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 September 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 October 31, 2003, common shares outstanding were 3,310,669,504.
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)Dollars in millions except per share amounts
Item 2. Management's Discussion and Analysis of Financial Condition and Results of OperationsDollars in millions except per share amounts
Throughout this document, SBC Communications Inc. is referred to as “we” or “SBC”. A reference to a “Note” in this section refers to the accompanying Notes to Consolidated Financial Statements.
Consolidated ResultsOur financial results in the third quarter and for the first nine months of 2003 and 2002 are summarized as follows:
Overview Our operating income declined $419, or 20.7%, in the third quarter and $1,118, or 17.5%, for the first nine months of 2003 due primarily to the continued loss of revenues from retail access lines caused by providing below-cost Unbundled Network Element-Platform (UNE-P) wholesale lines, which was greater than the expense reductions in response to UNE-P. (UNE-P rules require us to sell our lines and the end-to-end services provided over those lines to competitors at below cost while still absorbing the costs of deploying, provisioning, maintaining and repairing those lines. See our Competitive and Regulatory Environment for further discussion of UNE-P.) Additional factors contributing to the decline were the uncertain U.S. economy, and increased competition, including technology substitution such as wireless and cable. Although retail access line losses have continued, the trend has slowed recently in our West and Southwest regions, reflecting our ability in those regions to now offer retail interLATA (traditional) long-distance as well as the introduction of offerings combining multiple services for one fixed price (“bundles”).
An increase in our combined net pension and postretirement cost of $454 in the third quarter and $1,434 for the first nine months contributed to the decline in operating income. In addition, the change in our method of accounting for publishing directories from the “issue basis” method to the “amortization” method (see Note 1 and our Directory segment) decreased operating income approximately $43 in the third quarter and increased operating income $594 for the first nine months of 2003. Absent that accounting change, operating income would have declined 18.5% in the third quarter and 26.9% for the first nine months.
Operating revenuesOur operating revenues decreased $317, or 3.0%, in the third quarter and $1,145, or 3.6%, for the first nine months of 2003, primarily due to lower voice revenues resulting from the continued loss of retail access lines to UNE-P wholesale lines, as well as the uncertain U.S. economy and increased competition. The change in directory accounting mentioned above also decreased revenue approximately $54. However, for the first nine months of 2003 the directory accounting change still increased revenues by approximately $769 since under the former method of accounting, directory revenues were not earned evenly within each calendar year (see Note 1).
Operating expensesOur operating expenses increased $102, or 1.2%, in the third quarter and decreased $27, or 0.1%, for the first nine months of 2003. Our third quarter and year-to-date operating expenses reflect increasing costs related to our pension and postretirement benefit plans as well as increased expenses to enhance customer growth, including sales and advertising support for DSL and long-distance marketing initiatives. Our combined net pension and postretirement cost increased operating expenses approximately $454 in the third quarter and $1,434 for the first nine months of 2003 (see further discussion below). Additionally, the change in directory accounting mentioned above, increased year-to-date operating expenses approximately $175. However, the change in directory accounting decreased third-quarter expenses approximately $11.
Expense growth was partially offset in the third quarter and more than offset for the first nine months by several factors. Costs were reduced primarily due to the decline in our work force (down approximately 9,900 employees compared to the third quarter of 2002). Second, we recorded charges in 2002, which favorably affected comparisons with 2003. Specifically, these 2002 charges included $185 in the third quarter and $413 for the first nine months for enhanced pension benefits and severance costs related to a workforce-reduction program and additional bad debt reserves of $125 for the first nine months as a result of the WorldCom Inc. (WorldCom) bankruptcy filing. Third, the impact of the adoption of FAS 143 decreased our operating expenses approximately $70 in the third quarter and $210 for the first nine months of 2003 (see Note 1).
Combined Net Pension and Postretirement Benefit Our combined net pension and postretirement cost increased $454 in the third quarter and $1,434 for the first nine months of 2003. This cost increase primarily resulted from net investment losses and pension settlement gains recognized in 2002 and previous years, which reduced the amount of unrealized gains recognized in 2003. (See Note 7 for a discussion of pension settlement gains.)
Four other factors also increased our combined net pension and postretirement cost in the third quarter and first nine months of 2003. First, this cost increased approximately $86 in the third quarter and $257 for the first nine months due to our decision to lower our expected long-term rate of return on plan assets from 9.5% to 8.5% for 2003, based on our long-term view of future market returns. Second, the reduction of the discount rate used to calculate service and interest cost from 7.5% to 6.75%, in response to lower corporate bond interest rates, increased this cost approximately $41 in the third quarter and $122 for the first nine months. Third, medical and prescription drug claims increased expense approximately $38 in the third quarter and $114 for the first nine months. Fourth, in response to rising claim costs, we increased the assumed medical cost trend rate in 2003 from 8.0% to 9.0% for retirees 64 and under and from 9.0% to 10.0% for retirees 65 and over, trending to an expected increase of 5.0% in 2009 for all retirees, prior to adjustment for cost-sharing provisions of the medical and dental plans for certain retired employees. This increase in the medical cost trend rate increased our combined net pension and postretirement cost approximately $47 in the third quarter and $140 for the first nine months of 2003.
As a result of this increase in our combined net pension and postretirement cost, we have taken steps to implement additional cost controls. To offset some of the increases in medical costs mentioned above, in mid-2002, we implemented cost-saving design changes in our management medical and dental plans including increased participant contributions for medical and dental coverage and increased prescription drug co-payments which began in January 2003. These changes reduced our postretirement cost approximately $57 in the third quarter and $171 for the first nine months of 2003.
While we will continue our cost-cutting efforts discussed above, certain factors, such as investment returns, depend largely on trends in the U.S. securities market and the general U.S. economy. Our ability to improve the performance of those factors is limited. In particular, uncertainty in the securities markets and U.S. economy could result in investment losses and a decline in plan assets, which under accounting principles generally accepted in the United States (GAAP) we will recognize over the next several years. As a result of these economic impacts and assumption changes discussed below, we expect a combined net pension and postretirement cost of between $1,800 and $2,000 ($0.36 to $0.40 per share) in 2003. Approximately 10% of these costs will be capitalized as part of construction labor, providing a small reduction in the net expense recorded. Should the securities markets decline and medical and prescription drug costs continue to increase significantly, we would expect increasing annual combined net pension and postretirement cost for the next several years. Additionally, should actual experience differ from actuarial assumptions, combined net pension and postretirement cost would be affected in future years (see Note 7).
Interest expensedecreased $76, or 21.3%, in the third quarter and $74, or 7.1%, for the first nine months of 2003. This decrease in interest expense was due to a decrease of approximately $6,000 in outstanding debt compared to the third quarter of 2002.
Interest incomedecreased $11, or 8.0%, in the third quarter and $22, or 5.2%, for the first nine months of 2003 primarily due to a decrease in the interest rate charged to Cingular (see Note 6).
Equity in net income of affiliates decreased $392, or 53.8%, in the third quarter and $443, or 27.4%, for the first nine months of 2003. The decreases were due to lower results from our international holdings primarily due to gains which occurred in 2002 and forgone equity income from the disposition of investments. The decreases were also due to lower results from Cingular Wireless (Cingular). Income from our international holdings decreased approximately $320 in the third quarter and $407 for the first nine months. Our proportionate share of Cingular’s results decreased approximately $74 in the third quarter and $42 for the first nine months. We account for our 60% economic interest in Cingular under the equity method of accounting and therefore include our proportionate share of Cingular’s results in our equity in net income of affiliates line item in our consolidated financial statements. Results from our international holdings are discussed in detail in “International Segment Results” and Cingular’s operating results are discussed in detail in the “Cingular Segment Results” section.
Other income (expense) - net increased $20 in the third quarter and $1,460 for the first nine months of 2003. The increase in the third quarter of 2003 was primarily due to larger net gains on dispositions in the third quarter of 2003, specifically a gain of approximately $31 on the sale of shares of BCE, Inc. (BCE) which was partially offset by a $10 loss on the sale of a building. Results in the third quarter of 2002 included a $19 gain on the sale of shares of Amdocs Limited (Amdocs) and income of $28 related to market adjustments on Canadian dollar foreign-currency contracts. These third quarter 2002 gains were offset by charges of approximately $32 for the reduction in the value of wireless properties that may be received as a settlement of a receivable and $10 for adjustments to the market value of certain investments.
The increase for the first nine months of 2003 was primarily due to larger gains on 2003 dispositions compared to 2002. The 2003 gains included approximately $1,574 on the sale of our interest in Cegetel and gains of $104 on the sales of Yahoo! Inc. (Yahoo!) and BCE shares. These 2003 gains were partially offset by a $10 loss on the building sale, mentioned above, during the first nine months of 2003. Results for the first nine months of 2002 included gains of approximately $148 related to the redemption of a portion of our interest in Bell Canada, $109 on the sale of our investment of Amdocs shares mentioned above, and $59 on the sale of shares of our investments in Teléfonos de Mexico, S.A. de C.V. (Telmex) and América Móvil S.A. de C.V. (América Móvil). In addition, the first nine months of 2002 included income of $28 mentioned above, related to market adjustments on Canadian dollar foreign-currency contracts. These gains were partially offset by 2002 charges of approximately $60 related to the decline in value of our investment in Williams Communications Group Inc., $32 for the reduction in the value of wireless properties that may be received as a settlement of a receivable mentioned above, and $16 for market value adjustments mentioned in the third quarter 2002 discussion.
Income taxesdecreased $233, or 28.0%, in the third quarter and increased $10, or 0.4%, for the first nine months of 2003. The decrease in the third quarter was primarily due to lower income before income taxes. Year over year income taxes remained relatively steady. Our effective tax rate was 33% for the third quarter and for the first nine months of 2003, as compared to 32.7% for the third quarter and 32.6% for the first nine months of 2002.
Cumulative Effect of Accounting Changes 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. See Note 1 for further details. Our directory accounting change resulted in a noncash charge of $1,136, net of an income tax benefit of $714, recorded as a cumulative effect of accounting change on the Consolidated Statement of Income as of January 1, 2003.
On January 1, 2003, we adopted FAS 143, which changed the way we depreciate certain types of our property, plant and equipment. See Note 1 for further details. The noncash gain resulting from adoption was $3,684, net of deferred taxes of $2,249, recorded as a cumulative effect of accounting change on the Consolidated Statement of Income as of January 1, 2003.
On January 1, 2002, we adopted FAS 142. Adoption of FAS 142 means that we stopped amortizing goodwill, and at least annually we will test the remaining book value of goodwill for impairment. See Note 1 for further details. Our total cumulative effect of accounting change from adopting FAS 142 was a noncash charge of $1,820, net of an income tax benefit of $5, recorded as of January 1, 2002.
Selected Financial And Operating Data
Our segments represent strategic business units that offer different products and services and are managed accordingly. As required by GAAP, our operating segment results presented in Note 4 and discussed below for each segment follow our internal management reporting. Under GAAP segment reporting rules, we analyze our various operating segments based on segment income. Interest expense, interest income, other income (expense) – net and income tax expense are managed only on a total company basis and are, accordingly, reflected only in consolidated results. Therefore, these items are not included in the calculation of each segment’s percentage of our total segment income. We have five reportable segments that reflect the current management of our business: (1) wireline; (2) Cingular; (3) directory; (4) international; and (5) other.
The wireline segment provides landline telecommunications services, including local and long-distance voice, switched access, data and messaging services.
The Cingular segment reflects 100% of the results reported by Cingular, our wireless joint venture. This segment replaces our previously titled “wireless” segment, which included 60% of Cingular’s revenues and expenses. In our consolidated financial statements, we report our 60% proportionate share of Cingular’s results as equity in net income of affiliates.
The directory segment includes all directory operations, including Yellow and White Pages advertising and electronic publishing. In the first quarter of 2003 we changed our method of accounting for revenues and expenses in our directory segment. Results for 2003, and going forward, will be shown under the amortization method. This means that revenues and direct expenses are recognized ratably over the life of the directory, typically 12 months. This accounting change will affect only the timing of the recognition of revenues and direct expenses. It will not affect the total amounts recognized.
Our international segment includes all investments with primarily international operations. The other segment includes all corporate and other operations as well as the equity income from our investment in Cingular. Although we analyze Cingular’s revenues and expenses under the Cingular segment, we record equity in net income of affiliates (from non-international investments) in the other segment.
The following tables show components of results of operations by segment. A discussion of significant segment results is also presented following each table. Capital expenditures for each segment are discussed in “Liquidity and Capital Resources”.
Wireline Segment Results
Our wireline segment operating income margin was 11.3% in the third quarter of 2003, compared to 15.6% in the third quarter of 2002, and 12.5% for the first nine months of 2003, compared to 17.0% for the first nine months of 2002. The decline in our wireline segment operating income margin was due primarily to the loss of revenue from a decline from September 2002 to September 2003 in retail access lines of 4,238,000, or 8.1%, primarily caused by below-cost UNE-P. This decline was greater than the expense reductions in response to UNE-P. Additional factors contributing to the margin decrease were loss of revenues from the uncertain U.S. economy, increased competition, and an increase in our combined net pension and postretirement cost.
Total switched access lines in service at September 30, 2003 of 55,260,000 reflect a decline of 2,368,000, or 4.1%, from September 30, 2002 levels. Of this total, retail access lines of 47,780,000 represent 86.5% of total access lines, while at September 30, 2002, retail access lines accounted for 90.3% of total access lines. During this same period, wholesale lines (which include UNE-P and resale) increased by 1,899,000, or 37.2%, to 6,997,000. Wholesale lines represent 12.7% of total access lines at September 30, 2003, compared to 8.8% of total lines a year earlier. As our ratio of wholesale lines to total access lines continues to grow, additional pressure will be applied to our wireline segment operating margin, since the wholesale revenue we receive is limited by (generally below-cost) various state UNE-P rates but our cost to service and maintain wholesale lines is essentially the same as for retail lines.
While retail access lines have continued to decline during the third quarter, the trend has slowed recently in our West and Southwest regions reflecting our ability to now offer retail interLATA service in those regions and the introduction of bundled offerings in those regions (see “Long-distance voice” below). We also have now received approval from the Federal Communications Commission (FCC) to offer retail interLATA service in our Midwest region (see our Competitive and Regulatory Environment). Retail access lines for the Midwest region have decreased 10.7% since September 30, 2002, compared with declines of 5.6% in the Southwest region and 8.1% in the West region, for the same period. As we begin to offer interLATA long-distance service in the Midwest region, we expect that access line losses in this region will begin to moderate somewhat in the fourth quarter based on the experience of our other regions. However the expected favorable impact from offering interLATA long-distance service in the Midwest may be mitigated by the UNE-P rates in effect in those states, which are generally lower than in our other states. See further discussion of the details of our wireline segment revenue and expense fluctuations below.
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 Cingular’s 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 Federal Communications Commission (FCC) has adopted rules requiring companies to allow their customers to keep their wireless number when switching to another company (generally referred to as “number portability”). The FCC rules require number portability to be available to customers by November 24, 2003. These rules could increase Cingular’s customer turnover (“churn”) rate and thereby increase Cingular’s costs to retain or add new customers. Cingular has already incurred costs directed toward implementing these rules and minimizing customer churn and expects these costs, consisting primarily of handset subsidies, selling costs and greater staffing of customer care centers, to be higher during the year following the effectiveness of these new rules. To the extent industry churn remains higher than in the past, Cingular expects those costs to continue increasing.
Cingular’s wireless 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 upgrading its existing TDMA markets to use GSM technology in order to provide a common voice standard. Cingular’s GSM network upgrade is substantially complete and currently covers over 90% of Cingular’s population of potential customers (referred to in the media as “POPs”). Additionally, through roaming 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).
In August 2003, Cingular executed an agreement with NextWave Telecom, Inc. (NextWave) and certain of its affiliates pursuant to which Cingular would purchase FCC licenses for wireless spectrum in 34 markets from NextWave and its affiliates for $1,400 in cash. On September 25, 2003, the U.S. Bankruptcy Court for the Southern District of New York approved the sale. 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. The transaction is expected to close in the first half of 2004.
Our Cingular segment operating income margin was 12.3% in the third quarter and 17.3% for the first nine months of 2003, compared to 16.3% in the third quarter and 18.1% for the first nine months of 2002. The margins in the third quarter of 2003 were lower than recent quarters as a result of a number of factors. Cingular’s operating expenses increased primarily due to acquisition costs related to higher gross customer additions, and extensive customer retention and customer service initiatives in anticipation of number portability. Network operating costs also increased due to ongoing growth in customer usage and incremental costs related to Cingular’s GSM network upgrade. Partially offsetting these expense increases were modest revenue growth and decreased costs in other areas, including prior and ongoing system and process consolidations. At September 30, 2003, Cingular had approximately 23,385,000 customers, with net customer additions of approximately 745,000 in the third quarter. Net customer additions when compared to the same period in the prior year, increased in the third quarter of 2003 approximately 852,000 and increased for the first nine months of 2003 by approximately 980,000. Gross customer additions increased approximately 818,000 in the third quarter and 647,000 for the first nine 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.
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 (see Note 1 for additional detail). We made this change prospectively; therefore, in the table above, results in the third quarter and for the first nine months of 2003 are shown on the amortization basis, while the third quarter and first nine months of 2002 are shown on the issue basis.
Our directory segment income was $574 with an operating margin of 54.4% in the third quarter and $1,735 with an operating margin of 54.5% for the first nine months of 2003. In 2002, our directory segment income was $426 with an operating margin of 50.3% in the third quarter and $1,350 with a segment operating income margin of 51.9% for the first nine months. If we had been using the amortization method in 2002, our directory segment income would have been $560 with an operating margin of 52.4% in the third quarter of 2002 and $1,772 with an operating margin of 54.8% for the first nine months of 2002.
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 $617 and the operating margin would have been 55.6% in the third quarter and $1,141, with an operating margin of 47.3%, for the first nine months of 2003, compared to $644, with an operating margin of 56.9%, in the third quarter and $1,223, with an operating margin of 49.9%, for the first nine months of 2002. The decrease in segment income of $26 in the third quarter and $82 for the first nine months as well as the decreased operating margin was due primarily to increased employee related 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.
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 equity in net income of affiliates by major investment is listed below:
Other Segment Results
Our other segment results in the third quarter and for the first nine months of 2003 and 2002 primarily consist of corporate and other operations. Expenses increased in the third quarter of 2003 primarily due to favorable employee-benefit related mark-to-market and other adjustments that occurred in the third quarter of 2002. Substantially all of the Equity in Net Income of Affiliates represents the equity income from our investment in Cingular.
Overview 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 FCC for interstate services. For example, certain state commissions, including those in California, Illinois, Michigan, Wisconsin, Ohio and Indiana, have 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 third quarter of 2003, we had 401,000 more UNE-P lines than at the end of the second quarter. For the first nine months of 2003 we lost 1.7 million retail customer lines to competitors who obtained UNE-P lines from us.
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 uncertainty in the U.S. economy and increasing local competition from multiple wireline and wireless providers in various markets presents significant challenges for our business.
Triennial Review OrderOn August 21, 2003, the FCC released its Triennial Review Order (TRO), establishing new rules, which became effective October 2, 2003, concerning the obligations of incumbent local exchange carriers, such as our wireline subsidiaries, to make UNEs available. See our Overview section for a discussion of UNEs. These rules are intended to replace the FCC’s previous UNE rules, which were vacated by the United States Court of Appeals for the District of Columbia Circuit (D.C. Circuit). With limited exceptions, the new rules are consistent with the FCC’s February 2003 press release summarizing its review.
The TRO, rather than establishing a uniform national structure for UNEs as we believe was mandated by the D.C. Circuit, delegates key decisions on UNEs to the states, including rules for below-cost UNE-P. In addition, the TRO revised rules regarding combinations of unbundled local service (“loop”) and dedicated transport elements (see discussion of “enhanced extended links” below) which could allow competitors to access our wireline subsidiaries’ high-capacity lines without paying access charges. Numerous legal challenges to the TRO have been filed by SBC and others with the D.C. Circuit.
Set forth below is a summary of the most significant aspects of the new rules. While these rules apply only to our wireline subsidiaries, the words “we” or “our” are used to simplify the discussion. In addition, the following discussion is intended as a condensed summary of issues in the TRO rather than a precise legal description of all of those specific issues.
As the TRO is quite complex and we are still in the process of evaluating it completely, we cannot fully quantify the effects on our financial position or results of operations at this time. However, the new unbundling rules will most likely create an even more uncertain and more complex regulatory environment for our wireline subsidiaries, possibly resulting in further reductions in revenues, capital expenditures and employment levels. As the new rules give each state commission the authority to determine which network elements are to be unbundled and to set UNE-P rules, the rules will likely vary by state as well as be subject to implementation and federal appeal on a state-by-state basis rather than uniform implementation and review at the federal level. Although some relief appears to have been provided by the broadband provisions of the TRO, the new rules may create increased uncertainty and we expect that the TRO may have an overall unfavorable effect on our results of operations and financial position.
We have filed two legal challenges to these new rules with the D.C. Circuit. In August 2003, we, along with the United States Telecom Association (USTA), Qwest Communications Inc. (Qwest), and BellSouth Corporation (BellSouth), filed a Petition for a Writ of Mandamus with the Court. We asked that the Court vacate the rules governing the unbundling of switching serving non-large businesses and high-capacity facilities and issue such an order within 45 days. The Court has directed the FCC to respond. In September 2003, we, along with the USTA, Qwest, BellSouth, and Verizon Communications Inc. (Verizon), filed a notice of appeal and a motion for a stay of certain portions of the TRO, including those concerning UNE-P and EELs, with the D.C. Circuit, asking the court to reject the new rules. The D.C. Circuit has recently issued two orders relative to the TRO. The Court has consolidated all pending petitions for mandamus, petitions for review and requests for expedition into one proceeding. The Court has established an expedited schedule and has stated that it wants to be able to hear the cases as early as mid-December 2003 (the TRO became effective on October 2).
Long-Distance Applications The FCC approved our application to provide wireline interLATA (traditional) long-distance for Michigan customers effective September 17, 2003, and we launched service in Michigan under the SBC brand on September 26, 2003. Additionally, the FCC approved our applications to offer interLATA long-distance services in Illinois, Ohio, Wisconsin and Indiana effective October 15, 2003, and we began offering long-distance service in these states on October 24, 2003. We now have approval to offer interLATA long-distance nationwide and will begin offering a full bundle of telecommunications services to all of our customers.
We expect increased competition for our wireline subsidiaries in these five states, in particular, as they enter 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 previously obtained approval to offer wireline interLATA long-distance.
California Audit In August 2003, two alternate sets of proposed findings on the 1997-1999 audit of our California wireline subsidiary were presented to the California Public Utility Commission (CPUC). The two proposed sets of findings differed in many respects but both concluded that our subsidiary should issue refunds, i.e., service credits, in amounts ranging from $162 to $661. We believe that both sets of findings contain errors and that the refunds should be eliminated. These two alternative findings will be presented to the CPUC for consideration as early as November 2003. The CPUC may completely or partially accept or reject any of these proposed findings. We are not certain that the CPUC will make a final decision by the end of 2003.
Illinois Legislation In 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 issued a temporary order blocking implementation of this law. The order was made permanent in July 2003. In November 2003, the U.S. Court of Appeals for the Seventh Circuit (Seventh Circuit) affirmed that the law was invalid as it only addressed two of the factors required by the federal standards that instruct the states how to set the UNE rates. However, the Seventh Circuit also stated that the current UNE rates in effect must be updated to comply with federal law as of 2003. The Seventh Circuit instructed the ICC to quickly address these out-of-date rates and to reinstate the UNE rate proceeding that had been previously terminated by the law’s passage.
WorldCom Bankruptcy In July 2002, WorldCom and more than 170 related entities filed petitions for reorganization under Chapter 11 of the United States Bankruptcy Code (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 September 30, 2003, we had approximately $320 in receivables and reserves of which approximately $112 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. As of September 30, 2003, WorldCom had paid us $39 and escrowed the remaining $68 of our $107 settlement sum. 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. On October 31, 2003 the bankruptcy court approved WorldCom’s proposed POR. This approval will become final ten days following its entry on the court’s docket unless appealed. Even after approval, the POR remains contingent upon the FCC’s approval of various license transfers from the debtors to the reorganized WorldCom.
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.
Belgacom AgreementIn October 2003, ADSB Telecommunications B.V. (ADSB), of which we directly own 35%, announced that it had entered into an agreement with the Belgian government and Belgacom to proceed with the preparations for a potential Initial Public Offering (IPO) of Belgacom. ADSB owns one share less than 50% of Belgacom and is a consortium of SBC, TDC (of which we own 41.6%), Singapore Telecommunications and a group of Belgian financial investors. Through our 35% ownership of ADSB and our 41.6% ownership of TDC, we have a 24.4% economic ownership of Belgacom. Absent an IPO, ADSB will continue to be significantly involved in the operations of Belgacom.
As part of the agreement, ADSB will have the exclusive right from January 1, 2004 until July 31, 2005, subject to certain restrictions, to sell shares in an initial public equity offering of Belgacom. As a condition to the IPO and related transactions, Belgacom will transfer to the Belgian government the liabilities related to the statutory pension plan, proceeds from the sale of pension assets and cash sufficient to fully fund the obligations. This transfer is valued at Euro 5 billion and is expected to occur prior to December 31, 2003. The transfer, along with certain other transactions contemplated as part of the IPO, are expected to result in a one-time charge to the equity income of ADSB of between Euro 275 million and Euro 375 million, determined on a GAAP basis. Including our direct and indirect ownership, this charge is expected to reduce our fourth-quarter 2003 diluted earnings per share by $0.03 to $0.04.
Additionally, Belgacom has agreed to offer to buy back from ADSB, before year-end 2003, approximately 6% of the Belgacom shares ADSB holds (representing approximately 3% of the Belgacom shares outstanding) and to make a second buyback offer in the event of an IPO. Should the IPO occur, the price per share of both buybacks would be adjusted to the IPO price. If no IPO occurs before July 31, 2005, there will be no adjustment to the proceeds from the first buyback.
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.
Antitrust LitigationEight consumer antitrust class actions were filed last year against SBC in the United States District Court for the District of Connecticut. The primary claim in these suits is that SBC companies have, in violation of federal and state law, maintained monopoly power over local telephone service in all 13 states in which SBC subsidiaries are incumbent local exchange companies.
These cases have been consolidated under the first filed case Twombly v. SBC Communications Inc. and are now stayed by agreement of the parties pending the United States Supreme Court’s (Supreme Court) decision in a similar case against another incumbent local exchange company (Law Offices of Curtis V. Trinko v. Bell Atlantic Corp., 294 F.3d 307 (2d Cir. N.Y. 2002), argued October 14, 2003). That Court’s decision in Trinko may determine whether these actions will proceed and, if so, on what theories. If the consolidatedTwombly cases do go forward after the Supreme Court rules inTrinko, SBC expects to move for dismissal or summary disposition of the complaints and oppose class certification.
In addition to the Connecticut class actions described above, two consumer antitrust class actions were filed in the U.S. District Court for the Southern District of New York against SBC, Verizon, Bell South and Qwest alleging that they have violated federal and state antitrust laws by agreeing not to compete with one another and acting together to impede competition for local telephone services (Twombly v. Bell Atlantic Corp., et. al). In October 2003, the Court granted the joint defendants’ motion to dismiss on the ground that the plaintiffs’ complaint failed to state a claim under the antitrust laws. Plaintiffs may appeal.
We believe that an adverse outcome having a material effect on our financial statements in any of these cases is unlikely. We will continue to evaluate the potential impact of these suits on our financial results in light of Supreme Court and other appellate decisions that may impact the outcome of these cases and rulings by the courts in which these suits are pending on motions to dismiss or summary disposition and for class certification.
Number PortabilityThe FCC has adopted rules requiring companies to allow their customers to keep their wireline or wireless number when switching to another company (generally referred to as “number portability”). While customers have been able for several years to retain their numbers when switching their local service between wireline companies, the rules now require wireless companies to offer number portability to their customers, beginning November 24, 2003. Lawsuits challenging these rules are pending before the FCC and the U.S. Court of Appeals.
In October 2003, the FCC released an order addressing some of the wireless-wireless number portability implementation issues. This order states that wireless companies cannot delay switching a customer to collect early termination fees or other amounts owed by that customer. On November 10, 2003, the FCC issued a subsequent order addressing wireline-wireless number switching issues. At the time of this report, it is too soon to determine the impact of this order.
NextWave In September 2003, the U.S. Bankruptcy Court for the Southern District of New York approved the sale of certain cellular licenses held by NextWave to Cingular. The approval clears the way for Cingular to seek the regulatory approvals needed to complete the license transfers. The licenses cover approximately 83 million potential customers primarily in markets where Cingular currently has voice and data operations. Cingular expects this transaction to close during the first half of 2004.
Southern California Wildfires During October and November 2003 numerous wildfires caused damage throughout southern California. We have made preliminary estimates as to the extent of the damage and, at this time, do not expect it to be material.
Disposition In September 2003, we sold our remaining shares of BCE for $191 in cash and recorded a pre-tax gain of approximately $31. In October 2003, we sold an additional 3.9 million shares of Yahoo!, recording a fourth-quarter 2003 gain of approximately $97.
We had $4,940 in cash and cash equivalents available at September 30, 2003. Cash and cash equivalents included cash of approximately $318, municipal securities of $260, variable-rate securities of $1,266, money market funds of $3,043 and other cash equivalents of $53.
In addition, at September 30, 2003 we had other short-term held-to-maturity securities of $261 and long-term held-to-maturity securities of $154.
During the first nine 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.
In October 2003, we renewed our 364-day credit agreement totaling $4,250 with a syndicate of banks replacing our credit agreement of $4,250 that expired on October 21, 2003. The expiration date of the current credit agreement is October 19, 2004. 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 September 30, 2003.
Our commercial paper borrowings decreased $148 during the first nine months of 2003, and at September 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 nine months of 2003 consisted of $3,235 in construction and capital expenditures. Capital expenditures in the wireline segment, which represented substantially all of our total capital expenditures, decreased by approximately 35.9% for the first nine months of 2003 as compared to the same period in the prior year. We currently expect our capital spending for 2003 to be at or below $5,000, 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 nine 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 $364 from the sale of the remaining portion of our investment in BCE. In October 2003 we sold approximately 3.9 million shares of Yahoo! for proceeds of $164. At October 31, 2003 we held approximately 7 million shares of Yahoo!. We did not make any acquisitions during the first nine months of 2003.
For the first nine months of 2003 investing activities included the purchase of other held-to-maturity securities, with maturities greater than 90 days, of approximately $578.
Cash paid for dividends for the first nine months of 2003 was $3,271, or 23.0%, higher than for the first nine months of 2002, due to a 4.6% increase in quarterly dividends declared per share in 2003 and our additional dividends. For the first three quarters of 2003, we declared an additional dividend above our regular quarterly payout. These additional dividends declared for the first nine months totaled $0.25 per share. The third quarter regular dividend of $0.2825 and additional dividend of $0.10 per share will be paid on November 3, 2003. Our Board of Directors expects to evaluate the dividend policy in December 2003.
In July 2003, we announced our intention to resume our previously announced stock repurchase program. During the third quarter of 2003 we repurchased approximately 13 million shares at a cost of $299. As of September 30, 2003 we have repurchased 153 million shares of the 200 million shares previously authorized by our Board of Directors.
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.
During the first nine months of 2003 we 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 nine months of 2003, approximately $997 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 September 30, 2003, our debt ratio was 32.5% compared to 42.3% at September 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 160 basis points (1.6%).
In August 2003 we entered into $1,000 in variable interest rate swap contracts on our 5.875% fixed rate debt which matures in August 2012. At September 30, 2003 we had interest rate swaps with a notional value of $2,000 and a fair value of approximately $132.
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 September 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 September 30, 2003.
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.
During the third 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 16,343 SBC shares and DSUs were acquired by non-employee directors at prices ranging from $21.82 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 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.