FORM 10-Q

 

United States

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

(Mark One)

 

x

Quarterly Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2005

 

or

 

o

Transition Report Pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

 

For the transition period from       to     

 

Commission File Number 1-8610

 

SBC COMMUNICATIONS INC.

 

Incorporated under the laws of the State of Delaware

I.R.S. Employer Identification Number 43-1301883

 

175 E. Houston, San Antonio, Texas 78205

Telephone 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 No      

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes No     

 

At July 29, 2005, common shares outstanding were 3,303,925,461.



PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

SBC COMMUNICATIONS INC.

CONSOLIDATED STATEMENTS OF INCOME

Dollars in millions except per share amounts

(Unaudited)

 

 

Three months ended

 

Six months ended

 

 

June 30,

 

June 30,

 

 

2005

 

2004

 

2005

 

2004

Operating Revenues

 

 

 

 

 

 

 

 

Voice

$

4,974

$

5,205

$

10,060

$

10,418

Data

 

2,997

 

2,727

 

5,821

 

5,374

Long-distance voice

 

922

 

815

 

1,823

 

1,564

Directory advertising

 

949

 

959

 

1,895

 

1,921

Other

 

486

 

490

 

977

 

931

Total operating revenues

 

10,328

 

10,196

 

20,576

 

20,208

Operating Expenses

 

 

 

 

 

 

 

 

Cost of sales (exclusive of depreciation and

 

 

 

 

 

 

 

 

amortization shown separately below)

 

4,347

 

4,292

 

8,744

 

8,519

Selling, general and administrative

 

2,654

 

2,576

 

5,124

 

4,922

Depreciation and amortization

 

1,809

 

1,888

 

3,634

 

3,811

Total operating expenses

 

8,810

 

8,756

 

17,502

 

17,252

Operating Income

 

1,518

 

1,440

 

3,074

 

2,956

Other Income (Expense)

 

 

 

 

 

 

 

 

Interest expense

 

(349)

 

(235)

 

(702)

 

(467)

Interest income

 

100

 

120

 

209

 

236

Equity in net income of affiliates

 

181

 

369

 

123

 

961

Other income (expense) – net

 

34

 

(44)

 

81

 

817

Total other income (expense)

 

(34)

 

210

 

(289)

 

1,547

Income Before Income Taxes

 

1,484

 

1,650

 

2,785

 

4,503

Income taxes

 

484

 

515

 

900

 

1,457

Income From Continuing Operations

 

1,000

 

1,135

 

1,885

 

3,046

Income From Discontinued Operations, net of tax

 

-

 

33

 

-

 

59

Net Income

$

1,000

$

1,168

$

1,885

$

3,105

Earnings Per Common Share:

 

 

 

 

 

 

 

 

Income From Continuing Operations

$

0.30

$

0.34

$

0.57

$

0.92

Net Income

$

0.30

$

0.35

$

0.57

$

0.94

Earnings Per Common Share - Assuming Dilution:

 

 

 

 

 

 

 

 

Income From Continuing Operations

$

0.30

$

0.34

$

0.57

$

0.92

Net Income

$

0.30

$

0.35

$

0.57

$

0.94

Weighted Average Number of Common

 

 

 

 

 

 

 

 

Shares Outstanding – Basic (in millions)

 

3,302

 

3,312

 

3,303

 

3,310

Dividends Declared Per Common Share

$

0.3225

$

0.3125

$

0.645

$

0.625

See Notes to Consolidated Financial Statements.

 

2

SBC COMMUNICATIONS INC.

CONSOLIDATED BALANCE SHEETS

Dollars in millions except per share amounts

 

 

 

 

 

 

 

June 30,

 

 

December 31,

 

 

2005

 

 

2004

Assets

 

(Unaudited)

 

 

 

Current Assets

 

 

 

 

 

Cash and cash equivalents

$

406

 

$

760

Accounts receivable - net of allowances for

 

 

 

 

 

uncollectibles of $894 and $881

 

5,220

 

 

5,480

Prepaid expenses

 

867

 

 

746

Deferred income taxes

 

545

 

 

566

Other current assets

 

784

 

 

989

Total current assets

 

7,822

 

 

8,541

Property, plant and equipment - at cost

 

137,498

 

 

136,177

Less: accumulated depreciation and amortization

 

88,700

 

 

86,131

Property, Plant and Equipment – Net

 

48,798

 

 

50,046

Goodwill

 

1,769

 

 

1,625

Investments in Equity Affiliates

 

1,768

 

 

1,798

Investments in and Advances to Cingular Wireless

 

32,414

 

 

33,687

Other Assets

 

13,072

 

 

13,147

Total Assets

$

105,643

 

$

108,844

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current Liabilities

 

 

 

 

 

Debt maturing within one year

$

6,890

 

$

5,734

Accounts payable and accrued liabilities

 

9,208

 

 

10,038

Accrued taxes

 

1,762

 

 

1,787

Dividends payable

 

1,066

 

 

1,065

Liabilities of discontinued operations

 

-

 

 

310

Total current liabilities

 

18,926

 

 

18,934

Long-Term Debt

 

18,216

 

 

21,231

Deferred Credits and Other Noncurrent Liabilities

 

 

 

 

 

Deferred income taxes

 

15,157

 

 

15,621

Postemployment benefit obligation

 

9,347

 

 

9,076

Unamortized investment tax credits

 

177

 

 

188

Other noncurrent liabilities

 

3,334

 

 

3,290

Total deferred credits and other noncurrent liabilities

 

28,015

 

 

28,175

 

 

 

 

 

 

Stockholders’ Equity

 

 

 

 

 

Common shares issued ($1 par value)

 

3,433

 

 

3,433

Capital in excess of par value

 

12,557

 

 

12,804

Retained earnings

 

29,105

 

 

29,352

Treasury shares (at cost)

 

(4,034)

 

 

(4,535)

Additional minimum pension liability adjustment

 

(190)

 

 

(190)

Accumulated other comprehensive income

 

(385)

 

 

(360)

Total stockholders’ equity

 

40,486

 

 

40,504

Total Liabilities and Stockholders’ Equity

$

105,643

 

$

108,844

See Notes to Consolidated Financial Statements.

3

SBC COMMUNICATIONS INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Dollars in millions, increase (decrease) in cash and cash equivalents

(Unaudited)

Six months ended

 

June 30,

 

 

2005

 

2004

Operating Activities

 

 

 

 

Net income

$

1,885

$

3,105

Adjustments to reconcile net income to net cash

 

 

 

 

provided by operating activities:

 

 

 

 

Depreciation and amortization

 

3,634

 

3,811

Undistributed earnings from investments in equity affiliates

 

(87)

 

(671)

Provision for uncollectible accounts

 

413

 

388

Amortization of investment tax credits

 

(11)

 

(15)

Deferred income tax (benefit) expense

 

(264)

 

882

Net gain on sales of investments

 

(75)

 

(849)

Income from discontinued operations, net of tax

 

-

 

(59)

Retirement benefit funding

 

-

 

(232)

Changes in operating assets and liabilities:

 

 

 

 

Accounts receivable

 

(153)

 

230

Other current assets

 

(14)

 

10

Accounts payable and accrued liabilities

 

(753)

 

(1,035)

Other - net

 

465

 

126

Total adjustments

 

3,155

 

2,586

Net Cash Provided by Operating Activities

 

5,040

 

5,691

Investing Activities

 

 

 

 

Construction and capital expenditures

 

(2,329)

 

(2,138)

Receipts from (investments in) affiliates – net

 

1,179

 

-

Purchases of held-to-maturity securities

 

-

 

(135)

Maturities of held-to-maturity securities

 

98

 

237

Dispositions

 

86

 

5,179

Acquisitions

 

(169)

 

(9)

Proceeds from note repayment

 

37

 

50

Net Cash (Used in) Provided by Investing Activities

 

(1,098)

 

3,184

Financing Activities

 

 

 

 

Net change in short-term borrowings with original

 

 

 

 

maturities of three months or less

 

(882)

 

(35)

Repayment of long-term debt

 

(1,037)

 

(184)

Purchase of treasury shares

 

(235)

 

-

Issuance of treasury shares

 

298

 

93

Dividends paid

 

(2,130)

 

(2,069)

Net Cash Used in Financing Activities

 

(3,986)

 

(2,195)

Net increase (decrease) in cash and cash equivalents from continuing operations

 

(44)

 

6,680

Net increase (decrease) in cash and cash equivalents from discontinued operations

 

(310)

 

100

Net increase (decrease) in cash and cash equivalents

 

(354)

 

6,780

Cash and cash equivalents beginning of year

 

760

 

4,806

Cash and Cash Equivalents End of Period

$

406

$

11,586

Cash paid during the six months ended June 30 for:

Interest

$

752

$

536

Income taxes, net of refunds

$

1,493

$

144

See Notes to Consolidated Financial Statements.

4

 

 

 

SBC COMMUNICATIONS INC.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Dollars and shares in millions, except per share amounts

(Unaudited)

 

Six months ended

 

June 30, 2005

 

Shares

Amount

Common Stock

 

 

 

Balance at beginning of year

3,433

$

3,433

Balance at end of period

3,433

$

3,433

Capital in Excess of Par Value

 

 

 

Balance at beginning of year

 

$

12,804

Issuance of shares

 

 

(286)

Stock option expense

 

 

11

Other

 

 

28

Balance at end of period

 

$

12,557

Retained Earnings

 

 

 

Balance at beginning of year

 

$

29,352

Net income ($0.57 per share)

 

 

1,885

Dividends to stockholders ($0.645 per share)

 

 

(2,131)

Other

 

 

(1)

Balance at end of period

 

$

29,105

Treasury Shares

 

 

 

Balance at beginning of year

(132)

$

(4,535)

Purchase of shares

(10)

 

(235)

Issuance of shares

15

 

736

Balance at end of period

(127)

$

(4,034)

Additional Minimum Pension Liability Adjustment

 

 

 

Balance at beginning of year

 

$

(190)

Balance at end of period

 

$

(190)

Accumulated Other Comprehensive Income, net of tax

 

 

 

Balance at beginning of year

 

$

(360)

Other comprehensive income (loss) (see Note 2)

 

 

(25)

Balance at end of period

 

$

(385)

 

See Notes to Consolidated Financial Statements.

 

 

 

5

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Dollars in millions except per share amounts

 

 

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


Basis of Presentation – Throughout this document, SBC Communications Inc. is referred to as “we” or “SBC.” The consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) that permit reduced disclosure for interim periods. We believe that these consolidated financial statements include all adjustments (consisting only of normal recurring accruals) necessary to present fairly the results for the interim periods shown. The results for the interim periods are not necessarily indicative of results for the full year. You should read this document in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2004.

 

Our subsidiaries and affiliates operate in the communications services industry both domestically and worldwide providing wireline and wireless telecommunications services and equipment as well as directory advertising and publishing services.

 

The consolidated financial statements include the accounts of SBC and our majority-owned subsidiaries. All significant intercompany transactions are eliminated in the consolidation process. Investments in partnerships, joint ventures, including Cingular Wireless (Cingular), and less than majority-owned subsidiaries where we have significant influence are accounted for under the equity method. We account for our 60% economic interest in Cingular under the equity method 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. Earnings from foreign investments accounted for using the equity method are included for periods ended within up to three months of the date of our Consolidated Statements of Income.

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes, including estimates of probable losses and expenses. Actual results could differ from those estimates.

 

Share-Based Compensation – On December 16, 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), “Share-Based Payment” (FAS 123(R)), which is a revision of FASB Statement No. 123, “Accounting for Stock-Based Compensation” (FAS 123). FAS 123(R) supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and amends FASB Statement No. 95, “Statement of Cash Flows.” Generally, the approach in FAS 123(R) is similar to the approach described in FAS 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

 

For companies registered with the SEC, such as SBC, FAS 123(R) must be adopted no later than the fiscal year beginning after June 15, 2005. FAS 123(R) permits public companies to adopt its requirements using the following methods:

The “modified prospective” method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of FAS 123(R) for all share-based payments granted after the effective date and (b) based on the requirements of FAS 123 for all awards granted to employees prior to the effective date of FAS 123(R) that remain unvested on the effective date.

 

6

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

The “modified retrospective” method which includes the requirements of the modified prospective method described above, but also permits entities to restate based on the amounts previously recognized under FAS 123 for purposes of pro forma disclosures either (a) all prior periods presented or (b) prior interim periods of the year of adoption.

 

We are still considering which method to adopt under FAS 123(R). We adopted the fair-value-based method of accounting for share-based payments allowed under FAS 123 effective January 1, 2002, using the retroactive restatement method of adoption described in FASB Statement No. 148, “Accounting for Stock-Based Compensation Transition and Disclosure.” This included restatement of results from January 1, 2000 forward, as those were the years for which audited income statements were included in the 2002 SBC Annual Report. Upon adoption of FAS 123(R), if we were to adopt the modified retrospective method, we would also restate results for 1995 through 1999 for the effects on our equity. We are currently using the Black-Scholes option pricing model to estimate the fair value of stock options granted to employees and expect to continue to use this acceptable option valuation model upon the required adoption of FAS 123(R).

 

We anticipate that adoption of FAS 123(R) will not have a material impact on compensation expense. However, our current accounting under FAS 123 and prospective accounting under FAS 123(R) may affect our ability to fully realize the value shown on our balance sheet of deferred tax assets associated with compensation expense. Full realization of these deferred tax assets requires stock options to be exercised at a price equaling or exceeding the sum of the strike price plus the fair value of the option at the grant date. The provisions of FAS 123 and FAS 123(R), however, do not allow a valuation allowance to be recorded unless the company’s future taxable income is expected to be insufficient to recover the asset. Accordingly, there can be no assurance that the current stock price of SBC common shares will rise to levels sufficient to realize the entire tax benefit currently reflected in our balance sheet. However, to the extent that additional tax benefits are generated in excess of the deferred taxes associated with compensation expense previously recognized, the potential future impact on income would be reduced. Adoption of FAS 123(R) under the modified retrospective method would increase the amount of excess benefits we have previously recorded.

 

Conditional Asset Retirement Obligations – During the first quarter of 2005, the FASB issued FASB Interpretation Number 47, “Accounting for Conditional Asset Retirement Obligations, an Interpretation of FASB Statement 143” (FIN 47). Under the provisions of FIN 47, companies must accrue legally mandated costs to dispose of assets that are triggered by a future conditional action. This modifies FASB Statement 143, “Accounting for Asset Retirement Obligations” (FAS 143) which required accrual of costs only when removal and disposal were legally required. For example, assume there are specific disposal requirements for an asset once it is physically removed from service, but there is no legal requirement to remove the asset from service. Under FAS 143, nothing would have been accrued for disposal at time of purchase. Under FIN 47, only the cost of disposal would be accrued at the time of purchase, but not the cost of removal as it is the removal activity that triggers the required disposal. Any liability accrued would be offset by an increase in the value of the asset. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently studying the effects of FIN 47 on our financial statements and we do not expect it to have a material impact.

 

Reclassifications We have reclassified certain amounts in prior-period financial statements to conform to the current period’s presentation, including those related to our discontinued operations (see Note 7).

 

7

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

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. We provide valuation allowances against the deferred tax assets for amounts when the realization is uncertain. Management reviews these items regularly in light of changes in tax laws and court rulings at both the federal and state levels.

 

Our income tax returns are regularly audited and reviewed by the Internal Revenue Service (IRS) and state taxing authorities. The IRS has completed field examinations for all tax years through 1999 and examinations of subsequent years are in progress. The IRS has issued assessments challenging the timing and amounts of various deductions for the 1997-1999 period. We paid the taxes on these assessments and filed refund claims, which the IRS has denied. We are working with the IRS to resolve all the issues related to these claims. The ultimate resolution is not expected to have a material adverse impact on the financial statements. Additionally, the IRS is expected to complete fieldwork for the 2000-2002 period during 2005.

 

Investment tax credits earned prior to their repeal by the Tax Reform Act of 1986 are amortized as reductions in income tax expense over the lives of the assets which gave rise to the credits.

 

Cash Equivalents – Cash and cash equivalents include all highly liquid investments with original maturities of three months or less, and the carrying amounts approximate fair value. At June 30, 2005, we held $292 in cash, $42 in money market funds and $72 in other cash equivalents.

 

Investment Securities – Investments in securities principally consist of held-to-maturity or available-for-sale instruments. Short-term and long-term investments in money market securities are carried as held-to-maturity securities. Available-for-sale securities consist of various debt and equity securities that are long-term in nature. Unrealized gains and losses, net of tax, are recorded in accumulated other comprehensive income. Our investment securities maturing within one year are recorded in “Other current assets” and instruments with maturities more than one year are recorded in “Other Assets” on the Consolidated Balance Sheets.

 

Revenue Recognition – Revenues and associated expenses related to nonrefundable, up-front wireline service activation fees are deferred and recognized over the average customer life of five years. Expenses, though exceeding revenue, are only deferred to the extent of revenue.

 

Certain revenues derived from local telephone, long-distance, data and wireless services (principally fixed fees) are billed monthly in advance and are recognized the following month when services are provided. Other revenues derived from telecommunications services, principally long-distance and wireless airtime usage (in excess or in lieu of fixed fees) and network access, are recognized monthly as services are provided.

 

We recognize revenues and expenses related to publishing directories on the amortization method which recognizes revenues and expenses ratably over the life of the directory, which is typically 12 months.

 

Allowance for Uncollectibles Our bad debt allowance is estimated primarily based on analysis of history and future expectations of our retail and our wholesale customers in each of our operating companies. For retail customers, our estimates are based on our actual historical write-offs, net of recoveries, and the aging

 

8

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

of accounts receivable balances. Our assumptions are reviewed at least quarterly and adjustments are made to our bad debt allowance as appropriate. For our wholesale customers, we use a statistical model based on our aging of accounts receivable balances. Our risk categories, risk percentages and reserve balance assumptions built into the model are reviewed monthly and the bad debt allowance is adjusted accordingly.

 

Goodwill Goodwill represents the excess of consideration paid over net assets acquired in business combinations. Goodwill is not amortized, but is tested annually for impairment. During 2005, our goodwill increased $144 due to an acquisition by our consolidated subsidiary Sterling Commerce, Inc.

 

NOTE 2. COMPREHENSIVE INCOME

 

The components of our comprehensive income for the three and six months ended June 30, 2005 and 2004 include net income, adjustments to stockholders’ equity for the foreign currency translation adjustment, net unrealized gain (loss) on available-for-sale securities and net unrealized gain (loss) on cash flow hedges. The foreign currency translation adjustment is due to exchange rate changes in our foreign affiliates’ local currencies, Mexico in the second quarter and for the first six months of 2005 and primarily Denmark in the second quarter and for the first six months of 2004. The reclassification adjustment on cash flow hedges was due to the amortization of losses from our interest rate forward contracts.

 

Following is our comprehensive income:

 

 

Three months ended

Six months ended

 

 

June 30,

 

 

June 30,

 

 

2005

 

2004

 

 

2005

 

2004

Net income

$

1,000

$

1,168

 

$

1,885

$

3,105

Other comprehensive income, net of tax:

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment

 

32

 

(198)

 

 

30

 

(210)

Net unrealized gains (losses) on securities:

 

 

 

 

 

 

 

 

 

Unrealized gains (losses)

 

(7)

 

21

 

 

(23)

 

98

Less reclassification adjustment realized

in net income

 

(6)

 

(140)

 

 

(33)

 

(140)

Reclassification adjustment for losses

 

 

 

 

 

 

 

 

 

on cash flow hedges included in net income

 

-

 

10

 

 

1

 

10

Other comprehensive income (loss)

 

19

 

(307)

 

 

(25)

 

(242)

Total comprehensive income

$

1,019

$

861

 

$

1,860

$

2,863

 

 

9

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

NOTE 3. EARNINGS PER SHARE

 

A reconciliation of the numerators and denominators of basic earnings per share and diluted earnings per share for income from continuing operations for the three and six months ended June 30, 2005 and 2004 is shown in the table below.

 

 

Three months ended

 

Six months ended

 

June 30,

 

June 30,

 

2005

2004

 

 

2005

 

2004

Numerators

 

 

 

 

 

 

 

 

 

Numerator for basic earnings per share:

 

 

 

 

 

 

 

 

 

Income from continuing operations

$

1,000

$

1,135

 

$

1,885

$

3,046

Dilutive potential common shares:

 

 

 

 

 

 

 

 

 

Other stock-based compensation

 

1

 

2

 

 

3

 

4

Numerator for diluted earnings per share

$

1,001

$

1,137

 

$

1,888

$

3,050

Denominators (000,000)

 

 

 

 

 

 

 

 

 

Denominator for basic earnings per share:

 

 

 

 

 

 

 

 

 

Weighted-average number of common

 

 

 

 

 

 

 

 

 

shares outstanding

 

3,302

 

3,312

 

 

3,303

 

3,310

Dilutive potential common shares:

 

 

 

 

 

 

 

 

 

Stock options

 

1

 

2

 

 

1

 

2

Other stock-based compensation

 

9

 

9

 

 

10

 

11

Denominator for diluted earnings per share

 

3,312

 

3,323

 

 

3,314

 

3,323

Basic earnings per share

 

 

 

 

 

 

 

 

 

Income from continuing operations

$

0.30

$

0.34

 

$

0.57

$

0.92

Income from discontinued operations

 

-

 

0.01

 

 

-

 

0.02

Net income

$

0.30

$

0.35

 

$

0.57

$

0.94

Diluted earnings per share

 

 

 

 

 

 

 

 

 

Income from continuing operations

$

0.30

$

0.34

 

$

0.57

$

0.92

Income from discontinued operations

 

-

 

0.01

 

 

-

 

0.02

Net income

$

0.30

$

0.35

 

$

0.57

$

0.94

 

At June 30, 2005, we had issued and outstanding options to purchase approximately 206 million shares of SBC common stock. The exercise prices of options to purchase a weighted average of 199 million shares in the second quarter and 198 million shares for the first six months exceeded the average market price of SBC stock. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the respective periods. At June 30, 2005, the exercise prices of 8 million share options were below market price, commonly referred to as “in the money.” Of these “in the money” options, almost all will expire by the end of 2007.

 

At June 30, 2004, we had issued and outstanding options to purchase approximately 227 million shares of SBC common stock. The exercise prices of options to purchase a weighted average of 197 million shares in the second quarter and 194 million shares for the first six months exceeded the average market price of SBC stock. Accordingly, we did not include these amounts in determining the dilutive potential common shares for the respective periods. At June 30, 2004, the exercise prices of 30 million share options were below market price, commonly referred to as “in the money.” Of these “in the money” options, 19 million will expire by the end of 2006.

 

10

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

NOTE 4. SEGMENT INFORMATION

 

Our segments are strategic business units that offer different products and services and are managed accordingly. 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 consolidated results. 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 both retail and wholesale landline telecommunications services, including local and long-distance voice, switched access, data and messaging services and satellite television services through our agreement with EchoStar Communications Corp.

 

The Cingular segment reflects 100% of the results reported by Cingular, our wireless joint venture. In February 2005, we announced we were recording a charge against fourth-quarter 2004 results to reflect the correction of an error relating to the lease accounting practices of Cingular. Because Cingular restated previous financial results, we have reflected those adjustments in Cingular’s 2004 results recorded in the following table. However, due to the immateriality of this adjustment to the results of operations, cash flows and financial position of SBC, we did not adjust our presentation of equity in net income of affiliates in the second quarter and for the first six months of 2004, which is reflected in the “Other” segment. This charge does not affect Cingular’s cash flows and is primarily related to the timing of recording rental expense, which would balance out over the life of the affected operating leases. Cingular’s 2004 results have also been restated to conform the presentation of various state gross receipts taxes and other fees to the current year. In the following segment tables we present 100% of Cingular’s revenues and expenses including these adjustments under “Total segment operating revenues” and “Total segment operating expenses.” Although we analyze Cingular’s revenues and expenses under the Cingular segment, we eliminate the Cingular segment in our consolidated financial statements. In our consolidated financial statements, we report our 60% proportionate share of Cingular’s results as equity in net income of affiliates. For segment reporting, we report this equity in net income (loss) of affiliates in our other segment.

 

The directory segment includes our directory operations, including Yellow and White Pages advertising and electronic publishing. Results for this segment are shown under the amortization method, which means that revenues and direct expenses are recognized ratably over the life of a directory title, typically 12 months. Results for 2004 presented in this segment have been restated to reflect the sale of our interest in the directory advertising business in Illinois and northwest Indiana to R.H. Donnelley Corporation (Donnelley) (see Note 7). In November 2004, a subsidiary in our directory segment entered into a joint venture agreement with BellSouth Corporation (BellSouth) and purchased the online directory provider YellowPages.com (YPC). Our portion of the results from YPC is recorded as equity in net income of affiliates.

 

Our international segment includes all investments with primarily international operations. The other segment includes results from paging services, all corporate and other operations as well as the Cingular equity income, as discussed above.

 

11

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

In the following tables, we show how our segment results are reconciled to our consolidated results reported in accordance with GAAP. The Wireline, Cingular, Directory, International and Other columns represent the segment results of each such operating segment. The Wireline column includes revenues from services sold to Cingular of $205 in the second quarter and $387 for the first six months of 2005 and $137 in the second quarter and $285 for the first six months of 2004 (see Note 5). Since we account for Cingular using the equity method of accounting, these revenues are not eliminated upon consolidation and as such, remain in consolidated revenue. The Consolidation and Elimination column adds in those line items that we manage on a consolidated basis only: interest expense, interest income and other income (expense) - net. This column also eliminates any intercompany transactions included in each segment’s results. Since our 60% share of the results from Cingular is already included in the Other column, the Cingular Elimination column removes the results of Cingular shown in the Cingular segment.

 

 

12

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

 

For the three months ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidation

 

Cingular

 

Consolidated

 

 

Wireline

 

Cingular

 

Directory

 

International

 

Other

 

and Elimination

 

Elimination

 

Results

Revenues from external customers

$

9,369

$

8,609

$

901

$

2

$

56

$

-

$

(8,609)

$

10,328

Intersegment revenues

 

8

 

-

 

24

 

-

 

-

 

(32)

 

-

 

-

Total segment operating revenues

 

9,377

 

8,609

 

925

 

2

 

56

 

(32)

 

(8,609)

 

10,328

Operations and support expenses

 

6,571

 

6,476

 

433

 

4

 

26

 

(33)

 

(6,476)

 

7,001

Depreciation and amortization expenses

 

1,782

 

1,629

 

1

 

-

 

26

 

-

 

(1,629)

 

1,809

Total segment operating expenses

 

8,353

 

8,105

 

434

 

4

 

52

 

(33)

 

(8,105)

 

8,810

Segment operating income

 

1,024

 

504

 

491

 

(2)

 

4

 

1

 

(504)

 

1,518

Interest expense

 

-

 

326

 

-

 

-

 

-

 

349

 

(326)

 

349

Interest income

 

-

 

18

 

-

 

-

 

-

 

100

 

(18)

 

100

Equity in net income (loss) of affiliates

 

-

 

1

 

-

 

88

 

94

 

(1)

 

(1)

 

181

Other income (expense) – net

 

-

 

(26)

 

-

 

-

 

-

 

34

 

26

 

34

Segment income before income taxes

$

1,024

$

171

$

491

$

86

$

98

$

(215)

$

(171)

$

1,484

 

 

 

For the six months ended June 30, 2005

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidation

 

Cingular

 

Consolidated

 

 

Wireline

 

Cingular

 

Directory

 

International

 

Other

 

and Elimination

 

Elimination

 

Results

Revenues from external customers

$

18,650

$

16,838

$

1,806

$

5

$

115

$

-

$

(16,838)

$

20,576

Intersegment revenues

 

16

 

-

 

48

 

-

 

-

 

(64)

 

-

 

-

Total segment operating revenues

 

18,666

 

16,838

 

1,854

 

5

 

115

 

(64)

 

(16,838)

 

20,576

Operations and support expenses

 

13,036

 

12,916

 

876

 

11

 

8

 

(63)

 

(12,916)

 

13,868

Depreciation and amortization expenses

 

3,580

 

3,304

 

3

 

-

 

52

 

(1)

 

(3,304)

 

3,634

Total segment operating expenses

 

16,616

 

16,220

 

879

 

11

 

60

 

(64)

 

(16,220)

 

17,502

Segment operating income

 

2,050

 

618

 

975

 

(6)

 

55

 

-

 

(618)

 

3,074

Interest expense

 

-

 

664

 

-

 

-

 

-

 

702

 

(664)

 

702

Interest income

 

-

 

36

 

-

 

-

 

-

 

209

 

(36)

 

209

Equity in net income (loss) of affiliates

 

-

 

3

 

(1)

 

162

 

(38)

 

-

 

(3)

 

123

Other income (expense) – net

 

-

 

(40)

 

-

 

-

 

-

 

81

 

40

 

81

Segment income before income taxes

$

2,050

$

(47)

$

974

$

156

$

17

$

(412)

$

47

$

2,785

 

 

13

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

 

For the three months ended June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidation

 

Cingular

 

Consolidated

 

 

Wireline

 

Cingular

 

Directory

 

International

 

Other

 

and Elimination

 

Elimination

 

Results

Revenues from external customers

$

9,220

$

4,187

$

913

$

6

$

57

$

-

$

(4,187)

$

10,196

Intersegment revenues

 

7

 

-

 

20

 

-

 

-

 

(27)

 

-

 

-

Total segment operating revenues

 

9,227

 

4,187

 

933

 

6

 

57

 

(27)

 

(4,187)

 

10,196

Operations and support expenses

 

6,409

 

2,951

 

420

 

6

 

60

 

(27)

 

(2,951)

 

6,868

Depreciation and amortization expenses

 

1,863

 

565

 

2

 

-

 

23

 

-

 

(565)

 

1,888

Total segment operating expenses

 

8,272

 

3,516

 

422

 

6

 

83

 

(27)

 

(3,516)

 

8,756

Segment operating income

 

955

 

671

 

511

 

-

 

(26)

 

-

 

(671)

 

1,440

Interest expense

 

-

 

199

 

-

 

-

 

-

 

235

 

(199)

 

235

Interest income

 

-

 

-

 

-

 

-

 

-

 

120

 

-

 

120

Equity in net income (loss) of affiliates

 

-

 

(95)

 

-

 

149

 

220

 

-

 

95

 

369

Other income (expense) – net

 

-

 

(40)

 

-

 

-

 

-

 

(44)

 

40

 

(44)

Segment income before income taxes

$

955

$

337

$

511

$

149

$

194

$

(159)

$

(337)

$

1,650

 

 

 

For the six months ended June 30, 2004

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consolidation

 

Cingular

 

Consolidated

 

 

Wireline

 

Cingular

 

Directory

 

International

 

Other

 

and Elimination

 

Elimination

 

Results

Revenues from external customers

$

18,252

$

8,154

$

1,828

$

11

$

117

$

-

$

(8,154)

$

20,208

Intersegment revenues

 

15

 

-

 

43

 

-

 

-

 

(58)

 

-

 

-

Total segment operating revenues

 

18,267

 

8,154

 

1,871

 

11

 

117

 

(58)

 

(8,154)

 

20,208

Operations and support expenses

 

12,613

 

5,815

 

830

 

18

 

38

 

(58)

 

(5,815)

 

13,441

Depreciation and amortization expenses

 

3,761

 

1,118

 

5

 

-

 

45

 

-

 

(1,118)

 

3,811

Total segment operating expenses

 

16,374

 

6,933

 

835

 

18

 

83

 

(58)

 

(6,933)

 

17,252

Segment operating income

 

1,893

 

1,221

 

1,036

 

(7)

 

34

 

-

 

(1,221)

 

2,956

Interest expense

 

-

 

397

 

-

 

-

 

-

 

467

 

(397)

 

467

Interest income

 

-

 

2

 

-

 

-

 

-

 

236

 

(2)

 

236

Equity in net income (loss) of affiliates

 

-

 

(203)

 

-

 

601

 

360

 

-

 

203

 

961

Other income (expense) – net

 

-

 

(65)

 

-

 

-

 

-

 

817

 

65

 

817

Segment income before income taxes

$

1,893

$

558

$

1,036

$

594

$

394

$

586

$

(558)

$

4,503

 

14

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

NOTE 5. TRANSACTIONS WITH CINGULAR

 

We and BellSouth, the two owners of Cingular, have each made a subordinated loan to Cingular (shareholder loans). Our shareholder loan to Cingular totaled approximately $5,675 at June 30, 2005 and $5,855 at December 31, 2004, reflecting a repayment under the revolving credit agreement discussed below. This loan bears interest at an annual rate of 6.0% and matures in June 2008. We earned interest income on this loan of $87 in the second quarter and $174 for the first six months of 2005 and $88 in the second quarter and $176 for the first six months of 2004.

 

Effective August 1, 2004, we and BellSouth agreed to finance Cingular’s capital and operating cash requirements to the extent Cingular requires funding above the level provided by operations. We and BellSouth entered into a one-year revolving credit agreement with Cingular to provide short-term financing for operations on a pro rata basis at an interest rate of LIBOR (London Interbank Offer Rate) plus 0.05% which may be renewed annually upon agreement of the parties. This agreement includes a provision for the repayment of our and BellSouth’s shareholder loans made to Cingular in the event there are no outstanding amounts due under the revolving credit agreement and to the extent Cingular has excess cash, as defined by the agreement. Effective June 28, 2005, this agreement was amended to extend the termination date of the agreement to July 31, 2007. All other terms of the agreement remain substantially identical.

 

Under the revolving credit agreement we received net repayments from Cingular totaling $586 in the second quarter and $1,182 for the first six months of 2005. Under the terms of the agreement, these amounts were applied first to reduce the outstanding amount of advances (totaling approximately $406) previously made to Cingular under the agreement. After applying the net repayments, our share of advances to Cingular under the revolving credit agreement was $0 at June 30, 2005 and approximately $1,002 at December 31, 2004 and is reflected in “Investments in and Advances to Cingular Wireless” on our Consolidated Balance Sheet. Under the terms of the agreement, the remaining approximately $180 was applied to reduce the balance of our shareholder loan to Cingular.

 

In May 2005, we transferred wireless properties to Cingular to settle a liability related to the formation of Cingular. This transfer resulted in a decrease of approximately $35 to our “Investment in Cingular” account.

 

We generated revenues of $205 in the second quarter and $387 for the first six months of 2005 and $137 in the second quarter and $285 for the first six months of 2004 for services sold to Cingular. These revenues were primarily from access and long-distance services sold to Cingular on a wholesale basis, and commissions revenue related to customers added through SBC sales sources. The offsetting expense amounts are recorded by Cingular, and 60% of these expenses are included in our “Equity in net income of affiliates” line in our Consolidated Statements of Income when we report our 60% proportionate share of Cingular’s results.

 

 

15

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

NOTE 6. PENSION AND POSTRETIREMENT BENEFITS

 

Substantially all of our employees are covered by one of various noncontributory pension and death benefit plans. We also provide certain medical, dental and life insurance benefits to substantially all retired employees under various plans and accrue actuarially determined postretirement benefit costs as active employees earn these benefits. Our objective in funding these plans, in combination with the standards of the Employee Retirement Income Security Act of 1974, as amended (ERISA), is to accumulate assets sufficient to meet the plans’ obligations to provide benefits to employees upon their retirement. No significant cash contributions are required under ERISA regulations during 2005.

 

The following details pension and postretirement benefit costs included in operating expenses (in cost of sales and selling, general and administrative expenses) in the accompanying Consolidated Statements of Income. We account for these costs in accordance with Statement of Financial Accounting Standards No. 87, “Employers’ Accounting for Pensions” and Statement of Financial Accounting Standards No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” In the following table, gains are denoted with parentheses and losses are not.

 

 

Three months ended

 

Six months ended

 

June 30,

 

June 30,

 

2005

2004

 

 

2005

2004

Pension cost:

 

 

 

 

 

 

 

 

 

Service cost – benefits earned during the period

$

196

$

205

 

$

392

$

412

Interest cost on projected benefit obligation

 

404

 

409

 

 

807

 

821

Expected return on assets

 

(636)

 

(666)

 

 

(1,272)

 

(1,340)

Amortization of prior service cost and transition asset

 

46

 

48

 

 

93

 

95

Recognized actuarial loss

 

40

 

10

 

 

79

 

22

Net pension cost

$

50

$

6

 

$

99

$

10

 

 

 

 

 

 

 

 

 

 

Postretirement benefit cost:

 

 

 

 

 

 

 

 

 

Service cost – benefits earned during the period

$

96

$

97

 

$

195

$

188

Interest cost on accumulated postretirement

 

 

 

 

 

 

 

 

 

benefit obligation

 

355

 

378

 

 

722

 

738

Expected return on assets

 

(189)

 

(186)

 

 

(378)

 

(379)

Amortization of prior service benefit

 

(84)

 

(79)

 

 

(164)

 

(188)

Recognized actuarial loss

 

105

 

117

 

 

219

 

236

Postretirement benefit cost

$

283

$

327

 

$

594

$

595

 

 

 

 

 

 

 

 

 

 

Combined net pension and postretirement cost

$

333

$

333

 

$

693

$

605

 

Our combined net pension and postretirement cost did not change in the second quarter and increased approximately $88 for the first six months of 2005. In January 2004, the majority of nonmanagement retirees were informed of medical coverage changes. Concurrent with our second-quarter 2004 bargaining agreement with the Communications Workers of America, we also modified our nonmanagement retiree benefits. Because this modification of nonmanagement retiree medical coverage changes occurred in the second quarter of 2004 it only affected our first-quarter 2005 results on a comparative basis. Our combined pension and postretirement cost increased approximately $50 due to this contract modification for the first six months of 2005 when compared to the first six months of 2004.

 

16

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

During the second quarter of 2005 we made minor changes to our management medical coverage and now expect a combined net pension and postretirement cost of between $1,350 and $1,450 in 2005.

 

Included in “Postemployment benefit obligation” on our Consolidated Balance Sheets at December 31, 2004 was a phone concession for out-of region employees. The out-of-region phone concession, which is not part of the pension plan and not subject to ERISA, allowed for out-of-region retirees to receive reimbursements for phone services provided by a carrier other than SBC. During the second quarter of 2005 we notified certain out-of-region retirees of changes which allowed us to reduce this obligation by approximately $37 at June 30, 2005. We are in the process of notifying the remaining out-of-region retirees and will record an additional reduction of approximately $60 in the third quarter of 2005.

 

NOTE 7. DISCONTINUED OPERATIONS

 

In July 2004, we entered into an agreement to sell our interest in the directory advertising business in Illinois and northwest Indiana to Donnelley. In September 2004, we completed the sale and received net proceeds of approximately $1,397 and recorded a gain of approximately $1,357 ($827 net of tax).

 

In accordance with Statement of Financial Accounting Standards No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets,” we have reclassified the results from our directory advertising business in Illinois and northwest Indiana as discontinued operations, restating previously reported results to reflect the reclassification on a comparable basis. The operational results are presented in the “Income From Discontinued Operations, net of tax” line item on the Consolidated Statements of Income. Prior to the reclassification, these results were reported in our directory segment.

 

Summarized financial information for the Illinois and northwest Indiana directory advertising business is as follows:

 

 

 

Three months ended

June 30,

 

 

Six months ended

June 30,

 

 

2005

 

2004

 

 

2005

 

2004

 

 

 

 

 

 

 

 

 

 

Operating revenues

$

-

$

117

 

$

-

$

233

Operating income

 

-

 

54

 

 

-

 

97

Income taxes

 

-

 

21

 

 

-

 

38

Net income from operations

 

-

 

33

 

 

-

 

59

 

At June 30, 2005 and December 31, 2004, the assets of the discontinued operations were $0. The liabilities of the discontinued operations were $0 at June 30, 2005 and $310 at December 31, 2004 and are presented separately under the caption “Liabilities of discontinued operations” on our Consolidated Balance Sheets. At December 31, 2004, the liabilities of $310 were primarily tax liabilities associated with the gain on the disposition. These liabilities were all paid in 2005, as reflected on the Consolidated Statements of Cash Flows.

 

17

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued

Dollars in millions except per share amounts

 

 

 

NOTE 8. ACQUISITION OF AT&T

 

On January 30, 2005, we agreed to acquire AT&T Corp. (AT&T) in a transaction in which each share of AT&T common stock will be exchanged for 0.77942 of a share of SBC common stock. In addition, immediately prior to the closing of the transaction, AT&T will pay each AT&T shareholder a special dividend of $1.30 per share. Based on the closing price of SBC stock on January 28, 2005, the exchange ratio equals $18.41 per share and the total transaction is valued, for purchase accounting purposes, at approximately $16,000, including the special dividend. After the acquisition, AT&T will be a wholly owned subsidiary of SBC. The transaction has been approved by the Board of Directors of each company and was approved by the shareholders of AT&T on June 30, 2005. The transaction also is subject to review by the U.S. Department of Justice and approval by the Federal Communications Commission and various other regulatory authorities. We expect the transaction to close in late 2005.

 

Note 9. SUBSEQUENT EVENT

 

In July 2005, we redeemed approximately $809 of callable debt and recorded call premiums, and expensed unamortized discounts and debt issuance costs of $37 in the third quarter.

 

18

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS  

 

 

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. You should read this discussion in conjunction with the consolidated financial statements, accompanying notes and management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2004. In our tables throughout this section, percentage increases and decreases that equal or exceed 100% are not considered meaningful and are denoted with a dash.


Consolidated Results Our financial results in the second quarter and for the first six months of 2005 and 2004 are summarized as follows:

 


  Second Quarter Six-Month Period

Perc ent Perce nt
        2005     2004     Chan ge   2005     2004     Chan ge

Operating revenues   $ 10,328   $ 10,196    1.3 % $ 20,576   $ 20,208    1.8 %
Operating expenses    8,810    8,756    0.6    17,502    17,252    1.4  
Operating income    1,518    1,440    5.4    3,074    2,956    4.0  
Income before income taxes    1,484    1,650    (10.1 )  2,785    4,503    (38.2 )
Income from continuing operations    1,000    1,135    (11.9 )  1,885    3,046    (38.1 )
Income from discontinued  
   operations, net of tax    -    33    -    -    59    -  

Net Income    1,000    1,168    (14.4 )  1,885    3,105    (39.3 )

 

Overview Our operating income increased $78, or 5.4%, in the second quarter and $118, or 4.0%, for the first six months of 2005 and our operating income margin increased from 14.1% to 14.7% in the second quarter and from 14.6% to 14.9% for the first six months. The increases in the quarter and the six-month period were driven by further growth in data and long-distance voice revenues reflecting our continued emphasis on our bundling strategy and the addition of new business customers. These increases were partially offset by a decline in our voice revenue as we continue to experience increasing competition.

 

The decline in voice revenue also reflects decreasing wholesale revenues from lines provided under Unbundled Network Element-Platform (UNE-P) rules, reflecting developments in the federal regulatory environment over the past year. During the 12-month transition period for the elimination of the UNE-P requirements (which ends in March 2006), we expect continued decreases in the number of UNE-P lines as competitors move to alternate arrangements to serve their customers or their customers choose an alternative technology. We could experience increased pressure on our operating revenues should a customer that was receiving service from a UNE-P provider switch to an alternative technology or facilities-based competitor (a competitor with its own network). For a detailed discussion on UNE-P, see “December 2004 Unbundling Rules” in the Regulatory Developments section of our Annual Report for the year ended December 31, 2004.

 

Retail access lines continued to decline in the second quarter and for the first six months of 2005 due to increased competition, as customers disconnected both primary and additional lines and began using

 

19

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

wireless and, to a lesser extent, Voice over Internet Protocol (VoIP) technology and cable instead of phone lines for voice and data; this was also a contributing factor in the year-ago period. Retail access lines also declined for both periods due to customers disconnecting their additional lines when purchasing our broadband internet-access (DSL) services. While we lose some revenue when a wireline customer shifts from one of our retail lines to a competitor that relies on a resale agreement or the UNE-P rules to offer service (i.e., one of our wholesale customers), we lose all revenue when a wireline customer shifts to an alternative technology such as cable, wireless or VoIP or a facilities-based competitor. However, when a customer signs up for Cingular Wireless (Cingular) service, our net income impact of the lost revenue is lessened because we own a 60% economic interest in Cingular (see Note 5). Increasing use of alternative technologies and facilities-based competition will continue to pressure our operating margins. Although retail access line losses have continued, the trend has slowed, reflecting in part our ability to now offer retail nationwide long-distance service in all of our regions as well as the introduction of offerings combining multiple services for one fixed price (bundles).

 

Operating revenues Our operating revenues increased $132, or 1.3%, in the second quarter and $368, or 1.8%, for the first six months of 2005. Our significant revenue impacts are listed below and discussed in greater detail in our “Wireline Segment Results” section.

Data revenues increased $270 in the second quarter and $447 for the first six months, primarily driven by continued growth in DSL.

Long-distance voice revenues increased $107 in the second quarter and $259 for the first six months, primarily driven by increased bundled sales of combined long-distance and local calling fixed-fee offerings.

 

These increases in data and long-distance voice revenues were partially offset by declines of $231 in the second quarter and $358 for the first six months in voice revenues primarily resulting from the loss of retail access lines and lower prices due to increased competition.

 

Operating expenses Our operating expenses increased $54, or 0.6%, in the second quarter and $250, or 1.4%, for the first six months of 2005. Our significant expense increases are listed below and discussed in greater detail in our “Wireline Segment Results” section.

A charge of $236 in the second quarter of 2005 to terminate existing agreements with WilTel Communications (WilTel). See “Other Business Matters” for a discussion of the termination charge and the new agreement.

Costs associated with equipment sales and related network integration services reflecting sales in the large-business market, and our co-branded SBC | DISH Network satellite TV service, which had more total customers than in the prior year, increased expenses approximately $129 in the second quarter and $227 for the first six months.

Costs associated with the severe rains and floods in Southern California, increased expenses approximately $100 for the first six months.

Combined net pension and postretirement cost increased expenses approximately $88 for the first six months.

 

20

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Partially offsetting these increases was the fact that we recorded second-quarter 2004 charges of approximately $263 associated with strike preparation and labor settlements, lower depreciation expense of $81 in the second quarter and $181 for the first six months of 2005 in our wireline segment and a decrease of $37 associated with changes in out-of-region phone concessions. Out-of-region phone concessions consist of reimbursements made to retirees for phone services provided by a carrier other than SBC.

 

Our operating expenses for the remaining periods in 2005 will reflect second-quarter 2005 changes made to our management medical coverage, reducing our annual combined net pension and postretirement cost to between $1,350 and $1,450. Operating expenses in the third quarter will also reflect decreased expenses of approximately $60 associated with the previously discussed changes in out-of-region phone concessions for retirees. (See Note 6)

 

Interest expense increased $114, or 48.5%, in the second quarter and $235, or 50.3%, for the first six months of 2005. The increase is primarily due to our issuing additional debt of $8,750 in the fourth quarter of 2004 to finance our portion of Cingular’s acquisition of AT&T Wireless Services Inc. (AT&T Wireless). In July 2005, we redeemed approximately $809 of callable debt and recorded call premiums, and expensed unamortized discounts and debt issuance costs of $37 in the third quarter.

 

Interest income decreased $20, or 16.7%, in the second quarter and $27, or 11.4%, for the first six months of 2005. The decrease was primarily a result of a lower average investment balance in 2005 compared with 2004. In the fourth quarter of 2004 we used a significant amount of these investments to fund our portion of Cingular’s purchase price for AT&T Wireless.

 

Equity in net income of affiliates decreased $188, or 50.9%, in the second quarter and $838, or 87.2%, for the first six months of 2005. Results from our international investments declined approximately $61 in the second quarter and $439 for the first six months. The international decline was largely attributable to both gains that occurred in 2004 and foregone equity income in 2005 due to our 2004 investment dispositions. The 2005 decrease was also due to lower results from Cingular. Our proportionate share of Cingular’s results decreased approximately $123 in the second quarter and $403 for the first six months of 2005.

 

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 Statements of Income. Cingular’s operating results are discussed in detail in the “Cingular Segment Results” section and results from our international holdings are discussed in detail in “International Segment Results.” Our accounting for Cingular is described in more detail in Note 4.

 

Other income (expense) net We had other income of $34 in the second quarter and $81 for the first six months of 2005 as compared to other expense of $44 in the second quarter and other income of $817 for the first six months of 2004. Results for the second quarter of 2005 primarily consisted of gains related to the transfer of wireless properties to Cingular of approximately $24 (see Note 5) and a gain of $9 on the sale of shares of Yahoo! (Yahoo). Results for the second quarter of 2004 included losses of approximately $191 on the sale of shares of TDC and $68 on the sale of shares of Telkom S.A. Limited (Telkom), partially offset by gains of $219 on the sale of shares of Amdocs Limited (Amdocs) and Yahoo.

 

21

 

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Other income for the first six months of 2005 primarily included a gain of $77 on the sale of shares of Amdocs, SpectraSite, Inc. and Yahoo and the gain of $24 mentioned above, from the transfer of wireless properties to Cingular. These gains were partially offset by a charge of $21 related to the other-than-temporary decline in the value of various cost investments. Results for the first six months of 2004 primarily include a gain of approximately $832 on the sale of our investment in Belgacom S.A. (Belgacom), a gain of $57 on the sale of shares of Teléfonos de Mexico, S.A. de C.V. (Telmex) and América Móvil S.A. de C.V. (América Móvil) and gains of $219 mentioned above, on the sale of Amdocs and Yahoo. These 2004 gains were partially offset by losses of $259 mentioned above, on the sales of shares of TDC and Telkom.

 

Income taxes decreased $31, or 6.0%, in the second quarter and $557, or 38.2%, for the first six months of 2005. Our effective tax rates on continuing operations were 32.6% in the second quarter of 2005 compared to 31.2% in the second quarter of 2004 and 32.3% for the first six months of 2005 compared to 32.4% for the first six months of 2004. The decrease in income taxes in the second quarter and for the first six months of 2005 was primarily due to a decrease in income before income taxes, which was primarily the result of a decrease in “Equity in net income of affiliates” (see previous discussion) and a gain on the sale in the first quarter of 2004 of our interest in Belgacom.

 

Income from Discontinued Operations decreased $33 in the second quarter and $59 for the first six months of 2005. The decrease was due to the sale of our directory advertising business in Illinois and northwest Indiana in 2004. (See Note 7)

 

Selected Financial And Operating Data

 

 

June 30,

 

 

2005

 

2004

Debt ratio1

38.3%

 

31.0%

Network access lines in service (000)

51,032

 

53,590

Wholesale lines (000)

5,977

 

7,363

Long-distance lines in service (000)

22,776

 

18,432

DSL lines in service (000)

5,968

 

4,277

Number of SBC employees

157,610

 

167,170

Cingular Wireless customers2 (000)

51,596

 

25,044

 

1 See our “Liquidity and Capital Resources” section for discussion.
2 Numbers represent 100% of the cellular/PCS customers of Cingular (the 2004 number does not include AT&T Wireless customers prior to Cingular’s October 2004 acquisition of AT&T Wireless).

 

22

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Segment Results

 

Our segments represent strategic business units that offer different products and services and are managed accordingly. As required by U.S. generally accepted accounting principles (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 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 both retail and wholesale landline telecommunications services, including local and long-distance voice, switched access, data and messaging services and satellite television services through our agreement with EchoStar Communications Corp (“SBC | DISH Network” offering). In discussing regional trends in this segment, the “Midwest” refers to Illinois, Indiana, Michigan, Ohio and Wisconsin; the “Southwest” refers to Arkansas, Kansas, Missouri, Oklahoma and Texas; the “West” refers to California and Nevada; and the “East” refers to Connecticut (all combined, “13-state area”).

 

The Cingular segment reflects 100% of the results reported by Cingular, our wireless joint venture. In our consolidated financial statements, we report our 60% proportionate share of Cingular’s results as equity in net income of affiliates. Cingular’s results in the second quarter and for the first six months of 2004 have been restated to reflect the correction of an error relating to the lease accounting practices of Cingular, which was announced in February 2005, and to conform the presentation of various state gross receipts taxes and other fees to the current year.

 

The directory segment includes all directory operations, including Yellow and White Pages advertising and electronic publishing. Results for this segment are shown under the amortization method which means that revenues and direct expenses are recognized ratably over the life of the directory, typically 12 months. Results for all periods presented in this segment have been restated to reflect the sale of our interest in the directory advertising business in Illinois and northwest Indiana to R.H. Donnelley (see Note 7). In November 2004, a subsidiary in our directory segment entered into a joint venture agreement with BellSouth Corporation (BellSouth) and purchased the online directory provider YellowPages.com (YPC). Our portion of the results from YPC is recorded as equity in net income of affiliates.

 

Our international segment includes all investments with primarily international operations. The other segment includes results from paging services, 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.

 

23

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

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

 

 

Second Quarter

 

 

Six-Month Period

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Percent

 

 

2005

 

2004

 

Change

 

 

2005

 

2004

 

Change

Segment operating revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

Voice

$

4,974

$

5,205

 

(4.4)%

 

$

10,060

$

10,418

 

(3.4)%

Data

 

2,997

 

2,727

 

9.9

 

 

5,821

 

5,374

 

8.3

Long-distance voice

 

922

 

815

 

13.1

 

 

1,823

 

1,564

 

16.6

Other

 

484

 

480

 

0.8

 

 

962

 

911

 

5.6

Total Segment Operating Revenues

 

9,377

 

9,227

 

1.6

 

 

18,666

 

18,267

 

2.2

Segment operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

4,138

 

4,091

 

1.1

 

 

8,320

 

8,112

 

2.6

Selling, general and administrative

 

2,433

 

2,318

 

5.0

 

 

4,716

 

4,501

 

4.8

Depreciation and amortization

 

1,782

 

1,863

 

(4.3)

 

 

3,580

 

3,761

 

(4.8)

Total Segment Operating Expenses

 

8,353

 

8,272

 

1.0

 

 

16,616

 

16,374

 

1.5

Segment Income

$

1,024

$

955

 

7.2%

 

$

2,050

$

1,893

 

8.3%

 

Our wireline segment operating income margin was 10.9% in the second quarter of 2005, compared to 10.4% in the second quarter of 2004, and 11.0% for the first six months of 2005, compared to 10.4% for the first six months of 2004. The improvement in our wireline segment operating income margin for the quarter and the first six months was due primarily to the continued growth in our data and long-distance voice revenue, which more than offset the loss of voice revenue from the decline in total access lines (as shown in the following table) from 2004 to 2005 of approximately 2.6 million lines, or 4.8%.

 

Voice revenue declined due to customers continuing to disconnect primary and additional lines and using alternative technologies, such as wireless, and to a lesser extent VoIP and cable instead of phone lines for voice and data; our bundling strategy and other pricing responses to competitors’ offerings; and lower demand for services. Voice revenue also has declined over the past several years as our retail customers have disconnected their lines in order to obtain service from competitors who lease our UNE-P lines. However, that particular trend started to change in the third quarter of 2004 and for this quarter UNE-P lines declined by 1.5 million, or 21.9%, from June 30, 2004 levels (see table below). The impact of the UNE-P rules on our operating revenue is discussed below.

 

Our operating income margin was also pressured on the cost side for the second quarter due to a charge to terminate existing agreements with WilTel and by higher costs caused by our growth initiatives in long-

 

 

24

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

distance and DSL as well as our co-branded SBC | Dish Network satellite TV service and sales in the large-business market, and for the first quarter, by higher repair costs caused by severe weather.

 

Following is a summary of our switched access lines at June 30, 2005 and 2004:

Switched Access Lines

 

 

 

 

June 30,

 

 

 

 

Increase

(in 000’s)

2005

2004

(Decrease)

 

 

 

 

Retail Consumer

 

 

 

Primary

23,036

23,398

(362)

Additional

4,108

4,581

(473)

Retail Consumer Subtotal

27,144

27,979

(835)

 

 

 

 

Retail Business

17,513

17,794

(281)

Retail Subtotal

44,657

45,773

(1,116)

Percent of total switched access lines

87.5%

85.4%

 

 

 

 

 

UNE-P

5,444

6,974

(1,530)

Resale

533

389

144

Wholesale Subtotal

5,977

7,363

(1,386)

Percent of total switched access lines

11.7%

13.7%

 

 

 

 

 

Payphone (Retail and Wholesale)

398

454

(56)

Percent of total switched access lines

0.8%

0.9%

 

 

 

 

 

Total Switched Access Lines

51,032

53,590

(2,558)

 

 

 

 

DSL Lines in Service

5,968

4,277

1,691

 

Total switched access lines in service at June 30, 2005 declined 4.8% from June 30, 2004 levels. Retail access lines, while declining 2.4% from June 30, 2004 levels, represent 87.5% of total switched access lines at June 30, 2005 compared to 85.4% a year earlier. During this same period, wholesale lines (which include UNE-P, commercially negotiated UNE-P replacements and resale) decreased 18.8% and at June 30, 2005 represented 11.7% of total access lines, down from 13.7% a year earlier.

 

The decline in total access lines reflects many factors including the disconnection of additional lines as our existing customers purchase our DSL broadband services and for other reasons, the continued growth in

 

25

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

alternative communication technologies such as wireless, cable and other internet-based systems and continuing slow demand from U.S. businesses although business demand is improving on a sequential quarterly basis. While we lose some revenue when a wireline customer shifts from one of our retail lines to a competitor that relies on the UNE-P rules or a resale agreement to offer service (i.e., one of our wholesale customers), we lose all customer revenue when a retail wireline customer shifts to an alternative technology such as cable, wireless or the internet using VoIP or a competitor using its own traditional network. The UNE-P rules are scheduled to end after a twelve-month transition period that began March 11, 2005. However, it is unclear whether customers of competitors using these UNE-P lines will be retained by our wholesale customers that have negotiated commercial arrangements to replace the UNE-P or that have resale agreements, or whether customers that had used UNE-P service will return as our retail customers, shift to using an alternative technology or to a competitor using its own network. Increasing customer shifts from our traditional retail base to either alternative technologies or competitors using commercial or resale arrangement or their own facilities, as well as our pricing responses to retain or regain retail customers, will continue to pressure our wireline segment’s operating margins.

 

Voice revenues decreased $231, or 4.4%, in the second quarter and $358, or 3.4%, for the first six months of 2005 primarily due to the loss of retail access lines. The decline in retail lines primarily reflects increased competition, including customers using wireless, VoIP technology and cable instead of phone lines for voice and data, and the disconnection of additional lines for DSL service and other reasons. The access-line declines decreased revenues approximately $98 in the second quarter and $208 for the first six months of 2005. Pricing responses to competitors’ offerings and regulatory changes reduced revenues approximately $50 in the second quarter and $61 for the first six months. A decline in demand for calling features (e.g., Caller ID and voice mail) due primarily to the access-line declines decreased revenues approximately $25 in the second quarter and $56 for the first six months of 2005.

 

Lower demand for wholesale services, primarily due to the decline in UNE-P lines provided to competitors, decreased revenue approximately $13 in the second quarter and $22 for the first six months of 2005. Continued declines in demand for voice equipment located on customer premises decreased revenues approximately $10 in the second quarter and $33 for the first six months. Revenue from payphone services decreased approximately $10 in the second quarter and $20 for the first six months, primarily due to lower demand. We expect payphone access lines and revenue to continue to decline in future periods. Revenue from ‘local plus’ plans (expanded local calling area) declined approximately $6 in the second quarter and $17 for the first six months, as more customers chose broader long-distance and other bundled offerings. Partially offsetting these revenue declines were increased revenues with our wholesale customers, including settlements and billing adjustments, of approximately $64 for the first six months of 2005, of which $32 related to a carrier settlement in March 2005.

 

Data revenues increased $270, or 9.9%, in the second quarter and $447, or 8.3%, for the first six months of 2005. This increase was primarily due to continued growth in DSL, our broadband internet-access service. DSL and dial-up internet service increased data revenues approximately $114 in the second quarter and $240 for the first six months of 2005. The number of DSL lines in service grew to approximately 6.0 million

 

 

26

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

as compared to 4.3 million at June 30, 2004. Additionally, revenue from data equipment sales and network integration services increased approximately $104 in the second quarter and $124 for the first six months. Revenues from large-business customers typically consist of revenue from the initial installation of equipment followed by services provided over multiple years.

 

Revenue from our high-capacity transport services increased approximately $26 in the second quarter and $50 for the first six months of 2005. Our high-capacity transport services, which include DS1s and DS3s (types of dedicated high-capacity lines), and SONET (a dedicated high-speed solution for multi-site businesses), represented about 57% and 59% of total data revenues in the second quarter and for the first six months of 2005, respectively, and 62% of total data revenues in the second quarter and for the first six months of 2004.

 

Long-distance voice revenues increased $107, or 13.1%, in the second quarter and $259, or 16.6%, for the first six months of 2005. These increases were primarily driven by the increase in long-distance lines in service since the second quarter of 2004. The number of long-distance lines in service grew to approximately 22.8 million as compared to 18.4 million at June 30, 2004. Sales of combined long-distance and local calling fixed-fee offerings (referred to as “bundling”) also contributed to the increased long-distance revenues and lines. Sales of our bundling offers continued to increase in our Midwest, West and Southwest regions with the most significant improvements in results occurring in our Midwest region. However, we expect this growth to continue to slow, reflecting the market continuing to mature since we began providing service throughout our regions in late 2003.

 

Retail long-distance revenues increased approximately $112 in the second quarter and $269 for the first six months of 2005, reflecting our higher long-distance penetration levels. Also contributing to the increase was continued growth in our international and other long-distance services. Other long-distance revenues increased approximately $39 in the second quarter and $73 for the first six months of 2005, which includes wholesale long-distance services sold to Cingular and retail international long-distance. Partially offsetting these increases was a decline of approximately $35 in the second quarter and $77 for the first six months of 2005 due to increased competition and a reduction in our billed minutes of use mainly related to the increased sales of our fixed-fee bundles, which do not separately bill for minutes of use.

 

Other operating revenues increased $4, or 0.8% in the second quarter and $51, or 5.6% for the first six months of 2005. Our co-branded SBC | DISH Network satellite TV service increased revenue approximately $59 in the second quarter and $123 for the first six months of 2005. However, we expect future revenue growth for this service to reflect our strategy to target use of this service in those markets where the rate or risk of customer defections is highest. Partially offsetting this increase, revenue from directory and operator assistance and other miscellaneous products and services decreased approximately $22 in the second quarter and $52 for the first six months. Various one-time billing adjustments decreased revenue approximately $33 in the second quarter and $28 for the first six months of 2005.

 

27

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Cost of sales expenses increased $47, or 1.1%, in the second quarter and $208, or 2.6%, for the first six months of 2005. Cost of sales consists of costs we incur to provide our products and services, including costs of operating and maintaining our networks. Costs in this category include repair services, certain network planning and engineering expenses, operator services, information technology, property taxes related to elements of our network, and payphone operations. Pension and postretirement costs are also included to the extent that they are allocated to our network labor force and other employees who perform the functions listed in this paragraph.

 

Costs associated with equipment sales and related network integration services, and our co-branded SBC | DISH Network satellite TV service increased approximately $129 in the second quarter and $227 for the first six months of 2005 reflecting our emphasis on growth in DSL and sales in the large business market and video. Our DISH TV service has relatively high initial acquisition costs. Costs associated with equipment for large-business customers (as well as DSL and video) typically are greater than costs associated with services that are provided over multiple years.

 

Traffic compensation expense (for access to another carrier’s network) increased approximately $148 in the second quarter and $119 for the first six months of 2005. Approximately $50 in the second quarter and $47 for the first six months of 2005 resulted from higher traffic expense generated from our long-distance service, partially offset by lower rates paid for local traffic (telephone calls) terminating on competitor networks and wireless customers. Expense also increased $98 in the second quarter and for the first six months of 2005 resulting from traffic compensation settlements which reduced expense in 2004 and that did not recur. Offsetting these increases, traffic compensation expense decreased approximately $26 for the first six months related to a carrier settlement in March 2005.

 

Salary and wage merit increases and other bonus accrual adjustments increased expense approximately $49 in the second quarter and $61 for the first six months. Non-employee related expenses such as contract services, agent commissions and materials and supplies costs increased approximately $9 in the second quarter and $28 for the first six months. We incurred higher than normal weather-related repair costs of approximately $100 for the first six months of 2005 primarily related to floods in Southern California.

 

Partially offsetting the increases, lower employee levels decreased expenses, primarily salary and wages, approximately $82 in the second quarter and $183 for the first six months. Expenses also decreased $154 in the second quarter of 2005 and for the first six months of 2005 due to the one-time accrual for a retiree bonus as a result of the settlement of our labor contract negotiations in the second quarter of 2004.

 

Our combined net pension and postretirement cost was essentially flat in the second quarter and increased approximately $57 for the first six months of 2005, primarily resulting from changes made to management medical coverage in the second quarter of 2005 and second-quarter 2004 modifications of nonmanagement retiree medical coverage.

 

28

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

As part of an internal business unit realignment, cost of sales expenses of $46 incurred by the former unit in the second quarter of 2004 were reported by another unit as selling expenses in 2005. This resulted in reduced expense in the second quarter of 2005 and for the first six months of 2005.

 

Selling, general and administrative expenses increased $115, or 5.0%, in the second quarter and $215, or 4.8%, for the first six months of 2005. Selling, general and administrative expenses consist of our provision for uncollectible accounts, advertising costs, sales and marketing functions, including our retail and wholesale customer service centers, centrally managed real estate costs, including maintenance and utilities on all owned and leased buildings, credit and collection functions and corporate overhead costs, such as finance, legal, human resources and external affairs. Pension and postretirement costs are also included to the extent they relate to employees who perform the functions listed in this paragraph.

 

We incurred a charge of $236 in the second quarter of 2005 to terminate existing agreements with WilTel, which will continue to provide transitional and out-of-market long distance services under a new agreement following the close of our planned acquisition of AT&T (see “Other Business Matters” for additional information). Salary and wage merit increases and other bonus accrual adjustments increased expenses approximately $16 in the second quarter and $43 for the first six months of 2005. Expenses also increased approximately $20 for the first six months of 2005 due to higher severance accruals.

 

Partially offsetting the increases, lower employee levels decreased expenses, primarily salary and wages, approximately $35 in the second quarter and $76 for the first six months. Expenses also decreased $79 in the second quarter of 2005 and for the first six months of 2005 due to the one-time accrual for a retiree bonus as a result of the settlement of our labor contract negotiations in the second quarter of 2004. Advertising expense decreased approximately $26 in the second quarter and $57 for the first six months of 2005 primarily driven by higher costs in 2004 from our launch of long-distance service in our Midwest region and bundling initiatives. Other employee related expenses including travel, training and conferences decreased approximately $23 in the second quarter and $10 for the first six months of 2005.

 

Non-employee related expenses such as contract services, agent commissions, materials and supplies costs and corporate allocations decreased approximately $10 in the second quarter and increased $76 for the first six months of 2005, primarily due to higher parent charges and contract services during the first six months. Our combined net pension and postretirement cost was essentially flat in the second quarter and increased approximately $28 for the first six months of 2005, primarily resulting from changes made to management medical coverage in the second quarter of 2005 and second-quarter 2004 modifications of nonmanagement retiree medical coverage.

 

As part of an internal business unit realignment, cost of sales expenses of $46 incurred by the former unit in the second quarter of 2004 were reported by another unit as selling expenses in 2005. This resulted in increased expense in the second quarter of 2005 and for the first six months of 2005.

 

29

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

 

Depreciation and amortization expenses decreased $81, or 4.3%, in the second quarter and $181, or 4.8%, for the first six months of 2005. Lower expense in 2005 was due primarily to lower capital expenditures over the last three years.

 

30

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Cingular

Segment Results

 

 

Second Quarter

 

 

Six-Month Period

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Percent

 

 

2005

 

2004

 

Change

 

 

2005

 

2004

 

Change

Segment operating revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

Service revenues

$

7,719

$

3,833

 

-

 

$

15,138

$

7,416

 

-

Equipment revenues

 

890

 

354

 

-

 

 

1,700

 

738

 

-

Total Segment Operating Revenues

 

8,609

 

4,187

 

-

 

 

16,838

 

8,154

 

-

Segment operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of services and

 

 

 

 

 

 

 

 

 

 

 

 

 

      equipment sales

 

3,523

 

1,488

 

-

 

 

6,962

 

2,980

 

-

Selling, general and administrative

 

2,953

 

1,463

 

-

 

 

5,954

 

2,835

 

-

Depreciation and amortization

 

1,629

 

565

 

-

 

 

3,304

 

1,118

 

-

Total Segment Operating Expenses

 

8,105

 

3,516

 

-

 

 

16,220

 

6,933

 

-

Segment Operating Income

 

504

 

671

 

(24.9)

 

 

618

 

1,221

 

(49.4)

Interest Expense

 

326

 

199

 

63.8

 

 

664

 

397

 

67.3

Equity in net income (loss) of

 

 

 

 

 

 

 

 

 

 

 

 

 

affiliates – net

 

1

 

(95)

 

-

 

 

3

 

(203)

 

-

Other – net

 

(8)

 

(40)

 

80.0

 

 

(4)

 

(63)

 

93.7

Segment Income (Loss)

$

171

$

337

 

(49.3)%

 

$

(47)

$

558

 

-

 

Accounting for Cingular

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 BellSouth in the joint venture. We have equal voting rights and representation on the board of directors that controls Cingular. This means that our consolidated 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 using information provided by Cingular during the year. 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 net income.

 

In the first quarter of 2005, to be consistent with industry practices, Cingular changed its income statement presentation for the current and prior-year periods to record billings to customers for various state gross receipts taxes and other fees as “Service revenues” and the taxes assessed by the various state jurisdictions and other fees as “Cost of services and equipment sales.” This amount totaled $32 in the second quarter and $57 for the first six months of 2004. Operating income and net income for all restated periods were not affected.

 

 

31

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

In February 2005, Cingular announced restated 2004 results to correct an error relating to its lease accounting practices. This correction, which is reflected in the table above, reduced Cingular’s previously reported “Segment Operating Income” by approximately $9 in the second quarter and $18 for the first six months of 2004 and “Segment Income” by $12 in the second quarter and $24 for the first six months of 2004.

 

Acquisition of AT&T Wireless

On October 26, 2004, Cingular acquired AT&T Wireless for approximately $41,000 in cash. In connection with the acquisition, we entered into an investment agreement with BellSouth and Cingular. Under the investment agreement, we and BellSouth funded, by means of an equity contribution to Cingular, a significant portion of the acquisition’s purchase price. Based on our 60% equity ownership of Cingular, and after taking into account cash on hand at AT&T Wireless, we provided additional equity of approximately $21,600 to fund the purchase price. In exchange for this equity contribution, Cingular issued to us and BellSouth new membership interests in Cingular. Equity ownership and management control of Cingular remains unchanged after the acquisition.

 

Several class-action lawsuits have been filed against AT&T asserting claims under the federal securities laws in connection with the offering of AT&T Wireless tracking stock in April 2000. The plaintiffs have demanded damages in excess of $2,100 related to the offering of AT&T Wireless tracking stock. In connection with the split-off of AT&T Wireless, certain provisions of the separation agreement between AT&T Wireless and AT&T may result in Cingular, due to its acquisition of AT&T Wireless, being allocated as much as 70% of any liabilities arising out of these actions to the extent they relate to AT&T Wireless tracking stock.  At this time, management is assessing the potential amount, if any, of this preacquisition liability.

 

In the segment discussion below, Cingular’s 2004 operating results and customer metrics do not include AT&T Wireless since the acquisition closed in the fourth quarter of 2004.

 

 

32

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Cingular’s Customer and Operating Trends

Cingular is the largest provider of mobile wireless voice and data communications services in the United States, based on the number of wireless customers. Cingular also has license coverage serving an aggregate population of potential customers, referred to as “POPs,” of nearly 292 million, including all of the 100 largest metropolitan areas. As of June 30, 2005, Cingular served 51.6 million cellular/PCS (wireless) customers, compared to approximately 25 million at June 30, 2004. Cingular’s increase in customer gross additions during the second quarter and the first six months of 2005 was primarily due to the acquisition of AT&T Wireless in late October 2004 and the resulting inclusion of AT&T Wireless customers in Cingular’s results. The increase was also due to Cingular’s larger distribution network, its broad range of service offerings and increased advertising. Cingular’s recent customer activity is listed below:

 

Wireless Customer Activity

 

 

Three-Month Period

 

(in 000’s)

 

June 30,

2005

 

March 31,

2005

 

December 31, 2004

 

Gross additions

 

4,384

 

4,763

 

4,930

 

Net additions

 

1,071

 

1,419

 

1,713

 

Other adjustments*

 

156

 

(159)

 

21,724

 

Net additions including other adjustments*

 

1,227

 

1,260

 

23,437

 

*Other adjustments include customers gained or lost through property divestitures related to the AT&T Wireless acquisition and other adjustments. In the fourth quarter of 2004 other adjustments included approximately 21.9 million subscribers related to Cingular’s acquisition of AT&T Wireless.

 

Competition and the slowing rate of new wireless users as the wireless market matures will continue to adversely impact Cingular’s revenue growth, increase expenses and put pressure on margins. Cingular expects that future revenue growth will become increasingly dependent on minimizing customer turnover (customer churn) and increasing average revenue per user/customer (ARPU). Cingular’s ARPU has weakened over the past several years as it has offered a broader array of plans to expand its customer base and responded to increasing competition, resulting in pricing reductions. While Cingular’s ARPU has stabilized somewhat recently, Cingular nevertheless expects continued pressure on ARPU notwithstanding increasing revenue from data services. Cingular expects its cost of services to continue increasing due to higher network system usage, including the costs Cingular is now paying T-Mobile USA (T-Mobile) for the utilization of its network in California and Nevada, higher costs as Cingular integrates AT&T Wireless’ network and operations, and, to a lesser extent, redundant expenses related to operating multiple networks as Cingular’s customer base transitions from its Time Division Multiple Access (TDMA) network to its Global System for Mobile Communication (GSM) network.

 

Cingular’s Operating Results

Our Cingular segment operating income margin was 5.9% in the second quarter (1.4% in the first quarter of 2005) and 3.7% for the first six months of 2005, compared to 16.0% in the second quarter and 15.0% for the first six months of 2004. The lower 2005 margin was caused by increased expenses that were only partially offset by increased revenues. The primary driver for the 2005 increases in almost every component of Cingular’s total operating revenues and operating expenses was the acquisition of AT&T Wireless in late October 2004 and the resulting inclusion of AT&T Wireless operating results and wireless customers in Cingular’s results.

 

33

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Cingular’s operating expenses increased $4,589 in the second quarter and $9,287 for the first six months of 2005 primarily due to incremental expenses from AT&T Wireless; merger and integration costs of $204 in the second quarter and $309 for the first six months of 2005 related to the acquisition of AT&T Wireless; acquisition costs associated with significantly higher gross customer additions; extensive customer retention and customer service initiatives; and higher depreciation and amortization expenses including amortization expense related to Cingular’s purchase price valuation of AT&T Wireless customer contracts and other intangible assets acquired of $445 in the second quarter and $931 for the first six months of 2005. Network operating costs also increased due to growth in customer usage, increased costs Cingular is now paying T-Mobile for the use of its network in California and Nevada and redundant expenses related to concurrently operating its TDMA and GSM networks (see “Other Cingular Transactions” below). Handset equipment costs increased $725 in the second quarter and $1,483 for the first six months of 2005. Equipment costs increased at a higher rate than equipment revenues due to Cingular’s sales of handsets below cost, through direct sales sources, to customers who committed to one-year or two-year contracts or in connection with other promotions.

 

Largely offsetting these expense increases was revenue growth of $4,422 in the second quarter and $8,684 for the first six months of 2005, including incremental revenues from the acquisition of AT&T Wireless. ARPU decreased 0.6% in the second quarter and increased 0.9% for the first six months of 2005 compared to the second quarter and first six months of 2004. The decline in the second quarter ARPU was due to a decrease in local service and net roaming revenue partially offset by an increase in average data revenue per customer of approximately 185% and increased long-distance revenue per customer. The six-month increase in ARPU was due to increases in average data revenue per customer of approximately 205% for the first six months, increased long distance and regulatory fees revenue, partially offset by a decline in the local service revenue and net roaming revenue. Local service revenue declined primarily due to customer shifts to all-inclusive rate plans that offer lower monthly charges and “rollover” minutes (which allow customers to carry over unused minutes from month to month for up to one year) as well as Cingular’s free mobile to mobile plans, which allow Cingular customers to call other Cingular customers at no charge. An increase in customers on rollover plans tends to lower average monthly revenue since unused minutes (and associated revenue) are deferred until subsequent months, up to one year. These revenue and expense fluctuations are discussed in more detail below.

 

The effective management of wireless customer churn is critical to Cingular’s ability to maximize revenue growth and maintain and improve margins. Cingular’s wireless customer churn is calculated by dividing the aggregate number of wireless customers who cancel service during each month in a period by the total number of wireless customers at the beginning of each month in that period. For the second quarter and the first six months of 2005, Cingular’s churn rate was 2.2%, down from a 2.7% churn rate in the second quarter and first six months of 2004. Cingular’s second quarter churn rate remained unchanged from the churn rate for the first quarter of 2005. The decline in Cingular’s churn rate compared to 2004 resulted primarily from a lower postpaid customer churn rate, a change in methodology of calculating churn related to Cingular’s reseller customers and changes resulting from conforming Cingular’s and AT&T Wireless’ churn methodologies. Cingular’s postpaid churn rate was 1.8% in the second quarter and 1.9% for the first six months of 2005, down from a 2.3% churn rate in both the second quarter and for the first six months of 2004.

 

34

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Beginning in the first quarter of 2005, Cingular adopted a new reseller churn calculation methodology that resulted in an aggregate churn calculation that is more comparable with its major competitors. Prior to 2005, Cingular included gross reseller disconnects in its churn calculation. Effective with the first quarter of 2005, Cingular’s churn calculation is based on total net reseller disconnects. This change resulted in an improvement to second quarter and first six months of 2005 reported churn of approximately 30 basis points. Changes to conform the traditional Cingular presentation to certain of the AT&T Wireless churn methodologies resulted in an improvement to second quarter and first six months of 2005 reported churn of less than 10 basis points.

 

The decline in postpaid churn reflects Cingular’s ability to provide more attractive offerings to customers due to the acquisition of AT&T Wireless, including more affordable rate plans, broader network coverage, higher network quality, exclusive devices and free mobile-to-mobile calling among Cingular’s 51.6 million customers.

 

Service revenues are comprised of local voice and data services, roaming, long-distance and other revenue. The primary driver for the second quarter and first six months of 2005 increase in Cingular’s total operating revenues was the acquisition of AT&T Wireless in late October 2004 and inclusion of AT&T Wireless operating results. Service revenues increased $3,886 in the second quarter and $7,722 for the first six months of 2005 and consisted of:

Local voice revenues increased approximately $3,036 in the second quarter and $6,111 for the first six months due to the acquisition of AT&T Wireless (which more than doubled Cingular’s average number of wireless customers) and greater billed minutes of use. Increased Universal Service Fund (USF) and regulatory compliance fees also contributed to the local voice revenues increase in the second quarter and first six months of 2005.

Data service revenues increased $488 in the second quarter and $921 for the first six months due to increased average revenue per customer, increased use of text messaging services and the inclusion of former AT&T Wireless customers (who on average were heavier data users than Cingular customers). Data ARPU increased approximately 185% in the second quarter and 205% for the first six months of 2005 compared to 2004. Data service revenues represented approximately 7.6% of Cingular’s total revenues in the second quarter and 7.3% for the first six months of 2005.

Roaming revenues from Cingular customers and other wireless carriers for use of Cingular’s network increased $262 in the second quarter and $460 for the first six months primarily due to roaming revenues from the acquired AT&T Wireless customer base.

Long-distance and other revenue increased $100 in the second quarter and $230 for the first six months primarily due to increased long-distance revenues from the acquired AT&T Wireless customer base as well as increased international calling and property management fees.


Equipment revenues increased $536 in the second quarter and $962 for the first six months of 2005 due to increased handset revenues primarily as a result of significantly higher gross customer additions

 

35

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

and increases in existing customers upgrading their units. Upgrade unit sales reflect an increase in GSM upgrades and Cingular’s efforts to migrate former AT&T Wireless customers to Cingular service offerings.

 

Cost of services and equipment sales expenses increased $2,035 in the second quarter and $3,982 for the first six months of 2005 primarily due to increased cost of services resulting from incremental costs related to the acquired AT&T Wireless network. Cost of services increased $1,310 in the second quarter and $2,499 for the first six months of 2005 due to increases in network usage with a minutes of use increase of more than 150%, increased costs Cingular is now paying T-Mobile for the use of its network in California and Nevada, increased redundant expenses related to concurrently operating TDMA and GSM networks, higher roaming and long-distance cost and increased USF and regulatory fees related to the increase in the customer base.

 

Equipment sales expense increased $725 in the second quarter and $1,483 for the first six months of 2005 primarily due to higher handset unit sales associated with the increase in gross customer additions of 79.5% in the second quarter and 85.2% for the first six months, existing customers upgrading their units and the continued migration of former AT&T Wireless customers to Cingular service offerings. Equipment costs increased at a higher rate than equipment revenues due to Cingular’s sales of handsets below cost, through direct sales sources, to customers who committed to one-year or two-year contracts or in connection with other promotions.

 

Selling, general and administrative expenses increased $1,490 in the second quarter and $3,119 for the first six months of 2005 primarily due to incremental expenses associated with the acquisition of AT&T Wireless. These increases include $76 of integration costs in the second quarter and $178 for the first six months of 2005, which includes employee termination costs, re-branding and advertising of the Cingular and AT&T Wireless combination and customer service and systems integrations costs.

 

Total selling expenses increased $568, or 80.0%, in the second quarter and $1,195, or 88.3%, for the first six months of 2005 primarily due to the increase in gross customer additions of 79.5% in the second quarter and 85.2% for the first six months. Total selling expenses include sales, marketing, advertising and commissions expense. Commissions expense increased $204 in the second quarter and $424 for the first six months of 2005 and advertising expenses increased $158 in the second quarter and $348 for the first six months of 2005. Cingular’s sales expense increased approximately $183 in the second quarter and $370 for the first six months of 2005 primarily due to increased sales personnel costs associated with the acquired AT&T Wireless sales force.

 

General and administrative expenses increased $922 in the second quarter and $1,924 for the first six months of 2005 primarily due to incremental expenses from AT&T Wireless and integration costs, mentioned previously. General and administrative expenses include customer service, upgrade commissions, billing, bad debt, other maintenance and other administrative expense. Customer service expenses increased $323 in the second quarter and $683 for the first six months due to a higher number of employees and employee-related expenses related to the significant increase in customers, as well as customer retention and customer service improvement initiatives. Upgrade commissions increased $97 in the second quarter and $196 for the

 

36

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

first six months due to the increased customer migration and handset upgrade activity, mentioned previously. Billing, bad debt and other customer maintenance expense increased $220 in the second quarter and $426 for the first six months primarily due to the significant increase in Cingular’s customer base. Other administrative expenses increased $282 in the second quarter and $619 for the first six months primarily due to incremental expenses associated with the acquired AT&T Wireless administrative functions.

 

Depreciation and amortization expenses increased $1,064 in the second quarter and $2,186 for the first six months of 2005. Depreciation expense increased $644 in the second quarter and $1,300 for the first six months primarily due to incremental depreciation associated with the property, plant and equipment acquired in the AT&T Wireless acquisition. Depreciation expense increased due to Cingular’s on-going capital spending associated with its GSM network. Additionally, depreciation expense increased due to accelerated depreciation on certain TDMA network assets based on Cingular’s projected transition of network traffic to GSM technology and accelerated depreciation on certain other network assets, which includes integration costs of $109 in the second quarter and first six months. Substantially all of Cingular’s TDMA assets are anticipated to be fully depreciated by the end of 2007.

 

Amortization expense increased $420 in the second quarter and $886 for the first six months of 2005 primarily related to the purchase price valuation of AT&T Wireless customer contracts and other intangible assets acquired, partially offset by intangible assets that became fully amortized during 2004.

 

 

37

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Other Cingular Transactions

In November 2004, Cingular entered into a number of agreements to divest certain assets and spectrum in certain markets in response to the agreement made with the U.S. Department of Justice (DOJ) and the Federal Communications Commission (FCC) as a condition to receiving regulatory approval to acquire AT&T Wireless. In April 2005, Cingular sold certain former AT&T Wireless assets and properties, including licenses, network assets, and subscribers that Cingular operated in several markets, the largest of which is Oklahoma City, Oklahoma to Alltel Corporation (Alltel). As part of this agreement, Cingular also sold 20 MHz of spectrum and the network assets formerly held by AT&T Wireless in Wichita, Kansas, which it was not required to divest. Additionally, in February 2005, Cingular sold 10 MHz of former AT&T Wireless spectrum in each of Dallas, Texas and Detroit, Michigan to MetroPCS and 10 MHz of former AT&T Wireless spectrum in Knoxville, Tennessee to Cellco Partnership (d/b/a Verizon Wireless). In March 2005, Cingular sold AT&T Wireless properties and assets in specific rural regions of Arkansas, Mississippi, Missouri and Texas. Finally, in April 2005, Cingular completed the disposition of AT&T Wireless assets in Missouri. No gains or losses were recognized on the sale of these former AT&T Wireless properties or spectrum. Cingular has completed all required divestitures required by the FCC and DOJ.

 

In January 2005, Cingular and T-Mobile dissolved their network infrastructure joint venture. In connection with the dissolution, Cingular sold its ownership of the California/Nevada network assets to T-Mobile for approximately $2,500 in cash. In connection with the dissolution, Cingular was required to contribute an additional $200 to the venture to equalize the capital accounts. Cingular expects to use a significant portion of the proceeds from the sale to fund capital expenditures through July 2005 (see “Liquidity and Capital Resources”). At June 30, 2005, $1,488 of these funds remains designated for future capital expenditures.

 

In May 2005, we transferred wireless properties to Cingular to settle a liability related to the formation of Cingular. This transfer resulted in a decrease of approximately $35 to our “Investment in Cingular” account.

 

In June 2005, Cingular agreed to sell former AT&T Wireless operations and licenses in the Caribbean and Bermuda to Digicel Limited for approximately $61. This transaction is contingent upon regulatory approvals.

 

In July 2005, we received additional net repayments totaling approximately $1,179 from Cingular, which was applied as a reduction on our shareholder loan to Cingular.

 

 

38

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Supplemental Information

 

Because Cingular’s acquisition of AT&T Wireless has a significant effect on comparative financial information, we have included the following sequential quarterly results for comparative purposes.

 

Cingular

Sequential Segment Results

 

Three-Month Period Ended

 

 

June 30,

 

March 31,

 

December 31,

 

 

2005

 

2005

 

2004

Segment operating revenues

 

 

 

 

 

 

Service revenues

$

7,719

$

7,419

$

6,313

Equipment revenues

 

890

 

810

 

806

Total Segment Operating Revenues

 

8,609

 

8,229

 

7,119

Segment operating expenses

 

 

 

 

 

 

Cost of services and equipment sales

 

3,523

 

3,439

 

2,939

Selling, general and administrative

 

2,953

 

3,001

 

2,947

Depreciation and amortization

 

1,629

 

1,675

 

1,386

Total Segment Operating Expenses

 

8,105

 

8,115

 

7,272

Segment Operating Income (Loss)

 

504

 

114

 

(153)

Interest Expense

 

326

 

338

 

303

Equity in net income (loss) of

 

 

 

 

 

 

affiliates – net

 

1

 

2

 

(114)

Other – net

 

(8)

 

4

 

13

Segment Income (Loss)

$

171

$

(218)

$

(557)

 

 

39

 

SBC COMMUNICATIONS INC.

JUNE 30, 2005

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Dollars in Millions except per share amounts

 

RESULTS OF OPERATIONS - Continued

 

 

Directory

Segment Results

 

 

Second Quarter

 

 

Six-Month Period

 

 

 

 

 

 

Percent

 

 

 

 

 

 

Percent

 

 

2005

 

2004

 

Change

 

 

2005

 

2004

 

Change

Total Segment Operating Revenues

$

925

$

933

 

(0.9)%

 

$

1,854

$

1,871

 

(0.9)%

Segment operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

234

 

221

 

5.9

 

 

475

 

449

 

5.8

Selling, general and administrative

 

199

 

199

 

-

 

 

401

 

381

 

5.2

Depreciation and amortization

 

1

 

2

 

(50.0)

 

 

3

 

5

 

(40.0)

Total Segment Operating Expenses

 

434

 

422

 

2.8

 

 

879

 

835

 

5.3

Segment Operating Income

 

491

 

511

 

(3.9)

 

 

975

 

1,036

 

(5.9)

Equity in Net Income (Loss) of Affiliates