Exhibit 13
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Dollars in millions except per share amounts
SBC Communications Inc. (SBC) is a holding company whose subsidiaries and
affiliates operate predominantly in the communications services industry. SBC's
subsidiaries and affiliates provide landline and wireless telecommunications
services and equipment, directory advertising and cable television services.
SBC's largest subsidiary is Southwestern Bell Telephone Company (Telephone
Company), which provides telecommunications services over approximately
15 million access lines in Texas, Missouri, Oklahoma, Kansas and Arkansas (five-
state area). The Telephone Company is subject to regulation by each of the
state jurisdictions in which it operates and by the Federal Communications
Commission (FCC). In 1996, the Telephone Company provided 70% of SBC's
operating revenues and 65% of its net income.
This discussion should be read in conjunction with the consolidated financial
statements and the accompanying notes.
RESULTS OF OPERATIONS
SUMMARY
Financial results, including percentage changes from the prior year, are
summarized as follows:
SBC recognized an extraordinary loss in 1995 from the discontinuance of
regulatory accounting at the Telephone Company.
The primary factors contributing to the increase in income before extraordinary
loss in 1996 were growth in demand for services and products at the Telephone
Company and Southwestern Bell Mobile Systems, Inc. (Mobile Systems).
The primary factors contributing to the increase in income before extraordinary
loss in 1995 were growth in demand for services and products at the Telephone
Company and Mobile Systems, and an after-tax gain of $111 associated with the
merger of SBC's United Kingdom cable television operations into TeleWest P.L.C.
(TeleWest). These factors were partially offset by an after-tax charge of $88
recorded in connection with SBC's strategic functional realignment.
Items affecting the comparison of the operating results between 1996 and 1995,
and between 1995 and 1994, are discussed in the following sections.
OPERATING REVENUES
Total operating revenues increased $1,228, or 9.7%, in 1996 and $898, or 7.6%,
in 1995. Components of total operating revenues, including percentage changes
from the prior year, are as follows:
LOCAL SERVICE Landline revenues increased in 1996 and 1995 due to increases
in demand, primarily increases in residential and business access lines and
vertical services revenues. Total access lines increased 5.1% in 1996 and
4.5% in 1995. Nearly two-thirds of the access line growth occurred in
Texas, which now has approximately 59% of the Telephone Company's access
lines. Approximately 29% in 1996 and 25% in 1995 of access line growth was
due to the sales of additional access lines to existing residential
customers. Vertical services revenues, which include custom calling
options, Caller ID and other enhanced services, increased by approximately
22% in 1996 and 17% in 1995.
Wireless revenues increased in 1996 and 1995 due primarily to the growth in
the number of cellular customers of 20.2% and 22.3%. These increases were
partially offset by slight declines in average revenue per customer. Market
penetration at the end of 1996, 1995 and 1994 was 10.8, 9.0 and 7.4
customers per 100 residents in Mobile Systems' service areas.
NETWORK ACCESS Interstate network access revenues increased in 1996 and
1995 due largely to increases in demand for access services by interexchange
carriers. Growth in revenues from end user charges, attributable to an
increasing access line base, also contributed to the increases in both
years. Net rate reductions under the FCC's revised price cap plan, which
was effective August 1, 1995, partially offset these increases by
approximately $65 in both 1996 and 1995.
Intrastate network access revenues increased in 1996 and 1995 due primarily
to increases in demand, including usage by alternative intraLATA toll
carriers.
LONG-DISTANCE SERVICE revenues increased in 1996 due principally to growth
in Mobile Systems' wireless revenues including interLATA service that began
in February 1996, and the inclusion in 1995 of the Telephone Company's
intraLATA toll pool settlement payments and accruals for rate reductions
relating to an appealed 1992 rate order in Oklahoma. The settlement of the
appeals in October 1995 eliminated the need to continue these accruals.
Absent these accruals and settlements, the Telephone Company's long-distance
service revenues in 1996 would have decreased slightly due to the continuing
impact of price competition from alternative intraLATA toll carriers.
Competition had less impact on message volumes in 1996 due to the Telephone
Company's deployment and promotion of optional long-distance calling plans,
which generally result in higher message volumes but lower average revenue
per message. This message volume trend is not expected to continue, because
the Telephone Company plans to emphasize promotions of extended area local
service plans. Long-distance service revenues decreased in 1995, reflecting
competition-related decreases in residential message volumes and the impact
of optional calling plans and extended area service plans.
DIRECTORY ADVERTISING revenues decreased in 1996 as increased yellow pages
revenues from Southwestern Bell Yellow Pages, Inc. were more than offset by
the decrease resulting from the January 1996 sale of SBC's publishing
contracts for GTE Corporation's service areas to GTE Directories. Excluding
the impact of this sale, revenues increased 6.7% in 1996. Revenues in 1995
were relatively unchanged from 1994, reflecting the impact of increased
competition.
OTHER operating revenues in 1996 and 1995 reflect the increased demand for
the Telephone Company's non-regulated services and products, including
Caller ID equipment, computer network services, contract programming and
videoconferencing services. The increase in 1995 was offset by the decrease
in equipment sales revenues at Mobile Systems resulting primarily from
declining equipment prices.
OPERATING EXPENSES
Total operating expenses increased $709, or 7.4%, in 1996 and $623, or 6.9%, in
1995. Components of total operating expenses, including percentage changes from
the prior year, are as follows:
COST OF SERVICES AND PRODUCTS increased in 1996 due to increases at the
Telephone Company for network expansion and maintenance, employee
compensation and demand-related increases, primarily increases in switching
system software license fees. Other increases in 1996 related principally
to growth at Mobile Systems. Similarly, in 1995, expenses increased
primarily due to increases at the Telephone Company for network expansion
and maintenance, employee compensation, and demand-related increases for
enhanced services. These increases were mostly offset by decreased
switching system software license fees at the Telephone Company, decreased
equipment costs at Mobile Systems and the absence of expenses associated
with SBC's United Kingdom cable television operations (discussed in Other
Business Matters).
SELLING, GENERAL AND ADMINISTRATIVE expenses increased in 1996 and 1995
primarily due to growth-related increases at Mobile Systems and the
Telephone Company including increases in operating taxes, which include the
Texas Infrastructure Fund assessments, contracted services, employee
compensation, advertising and uncollectibles. The increase in 1995 was also
attributable to the $139 charge for costs associated with the strategic
realignment discussed in Other Business Matters.
DEPRECIATION AND AMORTIZATION increased in 1996 and 1995 due primarily to
growth in plant levels and changes in plant composition, primarily at Mobile
Systems and the Telephone Company. The increase in 1995 also reflects the
effect of regulatory depreciation represcription at the Telephone Company.
INTEREST EXPENSE decreased $43, or 8.3%, in 1996 due to lower interest rates on
short-term debt, lower long-term debt levels, and capitalization of interest
during construction required by the discontinuance of regulatory accounting in
the third quarter of 1995. Under regulatory accounting, the Telephone Company
accounted for a capitalization of both interest and equity costs during periods
of construction as other income. Interest expense increased $35, or 7.3%, in
1995 due primarily to an increase in the average amount of debt outstanding to
finance growth and acquisitions at Mobile Systems. Interest expense for 1995
also reflects debt issued for acquisitions in France and Chile.
EQUITY IN NET INCOME OF AFFILIATES increased $88 in 1996 and decreased $67 in
1995. The 1996 increase reflects increased income from Telefonos de Mexico,
S.A. de C.V. (Telmex), Mexico's national telecommunications company, due to the
relative stabilization of the peso, net gains on international affiliate
transactions and improved results from SBC's investment in French cellular
operations. Results for 1995 include losses on SBC's United Kingdom cable
television operations, which were accounted for under the equity method prior to
October 1995, and exchange losses on the non-peso denominated debt of Telmex.
Results for 1996 and 1995 also reflect reductions in the translated amount of
U.S. dollar earnings from Telmex's operations. Operational growth at Telmex in
both years somewhat offsets these declines. The 1995 decrease is also
attributable to SBC's investment in French cellular operations.
SBC's future earnings from Telmex will continue to be sensitive to changes in
the value of the peso. SBC's investment in Telmex has been recorded under U.S.
generally accepted accounting principles (GAAP), which exclude inflation
adjustments and include adjustments for the purchase method of accounting.
Beginning in 1997, SBC will use the U.S. dollar, instead of the peso, as the
functional currency for its investment in Telmex due to the Mexican economy
becoming highly inflationary as defined by GAAP. Earnings in 1997 will reflect
SBC's reduced ownership percentage in Telmex as discussed in Note 5 to the
financial statements. These changes are each expected to have a slightly
negative impact on equity in net income from Telmex.
OTHER INCOME (EXPENSE) - NET In 1995, SBC recognized a gain from the merger of
SBC's United Kingdom cable television operations into TeleWest (see Note 12 to
the financial statements). The gain was somewhat offset by expenses associated
with the refinancing of long-term debt by the Telephone Company (see Note 6 to
the financial statements).
FEDERAL INCOME TAX expense increased $233, or 28.3%, in 1996 and $140, or 20.5%,
in 1995, primarily due to higher income before income taxes. The elimination of
excess deferred taxes and the reduction in the amortization of investment tax
credits resulting from the discontinuance of regulatory accounting, as described
in Note 2 to the financial statements, also contributed to the increases in both
years.
EXTRAORDINARY LOSS In 1995, SBC recorded an extraordinary loss of $2.8 billion
from the discontinuance of regulatory accounting. The loss included a reduction
in the net carrying value of telephone plant partially offset by the elimination
of net regulatory liabilities of the Telephone Company (see Note 2 to the
financial statements).
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
REGULATORY ENVIRONMENT
The Telephone Company's telecommunications operations are subject to regulation
by each of the five states in which it operates for intrastate services and by
the FCC for interstate services. Through the end of 1996, the Telephone Company
operated under incentive regulation or price caps for various services provided
by the Telephone Company. In early 1997, Arkansas enacted legislation
establishing incentive regulation for electing companies, replacing a settlement
which had expired on December 31, 1996. Under price cap regulation, the
Telephone Company is permitted to establish and modify prices, not to exceed the
price caps, subject to expedited approval by the governing jurisdiction. Prices
for some other services not specifically covered by price caps are also subject
to regulatory approval.
The states set intrastate price caps for various periods, depending upon the
state. Price caps set by the FCC are adjusted annually for inflation, a
productivity offset and certain other changes in costs. The productivity offset
is a fixed percentage used to reduce price caps and is designed to encourage
increased productivity.
Under the original FCC plan adopted in 1991, the Telephone Company applied a
productivity offset of 3.3%, with sharing at various rates of return on
investment. The FCC adopted revised price cap rules effective August 1, 1995.
The new rules allowed a choice of three new productivity offsets, two of which
provide for a sharing of profits with consumers above certain earnings levels.
The Telephone Company elected a 5.3% productivity offset with no sharing.
The revised FCC price cap plan was intended to be an interim plan that would be
revised in 1996. However, with the passage of the Telecommunications Act of
1996 (the Telecom Act), the FCC is conducting further proceedings to address
various pricing and productivity issues, and is performing a broader review of
price cap regulation in a competitive environment. Additionally, the FCC will
also examine universal service and access charge rules during 1997. The Telecom
Act and FCC actions taken to implement provisions of the Telecom Act are
discussed further under the heading "Competition."
Following is a summary of significant state regulatory developments.
TEXAS The Public Utility Regulatory Act, which became effective in May 1995
(PURA), allows the Telephone Company and other Local Exchange Carriers (LECs) to
elect to move from rate of return regulation to price regulation with
elimination of earnings sharing. In September 1995, the Telephone Company
notified the Texas Public Utility Commission (TPUC) that it elected incentive
regulation under the new law. Basic local service rates are capped at existing
levels for four years following the election. The TPUC is prohibited from
reducing switched access rates charged by LECs to interexchange carriers for the
four-year election period.
LECs electing price regulation must commit to network and infrastructure
improvement goals, including expansion of digital switching and advanced
high-speed services to qualifying public institutions, such as schools,
libraries and hospitals, requesting the services. PURA also established an
infrastructure grant fund for use by public institutions in upgrading their
communications and computer technology. PURA provided for a total fund
assessment of $150 annually on all telecommunications providers in Texas for a
ten-year period, half of which would be paid by the cellular and wireless
industry. The provisions establishing different assessment rates for landline
and cellular and wireless service providers were ruled unconstitutional under
the Texas constitution in January 1996, and the lower rate was ordered to be
applied to both categories of service providers, resulting in less than a $150
annual assessment. Based on this order, SBC's total annual payment is estimated
to be approximately $35 to $45. The 1997 Texas legislative session is
considering this issue with the goal of restoring the assessment to its original
$150 annual amount. As a result, SBC's annual payment could increase.
PURA establishes local exchange competition by allowing other companies who
desire to provide local exchange services to apply for certification by the
TPUC, subject to certain build-out requirements, resale restrictions and minimum
service requirements. PURA provides that the Telephone Company will remain the
default carrier of "1 plus" intraLATA toll traffic until all LECs are allowed to
carry interLATA long-distance.
In 1996, MCI Communications Corporation (MCI) and AT&T Corp. (AT&T) sued the
state of Texas, alleging that PURA violates the Texas state constitution,
claiming PURA establishes anticompetitive barriers designed to prevent MCI, AT&T
and Sprint Corporation (Sprint) from providing local services within Texas. SBC
is unable to predict the outcome of this proceeding. During 1996, the TPUC
approved the application of Sprint to be granted a certificate of authority to
provide local service, waiving the build-out requirements specified under state
law for facilities-based certificates of authority. AT&T and MCI have also
filed petitions with the FCC arguing the build-out requirements should be
preempted; they have also requested TPUC grant them similar treatment as Sprint.
TPUC has also requested the FCC issue an expedited ruling on whether PURA's
build-out requirements are lawful under the Telecom Act.
More than 80 applications to provide competitive local service certification
have been approved by the TPUC, with over 30 more applications pending approval.
As a result, the Telephone Company expects competition to continue to develop
for local service, but the specific financial impacts of this competition cannot
be reasonably estimated until all required tariff filings are approved by the
TPUC for the Telephone Company and other companies intending to provide local
service.
MISSOURI During 1996, the 1995 Cole County Circuit Court ruling which
overturned the August 1994 settlement agreement reached among the Telephone
Company, the Missouri Public Service Commission (MPSC) and the Office of Public
Counsel (OPC) was upheld on appeal. The practical effect of this decision is to
eliminate the prospective commitments under the settlement agreement, including
a rate review moratorium and capital investment commitments. The decision has
no immediate impact on the Telephone Company's current rates because they were
approved by the MPSC in separate proceedings, which were not appealed.
OKLAHOMA On October 30, 1995, the Oklahoma Corporation Commission (OCC)
approved a settlement that resolved pending court appeals of a 1992 rate order.
Under the terms of the settlement, the Telephone Company paid a cash settlement
of $170 to business and residential customers, and offered discounts with a
retail value of $268 for certain Telephone Company services. Previously ordered
rate reductions of $100 were lowered to $84, of which $57 had already been
implemented. The settlement allowed the remaining $27 in rate reductions to be
deferred, with approximately $9 becoming effective in 1996 and the remainder
during 1997. The settlement also provides that no overearnings complaint can be
filed against the Telephone Company until January 1, 1998. The Telephone
Company began accruing for the order in 1992, and the settlement and associated
costs had been fully accrued as of the end of the third quarter of 1995.
COMPETITION
Competition continues to expand in the telecommunications industry. Legislation
and regulation have increased the opportunities for alternative service
providers offering telecommunications services. Technological advances have
expanded the types and uses of services and products available. Accordingly,
SBC faces increasing competition in significant portions of its business.
DOMESTIC
On February 8, 1996, the Telecom Act was enacted into law. The Telecom Act is
intended to address various aspects of competition within, and regulation of,
the telecommunications industry. The Telecom Act provides that all
post-enactment conduct or activities which were subject to the consent decree,
referred to as the Modification of Final Judgment (MFJ), issued at the time of
AT&T's divestiture of the Regional Holding Companies (RHCs) are now subject to
the provisions of the Telecom Act. Among other things, the Telecom Act also
defines conditions SBC must comply with before being permitted to offer
interLATA long-distance service within the five-state area and establishes
certain terms and conditions intended to promote competition for the Telephone
Company's local exchange services. Under terms of the Telecom Act, SBC may
immediately offer interLATA long-distance outside the five-state area and over
its wireless network both inside and outside the five-state area. Before being
permitted to offer landline interLATA long-distance service in any state within
the Telephone Company's five-state region, SBC must apply for and obtain state-
specific approval from the FCC. The FCC's approval, which involves consultation
with the United States Department of Justice, requires favorable determinations
that the Telephone Company has entered into interconnection agreement(s) that
satisfy a 14-point "competitive checklist" with predominantly facilities based
carrier(s) that serve residential and business customers or, alternatively, that
the Telephone Company has a statement of terms and conditions effective in that
state under which it offers the "competitive checklist" items. The FCC must
also make favorable public interest and structural separation determinations.
The Telecom Act directed the FCC to establish rules and regulations to implement
the Telecom Act, and to preempt specific state law provisions under certain
circumstances. The Telecom Act also allows RHCs to provide cable services over
their own networks, but sets limits on RHCs acquiring interests in cable
television operations in their telephone service areas.
In April 1996, the United States District Court for the District of Columbia
issued its Opinion and Order terminating the MFJ and dismissing all pending
motions related to the MFJ as moot. This ruling effectively ended 13 years of
RHC regulation under the MFJ.
In August 1996, the FCC issued rules by which competitors could connect with
LECs' networks, including those of the Telephone Company. Among other things,
the rules addressed unbundling of network elements, pricing for interconnection
and unbundled elements (Pricing Provisions), and resale of network services.
The FCC rules were appealed by numerous parties, including SBC, other LECs,
various state regulatory commissions and the National Association of Regulatory
Utility Commissioners.
On October 15, 1996, the United States Court of Appeals for the Eighth Circuit
(Eighth Circuit) issued an order to stay the FCC's Pricing Provisions and its
rules permitting new entrants to "pick and choose" among the terms and
conditions of approved interconnection agreements. The stay provides that it
will remain in effect while the Eighth Circuit considers the validity of the
rules. Other provisions of rules adopted by the FCC to implement the Telecom
Act remain in effect.
The effects of the FCC rules are dependent on many factors including, but not
limited to: the ultimate resolution of the pending appeals; the number and
nature of competitors requesting interconnection, unbundling or resale; and the
results of the state regulatory commissions' review and handling of related
matters within their jurisdictions. Accordingly, SBC is not able to assess the
impact of the FCC rules.
Recently enacted and pending state laws and regulations also allow increased
competition for local exchange services. Companies wishing to provide
competitive local service have filed numerous applications with state
commissions throughout the Telephone Company's five-state area, and the
commissions of each state have begun approving these applications. Under the
Telecom Act, companies seeking to interconnect to the Telephone Company's
network and exchange local calls must enter into interconnection agreements with
the Telephone Company, which are then subject to approval by the appropriate
state commission. Numerous interconnection agreements have been entered into
and approved in the Telephone Company's five-state area. Several companies who
have failed to agree on all interconnection terms have filed for arbitration
before the state commissions.
In October 1996, the TPUC announced its ruling in a consolidated arbitration
hearing between the Telephone Company and AT&T, MCI, MFS Communications Company,
Inc. (MFS), Teleport Communications Group, and American Communications Services,
Inc. The TPUC approved interim interconnection rates to be charged by the
Telephone Company as well as certain other terms of interconnection between the
parties. Some agreements containing the arbitrated rates and terms have been
approved by the TPUC. The Telephone Company also filed revised cost support for
the establishment of permanent rates with the TPUC, with an anticipated
effective date of April 1997. The Telephone Company has filed suit in state and
federal court maintaining that, for various reasons, the arbitration award is
unlawful.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing with
AT&T and MCI and on selected items with MFS. Among other terms, the orders
established discount rates for resale of Telephone Company services and prices
for unbundled network elements. The Telephone Company has filed suit in federal
court appealing the orders as unlawful.
As a result of the Telecom Act and conforming interconnection agreements, the
Telephone Company expects in 1997 it will experience local exchange competition
from multiple providers in various markets. SBC intends to use approved
agreements in support of its application to the FCC to provide interLATA long-
distance service in the Telephone Company's five-state area.
The Telephone Company also faces competition from various local service
providers that bypass the local exchange network. Some of these providers have
built fiber optic "rings" throughout large metropolitan areas to provide
transport services (generally high-speed data) for large business customers and
interexchange carriers. Others provide high-usage customers, particularly large
businesses, alternative telecommunications links for voice and data, such as
private network systems, shared tenant services or private branch exchange (PBX)
systems (which are customer-owned and provide internal switching functions
without using Telephone Company central office facilities). The extent of the
economic incentive to bypass the local exchange network depends upon local
exchange prices, access charges, regulatory policy and other factors. End user
charges ordered by the FCC are designed in part to mitigate the effect of system
bypass.
Competition continues to intensify in the Telephone Company's intraLATA toll
markets. Principal competitors are interexchange carriers, which are assigned
an access code (e.g., "10XXX") used by their customers to route intraLATA calls
through the interexchange carrier's network, and resellers, which sell toll
services obtained at bulk rates.
In 1993, the FCC adopted an order allocating radio spectrum and outlining the
development of licenses for new personal communications services (PCS). PCS
utilizes wireless telecommunications digital technology at a higher frequency
radio spectrum than cellular. Like cellular, it is designed to permit access to
a variety of communications services regardless of subscriber location. In an
FCC auction, which concluded in March 1995, PCS licenses were awarded in 51
major markets. SBC acquired PCS licenses in the Major Trading Areas (MTAs) of
Memphis, Tennessee; Little Rock, Arkansas; and Tulsa, Oklahoma. SBC is
currently in the build out phase of PCS in Tulsa, Oklahoma. During 1996, SBC
received several AT&T cellular networks in Arkansas in exchange for SBC's PCS
licenses in Memphis, Tennessee and Little Rock, Arkansas and other
consideration. In an FCC auction concluded January 1997, SBC acquired eight
additional PCS licenses for Basic Trading Areas (BTAs) that are within its five-
state area. SBC plans to build out the new BTAs as part of its strategy to be a
full service telecommunications provider. Including these new BTAs, SBC will be
able to offer approximately 85% of its landline local service customers wireless
service as well.
Companies granted licenses in MTAs and BTAs where SBC also provides service
include subsidiaries and affiliates of AT&T, Sprint and other RHCs. The degree
of competition which SBC will encounter from PCS providers will depend on the
timing and extent of the build out of PCS services.
In the future, it is likely that additional competitors will emerge in the
telecommunications industry. Cable television companies and electric utilities
have expressed an interest in, or already are, providing telecommunications
services. As a result of recent and prospective mergers and acquisitions within
the industry, SBC may face competition from entities offering both cable TV and
telephone services in the Telephone Company's operating territory.
Interexchange carriers have been certified to provide local service, and a
number of other major carriers have publicly announced their intent to provide
local service in certain markets, some of which are in the Telephone Company's
five-state area.
SBC is aggressively representing its interests regarding competition before
federal and state regulatory bodies, courts, Congress and state legislatures.
SBC will continue to evaluate the increasingly competitive nature of its
business to develop appropriate competitive, legislative and regulatory
responses.
INTERNATIONAL
Telmex was granted a concession in 1990 which expired in August 1996, as the
sole provider of long-distance services in Mexico. In 1995, the Mexican Senate
and Chamber of Deputies passed legislation encompassing a series of rules for
the introduction of competition into the Mexican long-distance market previously
issued by the Mexican Secretary of Communication and Transportation. Those
rules specified that there would be an unlimited number of long-distance
concessions and that Telmex was required to provide 60 interconnection points by
January 1, 1997, and more than 200 interconnection points by the year 2000.
Several large competitors have announced their intention to compete with Telmex
and have filed for licenses, including a joint venture between AT&T and Alfa, a
Mexican consortium, and Avantel, S.A., a joint venture between MCI and Grupo
Financiero Banamex-Accival, Mexico's largest financial group. Balloting for
presubscription of long-distance service has begun among Telmex's customers in
selected areas.
OTHER BUSINESS MATTERS
MERGER AGREEMENT On April 1, 1996, SBC and Pacific Telesis Group (PAC) jointly
announced a definitive agreement to merge an SBC subsidiary with PAC, in a
transaction in which each share of PAC common stock will be exchanged for 0.733
of a share of SBC common stock, subject to adjustment as
described in the merger agreement based upon an allocation of the costs, fees
and expenses and other financial effects incurred or sustained in connection
with obtaining state regulatory approvals. After the merger, PAC will be a
wholly-owned subsidiary of SBC. The transaction is intended to be accounted for
as a pooling of interests and to be a tax-free reorganization. On July 31,
1996, the shareowners of SBC and PAC each approved the transaction, which had
previously been approved by the board of directors of each company. On November
5, 1996, the United States Department of Justice announced it would not initiate
action on the merger under the Hart-Scott-Rodino antitrust law. The Public
Service Commission of Nevada approved the merger on December 31, 1996. The FCC
approved the transfer of licenses from PAC to SBC on January 31, 1997. The
merger agreement is subject to certain other regulatory approvals, including
approval by the California Public Utilities Commission, which has established a
schedule for review of the transaction with approval expected before the end of
the first quarter of 1997. If approvals are granted, the transaction is
expected to close in the first half of 1997 (see Note 3 to the financial
statements for more information).
ACQUISITIONS AND DISPOSITIONS SBC made several acquisitions and dispositions in
1996, 1995 and 1994.
SBC's acquisitions of two cable television systems located in Montgomery County,
Maryland, and Arlington County, Virginia, the domestic wireless business of
Associated Communications Corporation, adjacent properties in New York state and
an indirect 10% ownership of a nationwide cellular company in France are
described in Note 12 to the financial statements. In addition, the merger of
SBC's United Kingdom cable television operations into TeleWest is described in
Note 12 to the financial statements.
In October 1994, SBC sold an additional 25% of its United Kingdom cable
television operations to Cox Cable Communications. From October 1994 until the
merger into TeleWest in 1995, SBC's United Kingdom cable television investment
was accounted for under the equity method. In December 1996, SBC made an
additional investment to maintain its indirect 10% ownership in the French
cellular company to offset dilution of its interest resulting from other equity
sales.
During 1995, SBC also purchased a wireless system serving Watertown, New York,
and, as previously discussed, obtained at auction PCS licenses in Memphis,
Tennessee; Little Rock, Arkansas; and Tulsa, Oklahoma. During 1996, SBC
received several AT&T cellular networks in Arkansas in exchange for SBC's PCS
licenses in Memphis, Tennessee and Little Rock, Arkansas and other
consideration.
In 1995, SBC made an equity investment in Chile, purchasing 40% of VTR S.A.
(VTR), a privately owned telecommunications holding company, for $317. VTR
provides local, long-distance, wireless and cable television services in Chile
and is 51% owned by Grupo Luksic, a large Chilean conglomerate. During 1996,
SBC increased its holding in VTR to 49% through the purchase of shares from
another minority shareowner. Also, in 1995, SBC made an equity investment in a
South African wireless company.
Except as discussed in Note 12 to the financial statements, none of these
transactions had a material effect on SBC's financial results in 1996, 1995 or
1994, nor does management expect them to have a material effect on SBC's
financial position or results of operations in 1997.
STRATEGIC REALIGNMENT In July 1995, SBC announced a strategic realignment which
positions the company to be a single-source provider of telecommunications
services. All of SBC's operations within the five-state area report to one
management group, while international operations and domestic operations outside
the five-state area report to a separate management group.
In connection with this realignment of functions, in 1995 SBC recognized $139 in
selling, general and administrative expenses. These expenses include
postemployment benefits for approximately 2,400 employees arising from the
future consolidation of operations within the five-state area, streamlining
support and administrative functions and integrating financial systems.
Implementation of the realignment has been delayed due to the pending merger
with PAC. The charge reduced net income for 1995 by approximately $88.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL EXPENDITURES AND OTHER COMMITMENTS
To provide high-quality communications services to its customers, SBC,
particularly the Telephone Company and Mobile Systems, must make significant
investments in property, plant and equipment. The amount of capital investment
is influenced by regulatory commitments and demand for services and products.
SBC's capital expenditures totaled $3,027, $2,336 and $2,350 for 1996, 1995 and
1994. In 1996, Telephone Company and Mobile Systems expenditures increased 33%
and 10%. The Telephone Company's increase in capital expenditures was due
primarily to demand-related growth, network upgrades, customer-contracted
requirements, regulatory commitments and ISDN projects. Mobile Systems
expenditures increased due primarily to continued growth.
SBC's total reported 1995 capital expenditures were relatively unchanged
compared to 1994. Reported decreases in SBC's capital expenditures related to
the change in accounting for its United Kingdom cable television operations were
offset by capital expenditures increases of 5% at the Telephone Company and 6%
at Mobile Systems.
In 1997, management expects total capital spending to increase from 1996, to
between $3,300 and $3,500. Capital expenditures in 1997 will relate primarily
to the continued evolution of the Telephone Company's network, including amounts
agreed to under regulation plans, and continued build out of Mobile Systems'
markets. SBC expects to fund ongoing capital expenditures with cash provided by
operations.
The Telephone Company continues to make additional network and infrastructure
improvements over periods ranging through 2001 to satisfy regulatory
commitments. Total capital expenditures under these commitments can vary based
on actual demand of potential end users. The Telephone Company anticipates
spending approximately $150 to $200 in 1997 associated with these commitments.
Over the next few years, SBC is expecting to incur significant software
expenditures for interconnection and customer number portability. The extent
and timing of these expenditures will vary depending on the timing and nature of
regulatory actions and corresponding or compensating network improvements.
DIVIDENDS DECLARED
Dividends declared by SBC totaled $1,042 ($1.72 per share) in 1996, $1,004
($1.65 per share) in 1995 and $954 ($1.58 per share) in 1994. Management's
dividend policy considers both the expectations and requirements of shareowners,
internal requirements of SBC and long-term growth opportunities.
CASH, LINES OF CREDIT AND CASH FLOWS
SBC had $242 of cash and cash equivalents available at December 31, 1996.
Commercial paper borrowings as of December 31, 1996, totaled $1,318. SBC has
entered into agreements with several banks for lines of credit totaling $750,
all of which may be used to support commercial paper borrowings. SBC had no
borrowings outstanding under these lines of credit as of December 31, 1996.
During 1996, as in 1995 and 1994, SBC's primary source of funds continued to be
cash generated from operations, as shown in the Consolidated Statements of Cash
Flows. In 1996, 1995 and 1994, cash provided by operating activities was
reduced by the contribution of $57, $151 and $134 to the collectively bargained
Voluntary Employee Beneficiary Association trusts for the future payment of
postretirement benefits. Net cash provided by operating activities exceeded
SBC's construction and capital expenditures during 1996, as in 1995 and 1994;
this excess is referred to as free cash flow, a supplemental measure of
liquidity. SBC generated free cash flow of $1,797, $1,685 and $1,618 in 1996,
1995 and 1994.
During 1995, the Telephone Company refinanced long-term debt with an aggregate
principal amount of $450. Since June 1991, the Telephone Company has refinanced
$3,632 in long-term debt.
TOTAL CAPITAL
SBC's total capital consists of debt (long-term debt and debt maturing within
one year) and shareowners' equity. Total capital increased $454 in 1996 and
decreased $2,265 in 1995. The increase in 1996 was due to the reinvestment of
earnings, partially offset by the acquisition of treasury shares. The decrease
in 1995 was due to the effects of the discontinuance of regulatory accounting.
Absent this extraordinary charge, total capital increased by $554 in 1995 due
primarily to the reinvestment of earnings, partially offset by foreign currency
translation adjustments resulting from the decline in the value of the Mexican
peso.
DEBT RATIO
SBC's debt ratio (long-term debt and debt maturing within one year, as a
percentage of total capital) was 51.4%, 54.0% and 47.4% at December 31, 1996,
1995 and 1994. The debt ratio is affected by the same factors that affect total
capital. For 1995, the decrease in equity caused by the discontinuance of
regulatory accounting increased the debt ratio by 9.2 percentage points.
SHARE REPURCHASES
See Note 11 to the financial statements.
EMPLOYEE STOCK OWNERSHIP PLANS
See Note 9 to the financial statements.
Notes to Consolidated Financial Statements
Dollars in millions except per share amounts
1. Summary of Significant Accounting Policies
Basis of Presentation - The consolidated financial statements include the
accounts of SBC Communications Inc. and its majority-owned subsidiaries
(SBC). SBC's subsidiaries and affiliates operate predominantly in the
communications services industry, providing landline and wireless
telecommunications services and equipment, directory advertising and cable
television services both domestically and worldwide. Southwestern Bell
Telephone Company (Telephone Company) is SBC's largest subsidiary,
providing telecommunications services in Texas, Missouri, Oklahoma, Kansas
and Arkansas (five-state area).
All significant intercompany transactions are eliminated in the
consolidation process. Investments in partnerships, joint ventures and
less than majority-owned subsidiaries are principally accounted for under
the equity method. Earnings from certain foreign investments accounted for
under the equity method are included for periods ended within three months
of SBC's year end.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
Income Taxes - Deferred income taxes are provided for temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for tax purposes.
Investment tax credits resulted from federal tax law provisions that
allowed for a reduction in income tax liability based on certain
construction and capital expenditures. Corresponding income tax expense
reductions were deferred and are being amortized as reductions in income
tax expense over the life of the property, plant and equipment that gave
rise to the credits.
Cash Equivalents - Cash equivalents include all highly liquid investments
with original maturities of three months or less.
Deferred Charges - Certain sales commissions are deferred and amortized
over 12 months. Directory advertising costs are deferred until the
directory is published and advertising revenues related to these costs are
recognized.
Material and Supplies - New and reusable materials are carried principally
at average original cost. Specific costs are used for large individual
items. Nonreusable material is carried at estimated salvage value.
Property, Plant and Equipment - Property, plant and equipment is stated at
cost. The cost of additions and substantial betterments of property, plant
and equipment is capitalized. The cost of maintenance and repairs of
property, plant and equipment is charged to operating expenses.
Property, plant and equipment is depreciated using straight-line methods
over their estimated useful lives, generally ranging from 3 to 50 years.
Prior to September 1995, the Telephone Company computed depreciation using
certain straight-line methods and rates as prescribed by regulators. In
accordance with composite group depreciation methodology, when a portion of
the Telephone Company's depreciable property, plant and equipment is
retired in the ordinary course of business, the gross book value is charged
to accumulated depreciation.
Intangible Assets - Intangible assets consist primarily of wireless and
cable television licenses, customer lists and the excess of consideration
paid over net assets acquired in business combinations. These assets are
being amortized using the straight-line method, over periods generally
ranging from 5 to 40 years. At December 31, 1996 and 1995, amounts
included in net intangible assets for licenses were $1,838 and $1,798.
Management periodically reviews the carrying value and lives of all
intangible assets based on expected future cash flows.
Foreign Currency Translation - Local currencies are generally considered
the functional currency for SBC's share of foreign operations, except in
countries considered highly inflationary. SBC translates its share of
foreign assets and liabilities at current exchange rates. Revenues and
expenses are translated using average rates during the year. The ensuing
foreign currency translation adjustments are recorded as a separate
component of Shareowners' Equity. Other transaction gains and losses
resulting from exchange rate changes on transactions denominated in a
currency other than the local currency are included in earnings as
incurred.
Earnings Per Common Share - The earnings per common share computation uses
the weighted average number of common shares outstanding, including shares
held by employee stock ownership plans. Common stock equivalents
outstanding are not considered dilutive.
2. Discontinuance of Regulatory Accounting
In September 1995, the Telephone Company discontinued its application of
Statement of Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation" (FAS 71). FAS 71 requires
depreciation of telephone plant using lives set by regulators which are
generally longer than those established by unregulated companies, and
deferral of certain costs and obligations based on regulatory actions
(regulatory assets and liabilities). As a result of the adoption of price-
based regulation for most of the Telephone Company's revenues and the
acceleration of competition in the telecommunications market, management
determined that the Telephone Company no longer met the criteria for
application of FAS 71.
Upon discontinuance of FAS 71, the Telephone Company recorded a non-cash,
extraordinary charge to net income of $2,819 (after a net deferred tax
benefit of $1,764). This charge is comprised of an after-tax charge of
$2,897 to reduce the net carrying value of telephone plant, partially
offset by an after-tax benefit of $78 for the elimination of net regulatory
liabilities. The components of the charge are as follows:
The increase in accumulated depreciation of $4,657 reflects the effects of
adopting depreciable lives for many of the Telephone Company's plant
categories which more closely reflect the economic and technological lives
of the plant. The adjustment was supported by a discounted cash flow
analysis which estimated amounts of telephone plant that may not be
recoverable from future discounted cash flows. This analysis included
consideration of the effects of anticipated competition and technological
changes on plant lives and revenues. The adjustment also included
elimination of accumulated depreciation deficiencies recognized by
regulators and amortized as part of depreciation expense.
Following is a comparison of new lives to those prescribed by regulators
for selected plant categories:
The increase in accumulated depreciation also includes an adjustment of
approximately $450 to fully depreciate analog switching equipment scheduled
for replacement. Remaining analog switching equipment is being depreciated
using an average remaining life of four years.
Investment tax credits have historically been deferred and amortized over
the estimated lives of the related plant. The adjustment to unamortized
investment tax credits reflects the shortening of those plant lives
discussed above. Regulatory assets and liabilities are related primarily
to accounting policies used by regulators in the ratemaking process which
are different from those used by non-regulated companies, predominantly in
the accounting for income taxes and deferred compensated absences. These
items are required to be eliminated with the discontinuance of accounting
under FAS 71.
Additionally, in September 1995, the Telephone Company began accounting for
interest on funds borrowed to finance construction as an increase in
property, plant and equipment and a reduction of interest expense. Under
the provisions of FAS 71, the Telephone Company accounted for a
capitalization of both interest and equity costs allowed by regulators
during periods of construction as other income and as an addition to the
cost of plant constructed.
3. Merger Agreement
On April 1, 1996, SBC and Pacific Telesis Group (PAC) jointly announced a
definitive agreement to merge an SBC subsidiary with PAC, in a transaction
in which each share of PAC common stock will be exchanged for 0.733 of a
share of SBC common stock (equivalent to approximately 314 million shares),
subject to adjustment as described in the merger agreement based upon an
allocation of the costs, fees and expenses and other financial effects
incurred or sustained in connection with obtaining state regulatory
approvals. After the merger, PAC will be a wholly-owned subsidiary of SBC.
The transaction is intended to be accounted for as a pooling of interests
and to be a tax-free reorganization. On July 31, 1996, the shareowners of
SBC and PAC each approved the transaction, which had previously been
approved by the board of directors of each company. On November 5, 1996,
the United States Department of Justice announced it would not initiate
action on the merger under the Hart-Scott-Rodino antitrust law. The Public
Service Commission of Nevada approved the merger on December 31, 1996. The
FCC approved the transfer of licenses from PAC to SBC on January 31, 1997.
The merger agreement is subject to certain other regulatory approvals,
including approval by the California Public Utilities Commission, which has
established a schedule for review of the transaction with approval expected
before the end of the first quarter of 1997. If approvals are granted, the
transaction is expected to close in the first half of 1997.
The pro forma effect on SBC's consolidated statements of income had the
merger occurred on January 1, 1994 is as follows:
This pro forma information does not include the effect of changes, which
will be applied retroactively, to conform accounting methodologies between
PAC and SBC for, among other items, pensions, postretirement benefits,
sales commissions or merger transaction costs and certain deferred tax
adjustments resulting from the merger. Based on information currently
available, management estimates these changes will not materially affect
the pro forma operating revenues or income before extraordinary loss and
cumulative effect of accounting changes, and estimates the changes will
reduce the pro forma 1995 extraordinary loss from discontinuance of
regulatory accounting by between $100 and $200.
4. Property, Plant and Equipment
Property, plant and equipment is summarized as follows at December 31:
SBC's depreciation expense as a percentage of average depreciable plant
was 6.8% for 1996 and 6.9% for 1995 and 1994.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1996, 1995 and
1994 were $171, $138 and $126. At December 31, 1996, the future minimum
rental payments under noncancelable operating leases for the years 1997
through 2001 were $105, $91, $94, $51 and $30 and $167 thereafter. Capital
leases were not significant.
5. Equity Investments
Investments in affiliates accounted for under the equity method consist
principally of SBC's investment in Telefonos de Mexico, S.A. de C.V.
(Telmex), Mexico's national telecommunications company. SBC is a member
of a consortium that holds all of the Class AA shares of Telmex stock,
representing voting control of the company. The consortium is controlled
by a group of Mexican investors led by an affiliate of Grupo Carso, S.A.
de C.V. SBC also owns Class L shares which have limited voting rights.
In January 1997, SBC sold a portion of its Class L shares so that its total
equity investment was below 10% of Telmex's total equity capitalization.
In December 1994 SBC made an equity investment in French cellular
operations (see Note 12). Other equity investments held by SBC include
interests in Australian and Israeli operations which provide directory,
cable television and other services, minority ownership of several domestic
wireless properties and 1995 investments in Chilean telecommunications and
South African wireless operations.
The following table is a reconciliation of SBC's investments in equity
affiliates:
Currency translation adjustments for 1995 and 1994 primarily reflect the
effect on SBC's investment in Telmex resulting from the decline in the
value of the Mexican peso relative to the U.S. dollar during those years.
Beginning in 1997, SBC will use the U.S. dollar, instead of the peso, as
the functional currency for its investment in Telmex due to the Mexican
economy becoming highly inflationary.
Other adjustments for 1995 reflect the change to the cost method of
accounting in October 1995 for SBC's United Kingdom cable television
operations (see Note 12) and the reclassification of a credit deferred
in 1994 pending completion of the French cellular investment in 1995.
Other adjustments for 1994 reflect the change to the equity method of
accounting for SBC's previously consolidated United Kingdom cable
television operations.
Undistributed earnings from equity affiliates were $837 and $663 at
December 31, 1996 and 1995.
6. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
During 1995, SBC refinanced long-term debentures of the Telephone Company.
Costs of $18 associated with refinancing are included in other income
(expense) - net, with related income tax benefits of $7 included in income
taxes in SBC's Consolidated Statements of Income.
At December 31, 1996, the aggregate principal amounts of long-term debt
scheduled for repayment for the years 1997 through 2001 were $404, $302,
$447, $323 and $270. As of December 31, 1996, SBC 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:
The weighted average interest rate on commercial paper debt at December 31,
1996 and 1995 was 5.5% and 5.7%. SBC has entered into agreements with
several banks for lines of credit totaling $750. All of these agreements
may be used to support commercial paper borrowings and are on a negotiated
fee basis with interest rates negotiable at time of borrowing. There were
no borrowings outstanding under these lines of credit at December 31, 1996.
7. Financial Instruments
The carrying amounts and estimated fair values of SBC's long-term debt,
including current maturities, are summarized as follows at December 31:
The fair values of SBC's long-term debt were estimated based on quoted
market prices, where available, or on discounted future cash flows using
current interest rates. The carrying amounts of commercial paper debt
approximate fair values.
SBC does not hold or issue any financial instruments for trading
purposes. SBC's cash equivalents and short-term investments are
recorded at amortized cost. Short-term investments were $432 and $243
at December 31, 1996 and 1995. The carrying amounts of cash and cash
equivalents and short-term investments approximate fair values.
8. Income Taxes
Significant components of SBC's deferred tax liabilities and assets are as
follows at December 31:
As a result of implementing Financial Accounting Standards No. 109,
"Accounting for Income Taxes," in 1993, the Telephone Company recorded a
net reduction in its deferred tax liability. This reduction was
substantially offset by the establishment of a net regulatory liability,
which was eliminated with the discontinued application of FAS 71 in
September 1995 (see Note 2).
The decrease in the valuation allowance is the result of an evaluation of
the uncertainty associated with the realization of certain deferred tax
assets. The valuation allowance is maintained in deferred tax assets for
certain unused federal and state loss carryforwards.
The components of income tax expense are as follows:
A reconciliation of income tax expense and the amount computed by applying
the statutory federal income tax rate (35%) to income before income taxes
and extraordinary loss is as follows:
9. Employee Benefits
Pensions - Substantially all employees of SBC are covered by
noncontributory pension and death benefit plans. The pension benefit
formula used in the determination of pension cost is based on a flat dollar
amount per year of service according to job classification for
nonmanagement employees and a stated percentage of adjusted career income
for management employees.
SBC's objective in funding the plans, in combination with the standards of
the Employee Retirement Income Security Act of 1974 (as amended), is to
accumulate funds sufficient to meet its benefit obligations to employees
upon their retirement. Contributions to the plans are made to a trust for
the benefit of plan participants. Plan assets consist primarily of stocks,
U.S. government and domestic corporate bonds and real estate.
Net pension cost is composed of the following:
The following table sets forth the pension plans' funded status and the
amounts included in SBC's Consolidated Balance Sheets at December 31:
Significant assumptions used in developing pension information include:
The projected benefit obligation is the actuarial present value of all
benefits attributed by the pension benefit formula to previously rendered
employee service. It is measured based on assumptions concerning future
interest rates and employee compensation levels. Should actual experience
differ from the actuarial assumptions, the benefit obligation will be
affected.
The actuarial estimate of the accumulated benefit obligation does not
include assumptions about future compensation levels. The accumulated
benefit obligation as of December 31, 1996, was $6,562, of which $5,512 was
vested. At December 31, 1995, these amounts were $6,350 and $5,607.
In December 1996, under the provisions of Section 420 of the Internal
Revenue Code, SBC transferred $73 in pension assets to a health care
benefit account for the reimbursement of retiree health care benefits paid
by SBC.
Supplemental Retirement Plans - SBC also provides senior and middle
management employees with nonqualified, unfunded supplemental retirement
and savings plans. The plans allow employees to defer and invest portions
of their current compensation for later payment, and SBC matches a
percentage of the compensation deferral according to thresholds specified
in the plans. Expenses related to these plans were $69, $68 and $68 in
1996, 1995 and 1994. Liabilities of $626 and $584 related to these plans
have been included in other noncurrent liabilities in SBC's Consolidated
Balance Sheets at December 31, 1996 and 1995.
Postretirement Benefits - SBC 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.
Postretirement benefit cost is composed of the following:
SBC maintains collectively bargained Voluntary Employee Beneficiary
Association (CBVEBA) trusts to fund postretirement benefits. During 1996
and 1995, SBC contributed $57 and $151 into the CBVEBA trust to be
ultimately used for the payment of postretirement benefits. Assets consist
principally of stocks and U.S. government and corporate bonds.
The following table sets forth the plans' funded status and the amount
included in SBC's Consolidated Balance Sheets at December 31:
In December 1995, the life insurance benefit plan and the medical plan were
merged. Also in December 1995, $109 of postretirement life insurance
assets were transferred to the CBVEBA trusts. The fair value of plan
assets restricted to the payment of life insurance benefits only were $265
and $245 at December 31, 1996 and 1995. At December 31, 1996 and 1995, the
accrued life insurance benefits included in the accrued postretirement
benefit obligation were $107 and $91.
The assumed medical cost trend rate in 1997 is 8%, decreasing gradually to
5.5% in 2002, prior to adjustment for cost-sharing provisions of the plan
for active and certain recently retired employees. The assumed dental cost
trend rate in 1997 is 6.25%, reducing to 5.0% in 2002. Raising the annual
medical and dental cost trend rates by one percentage point increases the
APBO as of December 31, 1996 by $135 and increases the aggregate service
and interest cost components of the net periodic postretirement benefit
cost for the year ended December 31, 1996 by approximately $16.
Significant assumptions for the discount rate, long-term rate of return on
plan assets and composite rate of compensation increase used in developing
the APBO were the same as those used in developing the pension information.
Employee Stock Ownership Plans - SBC maintains contributory savings plans
which cover substantially all employees. Under the savings plans, SBC
matches a stated percentage of eligible employee contributions, subject to
a specified ceiling.
SBC has two leveraged Employee Stock Ownership Plans (ESOPs) as part of the
existing savings plans. The ESOPs were funded with notes issued by the
savings plans, the proceeds of which were used to purchase shares of SBC's
common stock in the open market. The notes are unconditionally guaranteed
by SBC and will be repaid with SBC contributions to the savings plans,
dividends paid on SBC shares and interest earned on funds held by the
ESOPs.
SBC's match of employee contributions to the savings plans is fulfilled
with shares of stock allocated from the ESOPs and with purchases of SBC's
stock in the open market. Benefit cost is based on a combination of the
contributions to the savings plans and the cost of shares allocated to
participating employees' accounts. Both benefit cost and interest expense
on the notes are reduced by dividends on SBC's shares held by the ESOPs and
interest earned on the ESOPs' funds.
Information related to the ESOPs and the savings plans is summarized below:
SBC shares held by the ESOPs are summarized as follows at December 31:
10. Stock Option Plans
Various SBC plans authorize the issuance of stock options to senior and
other management employees to purchase up to 69 million shares of SBC
common stock, of which 32 million have been issued. Options issued through
December 31, 1996 carry exercise prices equal to the market price of the
stock at the date of grant and have maximum terms ranging from five to ten
years. Depending upon the plan, vesting of options occurs one to three
years from the date of grant.
In 1996 SBC elected to continue measuring compensation cost for these plans
using the intrinsic value based method of accounting prescribed in
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 1996 and 1995 as defined by
FAS 123, SBC's net income (loss) would have been $2,075 and $(939) and net
income (loss) per share would have been $3.42 and $(1.54).
For purposes of these pro forma disclosures, the estimated fair value of
the options granted after 1994 is amortized to expense over the options'
vesting period. Because most employee options vest over a two to three
year period, these disclosures will not be indicative of future pro forma
amounts until the FAS 123 rules are applied to all outstanding non-vested
awards. The fair value for these options was estimated at the date of
grant, using a Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1996 and 1995: risk-free
interest rate of 6.37% and 6.31%; dividend yield of 3.45% and 3.45%;
expected volatility factor of 16% and 18%; and expected option life of 4.5
and 4.6 years.
Information related to options is summarized below:
Information related to options outstanding at December 31, 1996:
The weighted-average grant-date fair value of each option granted during
the year was $8.32 for 1996 and $8.45 for 1995.
11. Shareowners' Equity
Share Repurchases - From time to time, SBC has repurchased shares of common
stock for distribution, to offset shares distributed through its employee
benefit plans and SBC's Dividend Reinvestment Plan, in connection with
certain acquisitions or for general purposes. In January 1997, the Board
of Directors of SBC (Board) rescinded all authorizations to repurchase
common stock.
Guaranteed Obligations of Employee Stock Ownership Plans - SBC's guarantee
of the ESOPs' notes issued by the savings plans (see Note 9) is presented
as a reduction to shareowners' equity and an increase in long-term debt.
The amount of debt guaranteed decreases as the notes are repaid.
Shareowners' Rights Plan - The Shareowners' Rights Plan (Plan) becomes
operative in certain events involving the acquisition of 20% or more of
SBC's common stock by any person or group in a transaction not approved by
the Board, or the designation by the Board of a person or group owning more
than 10% of the outstanding stock as an adverse person, as provided in the
Plan. Upon the occurrence of these events, each right, unless redeemed by
the Board, generally entitles the holder (other than the holder triggering
the right) to purchase an amount of common stock of SBC (or, in certain
circumstances, of the potential acquiror) having a value equal to two times
the exercise price of $160. The rights expire in January 1999. After
giving effect to a stock split in May 1993, effected in the form of a stock
dividend, each share of common stock represents one-half of a right.
The rights have certain antitakeover effects. The rights will cause
substantial dilution to a person or group that attempts to acquire SBC on
terms not approved by the Board.
The rights should not interfere with any merger or other business
combination approved by the Board since the rights may be redeemed.
12. Acquisitions and Dispositions
In October 1995, SBC combined its United Kingdom cable television
operations with those of TeleWest Communications, P.L.C., a publicly held
joint venture between Telecommunications, Inc. and U S WEST, Inc. The
resulting entity, TeleWest P.L.C. (TeleWest), is the largest cable
television operator in the United Kingdom. SBC owns approximately 15% of
the new entity and accounts for its investment using the cost method of
accounting. Restrictions expiring over the next four years exist on the
sale of SBC's interest in TeleWest. SBC recorded an after-tax gain of $111
associated with the combination.
During 1994, SBC purchased two cable television systems located in
Montgomery County, Maryland, and Arlington County, Virginia, for $650.
Also in 1994, SBC acquired the domestic wireless business of Associated
Communications Corporation (Associated) for $705, including wireless
systems in Buffalo, Rochester, Albany and Glens Falls, New York, and in two
separate transactions purchased smaller wireless systems in Syracuse, Utica
and Ithaca, New York, which are adjacent to the Associated properties.
In October 1994, SBC formed a strategic alliance with Compagnie
Generale des Eaux (CGE), a French diversified public company. Through this
alliance, SBC acquired an indirect 10% ownership of Societe Francaise du
Radiotelephone S.A. (SFR), a nationwide cellular company in France, and
minority ownership interests in other communications businesses controlled
by CGE, and CGE obtained an effective 10% interest in SBC's wireless
operations in Washington, D.C.-Baltimore and surrounding rural markets.
SBC and CGE both made contributions to the alliance. SBC's effective
contribution was $376. This investment is accounted for under the equity
method of accounting.
In addition to payments shown in the Consolidated Statements of Cash Flows,
the 1994 acquisitions were also financed through the issuance of 16 million
new and treasury shares, valued at approximately $660, and the issuance of
approximately $360 of long-term debt. All of the acquisitions were
accounted for under the purchase method of accounting. The purchase prices
in excess of the underlying fair value of identifiable net assets acquired
are being amortized over periods not to exceed 40 years. Results of
operations of the properties acquired have been included in the
consolidated financial statements from their respective dates of
acquisition.
The above developments did not have a significant impact on consolidated
results of operations for 1995 and 1994, nor would they had they occurred
on January 1 of the respective periods.
13. Additional Financial Information
No customer accounted for more than 10% of consolidated revenues in 1996 or
1995. Approximately 10% of SBC's consolidated revenues in 1994 were from
services provided to AT&T Corp. No other customer accounted for more than
10% of consolidated revenues in 1994.
Three subsidiaries of SBC have negotiated contracts with the Communications
Workers of America (CWA), none of which is subject to renegotiation in
1997. Approximately 67% of SBC's employees are represented by the CWA.
14. Quarterly Financial Information (Unaudited)
Report of Management
The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. The
integrity and objectivity of the data in these financial
statements, including estimates and judgments relating to matters
not concluded by year end, are the responsibility of management,
as is all other information included in the Annual Report, unless
otherwise indicated.
The financial statements of SBC Communications Inc. (SBC) have
been audited by Ernst & Young LLP, independent auditors.
Management has made available to Ernst & Young LLP all of SBC's
financial records and related data, as well as the minutes of
shareowners' and directors' meetings. Furthermore, management
believes that all representations made to Ernst & Young LLP
during its audit were valid and appropriate.
Management has established and maintains a system of internal
accounting controls that provides reasonable assurance as to the
integrity and reliability of the financial statements, the
protection of assets from unauthorized use or disposition and the
prevention and detection of fraudulent financial reporting. The
concept of reasonable assurance recognizes that the costs of an
internal accounting controls system should not exceed, in
management's judgment, the benefits to be derived.
Management also seeks to ensure the objectivity and integrity of
its financial data by the careful selection of its managers, by
organizational arrangements that provide an appropriate division
of responsibility and by communication programs aimed at ensuring
that its policies, standards and managerial authorities are
understood throughout the organization. Management continually
monitors the system of internal accounting controls for
compliance. SBC maintains an internal auditing program that
independently assesses the effectiveness of the internal
accounting controls and recommends improvements thereto.
The Audit Committee of the Board of Directors, which consists of
six directors who are not employees, meets periodically with
management, the internal auditors and the independent auditors to
review the manner in which they are performing their
responsibilities and to discuss auditing, internal accounting
controls and financial reporting matters. Both the internal
auditors and the independent auditors periodically meet alone
with the Audit Committee and have access to the Audit Committee
at any time.
/s/ Edward E. Whitacre Jr.
Edward E. Whitacre Jr.
Chairman of the Board and
Chief Executive Officer
/s/ Donald E. Kiernan
Donald E. Kiernan
Senior Vice President, Treasurer
and Chief Financial Officer
Report of Independent Auditors
The Board of Directors and Shareowners
SBC Communications Inc.
We have audited the accompanying consolidated balance sheets of
SBC Communications Inc. (SBC) as of December 31, 1996 and 1995,
and the related consolidated statements of income, shareowners'
equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the
responsibility of SBC's management. Our responsibility is to
express an opinion on these financial statements 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 consolidated financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of SBC Communications Inc. at December 31,
1996 and 1995, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements,
SBC discontinued its application of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of
Certain Types of Regulation" in 1995.
ERNST & YOUNG LLP
San Antonio, Texas
February 14, 1997
Stock Trading Information
Trading: SBC is listed on the New York, Chicago and Pacific
stock exchanges, as well as The London Stock Exchange and The
Swiss Exchange.
Ticker symbol (NYSE): SBC
Newspaper stock listing: SBC Comm or SBC
The above information appears on the inside back cover of the printed Annual
Report.
APPENDIX
All page numbers referenced in this Exhibit and the Form 10-K
relate to the printed Annual Report. The order of the sections
is as they appear in the printed Annual Report. The colored
graphs and related footnotes that appear in the printed document
are approximately 1-1/2 inches by 3-1/2 inches. The Stock Data
section appears on the inside back cover.
The section titled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appears on pages
9-19. The text of this section appears in two columns.
A bar graph titled "Operating Income (dollars in billions)"
appears in the right column on page 9 and to the right side of
the section titled "Results of Operations - Summary". The graph
shows Operating Income for the past five years. The actual
figures are listed on the graph. Listed below are the plot
points:
1992 2.2
1993 2.4
1994 2.8
1995 3.0
1996 3.6
The following footnote appears at the base of the graph:
Operating income has grown by more than half since 1992.
A stacked bar graph titled "Local Service (dollars in billions)"
appears in the left column on page 10 and to the left of the
subsection titled "Local Service". The graph shows local service
revenues by categories for the past five years. Listed below are
the plot points:
Year Total Wireless Landline
1992 4.7 1.0 3.7
1993 5.2 1.3 3.9
1994 5.8 1.8 4.0
1995 6.5 2.2 4.3
1996 7.4 2.7 4.7
The following footnote appears at the base of the graph:
Wireless local services revenues have nearly tripled in the last
four years.
A stacked bar graph titled "Distribution of Revenues (dollars in
billions)" appears in the right column on page 11 and to the
right of the section titled "Operating Expenses". The graph
shows various categories of revenues for the past five years.
The actual figures are listed on the graph. Listed below are
the plot points by category:
Local Network Directory
Year Total service access Long- advertising Other
distance
1992 10.2 4.7 2.5 1.0 0.9 1.1
1993 10.8 5.2 2.7 1.0 0.8 1.1
1994 11.8 5.8 2.9 0.9 0.9 1.3
1995 12.7 6.5 3.1 0.8 1.0 1.3
1996 13.9 7.4 3.2 1.0 0.9 1.4
The following footnote appears at the base of the graph: Local
service revenue growth represents nearly three-fourths of the
increase in operating revenues since 1992.
A stacked bar graph titled "Distribution of Expenses (dollars in
billions)" appears in the left column on page 12 and to the
left side of the subsection titled "Equity in Net Income of
Affiliates". The graph shows the categories of expenses for the
past five years. The actual figures are listed on the graph.
Listed below are the plot points:
Cost of
services Selling, Depreciation
Year Total and general and and
products administrative amortization
1992 8.0 3.4 2.7 1.9
1993 8.5 3.4 3.1 2.0
1994 9.0 3.8 3.2 2.0
1995 9.6 3.8 3.6 2.2
1996 10.3 4.1 4.0 2.2
The following footnote appears at the base of the graph:
Expenses as a percentage of operating revenues decreased for the
fourth consecutive year.
In the section titled "Operating Environment and Trends of the
Business", on page 13 an icon (approximately one inch) of the state
of Texas, appears in the left column.
A stacked bar graph titled "Access Lines (in millions)" appears
in the right column on page 13 and to the right side of the
subsection titled "Texas". The graph shows access lines in total
and by state for the past five years. The actual figures are
listed on the graph. Listed below are the plot points:
Year Total Texas Missouri Oklahoma Kansas Arkansas
1992 12.7 7.3 2.1 1.4 1.1 0.8
1993 13.1 7.6 2.2 1.4 1.1 0.8
1994 13.6 7.9 2.2 1.4 1.2 0.9
1995 14.2 8.3 2.3 1.5 1.2 0.9
1996 15.0 8.8 2.4 1.6 1.3 0.9
The following footnote appears at the base of the graph: Texas
accounts for nearly two-thirds of access line growth since 1992.
A stacked bar graph titled "Business Access Lines (in millions)"
appears in the left column on page 14 and to the left side of the
subsection titled "Missouri". The graph shows business access
lines in total for the past five years. The actual figures are
listed on the graph. Listed below are the plot points:
Year Total
1992 3.7
1993 4.0
1994 4.2
1995 4.5
1996 4.9
The following footnote appears at the base of the graph: Business
access lines have grown nearly one-third 1992.
In the subsections titled "Missouri" and "Oklahoma" on page 14,
icons (approximately one inch) of the states of Missouri and
Oklahoma in the left and right columns, respectively.
A bar graph titled "Additional Lines (in thousands)" appears in
the right column on page 15 and to the right side of the
subsection titled "Domestic". The graph shows additional lines
for the past 5 years. The actual figures are listed on the
graph. Listed below are the plot points.
1992 732.5
1993 793.9
1994 878.9
1995 1,030.1
1996 1,244.2
The following footnote appears at the base of the graph:
Additional lines growth represents nearly one-fourth of the
increase in access lines since 1992.
A bar graph titled "Wireless Penetration (in percent)" appears in
the left column on page 16. The graph shows the percentage of
Wireless Penetration for the past five years. Listed below are
the plot points:
1992 4.0%
1993 5.7%
1994 7.4%
1995 9.0%
1996 10.8%
The following footnote appears at the base of the graph: SBC's
wireless penetration leads the industry.
In the subsection titled "International" on page 17, an icon
(approximately one inch) of the country of Mexico appears in the
left column.
A bar graph titled "Capital Expenditures (dollars in billions)"
appears in the left column on page 18 and to the left side of the
section titled "Liquidity and Capital Resources". The graph shows
Capital Expenditures for the past five years. The actual figures
are listed on the graph. Listed below are the plot points:
1992 2.1
1993 2.2
1994 2.4
1995 2.3
1996 3.0
The following footnote appears at the base of the graph: Capital
expenditures have increased for growth and network modernization.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Dollars in millions except per share amounts
SBC Communications Inc. (SBC) is a holding company whose subsidiaries and
affiliates operate predominantly in the communications services industry. SBC's
subsidiaries and affiliates provide landline and wireless telecommunications
services and equipment, directory advertising and cable television services.
SBC's largest subsidiary is Southwestern Bell Telephone Company (Telephone
Company), which provides telecommunications services over approximately
15 million access lines in Texas, Missouri, Oklahoma, Kansas and Arkansas (five-
state area). The Telephone Company is subject to regulation by each of the
state jurisdictions in which it operates and by the Federal Communications
Commission (FCC). In 1996, the Telephone Company provided 70% of SBC's
operating revenues and 65% of its net income.
This discussion should be read in conjunction with the consolidated financial
statements and the accompanying notes.
RESULTS OF OPERATIONS
SUMMARY
Financial results, including percentage changes from the prior year, are
summarized as follows:
SBC recognized an extraordinary loss in 1995 from the discontinuance of
regulatory accounting at the Telephone Company.
The primary factors contributing to the increase in income before extraordinary
loss in 1996 were growth in demand for services and products at the Telephone
Company and Southwestern Bell Mobile Systems, Inc. (Mobile Systems).
The primary factors contributing to the increase in income before extraordinary
loss in 1995 were growth in demand for services and products at the Telephone
Company and Mobile Systems, and an after-tax gain of $111 associated with the
merger of SBC's United Kingdom cable television operations into TeleWest P.L.C.
(TeleWest). These factors were partially offset by an after-tax charge of $88
recorded in connection with SBC's strategic functional realignment.
Items affecting the comparison of the operating results between 1996 and 1995,
and between 1995 and 1994, are discussed in the following sections.
OPERATING REVENUES
Total operating revenues increased $1,228, or 9.7%, in 1996 and $898, or 7.6%,
in 1995. Components of total operating revenues, including percentage changes
from the prior year, are as follows:
LOCAL SERVICE Landline revenues increased in 1996 and 1995 due to increases
in demand, primarily increases in residential and business access lines and
vertical services revenues. Total access lines increased 5.1% in 1996 and
4.5% in 1995. Nearly two-thirds of the access line growth occurred in
Texas, which now has approximately 59% of the Telephone Company's access
lines. Approximately 29% in 1996 and 25% in 1995 of access line growth was
due to the sales of additional access lines to existing residential
customers. Vertical services revenues, which include custom calling
options, Caller ID and other enhanced services, increased by approximately
22% in 1996 and 17% in 1995.
Wireless revenues increased in 1996 and 1995 due primarily to the growth in
the number of cellular customers of 20.2% and 22.3%. These increases were
partially offset by slight declines in average revenue per customer. Market
penetration at the end of 1996, 1995 and 1994 was 10.8, 9.0 and 7.4
customers per 100 residents in Mobile Systems' service areas.
NETWORK ACCESS Interstate network access revenues increased in 1996 and
1995 due largely to increases in demand for access services by interexchange
carriers. Growth in revenues from end user charges, attributable to an
increasing access line base, also contributed to the increases in both
years. Net rate reductions under the FCC's revised price cap plan, which
was effective August 1, 1995, partially offset these increases by
approximately $65 in both 1996 and 1995.
Intrastate network access revenues increased in 1996 and 1995 due primarily
to increases in demand, including usage by alternative intraLATA toll
carriers.
LONG-DISTANCE SERVICE revenues increased in 1996 due principally to growth
in Mobile Systems' wireless revenues including interLATA service that began
in February 1996, and the inclusion in 1995 of the Telephone Company's
intraLATA toll pool settlement payments and accruals for rate reductions
relating to an appealed 1992 rate order in Oklahoma. The settlement of the
appeals in October 1995 eliminated the need to continue these accruals.
Absent these accruals and settlements, the Telephone Company's long-distance
service revenues in 1996 would have decreased slightly due to the continuing
impact of price competition from alternative intraLATA toll carriers.
Competition had less impact on message volumes in 1996 due to the Telephone
Company's deployment and promotion of optional long-distance calling plans,
which generally result in higher message volumes but lower average revenue
per message. This message volume trend is not expected to continue, because
the Telephone Company plans to emphasize promotions of extended area local
service plans. Long-distance service revenues decreased in 1995, reflecting
competition-related decreases in residential message volumes and the impact
of optional calling plans and extended area service plans.
DIRECTORY ADVERTISING revenues decreased in 1996 as increased yellow pages
revenues from Southwestern Bell Yellow Pages, Inc. were more than offset by
the decrease resulting from the January 1996 sale of SBC's publishing
contracts for GTE Corporation's service areas to GTE Directories. Excluding
the impact of this sale, revenues increased 6.7% in 1996. Revenues in 1995
were relatively unchanged from 1994, reflecting the impact of increased
competition.
OTHER operating revenues in 1996 and 1995 reflect the increased demand for
the Telephone Company's non-regulated services and products, including
Caller ID equipment, computer network services, contract programming and
videoconferencing services. The increase in 1995 was offset by the decrease
in equipment sales revenues at Mobile Systems resulting primarily from
declining equipment prices.
OPERATING EXPENSES
Total operating expenses increased $709, or 7.4%, in 1996 and $623, or 6.9%, in
1995. Components of total operating expenses, including percentage changes from
the prior year, are as follows:
COST OF SERVICES AND PRODUCTS increased in 1996 due to increases at the
Telephone Company for network expansion and maintenance, employee
compensation and demand-related increases, primarily increases in switching
system software license fees. Other increases in 1996 related principally
to growth at Mobile Systems. Similarly, in 1995, expenses increased
primarily due to increases at the Telephone Company for network expansion
and maintenance, employee compensation, and demand-related increases for
enhanced services. These increases were mostly offset by decreased
switching system software license fees at the Telephone Company, decreased
equipment costs at Mobile Systems and the absence of expenses associated
with SBC's United Kingdom cable television operations (discussed in Other
Business Matters).
SELLING, GENERAL AND ADMINISTRATIVE expenses increased in 1996 and 1995
primarily due to growth-related increases at Mobile Systems and the
Telephone Company including increases in operating taxes, which include the
Texas Infrastructure Fund assessments, contracted services, employee
compensation, advertising and uncollectibles. The increase in 1995 was also
attributable to the $139 charge for costs associated with the strategic
realignment discussed in Other Business Matters.
DEPRECIATION AND AMORTIZATION increased in 1996 and 1995 due primarily to
growth in plant levels and changes in plant composition, primarily at Mobile
Systems and the Telephone Company. The increase in 1995 also reflects the
effect of regulatory depreciation represcription at the Telephone Company.
INTEREST EXPENSE decreased $43, or 8.3%, in 1996 due to lower interest rates on
short-term debt, lower long-term debt levels, and capitalization of interest
during construction required by the discontinuance of regulatory accounting in
the third quarter of 1995. Under regulatory accounting, the Telephone Company
accounted for a capitalization of both interest and equity costs during periods
of construction as other income. Interest expense increased $35, or 7.3%, in
1995 due primarily to an increase in the average amount of debt outstanding to
finance growth and acquisitions at Mobile Systems. Interest expense for 1995
also reflects debt issued for acquisitions in France and Chile.
EQUITY IN NET INCOME OF AFFILIATES increased $88 in 1996 and decreased $67 in
1995. The 1996 increase reflects increased income from Telefonos de Mexico,
S.A. de C.V. (Telmex), Mexico's national telecommunications company, due to the
relative stabilization of the peso, net gains on international affiliate
transactions and improved results from SBC's investment in French cellular
operations. Results for 1995 include losses on SBC's United Kingdom cable
television operations, which were accounted for under the equity method prior to
October 1995, and exchange losses on the non-peso denominated debt of Telmex.
Results for 1996 and 1995 also reflect reductions in the translated amount of
U.S. dollar earnings from Telmex's operations. Operational growth at Telmex in
both years somewhat offsets these declines. The 1995 decrease is also
attributable to SBC's investment in French cellular operations.
SBC's future earnings from Telmex will continue to be sensitive to changes in
the value of the peso. SBC's investment in Telmex has been recorded under U.S.
generally accepted accounting principles (GAAP), which exclude inflation
adjustments and include adjustments for the purchase method of accounting.
Beginning in 1997, SBC will use the U.S. dollar, instead of the peso, as the
functional currency for its investment in Telmex due to the Mexican economy
becoming highly inflationary as defined by GAAP. Earnings in 1997 will reflect
SBC's reduced ownership percentage in Telmex as discussed in Note 5 to the
financial statements. These changes are each expected to have a slightly
negative impact on equity in net income from Telmex.
OTHER INCOME (EXPENSE) - NET In 1995, SBC recognized a gain from the merger of
SBC's United Kingdom cable television operations into TeleWest (see Note 12 to
the financial statements). The gain was somewhat offset by expenses associated
with the refinancing of long-term debt by the Telephone Company (see Note 6 to
the financial statements).
FEDERAL INCOME TAX expense increased $233, or 28.3%, in 1996 and $140, or 20.5%,
in 1995, primarily due to higher income before income taxes. The elimination of
excess deferred taxes and the reduction in the amortization of investment tax
credits resulting from the discontinuance of regulatory accounting, as described
in Note 2 to the financial statements, also contributed to the increases in both
years.
EXTRAORDINARY LOSS In 1995, SBC recorded an extraordinary loss of $2.8 billion
from the discontinuance of regulatory accounting. The loss included a reduction
in the net carrying value of telephone plant partially offset by the elimination
of net regulatory liabilities of the Telephone Company (see Note 2 to the
financial statements).
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
REGULATORY ENVIRONMENT
The Telephone Company's telecommunications operations are subject to regulation
by each of the five states in which it operates for intrastate services and by
the FCC for interstate services. Through the end of 1996, the Telephone Company
operated under incentive regulation or price caps for various services provided
by the Telephone Company. In early 1997, Arkansas enacted legislation
establishing incentive regulation for electing companies, replacing a settlement
which had expired on December 31, 1996. Under price cap regulation, the
Telephone Company is permitted to establish and modify prices, not to exceed the
price caps, subject to expedited approval by the governing jurisdiction. Prices
for some other services not specifically covered by price caps are also subject
to regulatory approval.
The states set intrastate price caps for various periods, depending upon the
state. Price caps set by the FCC are adjusted annually for inflation, a
productivity offset and certain other changes in costs. The productivity offset
is a fixed percentage used to reduce price caps and is designed to encourage
increased productivity.
Under the original FCC plan adopted in 1991, the Telephone Company applied a
productivity offset of 3.3%, with sharing at various rates of return on
investment. The FCC adopted revised price cap rules effective August 1, 1995.
The new rules allowed a choice of three new productivity offsets, two of which
provide for a sharing of profits with consumers above certain earnings levels.
The Telephone Company elected a 5.3% productivity offset with no sharing.
The revised FCC price cap plan was intended to be an interim plan that would be
revised in 1996. However, with the passage of the Telecommunications Act of
1996 (the Telecom Act), the FCC is conducting further proceedings to address
various pricing and productivity issues, and is performing a broader review of
price cap regulation in a competitive environment. Additionally, the FCC will
also examine universal service and access charge rules during 1997. The Telecom
Act and FCC actions taken to implement provisions of the Telecom Act are
discussed further under the heading "Competition."
Following is a summary of significant state regulatory developments.
TEXAS The Public Utility Regulatory Act, which became effective in May 1995
(PURA), allows the Telephone Company and other Local Exchange Carriers (LECs) to
elect to move from rate of return regulation to price regulation with
elimination of earnings sharing. In September 1995, the Telephone Company
notified the Texas Public Utility Commission (TPUC) that it elected incentive
regulation under the new law. Basic local service rates are capped at existing
levels for four years following the election. The TPUC is prohibited from
reducing switched access rates charged by LECs to interexchange carriers for the
four-year election period.
LECs electing price regulation must commit to network and infrastructure
improvement goals, including expansion of digital switching and advanced
high-speed services to qualifying public institutions, such as schools,
libraries and hospitals, requesting the services. PURA also established an
infrastructure grant fund for use by public institutions in upgrading their
communications and computer technology. PURA provided for a total fund
assessment of $150 annually on all telecommunications providers in Texas for a
ten-year period, half of which would be paid by the cellular and wireless
industry. The provisions establishing different assessment rates for landline
and cellular and wireless service providers were ruled unconstitutional under
the Texas constitution in January 1996, and the lower rate was ordered to be
applied to both categories of service providers, resulting in less than a $150
annual assessment. Based on this order, SBC's total annual payment is estimated
to be approximately $35 to $45. The 1997 Texas legislative session is
considering this issue with the goal of restoring the assessment to its original
$150 annual amount. As a result, SBC's annual payment could increase.
PURA establishes local exchange competition by allowing other companies who
desire to provide local exchange services to apply for certification by the
TPUC, subject to certain build-out requirements, resale restrictions and minimum
service requirements. PURA provides that the Telephone Company will remain the
default carrier of "1 plus" intraLATA toll traffic until all LECs are allowed to
carry interLATA long-distance.
In 1996, MCI Communications Corporation (MCI) and AT&T Corp. (AT&T) sued the
state of Texas, alleging that PURA violates the Texas state constitution,
claiming PURA establishes anticompetitive barriers designed to prevent MCI, AT&T
and Sprint Corporation (Sprint) from providing local services within Texas. SBC
is unable to predict the outcome of this proceeding. During 1996, the TPUC
approved the application of Sprint to be granted a certificate of authority to
provide local service, waiving the build-out requirements specified under state
law for facilities-based certificates of authority. AT&T and MCI have also
filed petitions with the FCC arguing the build-out requirements should be
preempted; they have also requested TPUC grant them similar treatment as Sprint.
TPUC has also requested the FCC issue an expedited ruling on whether PURA's
build-out requirements are lawful under the Telecom Act.
More than 80 applications to provide competitive local service certification
have been approved by the TPUC, with over 30 more applications pending approval.
As a result, the Telephone Company expects competition to continue to develop
for local service, but the specific financial impacts of this competition cannot
be reasonably estimated until all required tariff filings are approved by the
TPUC for the Telephone Company and other companies intending to provide local
service.
MISSOURI During 1996, the 1995 Cole County Circuit Court ruling which
overturned the August 1994 settlement agreement reached among the Telephone
Company, the Missouri Public Service Commission (MPSC) and the Office of Public
Counsel (OPC) was upheld on appeal. The practical effect of this decision is to
eliminate the prospective commitments under the settlement agreement, including
a rate review moratorium and capital investment commitments. The decision has
no immediate impact on the Telephone Company's current rates because they were
approved by the MPSC in separate proceedings, which were not appealed.
OKLAHOMA On October 30, 1995, the Oklahoma Corporation Commission (OCC)
approved a settlement that resolved pending court appeals of a 1992 rate order.
Under the terms of the settlement, the Telephone Company paid a cash settlement
of $170 to business and residential customers, and offered discounts with a
retail value of $268 for certain Telephone Company services. Previously ordered
rate reductions of $100 were lowered to $84, of which $57 had already been
implemented. The settlement allowed the remaining $27 in rate reductions to be
deferred, with approximately $9 becoming effective in 1996 and the remainder
during 1997. The settlement also provides that no overearnings complaint can be
filed against the Telephone Company until January 1, 1998. The Telephone
Company began accruing for the order in 1992, and the settlement and associated
costs had been fully accrued as of the end of the third quarter of 1995.
COMPETITION
Competition continues to expand in the telecommunications industry. Legislation
and regulation have increased the opportunities for alternative service
providers offering telecommunications services. Technological advances have
expanded the types and uses of services and products available. Accordingly,
SBC faces increasing competition in significant portions of its business.
DOMESTIC
On February 8, 1996, the Telecom Act was enacted into law. The Telecom Act is
intended to address various aspects of competition within, and regulation of,
the telecommunications industry. The Telecom Act provides that all
post-enactment conduct or activities which were subject to the consent decree,
referred to as the Modification of Final Judgment (MFJ), issued at the time of
AT&T's divestiture of the Regional Holding Companies (RHCs) are now subject to
the provisions of the Telecom Act. Among other things, the Telecom Act also
defines conditions SBC must comply with before being permitted to offer
interLATA long-distance service within the five-state area and establishes
certain terms and conditions intended to promote competition for the Telephone
Company's local exchange services. Under terms of the Telecom Act, SBC may
immediately offer interLATA long-distance outside the five-state area and over
its wireless network both inside and outside the five-state area. Before being
permitted to offer landline interLATA long-distance service in any state within
the Telephone Company's five-state region, SBC must apply for and obtain state-
specific approval from the FCC. The FCC's approval, which involves consultation
with the United States Department of Justice, requires favorable determinations
that the Telephone Company has entered into interconnection agreement(s) that
satisfy a 14-point "competitive checklist" with predominantly facilities based
carrier(s) that serve residential and business customers or, alternatively, that
the Telephone Company has a statement of terms and conditions effective in that
state under which it offers the "competitive checklist" items. The FCC must
also make favorable public interest and structural separation determinations.
The Telecom Act directed the FCC to establish rules and regulations to implement
the Telecom Act, and to preempt specific state law provisions under certain
circumstances. The Telecom Act also allows RHCs to provide cable services over
their own networks, but sets limits on RHCs acquiring interests in cable
television operations in their telephone service areas.
In April 1996, the United States District Court for the District of Columbia
issued its Opinion and Order terminating the MFJ and dismissing all pending
motions related to the MFJ as moot. This ruling effectively ended 13 years of
RHC regulation under the MFJ.
In August 1996, the FCC issued rules by which competitors could connect with
LECs' networks, including those of the Telephone Company. Among other things,
the rules addressed unbundling of network elements, pricing for interconnection
and unbundled elements (Pricing Provisions), and resale of network services.
The FCC rules were appealed by numerous parties, including SBC, other LECs,
various state regulatory commissions and the National Association of Regulatory
Utility Commissioners.
On October 15, 1996, the United States Court of Appeals for the Eighth Circuit
(Eighth Circuit) issued an order to stay the FCC's Pricing Provisions and its
rules permitting new entrants to "pick and choose" among the terms and
conditions of approved interconnection agreements. The stay provides that it
will remain in effect while the Eighth Circuit considers the validity of the
rules. Other provisions of rules adopted by the FCC to implement the Telecom
Act remain in effect.
The effects of the FCC rules are dependent on many factors including, but not
limited to: the ultimate resolution of the pending appeals; the number and
nature of competitors requesting interconnection, unbundling or resale; and the
results of the state regulatory commissions' review and handling of related
matters within their jurisdictions. Accordingly, SBC is not able to assess the
impact of the FCC rules.
Recently enacted and pending state laws and regulations also allow increased
competition for local exchange services. Companies wishing to provide
competitive local service have filed numerous applications with state
commissions throughout the Telephone Company's five-state area, and the
commissions of each state have begun approving these applications. Under the
Telecom Act, companies seeking to interconnect to the Telephone Company's
network and exchange local calls must enter into interconnection agreements with
the Telephone Company, which are then subject to approval by the appropriate
state commission. Numerous interconnection agreements have been entered into
and approved in the Telephone Company's five-state area. Several companies who
have failed to agree on all interconnection terms have filed for arbitration
before the state commissions.
In October 1996, the TPUC announced its ruling in a consolidated arbitration
hearing between the Telephone Company and AT&T, MCI, MFS Communications Company,
Inc. (MFS), Teleport Communications Group, and American Communications Services,
Inc. The TPUC approved interim interconnection rates to be charged by the
Telephone Company as well as certain other terms of interconnection between the
parties. Some agreements containing the arbitrated rates and terms have been
approved by the TPUC. The Telephone Company also filed revised cost support for
the establishment of permanent rates with the TPUC, with an anticipated
effective date of April 1997. The Telephone Company has filed suit in state and
federal court maintaining that, for various reasons, the arbitration award is
unlawful.
In Missouri, the MPSC issued orders on a consolidated arbitration hearing with
AT&T and MCI and on selected items with MFS. Among other terms, the orders
established discount rates for resale of Telephone Company services and prices
for unbundled network elements. The Telephone Company has filed suit in federal
court appealing the orders as unlawful.
As a result of the Telecom Act and conforming interconnection agreements, the
Telephone Company expects in 1997 it will experience local exchange competition
from multiple providers in various markets. SBC intends to use approved
agreements in support of its application to the FCC to provide interLATA long-
distance service in the Telephone Company's five-state area.
The Telephone Company also faces competition from various local service
providers that bypass the local exchange network. Some of these providers have
built fiber optic "rings" throughout large metropolitan areas to provide
transport services (generally high-speed data) for large business customers and
interexchange carriers. Others provide high-usage customers, particularly large
businesses, alternative telecommunications links for voice and data, such as
private network systems, shared tenant services or private branch exchange (PBX)
systems (which are customer-owned and provide internal switching functions
without using Telephone Company central office facilities). The extent of the
economic incentive to bypass the local exchange network depends upon local
exchange prices, access charges, regulatory policy and other factors. End user
charges ordered by the FCC are designed in part to mitigate the effect of system
bypass.
Competition continues to intensify in the Telephone Company's intraLATA toll
markets. Principal competitors are interexchange carriers, which are assigned
an access code (e.g., "10XXX") used by their customers to route intraLATA calls
through the interexchange carrier's network, and resellers, which sell toll
services obtained at bulk rates.
In 1993, the FCC adopted an order allocating radio spectrum and outlining the
development of licenses for new personal communications services (PCS). PCS
utilizes wireless telecommunications digital technology at a higher frequency
radio spectrum than cellular. Like cellular, it is designed to permit access to
a variety of communications services regardless of subscriber location. In an
FCC auction, which concluded in March 1995, PCS licenses were awarded in 51
major markets. SBC acquired PCS licenses in the Major Trading Areas (MTAs) of
Memphis, Tennessee; Little Rock, Arkansas; and Tulsa, Oklahoma. SBC is
currently in the build out phase of PCS in Tulsa, Oklahoma. During 1996, SBC
received several AT&T cellular networks in Arkansas in exchange for SBC's PCS
licenses in Memphis, Tennessee and Little Rock, Arkansas and other
consideration. In an FCC auction concluded January 1997, SBC acquired eight
additional PCS licenses for Basic Trading Areas (BTAs) that are within its five-
state area. SBC plans to build out the new BTAs as part of its strategy to be a
full service telecommunications provider. Including these new BTAs, SBC will be
able to offer approximately 85% of its landline local service customers wireless
service as well.
Companies granted licenses in MTAs and BTAs where SBC also provides service
include subsidiaries and affiliates of AT&T, Sprint and other RHCs. The degree
of competition which SBC will encounter from PCS providers will depend on the
timing and extent of the build out of PCS services.
In the future, it is likely that additional competitors will emerge in the
telecommunications industry. Cable television companies and electric utilities
have expressed an interest in, or already are, providing telecommunications
services. As a result of recent and prospective mergers and acquisitions within
the industry, SBC may face competition from entities offering both cable TV and
telephone services in the Telephone Company's operating territory.
Interexchange carriers have been certified to provide local service, and a
number of other major carriers have publicly announced their intent to provide
local service in certain markets, some of which are in the Telephone Company's
five-state area.
SBC is aggressively representing its interests regarding competition before
federal and state regulatory bodies, courts, Congress and state legislatures.
SBC will continue to evaluate the increasingly competitive nature of its
business to develop appropriate competitive, legislative and regulatory
responses.
INTERNATIONAL
Telmex was granted a concession in 1990 which expired in August 1996, as the
sole provider of long-distance services in Mexico. In 1995, the Mexican Senate
and Chamber of Deputies passed legislation encompassing a series of rules for
the introduction of competition into the Mexican long-distance market previously
issued by the Mexican Secretary of Communication and Transportation. Those
rules specified that there would be an unlimited number of long-distance
concessions and that Telmex was required to provide 60 interconnection points by
January 1, 1997, and more than 200 interconnection points by the year 2000.
Several large competitors have announced their intention to compete with Telmex
and have filed for licenses, including a joint venture between AT&T and Alfa, a
Mexican consortium, and Avantel, S.A., a joint venture between MCI and Grupo
Financiero Banamex-Accival, Mexico's largest financial group. Balloting for
presubscription of long-distance service has begun among Telmex's customers in
selected areas.
OTHER BUSINESS MATTERS
MERGER AGREEMENT On April 1, 1996, SBC and Pacific Telesis Group (PAC) jointly
announced a definitive agreement to merge an SBC subsidiary with PAC, in a
transaction in which each share of PAC common stock will be exchanged for 0.733
of a share of SBC common stock, subject to adjustment as
described in the merger agreement based upon an allocation of the costs, fees
and expenses and other financial effects incurred or sustained in connection
with obtaining state regulatory approvals. After the merger, PAC will be a
wholly-owned subsidiary of SBC. The transaction is intended to be accounted for
as a pooling of interests and to be a tax-free reorganization. On July 31,
1996, the shareowners of SBC and PAC each approved the transaction, which had
previously been approved by the board of directors of each company. On November
5, 1996, the United States Department of Justice announced it would not initiate
action on the merger under the Hart-Scott-Rodino antitrust law. The Public
Service Commission of Nevada approved the merger on December 31, 1996. The FCC
approved the transfer of licenses from PAC to SBC on January 31, 1997. The
merger agreement is subject to certain other regulatory approvals, including
approval by the California Public Utilities Commission, which has established a
schedule for review of the transaction with approval expected before the end of
the first quarter of 1997. If approvals are granted, the transaction is
expected to close in the first half of 1997 (see Note 3 to the financial
statements for more information).
ACQUISITIONS AND DISPOSITIONS SBC made several acquisitions and dispositions in
1996, 1995 and 1994.
SBC's acquisitions of two cable television systems located in Montgomery County,
Maryland, and Arlington County, Virginia, the domestic wireless business of
Associated Communications Corporation, adjacent properties in New York state and
an indirect 10% ownership of a nationwide cellular company in France are
described in Note 12 to the financial statements. In addition, the merger of
SBC's United Kingdom cable television operations into TeleWest is described in
Note 12 to the financial statements.
In October 1994, SBC sold an additional 25% of its United Kingdom cable
television operations to Cox Cable Communications. From October 1994 until the
merger into TeleWest in 1995, SBC's United Kingdom cable television investment
was accounted for under the equity method. In December 1996, SBC made an
additional investment to maintain its indirect 10% ownership in the French
cellular company to offset dilution of its interest resulting from other equity
sales.
During 1995, SBC also purchased a wireless system serving Watertown, New York,
and, as previously discussed, obtained at auction PCS licenses in Memphis,
Tennessee; Little Rock, Arkansas; and Tulsa, Oklahoma. During 1996, SBC
received several AT&T cellular networks in Arkansas in exchange for SBC's PCS
licenses in Memphis, Tennessee and Little Rock, Arkansas and other
consideration.
In 1995, SBC made an equity investment in Chile, purchasing 40% of VTR S.A.
(VTR), a privately owned telecommunications holding company, for $317. VTR
provides local, long-distance, wireless and cable television services in Chile
and is 51% owned by Grupo Luksic, a large Chilean conglomerate. During 1996,
SBC increased its holding in VTR to 49% through the purchase of shares from
another minority shareowner. Also, in 1995, SBC made an equity investment in a
South African wireless company.
Except as discussed in Note 12 to the financial statements, none of these
transactions had a material effect on SBC's financial results in 1996, 1995 or
1994, nor does management expect them to have a material effect on SBC's
financial position or results of operations in 1997.
STRATEGIC REALIGNMENT In July 1995, SBC announced a strategic realignment which
positions the company to be a single-source provider of telecommunications
services. All of SBC's operations within the five-state area report to one
management group, while international operations and domestic operations outside
the five-state area report to a separate management group.
In connection with this realignment of functions, in 1995 SBC recognized $139 in
selling, general and administrative expenses. These expenses include
postemployment benefits for approximately 2,400 employees arising from the
future consolidation of operations within the five-state area, streamlining
support and administrative functions and integrating financial systems.
Implementation of the realignment has been delayed due to the pending merger
with PAC. The charge reduced net income for 1995 by approximately $88.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL EXPENDITURES AND OTHER COMMITMENTS
To provide high-quality communications services to its customers, SBC,
particularly the Telephone Company and Mobile Systems, must make significant
investments in property, plant and equipment. The amount of capital investment
is influenced by regulatory commitments and demand for services and products.
SBC's capital expenditures totaled $3,027, $2,336 and $2,350 for 1996, 1995 and
1994. In 1996, Telephone Company and Mobile Systems expenditures increased 33%
and 10%. The Telephone Company's increase in capital expenditures was due
primarily to demand-related growth, network upgrades, customer-contracted
requirements, regulatory commitments and ISDN projects. Mobile Systems
expenditures increased due primarily to continued growth.
SBC's total reported 1995 capital expenditures were relatively unchanged
compared to 1994. Reported decreases in SBC's capital expenditures related to
the change in accounting for its United Kingdom cable television operations were
offset by capital expenditures increases of 5% at the Telephone Company and 6%
at Mobile Systems.
In 1997, management expects total capital spending to increase from 1996, to
between $3,300 and $3,500. Capital expenditures in 1997 will relate primarily
to the continued evolution of the Telephone Company's network, including amounts
agreed to under regulation plans, and continued build out of Mobile Systems'
markets. SBC expects to fund ongoing capital expenditures with cash provided by
operations.
The Telephone Company continues to make additional network and infrastructure
improvements over periods ranging through 2001 to satisfy regulatory
commitments. Total capital expenditures under these commitments can vary based
on actual demand of potential end users. The Telephone Company anticipates
spending approximately $150 to $200 in 1997 associated with these commitments.
Over the next few years, SBC is expecting to incur significant software
expenditures for interconnection and customer number portability. The extent
and timing of these expenditures will vary depending on the timing and nature of
regulatory actions and corresponding or compensating network improvements.
DIVIDENDS DECLARED
Dividends declared by SBC totaled $1,042 ($1.72 per share) in 1996, $1,004
($1.65 per share) in 1995 and $954 ($1.58 per share) in 1994. Management's
dividend policy considers both the expectations and requirements of shareowners,
internal requirements of SBC and long-term growth opportunities.
CASH, LINES OF CREDIT AND CASH FLOWS
SBC had $242 of cash and cash equivalents available at December 31, 1996.
Commercial paper borrowings as of December 31, 1996, totaled $1,318. SBC has
entered into agreements with several banks for lines of credit totaling $750,
all of which may be used to support commercial paper borrowings. SBC had no
borrowings outstanding under these lines of credit as of December 31, 1996.
During 1996, as in 1995 and 1994, SBC's primary source of funds continued to be
cash generated from operations, as shown in the Consolidated Statements of Cash
Flows. In 1996, 1995 and 1994, cash provided by operating activities was
reduced by the contribution of $57, $151 and $134 to the collectively bargained
Voluntary Employee Beneficiary Association trusts for the future payment of
postretirement benefits. Net cash provided by operating activities exceeded
SBC's construction and capital expenditures during 1996, as in 1995 and 1994;
this excess is referred to as free cash flow, a supplemental measure of
liquidity. SBC generated free cash flow of $1,797, $1,685 and $1,618 in 1996,
1995 and 1994.
During 1995, the Telephone Company refinanced long-term debt with an aggregate
principal amount of $450. Since June 1991, the Telephone Company has refinanced
$3,632 in long-term debt.
TOTAL CAPITAL
SBC's total capital consists of debt (long-term debt and debt maturing within
one year) and shareowners' equity. Total capital increased $454 in 1996 and
decreased $2,265 in 1995. The increase in 1996 was due to the reinvestment of
earnings, partially offset by the acquisition of treasury shares. The decrease
in 1995 was due to the effects of the discontinuance of regulatory accounting.
Absent this extraordinary charge, total capital increased by $554 in 1995 due
primarily to the reinvestment of earnings, partially offset by foreign currency
translation adjustments resulting from the decline in the value of the Mexican
peso.
DEBT RATIO
SBC's debt ratio (long-term debt and debt maturing within one year, as a
percentage of total capital) was 51.4%, 54.0% and 47.4% at December 31, 1996,
1995 and 1994. The debt ratio is affected by the same factors that affect total
capital. For 1995, the decrease in equity caused by the discontinuance of
regulatory accounting increased the debt ratio by 9.2 percentage points.
SHARE REPURCHASES
See Note 11 to the financial statements.
EMPLOYEE STOCK OWNERSHIP PLANS
See Note 9 to the financial statements.
Notes to Consolidated Financial Statements
Dollars in millions except per share amounts
1. Summary of Significant Accounting Policies
Basis of Presentation - The consolidated financial statements include the
accounts of SBC Communications Inc. and its majority-owned subsidiaries
(SBC). SBC's subsidiaries and affiliates operate predominantly in the
communications services industry, providing landline and wireless
telecommunications services and equipment, directory advertising and cable
television services both domestically and worldwide. Southwestern Bell
Telephone Company (Telephone Company) is SBC's largest subsidiary,
providing telecommunications services in Texas, Missouri, Oklahoma, Kansas
and Arkansas (five-state area).
All significant intercompany transactions are eliminated in the
consolidation process. Investments in partnerships, joint ventures and
less than majority-owned subsidiaries are principally accounted for under
the equity method. Earnings from certain foreign investments accounted for
under the equity method are included for periods ended within three months
of SBC's year end.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements
and accompanying notes. Actual results could differ from those estimates.
Income Taxes - Deferred income taxes are provided for temporary differences
between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for tax purposes.
Investment tax credits resulted from federal tax law provisions that
allowed for a reduction in income tax liability based on certain
construction and capital expenditures. Corresponding income tax expense
reductions were deferred and are being amortized as reductions in income
tax expense over the life of the property, plant and equipment that gave
rise to the credits.
Cash Equivalents - Cash equivalents include all highly liquid investments
with original maturities of three months or less.
Deferred Charges - Certain sales commissions are deferred and amortized
over 12 months. Directory advertising costs are deferred until the
directory is published and advertising revenues related to these costs are
recognized.
Material and Supplies - New and reusable materials are carried principally
at average original cost. Specific costs are used for large individual
items. Nonreusable material is carried at estimated salvage value.
Property, Plant and Equipment - Property, plant and equipment is stated at
cost. The cost of additions and substantial betterments of property, plant
and equipment is capitalized. The cost of maintenance and repairs of
property, plant and equipment is charged to operating expenses.
Property, plant and equipment is depreciated using straight-line methods
over their estimated useful lives, generally ranging from 3 to 50 years.
Prior to September 1995, the Telephone Company computed depreciation using
certain straight-line methods and rates as prescribed by regulators. In
accordance with composite group depreciation methodology, when a portion of
the Telephone Company's depreciable property, plant and equipment is
retired in the ordinary course of business, the gross book value is charged
to accumulated depreciation.
Intangible Assets - Intangible assets consist primarily of wireless and
cable television licenses, customer lists and the excess of consideration
paid over net assets acquired in business combinations. These assets are
being amortized using the straight-line method, over periods generally
ranging from 5 to 40 years. At December 31, 1996 and 1995, amounts
included in net intangible assets for licenses were $1,838 and $1,798.
Management periodically reviews the carrying value and lives of all
intangible assets based on expected future cash flows.
Foreign Currency Translation - Local currencies are generally considered
the functional currency for SBC's share of foreign operations, except in
countries considered highly inflationary. SBC translates its share of
foreign assets and liabilities at current exchange rates. Revenues and
expenses are translated using average rates during the year. The ensuing
foreign currency translation adjustments are recorded as a separate
component of Shareowners' Equity. Other transaction gains and losses
resulting from exchange rate changes on transactions denominated in a
currency other than the local currency are included in earnings as
incurred.
Earnings Per Common Share - The earnings per common share computation uses
the weighted average number of common shares outstanding, including shares
held by employee stock ownership plans. Common stock equivalents
outstanding are not considered dilutive.
2. Discontinuance of Regulatory Accounting
In September 1995, the Telephone Company discontinued its application of
Statement of Financial Accounting Standards No. 71, "Accounting for the
Effects of Certain Types of Regulation" (FAS 71). FAS 71 requires
depreciation of telephone plant using lives set by regulators which are
generally longer than those established by unregulated companies, and
deferral of certain costs and obligations based on regulatory actions
(regulatory assets and liabilities). As a result of the adoption of price-
based regulation for most of the Telephone Company's revenues and the
acceleration of competition in the telecommunications market, management
determined that the Telephone Company no longer met the criteria for
application of FAS 71.
Upon discontinuance of FAS 71, the Telephone Company recorded a non-cash,
extraordinary charge to net income of $2,819 (after a net deferred tax
benefit of $1,764). This charge is comprised of an after-tax charge of
$2,897 to reduce the net carrying value of telephone plant, partially
offset by an after-tax benefit of $78 for the elimination of net regulatory
liabilities. The components of the charge are as follows:
The increase in accumulated depreciation of $4,657 reflects the effects of
adopting depreciable lives for many of the Telephone Company's plant
categories which more closely reflect the economic and technological lives
of the plant. The adjustment was supported by a discounted cash flow
analysis which estimated amounts of telephone plant that may not be
recoverable from future discounted cash flows. This analysis included
consideration of the effects of anticipated competition and technological
changes on plant lives and revenues. The adjustment also included
elimination of accumulated depreciation deficiencies recognized by
regulators and amortized as part of depreciation expense.
Following is a comparison of new lives to those prescribed by regulators
for selected plant categories:
The increase in accumulated depreciation also includes an adjustment of
approximately $450 to fully depreciate analog switching equipment scheduled
for replacement. Remaining analog switching equipment is being depreciated
using an average remaining life of four years.
Investment tax credits have historically been deferred and amortized over
the estimated lives of the related plant. The adjustment to unamortized
investment tax credits reflects the shortening of those plant lives
discussed above. Regulatory assets and liabilities are related primarily
to accounting policies used by regulators in the ratemaking process which
are different from those used by non-regulated companies, predominantly in
the accounting for income taxes and deferred compensated absences. These
items are required to be eliminated with the discontinuance of accounting
under FAS 71.
Additionally, in September 1995, the Telephone Company began accounting for
interest on funds borrowed to finance construction as an increase in
property, plant and equipment and a reduction of interest expense. Under
the provisions of FAS 71, the Telephone Company accounted for a
capitalization of both interest and equity costs allowed by regulators
during periods of construction as other income and as an addition to the
cost of plant constructed.
3. Merger Agreement
On April 1, 1996, SBC and Pacific Telesis Group (PAC) jointly announced a
definitive agreement to merge an SBC subsidiary with PAC, in a transaction
in which each share of PAC common stock will be exchanged for 0.733 of a
share of SBC common stock (equivalent to approximately 314 million shares),
subject to adjustment as described in the merger agreement based upon an
allocation of the costs, fees and expenses and other financial effects
incurred or sustained in connection with obtaining state regulatory
approvals. After the merger, PAC will be a wholly-owned subsidiary of SBC.
The transaction is intended to be accounted for as a pooling of interests
and to be a tax-free reorganization. On July 31, 1996, the shareowners of
SBC and PAC each approved the transaction, which had previously been
approved by the board of directors of each company. On November 5, 1996,
the United States Department of Justice announced it would not initiate
action on the merger under the Hart-Scott-Rodino antitrust law. The Public
Service Commission of Nevada approved the merger on December 31, 1996. The
FCC approved the transfer of licenses from PAC to SBC on January 31, 1997.
The merger agreement is subject to certain other regulatory approvals,
including approval by the California Public Utilities Commission, which has
established a schedule for review of the transaction with approval expected
before the end of the first quarter of 1997. If approvals are granted, the
transaction is expected to close in the first half of 1997.
The pro forma effect on SBC's consolidated statements of income had the
merger occurred on January 1, 1994 is as follows:
This pro forma information does not include the effect of changes, which
will be applied retroactively, to conform accounting methodologies between
PAC and SBC for, among other items, pensions, postretirement benefits,
sales commissions or merger transaction costs and certain deferred tax
adjustments resulting from the merger. Based on information currently
available, management estimates these changes will not materially affect
the pro forma operating revenues or income before extraordinary loss and
cumulative effect of accounting changes, and estimates the changes will
reduce the pro forma 1995 extraordinary loss from discontinuance of
regulatory accounting by between $100 and $200.
4. Property, Plant and Equipment
Property, plant and equipment is summarized as follows at December 31:
SBC's depreciation expense as a percentage of average depreciable plant
was 6.8% for 1996 and 6.9% for 1995 and 1994.
Certain facilities and equipment used in operations are under operating or
capital leases. Rental expenses under operating leases for 1996, 1995 and
1994 were $171, $138 and $126. At December 31, 1996, the future minimum
rental payments under noncancelable operating leases for the years 1997
through 2001 were $105, $91, $94, $51 and $30 and $167 thereafter. Capital
leases were not significant.
5. Equity Investments
Investments in affiliates accounted for under the equity method consist
principally of SBC's investment in Telefonos de Mexico, S.A. de C.V.
(Telmex), Mexico's national telecommunications company. SBC is a member
of a consortium that holds all of the Class AA shares of Telmex stock,
representing voting control of the company. The consortium is controlled
by a group of Mexican investors led by an affiliate of Grupo Carso, S.A.
de C.V. SBC also owns Class L shares which have limited voting rights.
In January 1997, SBC sold a portion of its Class L shares so that its total
equity investment was below 10% of Telmex's total equity capitalization.
In December 1994 SBC made an equity investment in French cellular
operations (see Note 12). Other equity investments held by SBC include
interests in Australian and Israeli operations which provide directory,
cable television and other services, minority ownership of several domestic
wireless properties and 1995 investments in Chilean telecommunications and
South African wireless operations.
The following table is a reconciliation of SBC's investments in equity
affiliates:
Currency translation adjustments for 1995 and 1994 primarily reflect the
effect on SBC's investment in Telmex resulting from the decline in the
value of the Mexican peso relative to the U.S. dollar during those years.
Beginning in 1997, SBC will use the U.S. dollar, instead of the peso, as
the functional currency for its investment in Telmex due to the Mexican
economy becoming highly inflationary.
Other adjustments for 1995 reflect the change to the cost method of
accounting in October 1995 for SBC's United Kingdom cable television
operations (see Note 12) and the reclassification of a credit deferred
in 1994 pending completion of the French cellular investment in 1995.
Other adjustments for 1994 reflect the change to the equity method of
accounting for SBC's previously consolidated United Kingdom cable
television operations.
Undistributed earnings from equity affiliates were $837 and $663 at
December 31, 1996 and 1995.
6. Debt
Long-term debt, including interest rates and maturities, is summarized as
follows at December 31:
During 1995, SBC refinanced long-term debentures of the Telephone Company.
Costs of $18 associated with refinancing are included in other income
(expense) - net, with related income tax benefits of $7 included in income
taxes in SBC's Consolidated Statements of Income.
At December 31, 1996, the aggregate principal amounts of long-term debt
scheduled for repayment for the years 1997 through 2001 were $404, $302,
$447, $323 and $270. As of December 31, 1996, SBC 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:
The weighted average interest rate on commercial paper debt at December 31,
1996 and 1995 was 5.5% and 5.7%. SBC has entered into agreements with
several banks for lines of credit totaling $750. All of these agreements
may be used to support commercial paper borrowings and are on a negotiated
fee basis with interest rates negotiable at time of borrowing. There were
no borrowings outstanding under these lines of credit at December 31, 1996.
7. Financial Instruments
The carrying amounts and estimated fair values of SBC's long-term debt,
including current maturities, are summarized as follows at December 31:
The fair values of SBC's long-term debt were estimated based on quoted
market prices, where available, or on discounted future cash flows using
current interest rates. The carrying amounts of commercial paper debt
approximate fair values.
SBC does not hold or issue any financial instruments for trading
purposes. SBC's cash equivalents and short-term investments are
recorded at amortized cost. Short-term investments were $432 and $243
at December 31, 1996 and 1995. The carrying amounts of cash and cash
equivalents and short-term investments approximate fair values.
8. Income Taxes
Significant components of SBC's deferred tax liabilities and assets are as
follows at December 31:
As a result of implementing Financial Accounting Standards No. 109,
"Accounting for Income Taxes," in 1993, the Telephone Company recorded a
net reduction in its deferred tax liability. This reduction was
substantially offset by the establishment of a net regulatory liability,
which was eliminated with the discontinued application of FAS 71 in
September 1995 (see Note 2).
The decrease in the valuation allowance is the result of an evaluation of
the uncertainty associated with the realization of certain deferred tax
assets. The valuation allowance is maintained in deferred tax assets for
certain unused federal and state loss carryforwards.
The components of income tax expense are as follows:
A reconciliation of income tax expense and the amount computed by applying
the statutory federal income tax rate (35%) to income before income taxes
and extraordinary loss is as follows:
9. Employee Benefits
Pensions - Substantially all employees of SBC are covered by
noncontributory pension and death benefit plans. The pension benefit
formula used in the determination of pension cost is based on a flat dollar
amount per year of service according to job classification for
nonmanagement employees and a stated percentage of adjusted career income
for management employees.
SBC's objective in funding the plans, in combination with the standards of
the Employee Retirement Income Security Act of 1974 (as amended), is to
accumulate funds sufficient to meet its benefit obligations to employees
upon their retirement. Contributions to the plans are made to a trust for
the benefit of plan participants. Plan assets consist primarily of stocks,
U.S. government and domestic corporate bonds and real estate.
Net pension cost is composed of the following:
The following table sets forth the pension plans' funded status and the
amounts included in SBC's Consolidated Balance Sheets at December 31:
Significant assumptions used in developing pension information include:
The projected benefit obligation is the actuarial present value of all
benefits attributed by the pension benefit formula to previously rendered
employee service. It is measured based on assumptions concerning future
interest rates and employee compensation levels. Should actual experience
differ from the actuarial assumptions, the benefit obligation will be
affected.
The actuarial estimate of the accumulated benefit obligation does not
include assumptions about future compensation levels. The accumulated
benefit obligation as of December 31, 1996, was $6,562, of which $5,512 was
vested. At December 31, 1995, these amounts were $6,350 and $5,607.
In December 1996, under the provisions of Section 420 of the Internal
Revenue Code, SBC transferred $73 in pension assets to a health care
benefit account for the reimbursement of retiree health care benefits paid
by SBC.
Supplemental Retirement Plans - SBC also provides senior and middle
management employees with nonqualified, unfunded supplemental retirement
and savings plans. The plans allow employees to defer and invest portions
of their current compensation for later payment, and SBC matches a
percentage of the compensation deferral according to thresholds specified
in the plans. Expenses related to these plans were $69, $68 and $68 in
1996, 1995 and 1994. Liabilities of $626 and $584 related to these plans
have been included in other noncurrent liabilities in SBC's Consolidated
Balance Sheets at December 31, 1996 and 1995.
Postretirement Benefits - SBC 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.
Postretirement benefit cost is composed of the following:
SBC maintains collectively bargained Voluntary Employee Beneficiary
Association (CBVEBA) trusts to fund postretirement benefits. During 1996
and 1995, SBC contributed $57 and $151 into the CBVEBA trust to be
ultimately used for the payment of postretirement benefits. Assets consist
principally of stocks and U.S. government and corporate bonds.
The following table sets forth the plans' funded status and the amount
included in SBC's Consolidated Balance Sheets at December 31:
In December 1995, the life insurance benefit plan and the medical plan were
merged. Also in December 1995, $109 of postretirement life insurance
assets were transferred to the CBVEBA trusts. The fair value of plan
assets restricted to the payment of life insurance benefits only were $265
and $245 at December 31, 1996 and 1995. At December 31, 1996 and 1995, the
accrued life insurance benefits included in the accrued postretirement
benefit obligation were $107 and $91.
The assumed medical cost trend rate in 1997 is 8%, decreasing gradually to
5.5% in 2002, prior to adjustment for cost-sharing provisions of the plan
for active and certain recently retired employees. The assumed dental cost
trend rate in 1997 is 6.25%, reducing to 5.0% in 2002. Raising the annual
medical and dental cost trend rates by one percentage point increases the
APBO as of December 31, 1996 by $135 and increases the aggregate service
and interest cost components of the net periodic postretirement benefit
cost for the year ended December 31, 1996 by approximately $16.
Significant assumptions for the discount rate, long-term rate of return on
plan assets and composite rate of compensation increase used in developing
the APBO were the same as those used in developing the pension information.
Employee Stock Ownership Plans - SBC maintains contributory savings plans
which cover substantially all employees. Under the savings plans, SBC
matches a stated percentage of eligible employee contributions, subject to
a specified ceiling.
SBC has two leveraged Employee Stock Ownership Plans (ESOPs) as part of the
existing savings plans. The ESOPs were funded with notes issued by the
savings plans, the proceeds of which were used to purchase shares of SBC's
common stock in the open market. The notes are unconditionally guaranteed
by SBC and will be repaid with SBC contributions to the savings plans,
dividends paid on SBC shares and interest earned on funds held by the
ESOPs.
SBC's match of employee contributions to the savings plans is fulfilled
with shares of stock allocated from the ESOPs and with purchases of SBC's
stock in the open market. Benefit cost is based on a combination of the
contributions to the savings plans and the cost of shares allocated to
participating employees' accounts. Both benefit cost and interest expense
on the notes are reduced by dividends on SBC's shares held by the ESOPs and
interest earned on the ESOPs' funds.
Information related to the ESOPs and the savings plans is summarized below:
SBC shares held by the ESOPs are summarized as follows at December 31:
10. Stock Option Plans
Various SBC plans authorize the issuance of stock options to senior and
other management employees to purchase up to 69 million shares of SBC
common stock, of which 32 million have been issued. Options issued through
December 31, 1996 carry exercise prices equal to the market price of the
stock at the date of grant and have maximum terms ranging from five to ten
years. Depending upon the plan, vesting of options occurs one to three
years from the date of grant.
In 1996 SBC elected to continue measuring compensation cost for these plans
using the intrinsic value based method of accounting prescribed in
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 1996 and 1995 as defined by
FAS 123, SBC's net income (loss) would have been $2,075 and $(939) and net
income (loss) per share would have been $3.42 and $(1.54).
For purposes of these pro forma disclosures, the estimated fair value of
the options granted after 1994 is amortized to expense over the options'
vesting period. Because most employee options vest over a two to three
year period, these disclosures will not be indicative of future pro forma
amounts until the FAS 123 rules are applied to all outstanding non-vested
awards. The fair value for these options was estimated at the date of
grant, using a Black-Scholes option pricing model with the following
weighted-average assumptions used for grants in 1996 and 1995: risk-free
interest rate of 6.37% and 6.31%; dividend yield of 3.45% and 3.45%;
expected volatility factor of 16% and 18%; and expected option life of 4.5
and 4.6 years.
Information related to options is summarized below:
Information related to options outstanding at December 31, 1996:
The weighted-average grant-date fair value of each option granted during
the year was $8.32 for 1996 and $8.45 for 1995.
11. Shareowners' Equity
Share Repurchases - From time to time, SBC has repurchased shares of common
stock for distribution, to offset shares distributed through its employee
benefit plans and SBC's Dividend Reinvestment Plan, in connection with
certain acquisitions or for general purposes. In January 1997, the Board
of Directors of SBC (Board) rescinded all authorizations to repurchase
common stock.
Guaranteed Obligations of Employee Stock Ownership Plans - SBC's guarantee
of the ESOPs' notes issued by the savings plans (see Note 9) is presented
as a reduction to shareowners' equity and an increase in long-term debt.
The amount of debt guaranteed decreases as the notes are repaid.
Shareowners' Rights Plan - The Shareowners' Rights Plan (Plan) becomes
operative in certain events involving the acquisition of 20% or more of
SBC's common stock by any person or group in a transaction not approved by
the Board, or the designation by the Board of a person or group owning more
than 10% of the outstanding stock as an adverse person, as provided in the
Plan. Upon the occurrence of these events, each right, unless redeemed by
the Board, generally entitles the holder (other than the holder triggering
the right) to purchase an amount of common stock of SBC (or, in certain
circumstances, of the potential acquiror) having a value equal to two times
the exercise price of $160. The rights expire in January 1999. After
giving effect to a stock split in May 1993, effected in the form of a stock
dividend, each share of common stock represents one-half of a right.
The rights have certain antitakeover effects. The rights will cause
substantial dilution to a person or group that attempts to acquire SBC on
terms not approved by the Board.
The rights should not interfere with any merger or other business
combination approved by the Board since the rights may be redeemed.
12. Acquisitions and Dispositions
In October 1995, SBC combined its United Kingdom cable television
operations with those of TeleWest Communications, P.L.C., a publicly held
joint venture between Telecommunications, Inc. and U S WEST, Inc. The
resulting entity, TeleWest P.L.C. (TeleWest), is the largest cable
television operator in the United Kingdom. SBC owns approximately 15% of
the new entity and accounts for its investment using the cost method of
accounting. Restrictions expiring over the next four years exist on the
sale of SBC's interest in TeleWest. SBC recorded an after-tax gain of $111
associated with the combination.
During 1994, SBC purchased two cable television systems located in
Montgomery County, Maryland, and Arlington County, Virginia, for $650.
Also in 1994, SBC acquired the domestic wireless business of Associated
Communications Corporation (Associated) for $705, including wireless
systems in Buffalo, Rochester, Albany and Glens Falls, New York, and in two
separate transactions purchased smaller wireless systems in Syracuse, Utica
and Ithaca, New York, which are adjacent to the Associated properties.
In October 1994, SBC formed a strategic alliance with Compagnie
Generale des Eaux (CGE), a French diversified public company. Through this
alliance, SBC acquired an indirect 10% ownership of Societe Francaise du
Radiotelephone S.A. (SFR), a nationwide cellular company in France, and
minority ownership interests in other communications businesses controlled
by CGE, and CGE obtained an effective 10% interest in SBC's wireless
operations in Washington, D.C.-Baltimore and surrounding rural markets.
SBC and CGE both made contributions to the alliance. SBC's effective
contribution was $376. This investment is accounted for under the equity
method of accounting.
In addition to payments shown in the Consolidated Statements of Cash Flows,
the 1994 acquisitions were also financed through the issuance of 16 million
new and treasury shares, valued at approximately $660, and the issuance of
approximately $360 of long-term debt. All of the acquisitions were
accounted for under the purchase method of accounting. The purchase prices
in excess of the underlying fair value of identifiable net assets acquired
are being amortized over periods not to exceed 40 years. Results of
operations of the properties acquired have been included in the
consolidated financial statements from their respective dates of
acquisition.
The above developments did not have a significant impact on consolidated
results of operations for 1995 and 1994, nor would they had they occurred
on January 1 of the respective periods.
13. Additional Financial Information
No customer accounted for more than 10% of consolidated revenues in 1996 or
1995. Approximately 10% of SBC's consolidated revenues in 1994 were from
services provided to AT&T Corp. No other customer accounted for more than
10% of consolidated revenues in 1994.
Three subsidiaries of SBC have negotiated contracts with the Communications
Workers of America (CWA), none of which is subject to renegotiation in
1997. Approximately 67% of SBC's employees are represented by the CWA.
14. Quarterly Financial Information (Unaudited)
Report of Management
The consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. The
integrity and objectivity of the data in these financial
statements, including estimates and judgments relating to matters
not concluded by year end, are the responsibility of management,
as is all other information included in the Annual Report, unless
otherwise indicated.
The financial statements of SBC Communications Inc. (SBC) have
been audited by Ernst & Young LLP, independent auditors.
Management has made available to Ernst & Young LLP all of SBC's
financial records and related data, as well as the minutes of
shareowners' and directors' meetings. Furthermore, management
believes that all representations made to Ernst & Young LLP
during its audit were valid and appropriate.
Management has established and maintains a system of internal
accounting controls that provides reasonable assurance as to the
integrity and reliability of the financial statements, the
protection of assets from unauthorized use or disposition and the
prevention and detection of fraudulent financial reporting. The
concept of reasonable assurance recognizes that the costs of an
internal accounting controls system should not exceed, in
management's judgment, the benefits to be derived.
Management also seeks to ensure the objectivity and integrity of
its financial data by the careful selection of its managers, by
organizational arrangements that provide an appropriate division
of responsibility and by communication programs aimed at ensuring
that its policies, standards and managerial authorities are
understood throughout the organization. Management continually
monitors the system of internal accounting controls for
compliance. SBC maintains an internal auditing program that
independently assesses the effectiveness of the internal
accounting controls and recommends improvements thereto.
The Audit Committee of the Board of Directors, which consists of
six directors who are not employees, meets periodically with
management, the internal auditors and the independent auditors to
review the manner in which they are performing their
responsibilities and to discuss auditing, internal accounting
controls and financial reporting matters. Both the internal
auditors and the independent auditors periodically meet alone
with the Audit Committee and have access to the Audit Committee
at any time.
/s/ Edward E. Whitacre Jr.
Edward E. Whitacre Jr.
Chairman of the Board and
Chief Executive Officer
/s/ Donald E. Kiernan
Donald E. Kiernan
Senior Vice President, Treasurer
and Chief Financial Officer
Report of Independent Auditors
The Board of Directors and Shareowners
SBC Communications Inc.
We have audited the accompanying consolidated balance sheets of
SBC Communications Inc. (SBC) as of December 31, 1996 and 1995,
and the related consolidated statements of income, shareowners'
equity and cash flows for each of the three years in the period
ended December 31, 1996. These financial statements are the
responsibility of SBC's management. Our responsibility is to
express an opinion on these financial statements 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 consolidated financial statements referred to
above present fairly, in all material respects, the consolidated
financial position of SBC Communications Inc. at December 31,
1996 and 1995, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended
December 31, 1996, in conformity with generally accepted
accounting principles.
As discussed in Note 2 to the consolidated financial statements,
SBC discontinued its application of Statement of Financial
Accounting Standards No. 71, "Accounting for the Effects of
Certain Types of Regulation" in 1995.
ERNST & YOUNG LLP
San Antonio, Texas
February 14, 1997
Stock Trading Information
Trading: SBC is listed on the New York, Chicago and Pacific
stock exchanges, as well as The London Stock Exchange and The
Swiss Exchange.
Ticker symbol (NYSE): SBC
Newspaper stock listing: SBC Comm or SBC
The above information appears on the inside back cover of the printed Annual
Report.
APPENDIX
All page numbers referenced in this Exhibit and the Form 10-K
relate to the printed Annual Report. The order of the sections
is as they appear in the printed Annual Report. The colored
graphs and related footnotes that appear in the printed document
are approximately 1-1/2 inches by 3-1/2 inches. The Stock Data
section appears on the inside back cover.
The section titled "Management's Discussion and Analysis of
Financial Condition and Results of Operations" appears on pages
9-19. The text of this section appears in two columns.
A bar graph titled "Operating Income (dollars in billions)"
appears in the right column on page 9 and to the right side of
the section titled "Results of Operations - Summary". The graph
shows Operating Income for the past five years. The actual
figures are listed on the graph. Listed below are the plot
points:
1992 2.2
1993 2.4
1994 2.8
1995 3.0
1996 3.6
The following footnote appears at the base of the graph:
Operating income has grown by more than half since 1992.
A stacked bar graph titled "Local Service (dollars in billions)"
appears in the left column on page 10 and to the left of the
subsection titled "Local Service". The graph shows local service
revenues by categories for the past five years. Listed below are
the plot points:
Year Total Wireless Landline
1992 4.7 1.0 3.7
1993 5.2 1.3 3.9
1994 5.8 1.8 4.0
1995 6.5 2.2 4.3
1996 7.4 2.7 4.7
The following footnote appears at the base of the graph:
Wireless local services revenues have nearly tripled in the last
four years.
A stacked bar graph titled "Distribution of Revenues (dollars in
billions)" appears in the right column on page 11 and to the
right of the section titled "Operating Expenses". The graph
shows various categories of revenues for the past five years.
The actual figures are listed on the graph. Listed below are
the plot points by category:
Local Network Directory
Year Total service access Long- advertising Other
distance
1992 10.2 4.7 2.5 1.0 0.9 1.1
1993 10.8 5.2 2.7 1.0 0.8 1.1
1994 11.8 5.8 2.9 0.9 0.9 1.3
1995 12.7 6.5 3.1 0.8 1.0 1.3
1996 13.9 7.4 3.2 1.0 0.9 1.4
The following footnote appears at the base of the graph: Local
service revenue growth represents nearly three-fourths of the
increase in operating revenues since 1992.
A stacked bar graph titled "Distribution of Expenses (dollars in
billions)" appears in the left column on page 12 and to the
left side of the subsection titled "Equity in Net Income of
Affiliates". The graph shows the categories of expenses for the
past five years. The actual figures are listed on the graph.
Listed below are the plot points:
Cost of
services Selling, Depreciation
Year Total and general and and
products administrative amortization
1992 8.0 3.4 2.7 1.9
1993 8.5 3.4 3.1 2.0
1994 9.0 3.8 3.2 2.0
1995 9.6 3.8 3.6 2.2
1996 10.3 4.1 4.0 2.2
The following footnote appears at the base of the graph:
Expenses as a percentage of operating revenues decreased for the
fourth consecutive year.
In the section titled "Operating Environment and Trends of the
Business", on page 13 an icon (approximately one inch) of the state
of Texas, appears in the left column.
A stacked bar graph titled "Access Lines (in millions)" appears
in the right column on page 13 and to the right side of the
subsection titled "Texas". The graph shows access lines in total
and by state for the past five years. The actual figures are
listed on the graph. Listed below are the plot points:
Year Total Texas Missouri Oklahoma Kansas Arkansas
1992 12.7 7.3 2.1 1.4 1.1 0.8
1993 13.1 7.6 2.2 1.4 1.1 0.8
1994 13.6 7.9 2.2 1.4 1.2 0.9
1995 14.2 8.3 2.3 1.5 1.2 0.9
1996 15.0 8.8 2.4 1.6 1.3 0.9
The following footnote appears at the base of the graph: Texas
accounts for nearly two-thirds of access line growth since 1992.
A stacked bar graph titled "Business Access Lines (in millions)"
appears in the left column on page 14 and to the left side of the
subsection titled "Missouri". The graph shows business access
lines in total for the past five years. The actual figures are
listed on the graph. Listed below are the plot points:
Year Total
1992 3.7
1993 4.0
1994 4.2
1995 4.5
1996 4.9
The following footnote appears at the base of the graph: Business
access lines have grown nearly one-third 1992.
In the subsections titled "Missouri" and "Oklahoma" on page 14,
icons (approximately one inch) of the states of Missouri and
Oklahoma in the left and right columns, respectively.
A bar graph titled "Additional Lines (in thousands)" appears in
the right column on page 15 and to the right side of the
subsection titled "Domestic". The graph shows additional lines
for the past 5 years. The actual figures are listed on the
graph. Listed below are the plot points.
1992 732.5
1993 793.9
1994 878.9
1995 1,030.1
1996 1,244.2
The following footnote appears at the base of the graph:
Additional lines growth represents nearly one-fourth of the
increase in access lines since 1992.
A bar graph titled "Wireless Penetration (in percent)" appears in
the left column on page 16. The graph shows the percentage of
Wireless Penetration for the past five years. Listed below are
the plot points:
1992 4.0%
1993 5.7%
1994 7.4%
1995 9.0%
1996 10.8%
The following footnote appears at the base of the graph: SBC's
wireless penetration leads the industry.
In the subsection titled "International" on page 17, an icon
(approximately one inch) of the country of Mexico appears in the
left column.
A bar graph titled "Capital Expenditures (dollars in billions)"
appears in the left column on page 18 and to the left side of the
section titled "Liquidity and Capital Resources". The graph shows
Capital Expenditures for the past five years. The actual figures
are listed on the graph. Listed below are the plot points:
1992 2.1
1993 2.2
1994 2.4
1995 2.3
1996 3.0
The following footnote appears at the base of the graph: Capital
expenditures have increased for growth and network modernization.