between 1998 and 1997
are discussed in the following sections.
Operating Revenues
Operating revenues were $10,752 in 1998 compared with $10,116 in 1997, a 6.3%
increase. Components of operating revenues including percentage changes from the
prior year, are as follows:
- --------------------------------------------------------------------------
Percent
1998 1997 Change
1998 vs.
1997
- --------------------------------------------------------------------------
Local service $ 5,397 $ 5,045 7.0%
Network access:
Interstate 2,305 2,176 5.9
Intrastate 1,095 1,078 1.6
Long distance service 770 803 (4.1)
Other 1,185 1,014 16.9
- --------------------------------------------------------------
Total $ 10,752 $ 10,116 6.3%
==========================================================================
<PAGE>
Local Service revenues increased $352, or 7.0%, in 1998 due primarily to
increases in demand totaling more than $324, including increases in access
lines, vertical services, and data-related services revenues. The number of
access lines increased by 4.6% since 1997, of which over two-thirds was due
to growth in Texas. Approximately 30% of access line growth was due to
sales of additional access lines to existing residential customers.
Vertical services revenues, which include custom calling services, call
control options, Caller ID and other services, increased by 14% totaling
more than $950 for 1998.
Additionally, local service revenues increased as a result of regulatory
actions that also had the effect of decreasing one or more types of
operating revenues. In 1998, federal payphone deregulation and the
introduction and deployment of extended local area service plans
collectively increased local service revenues by approximately $83 and
decreased long distance revenue by approximately $10 and interstate network
access approximately $12. The net effect on total operating revenue for
these items was an increase of nearly $69. The local service increases were
partially offset by decreases of approximately $71 resulting from cellular
interconnection rate reductions implemented in the third quarter of 1997.
Network Access Interstate network access revenues for 1997 reflect charges
of $52 due to the adverse impacts of several regulatory issues. These
issues include among other items, recovery of certain employee-related
expenses and the productivity factor adjustment in the Federal price cap
filing. Without these charges, total interstate network access revenues
increased $77, or 3.5%, in 1998 due largely to increases in demand for
access services by interexchange carriers, including special access, and
growth in revenues from end-user charges attributable to an increasing
access line base totaling approximately $224. Partially offsetting these
increases were the effects of rate reductions of approximately $95 related
to the federal productivity factor adjustment, access reform and other
changes, and regulatory shifts related to payphone deregulation of
approximately $12 as noted in local service. Additional decreases in 1998
totaling approximately $38 resulted from an increase in universal service
fund net payments implemented in the first quarter of 1998 that exceeded
the 1997 net payments of long-term support. The net federal universal fund
payments and receipts will be exogenous factors in future federal price cap
filings.
Intrastate network access revenues increased slightly in 1998 as increases
in demand totaling approximately $38, including usage by alternative
intraLATA toll carriers, were partially offset by state regulatory rate
reductions totaling approximately $19.
Long Distance Service revenues decreased $33, or 4.1%, in 1998. This
resulted from decreased demand and the effect of price competition from
alternative intraLATA toll carriers totaling approximately $23. As
discussed above under local service, long distance revenues decreased by
approximately $10 due to the introduction and deployment of extended area
local service plans.
Other operating revenues increased $171, or 16.9%, in 1998. Approximately
$107 of this increase was due to increased demand for nonregulated services
and products, including consumer equipment and network integration
services. Also contributing to the increase was the repricing of
maintenance and trouble diagnosis services related to inside wire located
on customers' premises during 1998 of approximately $30 and an increase in
state universal funds net receipts of approximately $15.
<PAGE>
Operating Expenses
Components of operating expenses, including percentage changes from the prior
year, are as follows:
- -------------------------------------------------------------------------------
Percent
1998 1997 Change
1998 vs.
1997
- -------------------------------------------------------------------------------
Operations and support $ 5,940 $ 5,997 (1.0)%
Depreciation and amortization 2,018 1,927 4.7
- ----------------------------------------------------------------
Total operating expenses $ 7,958 $ 7,924 0.4 %
===============================================================================
As discussed in Note 2 of Notes to Financial Statements, SWBell's operating
expenses in 1998 reflect $20 in benefits associated with an adjustment of
postemployment benefits accrual and in 1997 reflect $328 of adjustments for
charges related to SBC's strategic initiatives, a comprehensive review of
operations of the merged company, the impact of several regulatory rulings
and ongoing merger integration costs. SWBell manages its financial and
business operations excluding these items and refers to these adjusted
expenses as normalized operating expenses. Excluding these 1998 and 1997
adjustments, SWBell's normalized operating expenses increased $382, or
5.0%, for 1998.
Operations and Support expenses reflect $20 of a benefit in 1998 and $289
of charges in 1997 referred to above. Excluding these adjustments,
normalized operations and support in 1998 were $5,960, an increase of $252,
or 4.4%, over the normalized total in 1997 of $5,708.
The increase was due primarily to merger implementation costs in 1998 of
approximately $178 related to progression in the merger implementation
process including charges from support functions throughout SBC, and other
merger initiatives. Operations and support also increased in 1998 due to
increased costs associated with reciprocal compensation for the termination
of Internet traffic of approximately $68. Wages, salaries and benefits
increased approximately $91 and right to use fees and materials increased
approximately $45. These increases were partially offset by reductions in
the use of contract labor of approximately $121 and net reductions to agent
commissions, research and development and customer number portability costs
totaling approximately $65.
Depreciation and amortization expense for 1997 reflects one-time charges of
approximately $39 for the write off of voice dial equipment that was
discontinued and other adjustments. Excluding these adjustments,
depreciation and amortization increased $130, or 6.9%, in 1998. The net
increase was due primarily to increased depreciation expense of
approximately $104 resulting from overall higher plant levels and rate
variances related to the net impact of revised composite rates of
depreciation of approximately $27.
Interest Expense increased $31, or 9.0%, in 1998 due primarily to higher average
debt levels.
Other Income (Expense) - Net was net income of $39 in 1997 and included a gain
recognized for the sale of SWBell's interest in Bellcore of $24.
Income Taxes for 1997 reflect the tax effect of charges for strategic
initiatives resulting from SBC's merger with PAC, the impact of several
regulatory rulings and the gain on sale of SWBell's interest in Bellcore.
Excluding these items, income taxes for 1997 would have been $835. Income taxes
for 1998 were higher due primarily to higher income before income taxes.
<PAGE>
Operating Environment and Trends Of The Business
Regulatory Environment
Overview
The telecommunications industry is in a period of dynamic transition from a
tightly regulated industry overseen by multiple regulatory bodies to a
market-driven industry monitored by state and federal agencies. SWBell remains
subject to regulation by the five-state regulatory commissions for intrastate
services and by the FCC for interstate services.
Consolidation of companies is occurring within the marketplace for local
telephone service and across other telecommunications services, such as long
distance, cellular, cable television, Internet and other data transmission
services. Companies operating in some of these markets are also expanding into
others, such as the provision of local service by long distance companies.
Additionally, new technologies are also affecting the way people view and use
communications services.
SWBell is aggressively representing its interests 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.
Federal Regulation
Under the Telecom Act, before being permitted to offer landline interLATA long
distance service in any state within the regulated operating areas, SWBell 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 they offer the "competitive
checklist" items. The FCC must also make favorable public interest and
structural separation determinations in connection with such applications. See
"State Regulation" for status of the state applications.
In December 1997, in the United States District Court for the Northern District
of Texas ruled that parts of the Telecom Act were unconstitutional on the
grounds that they improperly discriminate against SWBell by imposing
restrictions that prohibit SWBell by name from offering interLATA long distance
and other services that other Local Exchange Carriers (LECs) are free to
provide. In September 1998, the United States Court of Appeals for the Fifth
Circuit (5th Circuit) reversed this decision and ruled that the challenged
provisions of the Telecom Act were constitutional. In January 1999, the United
States Supreme Court (Supreme Court) declined to hear an appeal of the 5th
Circuit's decision.
Interconnection 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, 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 (8th
Circuit) held that the FCC did not have the 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.
<PAGE>
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.
In January 1999, the Supreme Court ruled on an appeal of the 8th Circuit's
order. The ruling held that the Telecom Act gives the FCC the authority to set
guidelines for states to follow in setting prices under the Telecom Act, and
reinstated the FCC rules allowing those seeking to interconnect to "pick and
choose" specific provisions from previous interconnection agreements. Because
the 8th Circuit's decision did not address the lawfulness of the content of the
FCC pricing guidelines, the Supreme Court remanded that issue to the 8th Circuit
for further consideration. The ruling also upheld FCC rules forbidding incumbent
LECs from separating already combined network elements, but remanded back to the
FCC its determination of which network elements must be made available. The
Supreme Court also held that, before the FCC could require telecommunications
carriers to make a particular network element available to requesting carriers,
the FCC must first consider as to proprietary elements, whether access to the
elements was necessary and whether the failure to provide access to a particular
element would impair the requesting carrier's ability to provide the service it
seeks to offer. The effect of this ruling on SWBell cannot be determined at this
time.
Reciprocal Compensation Reciprocal compensation is billed to SWBell by
Competitive Local Exchange Carriers (CLECs) for the termination of certain local
exchange traffic to CLEC customers. Several state commissions have taken the
position that Internet communications is intrastate or local traffic and ordered
SWBell to pay reciprocal compensation to certain CLECs pursuant to then existing
contracts. State commissions in the five-state area other than Kansas have
issued orders finding that SWBell is required to pay reciprocal compensation to
certain CLECs. In June 1998, a U.S. District Court in Texas affirmed the Texas
Public Utility Commission's (TPUC) determination, and upheld payment of
reciprocal compensation, holding that an Internet call is comprised of two
portions, and that the TPUC has jurisdiction over the local portion of the
traffic and the FCC over the Internet component. SWBell has sought review or
reconsideration of these cases.
In February 1999, the FCC ruled that a substantial portion of Internet
communications is interstate traffic and therefore subject to federal
jurisdiction. The FCC noted that carriers were bound by existing interconnection
contracts as interpreted by state commissions. The FCC will issue rules
determining the extent, if any, such communications are subject to reciprocal
compensation. The FCC also ruled that, in the context of interpreting particular
interconnection agreements, the state commissions might determine that
reciprocal compensation was appropriately based on the agreement of the parties
or other factors. SBC believes that the FCC ruling should prevent state
commissions from imposing reciprocal compensation on this traffic.
<PAGE>
Asymmetrical Digital Subscriber Line ADSL is a high-speed data service
principally used for Internet access. In June 1998, SBC filed with the FCC a
petition requesting relief for ADSL from pricing, unbundling and resale
regulatory restrictions. The FCC denied the petition and declared that
incumbents must offer such services for resale at a discount and must offer
unbundled access to the equipment used in ADSL provisioning to the extent
possible. SBC has filed with the FCC a petition for reconsideration of this
order. The FCC sought comments on offering the incumbent LECs the option of
providing deregulated advanced services through an affiliate with appropriate
safeguards.
The effects of the FCC decisions on the above topics 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 orders and proposed
rulemaking at this time.
<PAGE>
State Regulation
<TABLE>
The following provides an overview of state regulation in the five states in
which SWBell operated at December 31, 1998.
<CAPTION>
- -------------- ------------------ --------------------- ---------------- --------------------------
Number of
Signed
Alternative Wireline Long Distance
State Regulation 1 Dialing Parity 2 Interconnection Application Status
Agreements 3
- -------------- ------------------ --------------------- ---------------- --------------------------
<S> <C> <C> <C> <C>
Presently not
required prior to
long distance
Arkansas Yes, Indefinite authorization 54 Decision Expected in 1999 4
- -------------- ------------------ --------------------- ---------------- --------------------------
Commission ordered
implementation by
2/1999; state
statute presently
prohibits
requirement before
long distance
Kansas Yes, Indefinite authorization 55 Decision Expected in 1999 4
- -------------- ------------------ --------------------- ---------------- --------------------------
Missouri Yes, Indefinite Proceeding pending 61 Decision Expected in 1999 4
- -------------- ------------------ --------------------- ---------------- --------------------------
Oklahoma Yes, Ends 2/2001 Ordered by 3/1999 52 Decision Expected in 1999 4
- -------------- ------------------ --------------------- ---------------- --------------------------
TPUC deferred its
decision pending FCC
issuance of new dialing
parity rules; state
statute presently
prohibits requirement
before long distance
Texas Yes, Ends 9/2001 authorization 175 Decision Expected in 1999 4
- -------------- ------------------ --------------------- ---------------- --------------------------
</TABLE>
Other significant notes:
1 Alternative regulation is other than rate of return regulation.
2 In a January 1999 decision, the Supreme Court ruled that the FCC had the
authority to issue rules implementing intrastate and intraLATA dialing
parity. Several interexchange carriers are arguing in pending state
proceedings that the ruling requires immediate implementation of dialing
parity, preempting state requirements. SWBell takes the position that
dialing parity requirements should be consistent with state laws and that
they should not be required to provide intraLATA toll dialing parity prior
to receiving authorization to provide interLATA long distance services. In
states where dialing parity exists, customers are able to subscribe to an
intraLATA toll carrier just as they do for long distance services.
3 Interconnection agreements are signed with CLECs for the purpose of allowing
the CLECs to exchange local calls with the incumbent telephone company.
4 Awaiting determination by state commissions on SWBell's compliance with the
14-point competitive checklist. FCC approval is required subsequent to state
The following presents highlights of certain regulatory developments.
Texas Under the Public Utility Regulatory Act, which became effective in May
1995 (PURA), SWBell elected to move from rate of return regulation to price
regulation with elimination of earnings sharing. Basic local service rates are
capped at existing levels for four years following the election, i.e., until
September 1999. The TPUC is prohibited from reducing switched access rates
charged by LECs to interexchange carriers while rates are capped.
<PAGE>
LECs electing price regulation are committed 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. The 1997 Texas legislative session
changed the funding for this infrastructure grant fund from annually collecting
$150 for ten years to a fixed percent (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 were approximately $36 in 1997 and
$56 in 1998. Due to the industry's growth in revenues, the fund should be
completely funded before the original ten years.
PURA establishes local exchange competition by allowing 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 in its territory until SWBell is allowed
to carry interLATA long distance. In 1996, MCI WorldCom, Inc. (MCI WorldCom) and
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 WorldCom, AT&T and Sprint Corporation from providing
local services within Texas. The FCC, also in response to petitions filed by
AT&T and MCI WorldCom, preempted and voided portions of PURA that required
certain buildout requirements. Furthermore, the FCC also preempted 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 WorldCom 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. This issue is still pending before the FCC.
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 on January 1, 1999 for non-basic services. On an exchange basis
where a competitor began operations, the freeze on maximum allowable rates for
non-basic services was removed. After January 1, 2000, caps for basic and access
services may be adjusted based on one of two government indices. After January
1, 1999, 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 WorldCom sought judicial review of the MPSC determination and in May
1998 the state circuit court affirmed the MPSC decision.
Competition
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 as well
as new opportunities in significant portions of its business.
<PAGE>
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 approximately 397 interconnection and resale agreements with competitive
local service providers, and most have been approved by the relevant state
commissions. AT&T, MCI WorldCom and other competitors are reselling SWBell's
local exchange services, and as of December 31, 1998, there were more than
520,000 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. SWBell also was granted facilities-based and resale operating
authority in certain territories served by other LECs and now offers local
exchange service offerings to these areas.
In Texas, the TPUC set rates in December 1997 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 wholesale customers, including AT&T and MCI WorldCom.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing with
AT&T and MCI WorldCom and on selected items with Metropolitan Fiber Systems.
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
ordered that a conforming interconnection agreement be filed. SWBell appealed
this order in April 1998.
SWBell expects increased competitive pressure in 1999 and beyond from multiple
providers in various markets, including facilities-based CLECs, interexchange
carriers and resellers. At this time, management is unable to assess the effect
of competition 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. In addition, if intraLATA toll dialing parity is required,
competition in intraLATA long distance markets is expected to increase.
OTHER BUSINESS MATTERS
New Accounting Standards In June 1998, the Financial Accounting Standards Board
issued Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (FAS 133), which will require all derivatives to be recorded on the
balance sheet at fair value, and will require changes in the fair value of the
derivatives to be recorded in net income or comprehensive income. FAS 133 must
be adopted for years beginning after June 15, 1999, with earlier adoption
permitted. Management is currently evaluating the impact of the change in
accounting required by FAS 133, but is not able to quantify the effect at this
time.
See Note 1 of Notes to Financial Statements for a discussion of the new
accounting standard on software costs.
SBC's Year 2000 Project SBC and its subsidiaries and affiliates, including
SWBell, operate numerous date-sensitive computer applications and systems
throughout its businesses. Since 1996, SBC has been working to upgrade its
networks and computer systems to properly recognize the Year 2000 and continue
to process critical operational and financial information. Companywide teams are
in place to address and resolve Year 2000 issues and processes are under way to
evaluate and manage the risks and costs associated with preparing SBC's
date-impacted systems and networks for the new millennium.
<PAGE>
SBC is using a four-step methodology to address the issue. The methodology
consists of inventory and assessment, hardware and software fixes, testing and
deployment. SBC measures its progress by tracking the number of completed
hardware and software applications, network components, personal computers and
building facilities that can correctly process Year 2000 dates.
Inventory and assessment is estimated to require 20% of the overall effort and
includes the identification of items (i.e., line-by-line review of software
code, switch generics, vendor products, etc.) that could be impacted by the Year
2000 and the determination of the work effort required to ensure compliance. The
inventory and assessment phase has been completed. This process involved
reviewing over 340 million lines of software code, 1,200 central office
switches, 7,000 company buildings, conducting an inventory and assessment of
117,000 personal computers, and coordinating with 1,300 suppliers of 14,000
products to obtain adequate assurance they will be Year 2000 compliant or
determine and address any appropriate contingency plans or backup systems.
Making the hardware and software fixes is the second phase of the process and is
estimated to require 25% of the overall effort. This activity involves modifying
program code, upgrading computer software and upgrading or replacing hardware.
As of December 31, 1998, the hardware and software fixes were substantially
complete.
Testing involves ensuring that hardware and software fixes will work properly in
1999 and beyond and occurs both before and after deployment. Testing is
estimated to comprise 45% of the overall effort. Testing began early in 1998, is
more than two-thirds complete, and will continue through 1999 to allow for
thorough testing before the Year 2000. Contingency plans and backup systems are
currently being written.
Deployment involves placing the "fixed" systems into a live environment to
ensure they are working properly. Additional testing is done after deployment as
well. Deployment is estimated to require 10% of the overall effort. More than
half of the deployment phase was completed as of December 31, 1998.
SBC expects to spend approximately $265 on the entire project, with
approximately $140 spent through December 31, 1998. As testing and hardware and
software fixes are estimated to require most of the expenditures, there is not a
strict correlation between expenditures and project completion.
The activities involved in SBC's Year 2000 project necessarily require estimates
and projections, as described above, of activities and resources that will be
required in the future. These estimates and projections could change as work
progresses on the project.
<PAGE>
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
SWBell's capital costs are managed by SBC, and are directly linked to financial
and business risks. SBC seeks to manage the potential negative effects from
market volatility and market risk. Certain financial instruments used to obtain
capital are subject to market risks from fluctuations in market interest rates.
The majority of SBC's financial instruments are medium- and long-term fixed rate
notes and debentures. Fluctuations in market interest rates can lead to
significant fluctuations in the fair value of these notes and debentures. It is
the policy of SBC to manage its debt structure and foreign exchange exposure in
order to manage capital costs, control financial risks and maintain financial
flexibility over the long term. Where appropriate, SBC will take actions to
limit the negative effect of interest and foreign exchange rates, liquidity and
counterparty risks on shareowner value.
Quantitative Information about Market Risk
Interest Rate Sensitivity
The principal amount by expected maturity, average interest rate and fair values
of SWBell's liabilities that are exposed to interest rate risk are described in
Notes 4 and 5 of Notes to Financial Statements. Following are SWBell's interest
rate derivatives subject to interest rate risk (none of these derivatives mature
in 2000 through 2003):
- -------------------------------------------------------
Maturity
- -------------------------------------------------------
Fair
After Value
1999 2003 Total 12/31/98
- -------------------------------------------------------
Interest Rate Derivatives
- -------------------------------------------------------
Interest Rate Swaps
- -------------------------------------------------------
Receive Variable/Pay
Fixed - $13 $13 ($1)
Notional Amount 1
Fixed Rate Payable 6.7% 6.7%
Weighted Average
Variable Rate 5.0% 5.5%
Receivable 2
- -------------------------------------------------------
Notes:
1 Receive Variable/Pay Fixed amount offsets $13 in lease obligation due after
2003 with an average interest rate of 5.8% and a fair value of $13.
2 Weighted Average Variable Rate Receivable based on current and the implied
forward rates in the yield curve at the reporting date for One Month LIBOR.
As a result of interest rate fluctuations, if SWBell were to terminate the
contracts, it would be required to pay $1 to replace the fixed rate flows or
"unwind" the interest swaps.
There has been no material change in the updated market risks since December 31,
1997.
<PAGE>
Qualitative Information about Market Risk
Interest Rate Risk
SWBell's interest rate risk is managed by SBC. SBC issues debt in fixed and
floating rate instruments. Interest rate swaps are used for the purpose of
controlling interest expense by fixing the interest rate of floating rate debt.
When market conditions favor issuing debt in floating rate instruments, and SBC
prefers not to take the risk of floating rates, SBC will enter interest rate
swap contracts to obtain floating rate payments to service the debt in exchange
for paying a fixed rate. SBC does not seek to make a profit from changes in
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 amount, SBC reduces risk through the issuance of fixed rate
instruments and purchasing derivatives.
Cautionary Language Concerning Forward-Looking Statements
Information set forth in this report contains forward-looking statements that
are subject to risks and uncertainties. SWBell claims the protection of the safe
harbor for forward-looking statements provided by the Private Securities
Litigation Reform Act of 1995.
The following factors could cause SWBell's future results to differ materially
from those expressed in the forward-looking statements: (1) adverse economic
changes in the markets served by SWBell or changes in available technology; (2)
the final outcome of various FCC rulemakings and judicial review, if any, of
such rulemakings; (3) the final outcome of various state regulatory proceedings
in SWBell's five-state area, and judicial review, if any, of such proceedings;
and (4) the timing of entry and the extent of competition in the local and
intraLATA toll markets in SWBell's five-state area. Readers are cautioned that
other factors discussed in this report, although not enumerated here, also could
materially impact SWBell's future earnings.
<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, 1998 and 1997, and the related statements of income, shareowner's equity and
cash flows for each of the three years in the period ended December 31, 1998.
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 the Company at December 31,
1998 and 1997, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1998, 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.
ERNST & YOUNG LLP
San Antonio, Texas
February 12, 1999
<PAGE>
<TABLE>
<CAPTION>
SOUTHWESTERN BELL TELEPHONE COMPANY
- -----------------------------------------------------------------------------------
STATEMENTS OF INCOME
Dollars in millions
- -----------------------------------------------------------------------------------
1998 1997 1996
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Revenues
Local service $ 5,397 $ 5,045 $ 4,537
Network access:
Interstate 2,305 2,176 2,145
Intrastate 1,095 1,078 1,099
Long distance service 770 803 883
Other 1,185 1,014 885
- -----------------------------------------------------------------------------------
Total operating revenues 10,752 10,116 9,549
- -----------------------------------------------------------------------------------
Operating Expenses
Operations and support 5,940 5,997 5,264
Depreciation and amortization 2,018 1,927 1,795
- -----------------------------------------------------------------------------------
Total operating expenses 7,958 7,924 7,059
- -----------------------------------------------------------------------------------
Operating Income 2,794 2,192 2,490
- -----------------------------------------------------------------------------------
Other Income (Expense)
Interest expense (374) (343) (327)
Other income (expense) - net (10) 39 5
- -----------------------------------------------------------------------------------
Total other income (expense) (384) (304) (322)
- -----------------------------------------------------------------------------------
Income Before Income Taxes 2,410 1,888 2,168
- -----------------------------------------------------------------------------------
Income Taxes 883 701 799
- -----------------------------------------------------------------------------------
Net Income $ 1,527 $ 1,187 $ 1,369
===================================================================================
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SOUTHWESTERN BELL TELEPHONE COMPANY
- -----------------------------------------------------------------------------------
BALANCE SHEETS
Dollars in millions
December 31,
-------------------------
1998 1997
- -----------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current Assets
Cash and cash equivalents $ 60 $ 79
Accounts receivable - net of allowances for
uncollectibles of $47 and $33 1,953 1,819
Prepaid expenses 174 156
Deferred charges 34 39
Deferred income taxes 152 192
Other current assets 165 167
- -----------------------------------------------------------------------------------
Total current assets 2,538 2,452
- -----------------------------------------------------------------------------------
Property, Plant and Equipment - at cost 32,602 31,011
Less: Accumulated depreciation and amortization 19,398 18,460
- -----------------------------------------------------------------------------------
Property, Plant and Equipment - Net 13,204 12,551
- -----------------------------------------------------------------------------------
Other Assets 37 11
- -----------------------------------------------------------------------------------
Total Assets $ 15,779 $ 15,014
===================================================================================
Liabilities and Shareowner's Equity
Current Liabilities
Intercompany loans $ 1,766 $ 473
Current portion of long-term obligations 64 172
- -----------------------------------------------------------------------------------
Total debt maturing within one year 1,830 645
Accrued taxes 526 442
Accounts payable and accrued liabilities 2,323 2,599
- -----------------------------------------------------------------------------------
Total current liabilities 4,679 3,686
- -----------------------------------------------------------------------------------
Long-Term Debt 4,358 4,824
- -----------------------------------------------------------------------------------
Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 461 383
Postemployment benefit obligation 2,528 2,574
Unamortized investment tax credits 193 224
Other noncurrent liabilities 298 305
- -----------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities 3,480 3,486
- -----------------------------------------------------------------------------------
Shareowner's Equity
Common stock - one share, no par value 1 1
Paid-in surplus 2,545 2,745
Retained earnings 716 272
- -----------------------------------------------------------------------------------
Total shareowner's equity 3,262 3,018
- -----------------------------------------------------------------------------------
Total Liabilities and Shareowner's Equity $ 15,779 $ 15,014
===================================================================================
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SOUTHWESTERN BELL TELEPHONE COMPANY
- ---------------------------------------------------------------------------------------
STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
- ---------------------------------------------------------------------------------------
1998 1997 1996
- ---------------------------------------------------------------------------------------
<S> <C> <C> <C>
Operating Activities
Net income $ 1,527 $ 1,187 $ 1,369
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,018 1,927 1,795
Provision for uncollectible accounts 133 123 102
Amortization of investment tax credits (31) (31) (31)
Deferred income taxes 120 81 95
Changes in operating assets and liabilities:
Accounts receivable (268) (268) (267)
Other current assets (10) (22) (96)
Accounts payable and accrued liabilities (192) 523 228
Other - net (172) (127) 71
- ---------------------------------------------------------------------------------------
Total adjustments 1,598 2,206 1,897
- ---------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 3,125 3,393 3,266
- ---------------------------------------------------------------------------------------
Investing Activities
Construction and capital expenditures (2,566) (2,649) (2,305)
Dispositions - 65 -
Other - (25) -
- ---------------------------------------------------------------------------------------
Net Cash Used in Investing Activities (2,566) (2,609) (2,305)
- ---------------------------------------------------------------------------------------
Financing Activities
Net change in short-term borrowings with
original maturities of three months or less 1,293 (252) 176
Issuance of other short-term borrowings - 120 209
Repayment of other short-term borrowings - (195) (134)
Issuance of long-term debt 196 729 166
Repayment of long-term debt (784) (121) (201)
Dividends paid (1,383) (1,395) (1,350)
Net equity received from parent 100 340 199
- ---------------------------------------------------------------------------------------
Net Cash Used in Financing Activities (578) (774) (935)
- ---------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (19) 10 26
- ---------------------------------------------------------------------------------------
Cash and cash equivalents beginning of year 79 69 43
- ---------------------------------------------------------------------------------------
Cash and Cash Equivalents End of Year $ 60 $ 79 $ 69
=======================================================================================
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
SOUTHWESTERN BELL TELEPHONE COMPANY
- -----------------------------------------------------------------------------------
STATEMENTS OF SHAREOWNER'S EQUITY
Dollars in millions
- -----------------------------------------------------------------------------------
Retained
Common Paid-in Earnings
Stock Surplus (Deficit)
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
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
- -----------------------------------------------------------------------------------
Net income - - 1,527
Dividend to shareowner - (300) (1,083)
Equity from parent - 100 -
- -----------------------------------------------------------------------------------
Balance, December 31, 1998 $ 1 $ 2,545 $ 716
===================================================================================
The accompanying notes are an integral part of the financial statements.
</TABLE>
<PAGE>
Notes To Financial Statements
Dollars in millions
1. Summary of Significant Accounting Policies
Basis of Presentation - 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 (GAAP) 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 amounts in prior period financial statements
have been reclassified to conform to the current year's presentation.
Comprehensive Income - Comprehensive income for SWBell is the same as net
income for all periods presented.
Operating Segments - In June 1997, the Financial Accounting Standards
Board issued Statement No. 131, "Disclosures About Segments of an
Enterprise and Related Information" (FAS 131), which establishes standards
for the way that public business enterprises report information about
operating segments in quarterly and annual financial statements. FAS 131
changes segment reporting from an industry segment basis to an operating
segment basis defined based on how the business is managed. As SWBell
operates in only one of SBC's segments, wireline telecommunications
services, separate segment reporting does not apply to SWBell.
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 earned prior to their repeal by the Tax Reform Act
of 1986 are amortized as reductions in income tax expense over the lives
of the assets which gave rise to the credits.
Cash Equivalents - Cash equivalents include all highly liquid investments
with original maturities of three months or less.
Revenue Recognition - SWBell recognizes revenues as earned. Amounts billed
in advance of the period in which service is rendered are recorded as a
liability.
<PAGE>
Property, Plant and Equipment - Property, plant and equipment is stated at
cost. The cost of additions and substantial betterments of property, plant
and equipment is capitalized. The cost of maintenance and repairs of
property, plant and equipment is charged to operating expenses. Property,
plant and equipment is depreciated using straight-line methods over their
estimated economic lives, generally ranging from 3 to 50 years. In
accordance with composite group depreciation methodology, when a portion
SWBell's depreciable property, plant and equipment is retired in the
ordinary course of business, the gross book value is charged to
accumulated depreciation; no gain or loss is recognized on the disposition
of this plant.
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 estimated economic
lives of the associated hardware. The American Institute of Certified
Public Accountants has issued a Statement of Position (SOP) that requires
capitalization of certain computer software expenditures beginning in
1999.
Management continues to evaluate the impact of the change in accounting
required by the SOP and anticipates that it will increase net income by
less than $100 in 1999. With comparable levels of software expenditures,
the SOP would tend to increase net income in comparison with SWBell's
current method of accounting for software costs. However, the increases
would be largest in the year of adoption with diminishing levels of
increases compared with current accounting throughout the amortization
period. Consequently, given otherwise comparable income levels excluding
software, and otherwise comparable software expenditures, the effect of
the SOP would be to increase income in the first year and decrease income
in each subsequent year until the number of years affected by the SOP
equals the amortization period.
Advertising Costs - Costs for advertising products and services or
corporate image are expensed as incurred (see Note 9).
Derivative Financial Instruments - SWBell does not invest in any
derivatives for trading purposes. From time to time as part of its risk
management strategy, SWBell uses immaterial amounts of derivative
financial instruments including interest rate swaps to hedge exposures to
interest rate risk on debt obligations. Derivative contracts are entered
into for hedging of firm commitments only. SWBell currently does not
recognize the fair values of these derivative financial investments or
their changes in fair value in its financial statements. Interest rate
swap settlements are recognized as adjustments to interest expense in the
statements of income when paid or received.
2. Completion of Merger On April 1, 1997, SBC and Pacific Telesis Group (PAC)
completed the merger of an SBC subsidiary with PAC, in a transaction in
which each outstanding share of PAC common stock was exchanged for 1.4629
shares of SBC common stock (equivalent to approximately 626 million
shares). With the merger, PAC became a wholly-owned subsidiary of SBC. The
transaction has been accounted for as a pooling of interests and a
tax-free reorganization.
On October 26, 1998, SBC and Southern New England Telecommunications
Corporation (SNET) completed the merger of an SBC subsidiary with SNET, in
a transaction in which each share of SNET common stock was exchanged for
1.7568 shares of SBC common stock (equivalent to approximately 120 million
shares). SNET became a wholly-owned subsidiary of SBC effective with the
merger and the transaction has been accounted for as a pooling of
interests and a tax-free reorganization.
<PAGE>
Post-merger initiatives
During the second quarter of 1997, SBC announced several strategic
decisions resulting from the merger integration process that began with
the April 1, 1997 closing of its merger with PAC. The decisions resulted
from an extensive review of operations throughout the merged company and
include significant integration of operations and consolidation of some
administrative and support functions. In connection with these
initiatives, SWBell recognized several charges during the second quarter.
During the fourth quarter of 1998, SBC again performed a complete review
of all operations affected by the merger with SNET to determine the impact
on ongoing merger integration processes. Review teams examined operational
functions and evaluated all strategic initiatives.
As a result of these reviews, a benefit of $20 ($13 after-tax) in the
fourth quarter of 1998 and charges of $141 ($87 after tax) in the second
quarter of 1997 were recognized. At December 31, 1998 and 1997, remaining
accruals for anticipated cash expenditures related to these decisions were
approximately $27 and $78.
Reorganization SBC is centralizing several key functions that will support
the operations of SWBell, Pacific Bell, Nevada Bell and The Southern New
England Telephone Company (collectively the Telephone Companies),
including network planning, strategic marketing and procurement. It is
also consolidating a number of corporate-wide support activities,
including research and development, information technology, financial
transaction processing and real estate management. The Telephone Companies
will continue as separate legal entities. These initiatives continue to
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 benefit of approximately $20 ($13 net of tax) during
the fourth quarter of 1998 and charges of $57 ($36 net of tax) during the
second quarter of 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. The benefits were associated with an
adjustment to the postemployment accrual necessitated by the review. 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. The initial integration process
subsequent to the PAC merger resulted in SWBell incurring expenses for
these merger-related items in advance of any substantial synergistic
benefits. During the second half of 1997, these merger-related charges
totaled $181 ($113 net of tax).
Impairments/asset valuation As a result of SBC's merger integration plans,
strategic review of domestic operations and organizational alignments,
SWBell reviewed the carrying values of related long-lived assets in the
fourth quarter of 1998 and the second quarter of 1997. The reviews were
conducted company-wide, although the fourth quarter 1998 review focused
primarily on SNET and did not result in any additional impairments at
SWBell. These reviews included estimating remaining useful lives and cash
flows and identifying assets to be abandoned. Where this review indicated
impairment, discounted cash flows related to those assets were analyzed to
determine the amount of the impairment. As a result of these reviews,
SWBell wrote off some assets and recognized impairments to the value of
other assets, recording a combined charge of $84 ($51 after tax) in 1997,
including the write off of voice dial equipment that was discontinued.
<PAGE>
3. Property, Plant and Equipment
Property, plant and equipment is summarized as follows at December 31:
1998 1997
---------------------------------------------------------------------
Land $ 187 $ 182
Buildings 2,755 2,622
Central office equipment 13,097 12,137
Cable, wiring and conduit 14,291 13,759
Other equipment 2,010 1,970
Under construction 262 341
---------------------------------------------------------------------
32,602 31,011
Accumulated depreciation and amortization 19,398 18,460
---------------------------------------------------------------------
Property, plant and equipment-net $ 13,204 $ 12,551
=====================================================================
SWBell's depreciation expense as a percentage of average depreciable plant
was 6.4%, 6.5% and 6.4% for 1998, 1997 and 1996.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1998, 1997 and
1996 were $134, $122 and $99. At December 31, 1998, the future minimum
rental payments under noncancelable operating leases for the years 1999
through 2003 were $34, $24, $6, $3 and $2 and $50 thereafter. Capital
leases were not significant.
<PAGE>
4. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
- -------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------
Debentures
5.38%-5.88% 2003-2006 $ 500 $500
6.13%-6.88% 2000-2048 1,750 1,550
7.00%-7.75% 2009-2027 1,150 1,750
- -------------------------------------------------------------------------------
3,400 3,800
Unamortized discount--net of premium (38) (36)
- -------------------------------------------------------------------------------
Total debentures 3,362 3,764
- -------------------------------------------------------------------------------
Notes
5.04%-7.67% 1998-2010 1,063 1,236
Unamortized discount (5) (6)
- -------------------------------------------------------------------------------
Total notes 1,058 1,230
- -------------------------------------------------------------------------------
Capitalized leases 2 2
- -------------------------------------------------------------------------------
Total long-term debt, including current maturities 4,422 4,996
Current maturities (64) (172)
- -------------------------------------------------------------------------------
Total long-term debt $ 4,358 4,824
===============================================================================
In February and September 1998, SWBell called $600 of long-term debt for
retirement. SWBell recognized after-tax charges of $9 associated with the
calling of this debt.
At December 31, 1998, the aggregate principal amounts of long-term debt
and average interest rate scheduled for repayment for the years 1999
through 2003 were $64 (6.4%), $150 (6.1%), $237 (6.3%), $326 (6.4%), $298
(6.1%) with $3,390 (6.8%) due thereafter. As of December 31, 1998, 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:
- --------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------
Intercompany loans $ 1,766 $ 473
Current maturities of long-term debt 64 172
- --------------------------------------------------------------------------------
Total $ 1,830 $ 645
================================================================================
During the third quarter of 1997, SWBell's commercial paper was replaced
by intercompany loans from SBC. The weighted average interest rate on debt
maturing within one year, excluding current maturities of long-term debt,
at December 31, 1998 and 1997 was 5.0% and 6.0%.
<PAGE>
5. 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:
- --------------------------------------------------------------------------------
1998 1997
- --------------------------------------------------------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
- -------------------------------------------------------------------------------
Debentures $3,362 $3,531 $3,764 $3,828
Notes 1,058 1,129 1,230 1,271
===============================================================================
The fair values of long-term debt were estimated based on quoted market
prices. The carrying amounts of cash and cash equivalents and customer
deposits approximate fair values.
SWBell does not hold or issue any financial instruments for trading
purposes.
6. Income Taxes
Significant components of SWBell's deferred tax liabilities and assets are
as follows at December 31:
- -------------------------------------------------------------------------------
1998 1997
- -------------------------------------------------------------------------------
Depreciation $ 1,716 $ 1,580
Other 50 158
- -------------------------------------------------------------------------------
Gross deferred tax liabilities 1,766 1,738
- -------------------------------------------------------------------------------
Employee benefits 1,248 1,235
Unamortized investment tax credits 73 85
Other 136 227
- -------------------------------------------------------------------------------
Gross deferred tax assets 1,457 1,547
- -------------------------------------------------------------------------------
Net deferred tax liabilities $ 309 $ 191
===============================================================================
The components of income tax expense are as follows:
- --------------------------------------------------------------------------------
1998 1997 1996
- --------------------------------------------------------------------------------
Federal
Current $ 707 $ 593 $ 665
Deferred-net 109 64 77
Amortization of investment tax credits (31) (31) (31)
- --------------------------------------------------------------------------------
785 626 711
- --------------------------------------------------------------------------------
State and local
Current 87 58 70
Deferred-net 11 17 18
- --------------------------------------------------------------------------------
98 75 88
- --------------------------------------------------------------------------------
Total $ 883 $ 701 $ 799
================================================================================
<PAGE>
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:
- -------------------------------------------------------------------------------
1998 1997 1996
- -------------------------------------------------------------------------------
Taxes computed at federal statutory rate $ 843 $ 661 $ 759
Increases (decreases) in taxes resulting from:
Amortization of investment tax credits
over the life of the plant that
gave rise to the credits (20) (20) (20)
State and local income taxes-net of
federal tax benefit 64 49 57
Other-net (4) 11 3
- -------------------------------------------------------------------------------
Total $ 883 $ 701 $ 799
===============================================================================
7. 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:
- ------------------------------------------------------------------------------
1998 1997 1996
- ------------------------------------------------------------------------------
Discount rate for determining projected
benefit obligation 7.0% 7.25% 7.5%
Long-term rate of return on plan assets 8.5% 8.5% 8.5%
Composite rate of compensation increase 4.3% 4.3% 4.3%
- ------------------------------------------------------------------------------
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 1998, 1997 and 1996 of $15, $43, and
$104. As of December 31, 1998 and 1997, the amount of SWBell's cumulative
amount of pension cost recognized in excess of its cumulative
contributions made to the trust was $284 and $269.
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.
<PAGE>
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 1998, 1997 and 1996 of $192, $176 and $211. At December
31, 1998 and 1997, the amount included in the balance sheets for accrued
postretirement benefit obligation was $2,566 and $2,599. 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.
SBC maintains Collectively Bargained Voluntary Employee Beneficiary
Association (CBVEBA) trusts to fund postretirement benefits. During 1998
and 1997, SWBell contributed $80 and $111, 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.
The assumed medical cost trend rate in 1999 is 7.0%, decreasing linearly
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 1999 is 5.75%, 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, 1998 by approximately 8.9%. Decreasing the annual medical and
dental cost trend rates by one percentage point decreases the net periodic
postretirement benefit cost for 1998 by approximately 7.1%.
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 $23, $26 and $29 in 1998, 1997 and
1996.
8. Stock Option Plans
Management employees of SWBell participate in various stock option plans
sponsored by SBC. Options issued through December 31, 1998 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 206 million shares may be issued to SBC employees under these plans.
<PAGE>
In 1996, 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 1998, 1997 and 1996 as
defined by FAS 123, SWBell's net income would have been $1,487, $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 1998, 1997 and 1996:
risk-free interest rate of 5.72%, 6.56% and 6.25%; dividend yield of
2.21%, 3.07% and 4.91%; expected volatility factor of 15%, 15% and 18%;
and expected option life of 5.3, 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>
9. Additional Financial Information
- -------------------------------------------------------------------------------
December 31,
-----------------------
Balance Sheets 1998 1997
- -------------------------------------------------------------------------------
Accounts payable and accrued liabilities:
Accounts payable $ 856 $ 956
Advance billing and customer deposits 337 302
Compensated future absences 198 193
Accrued interest 79 93
Accrued payroll 176 184
Other 677 871
- -------------------------------------------------------------------------------
Total $ 2,323 $ 2,599
===============================================================================
- -------------------------------------------------------------------------------
Statements of Income 1998 1997 1996
- -------------------------------------------------------------------------------
Advertising expense $ 68 $ 73 $ 78
===============================================================================
Interest expense incurred $ 392 $ 370 $ 348
Capitalized interest (18) (27) (21)
- -------------------------------------------------------------------------------
Total interest expense $ 374 $ 343 $ 327
===============================================================================
- -------------------------------------------------------------------------------
Statements of Cash Flows 1998 1997 1996
- -------------------------------------------------------------------------------
Cash paid during the year for:
Interest $ 388 $ 330 $ 327
Income taxes $ 721 $ 629 $ 721
===============================================================================
Approximately 9% in 1998, 11% in 1997 and 12% in 1996 of SWBell's revenues
were from services provided to AT&T Corp. No other customer accounted for
more than 10% of total revenues.
Approximately three-fourths of SWBell's employees are represented by the
Communications Workers of America (CWA). A new agreement between the CWA
and SWBell was reached on April 7, 1998, covering an estimated 39,000
employees through April 1, 2001. Among other items, the agreement
specifies an 11% increase in wages over the life of the contract. No
contracts are expiring in 1999.
<PAGE>
10. Quarterly Financial Information (Unaudited)
- -------------------------------------------------------------------------------
Calendar Total Operating
Quarter Revenues Operating Income Net Income
--------------------------------------------------------------
1998 1997 1998 1997 1998 1997
- -------------------------------------------------------------------------------
First $ 2,601 $ 2,485 $ 738 $ 710 $ 402 $ 395
Second 2,700 2,491 730 454 402 228
Third 2,743 2,579 736 666 403 374
Fourth 2,708 2,561 590 362 320 190
- -------------------------------------------------------------------------------
Annual $ 10,752 $ 10,116 $ 2,794 $ 2,192 $ 1,527 $ 1,187
===============================================================================
Net income includes $13 in fourth quarter 1998 benefits and $139 million
in second quarter 1997 charges related to post-merger initiatives (see
Note 2), $4 and $109 of third and fourth 1997 quarter merger integration
costs and $15 fourth quarter 1997 gain on sale of SWBell's interest in
Bell Communications Research, Inc.
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.
<PAGE>
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.......................... 22
Financial Statements Covered by Report of Independent Auditors:
Statements of Income.................................... 23
Balance Sheets.......................................... 24
Statements of Cash Flows................................ 25
Statements of Shareowner's Equity....................... 26
Notes to Financial Statements........................... 27
(2) Financial Statement Schedules:
II - Valuation and Qualifying Accounts.................. 39
Financial statement schedules other than those listed above have been
omitted because the required information is contained in the financial
statements and notes thereto, or because such schedules are not required or
applicable.
(3) Exhibits:
Exhibit
Number......................................................
4 Pursuant to Regulation S-K, Item 601(b)(4)(iii)(A), no instrument
which defines the rights of holders of long-term debt of the
registrant is filed herewith. Pursuant to this regulation, the
registrant hereby agrees to furnish a copy of any such instrument to
the SEC upon request.
12 Computation of Ratios of Earnings to Fixed Charges.
23 Consent of Ernst & Young LLP.
24 Powers of Attorney.
27 Financial Data Schedule.
(b) Reports on Form 8-K:
There were no reports on Form 8-K filed during the fourth quarter ended
December 31, 1998.
<PAGE>
<TABLE>
<CAPTION>
SOUTHWESTERN BELL TELEPHONE COMPANY
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Allowance for Uncollectibles
Dollars in Millions
- ---------------------------------------------------------------------------------------------------------------------
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 1998.............................. $ 33 133 39 158 $ 47
Year 1997.............................. $ 23 123 29 142 $ 33
Year 1996.............................. $ 15 102 27 121 $ 23
(a) Amounts previously written off which were credited directly to this account when recovered.
(b) Amounts written off as uncollectible.
</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 12th day of March,
1999.
SOUTHWESTERN BELL TELEPHONE COMPANY
By /s/ William B. McCullough
(William B. McCullough
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:
John H. Atterbury III*
President and Chief
Executive Officer
and Chairman of the Board
Principal Financial and
Accounting Officer:
William B. McCullough
Vice President and Chief Financial
Officer
/s/ Alfred G. Richter, Jr.
Directors: (Alfred G. Richter, Jr., as attorney-in-fact
and on his own behalf as Associate
John H. Atterbury III* General Counsel)
Royce S. Caldwell*
Cassandra C. Carr*
Charles E. Foster*
Karen E. Jennings*
Donald E. Kiernan* March 12, 1999
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
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Income Before Income Taxes and
Extraordinary Loss $ 2,410 $ 1,888 $ 2,168 $ 1,688 $ 1,586
Add: Interest Expense 374 343 327 340 358
1/3 Rental Expense 45 41 33 26 25
------------- ------------- ------------- ------------- -------------
Adjusted Earnings $ 2,829 $ 2,272 $ 2,528 $ 2,054 $ 1,969
============= ============= ============= ============= =============
Total Interest Charges $ 392 $ 370 $ 348 $ 340 $ 358
1/3 Rental Expense 45 41 33 26 25
------------- ------------- ------------- ------------- -------------
Adjusted Fixed Charges $ 437 $ 411 $ 381 $ 366 $ 383
============= ============= ============= ============= =============
Ratio of Earnings to Fixed Charges 6.47 5.53 6.64 5.61 5.14
</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 12, 1999, 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, 1998.
ERNST & YOUNG LLP
San Antonio, Texas
March 8, 1999
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 Richard
G. Lindner and Alfred G. Richter, 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/ John H. Atterbury 2/25/99
John H. Atterbury Date
Chairman of the Board
/s/ Royce S. Caldwell 3/4/99
Royce S. Caldwell Date
Director
<PAGE>
/s/ Cassandra C. Carr 3/5/99
Cassandra C. Carr Date
Director
/s/ Charles E. Foster 3/5/99
Charles E. Foster Date
Director
/s/ Karen E. Jennings 3/3/99
Karen E. Jennings Date
Director
/s/ Donald E. Kiernan 3/8/99
Donald E. Kiernan Date
Director
/s/ Richard G. Lindner 2/26/99
Richard G. Lindner Date
Director
/s/ Alfred G. Richter 2/25/99
Alfred G. Richter Date
Director
Exhibit 24
Page 2 of 2
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANACIAL INFORMATION EXTRACTED FROM
SOUTHWESTERN BELL TELEPHONE COMPANY'S DECEMBER 31, 1998 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-31-1998
<PERIOD-END> DEC-31-1998
<CASH> 60
<SECURITIES> 0
<RECEIVABLES> 2,000
<ALLOWANCES> 47
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 2,538
<PP&E> 32,602
<DEPRECIATION> 19,398
<TOTAL-ASSETS> 15,779
<CURRENT-LIABILITIES> 4,679
<BONDS> 4,358
0
0
<COMMON> 1
<OTHER-SE> 2,545
<TOTAL-LIABILITY-AND-EQUITY> 15,779
<SALES> 0<F2>
<TOTAL-REVENUES> 10,752
<CGS> 0<F3>
<TOTAL-COSTS> 4,226
<OTHER-EXPENSES> 2,018
<LOSS-PROVISION> 133
<INTEREST-EXPENSE> 374
<INCOME-PRETAX> 2,410
<INCOME-TAX> 883
<INCOME-CONTINUING> 1,527
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,527
<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>
