AT&T Inc. is a North American telecommunications company. In addition to telephone, data and video telecommunications, AT&T also provides mobile communications and internet services for companies, private customers and government organizations. AT&T has long had a monopoly in the United States and Canada.
United StatesSECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549
For the quarterly period ended June 30, 2003
or
For the transition period from toCommission File Number 1-8610
Incorporated under the laws of the State of DelawareI.R.S. Employer Identification Number 43-1301883175 E. Houston, San Antonio, Texas 78205Telephone Number: (210) 821-4105
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No
At July 31, 2003, common shares outstanding were 3,323,584,593.
See Notes to Consolidated Financial Statements.
SBC COMMUNICATIONS INC.June 30, 2003
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)Dollars in millions except per share amounts
Selected Financial And Operating Data
Our wireline segment operating income margin was 11.5% in the second quarter of 2003, compared to 16.1% in the second quarter of 2002, and 13.1% for the first six months of 2003, compared to 17.7% for the first six months of 2002. The decline in our wireline segment operating income margin was due primarily to the loss of revenue from retail access lines caused by below-cost UNE-P, which was greater than the expense reductions in response to UNE-P. While retail access lines have continued to decline, the trend has slowed recently in our West and Southwest regions reflecting our ability to now offer traditional long-distance service in those regions and the introduction of bundled offerings in those regions (see “Long-distance voice” below.) The allocation of advertising and other employee related expenses to the wireline segment in the second quarter of 2003, that were incurred in the previous quarter, contributed to the decline in the wireline segment operating income margin in the second quarter of 2003 compared to the first quarter of 2003. Additional factors contributing to the margin decrease were loss of revenues from the weak U.S. economy and increased competition, and an increase in our combined net pension and postretirement cost. See further discussion of the details of our wireline segment revenue and expense fluctuations below.
Cingular Segment Results
We account for our 60% economic interest in Cingular under the equity method of accounting in our consolidated financial statements since we share control equally (i.e. 50/50) with our 40% economic partner in the joint venture. We have equal voting rights and representation on the board of directors that controls Cingular. This means that our reported results include Cingular’s results in the “Equity in Net Income of Affiliates” line. However, when analyzing our segment results, we evaluate Cingular’s results on a stand-alone basis. Accordingly, in the segment table above, we present 100% of the Cingular revenues and expenses under “Segment operating revenues” and “Segment operating expenses”. Including 100% of Cingular’s results in our segment operations (rather than 60% in equity in net income of affiliates) affects the presentation of this segment’s revenues, expenses, operating income, nonoperating items and segment income, but does not affect our consolidated reported net income.
The FCC has adopted rules, effective November 2003, that will allow customers to keep their wireless phone number when switching to another wireless company. These rules could significantly increase Cingular’s customer turnover (“churn”) rate and thereby increase Cingular’s costs to retain or add new customers. We expect certain of Cingular’s operating costs, consisting primarily of handset subsidies, selling costs and greater staffing of customer care centers, to be higher during the first year these rules become effective. To the extent industry churn remains higher than in the past, we would expect those costs to continue at a significant level.
Cingular’s cellular/PCS networks use equipment with digital transmission technologies known as Time Division Multiple Access (TDMA) technology and Global System for Mobile Communication (GSM) technology. Cingular is currently in the process of adding GSM equipment (GSM overlay) throughout its existing TDMA markets to provide a common voice standard. Cingular’s GSM network upgrade is expected to be substantially complete by the end of 2003 when approximately 90% of Cingular’s population of potential customers (referred to in the media as “POPs”) will be covered by GSM. Additionally, through agreements with other carriers, Cingular customers will have GSM coverage in 90% of the U.S. at the end of 2003. Also, Cingular is adding high-speed technologies for data services known as General Packet Radio Services (GPRS) and Enhanced Data Rate for Global Evolution (EDGE).
On August 5, 2003, Cingular executed an agreement with NextWave Telecom Inc. (NextWave) and certain of its affiliates under which Cingular will purchase FCC licenses for wireless spectrum in 34 markets from NextWave for $1,400 in cash, subject to the terms and conditions set forth in the agreement. Because NextWave and its affiliates are currently seeking relief under Chapter 11 of the United States Bankruptcy Code, the agreement is subject to the approval of the United States Bankruptcy Court for the Southern District of New York. In addition, the transaction is subject to various other closing conditions, many of which are outside of Cingular’s control, including approval from the FCC.
Our Cingular segment operating income margin was 20% in the second quarter and for the first six months of 2003, compared to 19.3% in the second quarter and 19.1% for the first six months of 2002. The increase in our Cingular segment operating income margin was due primarily to reduced selling, billing and other expenses related to 2002 conversion and reorganization programs, which offset the increased network and depreciation expenses. The slower rate of growth in revenues continues to reflect the impact of competition on pricing levels and customer growth rates. At June 30, 2003, Cingular had approximately 22,600,000 customers, with net customer additions of approximately 540,000 in the second quarter. Net customer additions when compared to the same period in the prior year, increased in the second quarter of 2003 approximately 187,000 and increased for the first six months of 2003 by approximately 142,000. Gross customer additions decreased in the second quarter and for the first six months of 2003 when compared to the same periods in 2002. See further discussion of the details of the Cingular segment revenue and expense fluctuations below.
Directory Segment Results
Effective January 1, 2003, we changed our method of recognizing revenues and expenses related to publishing directories from the “issue basis” method to the “amortization” method. The issue basis method recognizes revenues and expenses at the time the initial delivery of the related directory is completed. The amortization method recognizes revenues and expenses ratably over the life of the directory, which is typically 12 months. We made this change prospectively; therefore, in the table above, results in the second quarter and for the first six months of 2003 are shown on the amortization basis, while the second quarter and first six months of 2002 are shown on the issue basis.
Our directory segment income was $579 with a margin of 54.3% in the second quarter and $1,161 with a margin of 54.6% for the first six months of 2003. In 2002, our directory segment income was $613 with a margin of 58.0% in the second quarter and $924 with a margin of 52.6% for the first six months. If we were to eliminate the effects of the accounting change and shifts in the schedule of directory titles published, our directory segment income would have been $358 and the segment operating income margin would have been 48.2% in the second quarter and $523 with a margin of 40.1% for the first six months of 2003, compared to $376 with a margin of 49.6% in the second quarter and $579 with a margin of 43.8% for the first six months of 2002. The decrease in operating income of $18 in the second quarter and $56 for the first six months as well as the decreased margin was due primarily to increased pension and postretirement costs combined with pressure on revenues from increased competition and lower demand from advertisers. See further discussion of the details of our directory segment revenue and expense fluctuations below.
International Segment Results
Our international segment consists almost entirely of equity investments in international companies, the income from which we report as equity in net income of affiliates. Revenues from direct international operations are less than 1% of our consolidated revenues. We discuss our quarterly results first and then summarize in a table the individual results for our significant equity holdings.
Our earnings from foreign affiliates are sensitive to exchange-rate changes in the value of the respective local currencies. Our foreign investments are recorded under GAAP, which include adjustments for the purchase method of accounting and exclude certain adjustments required for local reporting in specific countries.
Our other segment results in the second quarter and for the first six months of 2003 and 2002 primarily consist of corporate and other operations. Expenses decreased primarily due to a favorable return on insurance assets in the second quarter of 2003, and advertising and employee related costs incurred in the first quarter of 2003 but allocated to our subsidiaries as corporate charges in the second quarter of 2003. Substantially all of the Equity in Net Income of Affiliates represents the equity income from our investment in Cingular.
COMPETITIVE AND REGULATORY ENVIRONMENT
Overview Passage of the Telecommunications Act of 1996 (Telecom Act) was intended to promote competition and reduce regulation in U.S. telecommunications markets. Despite passage of the Telecom Act, the telecommunications industry, particularly incumbent local exchange carriers such as our wireline subsidiaries, continues to be subject to significant regulation. The expected transition from an industry extensively regulated by multiple regulatory bodies to a market-driven industry monitored by state and federal agencies has not occurred as anticipated.
Our wireline subsidiaries remain subject to extensive regulation by state regulatory commissions for intrastate services and by the Federal Communications Commission (FCC) for interstate services. For example, certain state commissions, including those in California, Illinois, Michigan, Wisconsin, Ohio and Indiana, significantly lowered the wholesale rates we are allowed to charge competitors, including AT&T and MCI (formerly known as WorldCom), for leasing parts of our network (unbundled network elements, or UNEs). These mandated rates, which are generally below our cost, are significantly contributing to continuing declines in our access-line revenues and profitability. When UNEs are combined by incumbent local exchange carriers and offered as a product to competitors as required by various state and federal regulations, that complete set capable of providing total local service to a customer is referred to as a UNE-P. Under UNE-P, our competitors market the lines and collect revenues from customers, and from inter-exchange carriers for originating and terminating long-distance traffic, but we still incur the network costs, which generally exceed the rates we are permitted to charge competitors for UNE-P. At the end of the second quarter of 2003, we had 375,000 more UNE-P lines than at the end of the first quarter. Taking into consideration an adjustment of 113,000 for the timing for disconnected UNE-P lines in California and Nevada, we lost an additional 488,000 retail lines to competitors who obtained UNE-P lines from us. For the first six months of 2003 we lost 1.3 million retail customer lines to competitors who obtained UNE-P lines from us.
As discussed in our 2002 Annual Report to Shareowners, in February 2003, the FCC completed its triennial review of UNE regulations. The FCC review included a wide range of UNE issues, including UNE-P, dark fiber (unused fiber that does not have a communications signal) and unbundled transport of communications services. Several state commissions are also reviewing unbundling regulations, including those for broadband services. If current UNE-P regulations remain in place or are revised to be even more detrimental to our business, we could experience additional and more significant declines in access-line revenues, which, in turn, could reduce returns on our invested capital and result in further reductions in capital expenditures and employment levels. The FCC did not release a text of its decision prior to the filing of this Form 10-Q and public information about the FCC’s ruling is somewhat limited; therefore we cannot analyze or quantify the effects of this decision until we review the text of the decision.
Should this difficult and uncertain regulatory environment stabilize, we expect that additional business opportunities, especially in the broadband area, would be created. At the same time, the continued weakness in the U.S. economy and increasing local competition from multiple wireline and wireless providers in various markets presents significant challenges for our business.
Long-Distance Applications In May and June 2003, respectively, the Illinois Commerce Commission (ICC) and the Public Utilities Commission of Ohio approved our Illinois and Ohio wireline subsidiaries’ applications to enter the interLATA long-distance markets in Illinois and Ohio. In July 2003, the Public Service Commission of Wisconsin approved our Wisconsin, and the Indiana Utility Regulatory Commission provided preliminary support for our Indiana (final approval was given in August 2003), wireline subsidiaries’ applications to enter the interLATA long-distance markets in those states. We filed applications for approval to offer interLATA long-distance services in Illinois, Ohio, Wisconsin and Indiana with the FCC on July 17, 2003. Additionally, we re-filed our Michigan long-distance application with the FCC on June 19, 2003. The FCC must issue its decision within 90 days of each filing, if it deems our filings complete. We expect increased competition for our wireline subsidiaries in these states as they approach entrance into the long-distance markets. However, ultimately we expect that providing long-distance service in these states will improve trends in access line losses, customer winback and retention, similar to those experienced in other states in our 13-state area where we offer wireline interLATA long-distance. We currently offer wireline interLATA long-distance service in Texas, Kansas, Oklahoma, Arkansas, Missouri, Connecticut, California and Nevada.
Illinois LegislationIn May 2003, the Illinois legislature passed legislation concerning wholesale prices our Illinois wireline subsidiary can charge local service competitors, such as AT&T and MCI, for leasing its local telephone network (UNE rates). The new law directed the ICC to set wholesale rates based on actual data, including our subsidiary’s actual network capacity and actual depreciation rates shown on our financial statements. In June 2003, the United States District Court for the Northern District of Illinois Eastern Division (Illinois District Court) issued a temporary order blocking implementation of this law. The order was made permanent in July 2003. We have appealed the Illinois District Court decision. If we win on appeal and this legislation is implemented, we expect the wholesale price we charge competitors to increase approximately seven dollars per month for each wholesale line, after the first 35,000 lines per competitor. As of June 30, 2003, there were approximately 900,000 wholesale lines in Illinois and a number of competitors providing service.
Telecommunications Infrastructure Fund (TIF) The TIF was established by the Texas legislature in 1995 as a tax on local, long-distance and wireless telecommunications companies and was designed to provide technology for Texas’ schools, hospitals and libraries. In June 2003, the Texas legislature extended the tax past its original goal, directing the TIF to collect $250 more than originally planned. We expect to incur operating expenses of approximately $45 in our wireline segment in 2004 related to the TIF.
OTHER BUSINESS MATTERS
WorldCom Bankruptcy In July 2002, WorldCom Inc. (WorldCom) and more than 170 related entities filed petitions for reorganization under Chapter 11 of the United States Bankruptcy Code. Our claims against WorldCom total approximately $661 and include receivables, issues that are the subject of litigation, and a variety of contingent and unliquidated items. At June 30, 2003, we had approximately $320 in receivables and reserves of approximately $140 related to the WorldCom bankruptcy filing.
In addition to the reserves, we are withholding payments on amounts we owed WorldCom as of its bankruptcy filing date that equal or exceed our remaining net receivable. These withholdings relate primarily to amounts collected from WorldCom’s long-distance customers in our role as billing agent and other general payables. We estimate our post-petition billing to WorldCom to be approximately $160 per month. To date, WorldCom generally has paid its post-petition obligations to us on a timely basis.
On July 25, 2003, WorldCom agreed to pay us approximately $107 to settle many, but not all, of the issues that arose prior to WorldCom’s bankruptcy. This settlement was approved by the bankruptcy court on August 5, 2003; however, most of the provisions are also contingent upon WorldCom obtaining approval of its Plan of Reorganization (POR). This settlement does not include issues related primarily to reciprocal compensation we paid to WorldCom for internet service provider traffic and certain pre-bankruptcy switched access charges not billed to WorldCom based on usage information provided by WorldCom. The bankruptcy court has scheduled hearings to begin in September 2003 to consider whether WorldCom’s proposed POR should be approved. Two creditor groups are opposing approval of the proposed POR; the impact they may have on WorldCom’s proposed reorganization is not yet clear. On July 26, 2003, the United States Attorney for the Southern District of New York announced an investigation with respect to recently disclosed information alleging that WorldCom is committing access fraud in the manner in which it routes and classifies long-distance calls. The impact of this investigation on WorldCom’s proposed reorganization is not yet clear.
EchoStar AgreementIn July 2003, we announced an agreement with EchoStar Communications Corporation (EchoStar) that will allow us to provide multichannel satellite television service as part of our bundled services (local phone service, long-distance, broadband, wireless and video together) throughout our 13-state traditional service area. As part of the multi-year agreement, we will help fund development of the co-branded bundled video services. We expect to receive timely regulatory approval and to launch the new “SBC DISH Network” entertainment service in early 2004. In a separate transaction, we also made a $500 investment in EchoStar in the form of debt convertible into EchoStar shares.
LIQUIDITY AND CAPITAL RESOURCES
We had $5,139 in cash and cash equivalents available at June 30, 2003. Cash and cash equivalents included cash of $294, municipal securities of $222, variable-rate securities of $1,292, money market funds of $3,242 and other short-term securities of $89.
During the first six months of 2003 our primary source of funds was cash from operating activities supplemented by cash from our disposition of Cegetel. Our primary source of funds for 2002 was cash provided by operating activities.
We currently have a credit agreement totaling $4,250 with a syndicate of banks set to expire on October 21, 2003. Advances under this agreement may be used for general corporate purposes, including support of commercial paper borrowings and other short-term borrowings. Under the terms of the agreement, repayment of advances up to $1,000 may be extended two years from the termination date of the agreement. Repayment of advances up to $3,250 may be extended to one year from the termination date of the agreement. There is no material adverse change provision governing the drawdown of advances under this credit agreement. We had no borrowings outstanding under committed lines of credit as of June 30, 2003. Upon expiration, we believe that we will be able to renew our credit facility.
Our commercial paper borrowings decreased $148 during the first six months of 2003, and at June 30, 2003, totaled $1,000, all of which was due within 90 days and issued under a program initiated by a wholly-owned subsidiary, SBC International, Inc., in the first quarter of 2002. This program was initiated in order to simplify intercompany borrowing arrangements.
Our investing activities during the first six months of 2003 consisted of $1,969 in construction and capital expenditures. Capital expenditures in the wireline segment, which represented substantially all of our total capital expenditures, decreased by approximately 44.2% in the first six months of 2003 as compared to the same period in the prior year. We currently expect our capital spending for 2003 to be between $5,000 and $6,000, excluding Cingular, substantially all of which we expect to relate to our wireline segment. We expect to continue to fund these expenditures using cash from operations, and depending on interest rate levels and overall market conditions, incremental borrowings. The Cingular and international segments should be self-funding as they are substantially equity investments and not direct SBC operations. We expect to fund any directory segment capital expenditures using cash from operations. As discussed in our 2002 Annual Report to Shareowners, our capital spending plans described above reflect continued pressure from the U.S. economic and regulatory environments and our resulting lower revenue expectations.
Investing activities during the first six months of 2003 also include proceeds of $2,270 relating to the sale of our interest in Cegetel, $177 from the sale of a portion of our interest in Yahoo! and $173 from the sale of a portion of our investment in BCE. At June 30, 2003 we held approximately 11 million shares of Yahoo! and 9 million shares of BCE. We did not make any acquisitions during the first six months of 2003.
Cash paid for dividends in the first six months of 2003 was $1,999, or 13.5% higher than in the first six months of 2002, due to a 4.6% increase in dividends declared per share in 2003 and an additional dividend of $0.05 per share. On June 27, 2003, we declared a regular quarterly dividend of $0.2825 per share and an additional dividend of $0.10 per share. These dividends will be paid on August 1, 2003.
In July 2003, we announced our intention to resume our previously announced stock repurchase program. At December 31, 2002, our Board of Directors had authorized the repurchase of 200 million shares, of which approximately 140 million shares had been repurchased as of June 30, 2003.
Also in July 2003, we entered into a co-branded service agreement with EchoStar to offer satellite television service to our in-region customers. On July 21, 2003, we invested $500 in debt that is convertible into EchoStar shares.
As of July 31, 2003, we had called, prior to maturity, approximately $1,743 of debt obligations with maturities ranging between February 2007 and March 2048, and interest rates ranging between 6.5% and 7.9%. Of the $1,743 called debt, approximately $264, with an average yield of 7.2% was called in July; $1,462, with an average yield of 7.4% was called in June; and $17, with an average yield of 6.9% was called in March. Funds from operations and dispositions were used to pay off these notes.
During the first six months of 2003, approximately $952 of long-term debt obligations, and $1,000 of one-year floating rate securities matured. The long-term obligations carried interest rates ranging from 5.9% to 9.5%, with an average yield of 6.0%. The short-term notes paid quarterly interest based on the London Interbank Offer Rate (LIBOR). Funds from operations and dispositions were used to pay off these notes.
At June 30, 2003, our debt ratio was 32.7% compared to 44.5% at June 30, 2002. The decline was primarily due to lower debt levels and our 2003 cumulative effect of accounting changes. These accounting changes increased equity $2,548, which decreased our debt ratio approximately 150 basis points (1.5%).
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the disclosures about our sensitivities to market risks related to financial instruments since December 31, 2002.
Item 4. Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed by the Company is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. The Chief Executive Officer and Chief Financial Officer have performed an evaluation of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of June 30, 2003. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective in all material respects as of June 30, 2003.
CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS
Information set forth in this report contains forward-looking statements that are subject to risks and uncertainties. We claim the protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.
The following factors could cause our future results to differ materially from those expressed in the forward-looking statements:
Readers are cautioned that other factors discussed in this report, although not enumerated here, also could materially impact our future earnings.
PART II - OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds
During the second quarter of 2003, non-employee directors acquired from the Company shares of common stock pursuant to the Company’s Non-Employee Director Stock and Deferral Plan. Under the plan, a director may make an annual election to receive all or part of his or her annual retainer or fees in the form of SBC shares or deferred stock units (DSUs) that are convertible into SBC shares. Each Director also receives an annual grant of DSUs. During this period, an aggregate of 97,643 SBC shares and DSUs were acquired by non-employee directors at prices ranging from $21.05 to $26.03, in each case the fair market value of the shares on the date of acquisition. The issuances of shares and DSUs were exempt from registration pursuant to Section 4(2) of the Securities Act.
Item 4. Submission of Matters to a Vote of Security Holders
Annual Meeting of Shareowners
Item 6. Exhibits
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.