FORM 10-K
(Mark One)
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ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2004 | ||
OR | ||
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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 1-8607 |
BELLSOUTH CORPORATION
A GEORGIA CORPORATION
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I.R.S. EMPLOYER NO. 58-1533433 |
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1155 Peachtree Street, N.E., Room 15G03,
Atlanta, Georgia 30309-3610 Telephone number 404-249-2000 |
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SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: | ||
TITLE OF EACH CLASS
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NAME OF EACH EXCHANGE ON WHICH REGISTERED |
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See Attachment.
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See Attachment. | |
SECURITIES REGISTERED PURSUANT TO SECTION
12(g) OF THE ACT: None. |
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 ü No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Yes No ü
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes ü No
At January 31, 2005, 1,831,554,092 shares of Common Stock and Preferred Stock Purchase Rights were outstanding.
At June 30, 2004, the aggregate market value of the voting and non-voting stock held by nonaffiliates was $48,748,103,573.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrants definitive proxy statement dated March 11, 2005, issued in connection with the 2005
Name of Each Exchange | |||
Title of Each Class | On Which Registered | ||
Common Stock (par value $1 per share) and | |||
Preferred Stock Purchase Rights
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New York Stock Exchange | ||
Debt
Securities(a):
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New York Stock Exchange | ||
Issued by BellSouth Capital Funding
Corporation(b)
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7.12% Debentures due 2097
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Issued by BellSouth Telecommunications, Inc.
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Fifteen Year 5 7/8% Debentures, due
January 15, 2009
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Forty Year 7 5/8% Debentures, due May 15,
2035
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Thirty Year 7% Debentures, due October 1,
2025
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Fifty Year 5.85% Debentures, due
November 15, 2045
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One Hundred Year 7% Debentures, due
December 1, 2095
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Principal Amount of One Hundred Year 6.65%
Zero-To-Full Debentures, due December 15, 2095
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Ten Year 6 1/2% Notes, due June 15, 2005
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Thirty Year 6 3/8% Debentures, due June 1,
2028
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(a) As of filing date.
(b) Subsequently merged with and into BellSouth Corporation.
Item | Page | |||
PART I
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Cautionary Language Concerning
Forward-Looking Statements |
3 | |||
1. Business
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3 | |||
Communications
Group
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4 | |||
Domestic
Wireless
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7 | |||
Advertising
& Publishing Group
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11 | |||
Latin
American Group
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11 | |||
Intellectual
Property
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12 | |||
Research
and Development
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12 | |||
Employees
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12 | |||
2. Properties
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12 | |||
3. Legal
Proceedings
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12 | |||
4. Submission
of Matters to
a
Vote of Shareholders |
14 | |||
Additional Information
Description of BellSouth Stock |
14 | |||
Executive Officers
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16 | |||
Website Access
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16 | |||
PART II
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5. Market
for Registrants Common
Equity,
Related Shareholder Matters and Issuer Purchases of Equity Securities |
16 | |||
6. Selected
Financial and
Operating
Data |
18 | |||
7. Managements
Discussion
and
Analysis of Financial Condition and Results of Operations |
19 | |||
Overview
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19 | |||
Consolidated
Results of Operations
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21 | |||
Results
by Segment
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25 | |||
Communications
Group
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26 | |||
Domestic
Wireless
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30 | |||
Advertising
& Publishing Group
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34 | |||
Liquidity
and Financial Condition
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36 | |||
Off-Balance
Sheet Arrangements
and
Aggregate Contractual Obligations |
39 | |||
Quantitative
and
Qualitative
Disclosure About Market Risk |
40 | |||
Operating
Environment
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41 | |||
Critical
Accounting Policies
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47 | |||
Cautionary
Language
Concerning
Forward-Looking Statements |
49 | |||
8. Consolidated
Financial Statements
of
BellSouth Corporation |
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Consolidated
Statements of Income
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50 | |||
Consolidated
Balance Sheets
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51 | |||
Consolidated
Statements of Cash Flows
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52 | |||
Consolidated
Statements
of Shareholders Equity and Comprehensive Income |
53 | |||
Notes
to Consolidated
Financial
Statements |
54 | |||
Reports
of Independent
Registered
Public Accounting Firms |
84 | |||
Report
of Management on
Internal
Control Over Financial Reporting |
85 | |||
9. Changes
in and
Disagreements
with Accountants on Accounting and Financial Disclosure |
86 | |||
9A. Controls
and Procedures
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86 | |||
9B. Other
Information
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86 | |||
PART III
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*10. Directors
and Executive
Officers
of the Registrant |
86 | |||
*11. Executive
Compensation
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86 | |||
*12. Security
Ownership of
Certain
Beneficial Owners and Management and Related Shareholder Matters |
87 | |||
*13. Certain
Relationships
and
Related Transactions |
87 | |||
*14. Principal
Accountant
Fees
and Services |
87 | |||
PART IV
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15. Exhibits
and Financial
Statement
Schedules |
88 | |||
Signatures
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* | All or a portion of the referenced sections have been included in BellSouth Corporations definitive proxy statement dated March 11, 2005 and incorporated herein by reference. |
PART I
In addition to historical information, this document contains forward-looking statements regarding events, financial trends and critical accounting policies that may affect our future operating results, financial position and cash flows. These statements are based on our assumptions and estimates and are subject to risks and uncertainties. For these statements, we claim the protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.
| a change in economic conditions in the markets where we operate or have material investments which could affect demand for our services; | |
| the impact and the success of Cingular Wireless, our wireless joint venture with SBC Communications, Inc. (SBC), including marketing and product development efforts, technological changes and financial capacity; | |
| Cingular Wireless failure to realize, in the amounts and within the timeframe contemplated, the capital and expense synergies and other financial benefits expected from its acquisition of AT&T Wireless as a result of technical, logistical, regulatory and other factors; | |
| changes in laws or regulations, or in their interpretations, which could result in the loss, or reduction in value, of our licenses, concessions or markets, or in an increase in competition, compliance costs or capital expenditures; | |
| continued pressures on the telecommunications industry from a financial, competitive and regulatory perspective; | |
| the intensity of competitive activity and its resulting impact on pricing strategies and new product offerings; | |
| changes in the federal and state regulations governing the terms on which we offer retail and wholesale services; | |
| continued successful penetration of the interLATA long distance market; | |
| the impact on our business of consolidation in the wireline and wireless industries in which we operate; | |
| the issuance by the Financial Accounting Standards Board or other accounting bodies of new accounting standards or changes to existing standards; | |
| changes in available technology that increase the likelihood of our customers choosing alternate technology to the products offered by BellSouth (technology substitution); | |
| higher than anticipated start-up costs or significant up-front investments associated with new business initiatives; | |
| the outcome of pending litigation; and | |
| unanticipated higher capital spending from, or delays in, the deployment of new technologies. |
Business
OVERVIEW
In this document, BellSouth Corporation and its subsidiaries are referred to as we or BellSouth.
| Communications Group; | |
| Domestic Wireless; and | |
| Advertising & Publishing Group. |
See Note P to our consolidated financial statements for financial data on each of our segments.
Communications Group
OVERVIEW
We are the leading communications service provider in the southeastern United States (US), serving substantial portions of the population within Alabama, Florida, Georgia, Kentucky, Louisiana, Mississippi, North Carolina, South Carolina and Tennessee. BellSouth Telecommunications, Inc. (BST), our wholly-owned subsidiary, provides wireline communications services, including local exchange, network access, intraLATA long distance services and Internet services. BellSouth Long Distance, Inc. (BSLD), our long distance subsidiary, provides long distance services to residential and small business customers in our nine southeastern states, long distance services to enterprise customers with locations throughout the country, and wholesale long distance primarily to wireless communications providers, smaller wireline telecommunications providers and unaffiliated long distance providers. Communications Group operations generated 90% of our total operating revenues in 2004, 2003 and 2002.
Consumer. This unit serves the largest segment of the market within our region, the residential customer. While traditional local and long distance telephone service remains the core of this market, customer demands are rapidly broadening to include an expanded range of services, from convenience features such as caller ID, call forwarding and voice mail, to dial-up access to the Internet, high-speed DSL and video services. During 2004, the Consumer unit represented 43% of Communications Group revenues. | |
Small Business. This unit focuses on providing, in addition to traditional local and long distance voice services, advanced voice, data, Internet and networking solutions to small and medium-sized businesses. It offers a full selection of standard and customized communications services to this market. During 2004, the Small Business unit represented 12% of Communications Group revenues. | |
Large Business. This unit, known as BellSouth Business, provides a wide range of standard and highly specialized services and products to large and complex business customers. In addition to traditional local and long distance voice services, product and service offerings to these customers include Internet access, private networks, high-speed data equipment and transmission, conferencing and industry-specific communications arrangements for industries such as banking, healthcare and manufacturing. During 2004, the Large Business unit represented 17% of Communications Group revenues. | |
Interconnection Services. This unit provides interconnection to our network and other related wholesale services to telecommunications carriers for use in providing services to their customers. Interconnection refers to the link between our telecommunications network and the telecommunications network of other service providers. In addition to interconnection services, we provide services such as voice and data transport services. During 2004, the Interconnection Services unit represented 24% of Communications Group revenues and generated 45% of our reported data revenues. The unit provides services to both affiliated and nonaffiliated customers in five different carrier markets: wireless service providers, competitive local exchange carriers, competitive switched and special access providers, long distance carriers and information service providers. |
BUSINESS STRATEGY
Our business strategy is to solidify BellSouth as the leading choice of customers in the southeast for an expanding array of voice, data and Internet services and to meet our customers needs through teaming or wholesale service arrangements with other companies.
We intend to:
| optimize our portfolio of retail and wholesale products and services by utilizing marketing approaches targeted to our different customer segments, by providing superior service and by offering flexible packages of voice, data and multimedia applications through improved distribution channels and systems; |
| become the leading provider of local broadband/Internet Protocol (IP) services in the southeast by deploying new broadband/IP platforms that support both voice and data services as well as applications; and |
| reduce our cost structure by managing the utilization of existing assets and redirecting spending to focus new investment on high-growth products and services. |
BUSINESS OPERATIONS
Voice services
Voice services include basic dial-tone telephone service and switching services provided through the regular switched network. In addition, we offer various standard convenience features, such as caller ID, call waiting, call return and 3-way calling on a monthly subscription or, for some, on a per-use basis. Additional voice related revenues are derived from charges for inside wire maintenance contracts, voice messaging services, directory assistance and operator services. Voice revenues also include end-user charges and cost recoveries related to the federal universal service fund.
Broadband and data services
As use of the Internet grows and as corporate data applications increase in sophistication and scope, the market for broadband and data services is expanding and evolving. BellSouth will continue to expand its capabilities in order to maintain a leadership position in the broadband and data communications market. Investment in service infrastructure is strategically managed to enable delivery of services offering increasing capacity and functionality. In parallel, we continue to use new advances in digital technology to bolster the broadband capabilities of our entire network. The emergence of high-performance broadband and digital infrastructure offers the ability to use these networks for real-time communications including voice and video using various technologies such as softswitches (software-based switching platforms) and voice over Internet protocol (VoIP).
| a suite of VoIP network based IP products, including Centrex IP service for Large Business customers, Internet Protocol Telephone Gateway (IPTG) service and VoIP Conversion service for Interconnection Service customers; |
| a VoIP service specifically designed for Large Business customers and known as BellSouth Converged Solutions; and |
| a number of PBX equipment-based IP voice and data services. |
Video
In August 2004, we began acting as a selling agent for DirecTV. Although this relationship has little impact on our revenues, it enables us to offer a bundle of wireline and wireless voice along with data and video. As technology evolves, we are continuing to look at future options for providing video services. For example, in 2005 we commenced a trial of Microsofts IP-TV technology that, if commercially deployed, would enable BellSouth to deliver an integrated suite of new voice, data and interactive video capabilities and services to our customers over an upgraded DSL-based broadband transmission platform.
Other Communications Group revenues
Other Communications Group revenues are comprised primarily of charges for billing and collection services for long distance carriers, enhanced white pages listings, customer late payment fees, customer premises equipment sales and maintenance services. Other revenue also includes charges for permitting our competitors to set up their equipment in our facilities (referred to as collocation). Historically, revenues from local payphone services were included in this category. By the end of 2003, we had ceased offering local payphone services. BellSouth also provides wholesale long distance services, primarily to wireless communications providers and smaller wireline telecommunications providers, as well as to unaffiliated long distance providers. Other Communications Group services provided approximately 7% of BellSouths total operating revenues for 2004 and 2003 and 8% for 2002.
WIRELINE REGULATORY ENVIRONMENT
The FCC regulates rates and other aspects of our provision of interstate telecommunications services, including international rates and interstate access charges. State regulatory commissions have jurisdiction over our provision of intrastate telecommunications services, including local and long distance rates and network access services. Access charges are designed to compensate our wireline subsidiary for the use of its networks by other carriers. Our future operations and financial results will be substantially influenced by developments in a number of federal and state regulatory proceedings. Adverse results in these proceedings could materially affect our revenues, expenses and ability to compete effectively against other telecommunications carriers.
COMPETITION
We face significant competition from traditional telecommunications providers. Further, we are increasingly seeing competition from wireless, cable and other providers that have not historically competed with us for telecommunications customers.
Wireless providers
We face strong competition from wireless service providers. Competition in the wireless industry has created lower price point service offerings that include larger buckets of anytime minutes that include long distance, causing many customers to choose wireless for their primary voice communications option. As wireless companies expand their offerings to include high speed data services, we expect this migration trend to continue.
Traditional telecommunication service providers
We compete for customers based principally on service offerings, price and customer service. Increasing competition has resulted in innovative packaging and services that strive to simplify the customers experience. Pricing pressures in the market have increased resulting in opportunities for the customer to purchase value based packages and services. Competitive pressures across the board have resulted in an increase in advertising and promotional spending. Competitors are able to resell our local services, or lease separate unbundled network elements (UNE). In addition, an increasing number of voice and data communications networks utilizing fiber optic lines have been constructed by communications providers in all major metropolitan areas throughout our wireline service territory.
Broadband service providers
Technological developments have made it feasible for cable television networks to carry data and voice communications. We are seeing new competition as a result of the development of commercial applications using Internet Protocol technology (VoIP). This medium could attract substantial traffic because of its lower cost structure due to the fact that FCC rules do not currently impose access charges on most communications carried over this technology.
FRANCHISES AND LICENSES
Our local exchange business is typically provided under certificates of public convenience and necessity granted pursuant to state statutes and public interest findings of the various public utility commissions of the states in which we do business. These certificates provide for franchises of indefinite duration, subject to the maintenance of satisfactory service at reasonable rates. The Telecommunications Act of 1996 provides that these franchises must be non-exclusive.
OVERVIEW
Our domestic wireless business consists of a 40% interest in Cingular Wireless. Cingular is a joint venture that was formed by the combination of most of the former domestic wireless operations of BellSouth and SBC. Cingular is operated independently from both parents, currently with a six-seat Board of Directors comprised of three directors from each parent. BellSouth and SBC share control of Cingular. Cingular is a SEC registrant by virtue of its publicly traded debt securities. Accordingly, it files separate reports with the SEC.
| Cingular reported US wireless cellular service and personal communication services (PCS) customers totaling 49.1 million; | |
| Cingular had access to licenses to provide cellular or PCS wireless communications services covering an aggregate of 290 million in population (POPs), or approximately 98% of the US population, including all of the 100 largest US metropolitan areas; | |
| Cingulars primary digital networks utilize Global System for Mobile Communication (GSM) technology and Time Division Multiple Access (TDMA) technology; | |
| 65% of Cingulars subscriber base was GSM equipped and 79% of its total minutes were carried on its GSM network; and | |
| Cingular had over 17 million active users of its data services. |
Cingular supplements its own networks with roaming agreements that allow its subscribers to use other providers wireless services in regions where Cingular does not have network coverage. Cingular refers to the area covered by its network footprint and roaming agreements as its coverage area. With these roaming agreements, as of December 31, 2004, Cingular was able to offer its customers digital wireless services covering 95% of the US population.
BUSINESS STRATEGY
Cingular intends to be the pre-eminent wireless communications company in the US. Its business strategies to achieve that goal are to:
| build the best network by integrating the Cingular and AT&T Wireless networks, accelerating the build out of the network to improve coverage in suburban and neighborhood areas and strengthen the in-building penetration in urban areas, deploying its 3rd generation cellular/PCS system in major markets across the country and working with its rural roaming partners to improve and expand coverage outside of its footprint and assist them in providing consistent products and services to its customers that roam across their networks; | |
| deliver exceptional customer service through the implementation of policies and procedures at every point of contact with its customers to improve the customer experience; | |
| rationalize its direct and indirect distribution channels and expand sales locations opportunistically to create an unmatched distribution network; | |
| continue to offer compelling products and services, including devices, features and pricing plans, that differentiate Cingular from its competitors; and | |
| efficiently integrate AT&T Wireless business and operations. |
OPERATIONS
Voice services
Cingular offers a comprehensive range of high-quality wireless voice communications services in a variety of pricing plans, including national and regional rate plans as well as prepaid service plans. Its voice offerings are tailored to meet the communications needs of targeted customer segments, including youth, family, active professionals, local and regional businesses and major national corporate accounts. The marketing and distribution plans for Cingulars voice services are further targeted to the specific geographic and demographic characteristics of each of its markets.
POSTPAID VOICE SERVICE
Consumer postpaid voice service is generally offered on a contract basis for one or two year periods. Under the terms of these contracts, service is provided and billed on a monthly basis according to the applicable pricing plan chosen. Cingulars wireless services include basic local wireless communications service, long distance service and roaming services, which enable customers to utilize other carriers networks when they are roaming outside Cingulars network. Cingular also bills other carriers for providing roaming services to their customers when their customers utilize Cingulars network. Cingular had approximately 42.9 million postpaid contract customers (excluding reseller customers) at December 31, 2004. In addition to basic wireless voice telephony services, Cingular offers many enhanced features, such as caller ID, call waiting, call forwarding, three-way calling, no answer/busy transfer and voice mail, with many of its pricing plans. In some markets, Cingular makes available additional services for a monthly fee, such as unlimited Mobile-to-Mobile calling, discounted international roaming and international long distance, expanded off peak hours, roadside assistance and handset insurance.
PREPAID VOICE SERVICE
Cingular offers prepaid service to meet the demands of distinct consumer segments, such as the youth market, families and small business customers, who prefer to pay in advance. As of December 31, 2004, retail prepaid users represented approximately 7% of Cingulars total customers. Cingular believes its prepaid service offering benefits from being part of a national brand, particularly with regard to distribution. Its prepaid strategy focuses on increasing the profitability of this customer segment by offering a wider array of services and features to increase the revenue and retention of these customers. Its prepaid services offer customers many features available on its postpaid plans, including unlimited nights and weekends, long distance, caller ID, call waiting, voicemail and off-network roaming, as well as enhanced features like text messaging, downloadable graphics and ringtones, games and information alerts. At the same time, the customer retains the benefits of no credit check and enhanced ability to control spending and some of its prepaid customers have no contract or monthly billing. In addition, Cingular continues to focus on increasing the distribution of its prepaid offering to include the Internet, automated replenishment services and strategic retail partners.
Data services
Cingular currently offers a wide array of consumer data services such as wireless Internet browsing, wireless e-mail, text messaging, instant messaging, multi-media messaging and downloadable content and applications. Cingular continues to focus on improving the customer experience through the deployment of advanced data capable devices, through constantly enhancing the user interface on these devices, and by making the provisioning of data services on these devices as seamless as possible. With the acquisition of AT&T Wireless, we believe that Cingular is the largest provider of wireless data in the US wireless industry based on annual data revenues for 2004.
Equipment sales
Cingular sells a wide variety of handsets, integrated PDAs and wireless PC card modems manufactured by various suppliers for use with its service. Cingular provides postpaid contract customers substantial equipment subsidies to initiate or upgrade service. Cingular also provides its customers and resellers with subscriber identity modules (SIMs) to use in special purpose devices that they can buy directly from equipment manufacturers. In addition, Cingular sells accessories, such as carrying cases, hands-free devices, batteries, battery chargers and other items to consumers and to agents and other third-party distributors for resale.
NETWORK
Licenses
Cingular has access to wireless licenses to provide voice and data services over cellular/PCS networks in all 100 of the largest US metropolitan areas, covering an aggregate of 290 million POPs, or approximately 98% of the US population. Cingular has also signed numerous roaming agreements to ensure its customers can receive wireless service in virtually all areas in the United States where cellular/PCS service is available. Cingulars cellular/PCS networks are substantially complete.
Technology
In the US wireless telecommunications industry, there are two principal frequency bands currently licensed by the FCC for transmitting two-way voice and data signals. Analog and digital cellular services are provided over the 850 MHz band and digital PCS services are provided over the 1900 MHz band. PCS infrastructure is characterized by shorter transmission distances and the need for closer spacing of cells and towers than in a cellular network to accommodate the different characteristics of the PCS radio signals. However, PCS service does not differ functionally to the end-user from digital cellular service.
Spectrum capacity and coverage
Cingular currently owns licenses for spectrum in the 850 MHz and 1900 MHz bands. We expect that the demand for its wireless services will grow over the next several years as the demand for both traditional wireless voice services and wireless data and Internet services increases significantly. We anticipate that Cingular will need access to additional spectrum in selected densely populated markets to meet expected demand for existing services and throughout its network to provide UMTS/HSDPA. Some of this additional spectrum requirement was met by the acquisition of AT&T Wireless and the purchase of 1900 MHz spectrum from NextWave Telecom, Inc. (NextWave).
Network integration
The acquisition of AT&T Wireless provided Cingular with significantly more cell sites covering its footprint than any other operator in the US. To ensure the additional cell sites result in improved coverage for its customers, Cingular has activated home-on-home roaming between the previous AT&T Wireless and Cingular systems allowing former AT&T Wireless customers to roam onto Cingular networks where they did not have AT&T Wireless coverage and similarly for Cingular customers. Cingular intends to maintain this improved coverage and to continue network construction to add a large number of new cell sites to further bolster its coverage advantage.
COMPETITION
There is substantial and increasing competition in all aspects of the wireless communications industry. Cingular competes for customers based principally on its reputation, network quality, customer service, price and service offerings.
| increase its spending to retain customers; | |
| restructure its service packages to include more compelling products and services; | |
| further upgrade its network infrastructure and the handsets it offers; and | |
| increase its advertising, promotional spending, commissions and other customer acquisition costs. |
WIRELESS REGULATORY ENVIRONMENT
The FCC regulates the licensing, construction, operation, acquisition and transfer of wireless systems in the US pursuant to the Communications Act of 1934 and its associated rules, regulations and policies. Additional information relating to federal and state regulation of Cingulars wireless operations is contained under the heading Managements Discussion and Analysis of Financial Condition and Results of Operations Operating Environment Wireless Regulatory Environment, and is incorporated herein by reference.
Advertising & Publishing Group
OVERVIEW
We are one of the leading publishers of telephone directories in the United States. Our Advertising & Publishing Group publishes more than 500 directories and distributes approximately 63 million copies to residences, businesses and government agencies in the Southeast. Revenues from this group represented approximately 10% of our total operating revenues in 2004, 2003 and 2002.
BUSINESS STRATEGY
We are committed to remaining the preferred comprehensive source linking buyers and sellers in the local, regional and national marketplace. To achieve this objective, we intend to:
| maintain product leadership by reinvesting in our products and making strategic investments to promote our products; | |
| grow revenues through new products and product enhancements, including the development and increased distribution of Internet and niche products and by expanding our existing markets through new market overlays and traditional market re-scoping; | |
| attract new customers and retain our existing customer base by offering competitive pricing and incentive programs to encourage new customers and to reward current customers for their tenure; and | |
| continue to improve operational efficiency. |
COMPETITION
Competition in the yellow pages industry continues to intensify. Major markets are seeing multiple competitors, with many different media competing for advertising revenue. Within the print yellow pages, we compete primarily with Yellow Book USA, White Publishing, R.H. Donnelly, and Verizon. Other electronic competitors include Google, YahooLocal, SuperPages.com and other Internet search engines that have a small but growing percentage of yellow page-like searches. Competition for directory sales agency contracts for the sale of advertising in publications of nonaffiliated companies also continues to be strong. We continue to respond to the increasing competition and the dynamic media environment with investments in product enhancements, multiple delivery options, local promotions, customer value plans, increased advertising, and sales execution.
Latin American Group
On March 5, 2004, we signed an agreement with Telefónica Móviles, S.A., the wireless affiliate of Telefónica, S.A., to sell all our interests in our Latin American operations. During October 2004, we closed on the sale of 8 of the 10 properties: Venezuela, Colombia, Ecuador, Peru, Guatemala, Nicaragua, Uruguay and Panama. We closed on the sale of the remaining two properties (Argentina and Chile) in January 2005.
Intellectual Property
BellSouths intellectual property portfolio is a major component of our ability to be a leading and innovative telecommunications services provider. We diligently protect and work to build our intellectual property rights through patent, copyright, trademark and trade secret laws. We also use various licensed intellectual property to conduct our business.
Research and Development
Research and development in our industry is primarily driven by equipment manufacturers. In addition, we conduct research and development activities internally and through external vendors, primarily Telcordia Technologies. Telcordia provides research and development and other services to us and other telecommunications companies. We have contracted with Telcordia for ongoing support of engineering and systems. In addition, we are a member of the National Telecommunications Alliance, an organization that supports our commitment to national security and emergency preparedness.
Employees
At December 31, 2004, we employed almost 63,000 individuals. About 67% of BellSouths employees at December 31, 2004 were represented by the Communications Workers of America (CWA), which is affiliated with the AFL-CIO. Collective bargaining agreements with the CWA were last ratified in September 2004. These five-year contracts, which expire August 8, 2009, cover approximately 42,000 employees. The contracts include basic wage increases of 1% in year one, 2% in year two and annual increases of 2.5% in years three through five totaling 10.5% over the contract term. The contracts also provide for a 4% lump-sum payment upon ratification by the membership. In addition, the agreements provide for a standard incentive award of 2% in the first three years of the contract increasing to 3% in years four and five. Other terms of the agreements include pension band increases and pension plan cash balance improvements for active employees. We expect the agreements to continue to give us the workforce planning flexibility needed to respond to changing marketplace conditions.
Properties
Our properties do not lend themselves to description by character or location of principal units. Our investment in property, plant and equipment in our consolidated operations consisted of the following at December 31:
2003 | 2004 | |||||||
Outside plant
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40.5 | % | 43.0 | % | ||||
Central office equipment
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39.7 | 41.7 | ||||||
Operating and other equipment
|
7.9 | 3.6 | ||||||
Land and buildings
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7.7 | 7.6 | ||||||
Furniture and fixtures
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3.8 | 3.8 | ||||||
Plant under construction
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0.4 | 0.3 | ||||||
100 | % | 100 | % | |||||
Almost all of these properties are located in our Communications Group segment.
Legal Proceedings
EMPLOYMENT CLAIM
On April 29, 2002, five African-American employees filed a putative class action lawsuit, captioned Gladys Jenkins et al. v. BellSouth Corporation, against the Company in the United States District Court for the Northern District of Alabama. The complaint alleges that BellSouth discriminated against current and former African-American employees with respect to compensation and promotions in violation of Title VII of the Civil Rights Act of 1964 and 42 USC Section 1981. Plaintiffs purport to bring the claims on behalf of two classes: a class of all African-American hourly workers employed by BellSouth Telecommunications at any time since April 29, 1998, and a class of all African-American salaried workers employed by BellSouth Telecom-
SECURITIES AND ERISA CLAIMS
From August through October 2002, several individual shareholders filed substantially identical class action lawsuits against BellSouth and three of its senior officers alleging violations of the federal securities laws. The cases have been consolidated in the United States District Court for the Northern District of Georgia and are captioned In re BellSouth Securities Litigation. Pursuant to the provisions of the Private Securities Litigation Reform Act of 1995, the court has appointed a Lead Plaintiff. The Lead Plaintiff filed a Consolidated and Amended Class Action Complaint in July 2003 on behalf of two putative classes: (1) purchasers of BellSouth stock during the period November 7, 2000 through February 19, 2003 (the class period) for alleged violations of Sections 10(b) and 20 of the Securities Exchange Act of 1934 and (2) participants in BellSouths Direct Investment Plan during the class period for alleged violations of Sections 11, 12 and 15 of the Securities Act of 1933. Four outside directors were named as additional defendants. The Consolidated and Amended Class Action Complaint alleged that during the class period, the Company (1) overstated the unbilled receivables balance of its Advertising & Publishing subsidiary; (2) failed to properly implement SAB 101 with regard to its recognition of Advertising & Publishing revenues; (3) improperly billed competitive local exchange carriers (CLEC) to inflate revenues; (4) failed to take a reserve for refunds that ultimately came due following litigation over late payment charges; and (5) failed to properly write down goodwill of its Latin American operations. On February 8, 2005, the district court dismissed the Exchange Act claims, except for those relating to the writedown of Latin American goodwill. On that date, the district court also dismissed the Securities Act claims, except for those relating to the writedown of Latin American goodwill, the allegations relating to unbilled receivables of the Companys Advertising & Publishing subsidiary, the implementation of SAB 101 regarding recognition of Advertising & Publishing revenues and alleged improper billing of CLECs. The plaintiffs are seeking an unspecified amount of damages, as well as attorneys fees and costs. At this time, the likely outcome of the case cannot be predicted, nor can a reasonable estimate of loss, if any, be made.
ANTITRUST CLAIMS
In December 2002, a consumer class action alleging antitrust violations of Section 1 of the Sherman Antitrust Act was filed against BellSouth, Verizon, SBC and Qwest, captioned William Twombley, et al v. Bell Atlantic Corp., et al, in Federal Court in the Southern District of New York. The complaint alleged that defendants conspired to restrain competition by agreeing not to compete with one another and otherwise allocating customers and markets to one another. The plaintiffs are seeking an unspecified amount of treble damages and injunctive relief, as well as attorneys fees and expenses. In October 2003, the district court dismissed the complaint for failure to state a claim and the case is now on appeal.
ENVIRONMENTAL MATTERS
We are subject to a number of environmental matters as a result of our operations and the shared liability provisions related to the breakup of the Bell System. At December 31, 2004, our recorded liability related to these matters was approximately $10 million. We continue to believe that expenditures in connection with additional remedial actions under the current environmental protection laws or related matters will not be material to our results of operations, financial position or cash flows.
OTHER MATTERS
We are subject to claims arising in the ordinary course of business involving allegations of personal injury, breach of contract, anti-competitive conduct, employment law issues, regulatory matters and other actions. BST is also subject to claims attributable to pre-divestiture events, including environmental liabilities, rates and contracts. Certain contingent liabilities for pre-divestiture events are shared with AT&T Corp. While complete assurance cannot be given as to the outcome of any legal claims, we believe that any financial impact should not be material to our results of operations, financial position or cash flows. See Note Q to our consolidated financial statements.
Submission of Matters to a Vote of Shareholders
No matter was submitted to a vote of shareholders in the fourth quarter of the fiscal year ended December 31, 2004.
Additional Information Description of BellSouth Stock
GENERAL
Our Articles of Incorporation authorize the issuance of 8,650,000,000 shares of common stock, par value $1 per share, and 100,000,000 shares of cumulative, first preferred stock, par value $1 per share. Our Board of Directors is authorized to create from the unissued common stock one or more series, and, prior to the issuance of any shares in any particular series, to fix the voting powers, preferences, designations, rights, qualifications, limitations or restrictions of such series. The Board has not created any series of common stock. The Board is also authorized to provide for the issuance, from time to time, of the first preferred stock in series and, as to each series, to fix the number of shares in such series and the voting, dividend, redemption, liquidation, retirement and conversion provisions applicable to the shares of such series. No shares of first preferred stock are outstanding. The Board has created Series B First Preferred Stock consisting of 30 million shares for possible issuance under the BellSouth Shareholder Rights Plan. The Series A First Preferred Stock was created for a previous shareholder rights plan, which has expired. See Preferred Stock Purchase Rights and Market for Registrants Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities.
DIVIDEND RIGHTS
The holders of common stock are entitled to receive, from funds legally available for the payment thereof, dividends when and as declared by resolution of the Board. While any series of preferred stock is outstanding, no dividends, other than dividends payable solely in common stock, may be declared or paid on common stock, and no common stock may be purchased, redeemed or otherwise acquired for value, unless (a) dividends on all outstanding shares of preferred stock for the current and all past dividend periods have been paid or declared and provision made for payment thereof and (b) all requirements with respect to any purchase, retirement or sinking fund or funds applicable to all outstanding series of preferred stock have been satisfied.
VOTING RIGHTS
Except in connection with the business combinations and fair price provisions discussed below, holders of shares of common stock are entitled to one vote, in person or by proxy, for each share held on the applicable record date with respect to each matter submitted to a vote at a meeting of shareholders, but such holders do not have cumulative voting rights. The holders of any series of preferred stock, when issued, may receive the right to vote as a class on certain amendments to the Articles of Incorporation and on certain other matters, including the election of directors in the event of certain defaults, which may include nonpayment of preferred stock dividends.
LIQUIDATION RIGHTS
In the event of voluntary or involuntary liquidation of BellSouth, holders of the common stock will be entitled to receive, after creditors have been paid and the holders of the preferred stock, if any, have received their liquidation preferences and accumulated and unpaid dividends, all the remaining assets of BellSouth.
DIRECTORS
In 2004, our shareholders approved an amendment to our By-laws to eliminate the classified Board structure. As a result, each director is elected annually for a one year term. The By-laws also provide that shareholders may remove directors from office only for cause, and can amend the By-laws with respect to the number of directors or amend the board classification provisions only by the affirmative vote of the holders of at least 75% of the outstanding shares entitled to vote for the election of directors.
PRE-EMPTIVE RIGHTS; CONVERSION RIGHTS; REDEMPTION
No shareholders of any class shall be entitled to any preemptive rights to subscribe for or purchase any shares or other securities issued by BellSouth. The common stock has no conversion rights and is not subject to redemption.
PREFERRED STOCK PURCHASE RIGHTS
Each share of common stock outstanding includes one preferred stock purchase right (Right). Under certain circumstances, each Right will entitle the holder to purchase one one-thousandth of a share of Series B Preferred Stock, $1 par value (Common Equivalent Preferred Stock), which unit is substantially equivalent in voting and dividend rights to one whole share of the common stock, at a price of $200 per unit (the Purchase Price). The Rights are not presently exercisable and may be exercised only if a person or group (Acquiring Person) acquires 15% of the outstanding voting stock of BellSouth without the prior approval of the Board or announces a tender or exchange offer that would result in ownership of 15% or more of the common stock.
BUSINESS COMBINATIONS
The Georgia legislature has enacted legislation which generally prohibits a corporation which has adopted a By-law electing to be covered thereby, which BellSouth has done, from engaging in any business combination, that is a merger, consolidation or other specified corporate transaction, with an interested shareholder, a 10% shareholder or an affiliate of the corporation which was a 10% shareholder at any time within the preceding two years, for a period of five years from the date such person becomes an interested shareholder, unless the interested shareholder (a) prior to becoming an interested shareholder, obtained the approval of the Board of Directors for either the business combination or the transaction which resulted in the shareholder becoming an interested shareholder, (b) becomes the owner of at least 90% of the outstanding voting stock of the corporation in the same transaction in which the interested shareholder became an interested shareholder, excluding for purposes of determining the number of shares outstanding those shares owned by officers, directors, subsidiaries and certain employee stock plans of the corporation or (c) subsequent to the acquisition of 10% or more of the outstanding voting stock of the corporation, acquires additional shares resulting in ownership of at least 90% of the outstanding voting stock of the corporation and obtains approval of the business combination by the holders of a majority of the shares of voting stock of the corporation, other than those shares held by an interested shareholder, officers, directors, subsidiaries and certain employee stock plans of the corporation. BellSouths business combinations By-law may be repealed only by an affirmative vote of two-thirds of the continuing directors and a majority of the votes entitled to be cast by the shareholders, other than interested shareholders, and shall not be effective until 18 months after such shareholder vote. The Georgia statute provides that a domestic corporation which has thus repealed such a By-law may not thereafter readopt the By-law as provided therein.
FAIR PRICE PROVISIONS
Fair price provisions contained in the Articles of Incorporation require, generally, in connection with a merger or similar transaction between BellSouth and an interested shareholder, the unanimous approval of BellSouths directors not affiliated with the interested shareholder or the affirmative vote of two-thirds of such directors and a majority of the outstanding shares held by disinterested shareholders, unless (a) within the past three years the shareholder has been an interested shareholder and has not increased its shareholdings by more than one percent in any 12-month period or (b) all shareholders receive at least the same consideration for their shares as the interested shareholder previously paid. Additionally, these provisions may be revised or rescinded only upon the affirmative vote of at least two-thirds of the directors not affiliated with an interested shareholder and a majority of the outstanding shares held by disinterested shareholders.
LIMITATION ON SHAREHOLDERS PROCEEDINGS
Our By-laws require that notice of shareholder nominations for directors and of other matters to be brought before annual shareholders meetings must be provided in writing to the Corporate Secretary of BellSouth not later than the 75th day nor earlier than the 120th day prior to the date which is the anniversary of the annual meeting of shareholders held in the prior year. Such By-laws also provide that a special shareholders meeting may be called by shareholders only upon written request signed by the holders of at least three-quarters of the outstanding shares entitled to vote at the meeting.
Executive Officers
The executive officers of BellSouth Corporation are listed below:
This | ||||||||||||||||
Officer | Office | |||||||||||||||
Name | Age | Office | Since | Since | ||||||||||||
F. Duane Ackerman
|
62 |
Chairman of the Board, President and Chief Executive Officer |
1983 | 1997 | ||||||||||||
Richard A. Anderson
|
46 | Vice Chairman Planning and Administration | 1993 | 2005 | ||||||||||||
Francis A. Dramis, Jr.
|
56 | Chief Information, E-Commerce and Security Officer | 1998 | 2000 | ||||||||||||
Ronald M. Dykes
|
58 | Chief Financial Officer | 1988 | 1995 | ||||||||||||
Mark L. Feidler
|
48 | Chief Operating Officer | 2004 | 2005 | ||||||||||||
Marc Gary
|
52 | General Counsel | 2004 | 2004 | ||||||||||||
Isaiah Harris, Jr.
|
52 | President BellSouth Advertising & Publishing Group | 1997 | 2005 | ||||||||||||
W. Patrick Shannon
|
42 | Senior Vice President Finance and Controller | 1997 | 2005 | ||||||||||||
All of the executive officers of BellSouth, other than Mr. Feidler and Mr. Gary, have for at least the past five years held high level management or executive positions with BellSouth or its subsidiaries. Prior to joining BellSouth in January 2004, Mr. Feidler had been Chief Operating Officer of Cingular since October 2000. Prior to that, he held various senior positions with BellSouths domestic wireless operations. Prior to his election as General Counsel effective in October 2004, Mr. Gary was Vice President and Associate General Counsel since May 2000 and, prior to that, he was a partner at the law firm of Mayer Brown & Platt.
Website Access
Our website address is www.bellsouth.com. You may obtain free electronic copies of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports at our investor relations website, www.bellsouth.com/investor/, under the heading SEC Filings. These reports are available on our investor relations website as soon as reasonably practicable after we electronically file them with the SEC.
The principal market for trading in BellSouth common stock is the New York Stock Exchange, Inc. (NYSE). BellSouth common stock is also listed on the London, Frankfurt, Amsterdam and Swiss exchanges. The ticker symbol for BellSouth common stock is BLS. At January 31, 2005, there were 688,379 holders of record of BellSouth common stock. Market price data was obtained from the NYSE Composite Tape, which encompasses trading on the principal United States stock exchanges as well as off-board trading. High and low prices represent the highest and lowest sales prices for the periods indicated.
Per Share | ||||||||||||
Market Prices | Dividends | |||||||||||
High | Low | Declared | ||||||||||
2003
|
||||||||||||
First Quarter
|
$ | 30.00 | $ | 19.79 | $ | .21 | ||||||
Second Quarter
|
27.98 | 21.00 | .23 | |||||||||
Third Quarter
|
27.92 | 23.15 | .23 | |||||||||
Fourth Quarter
|
28.37 | 22.19 | .25 | |||||||||
2004
|
||||||||||||
First Quarter
|
$ | 31.00 | $ | 26.13 | $ | .25 | ||||||
Second Quarter
|
27.86 | 24.46 | .27 | |||||||||
Third Quarter
|
27.94 | 25.08 | .27 | |||||||||
Fourth Quarter
|
28.96 | 25.65 | .27 |
The following table contains information about our purchases of equity securities during the fourth quarter of 2004.
Issuer Purchases of Equity Securities
Total Number of Shares | Approximate Dollar | |||||||||||||||
Purchased as Part of a | Value that May Yet Be | |||||||||||||||
Total Number of | Average Price | Publicly Announced | Purchased Under the | |||||||||||||
Period | Shares Purchased(1) | Paid per Share | Plan(2) | Plan(2) | ||||||||||||
October 1-31, 2004
|
76,275 | $ | 27.50 | | | |||||||||||
November 1-30, 2004
|
1,699,800 | $ | 27.88 | | | |||||||||||
December 1-31, 2004
|
62,621 | $ | 27.96 | | | |||||||||||
Total
|
1,838,696 | | | |||||||||||||
(1) | Includes 138,896 shares purchased from employees to pay taxes related to the vesting of restricted shares, at an average price of $27.70, and 1,699,800 shares purchased from the external markets, at an average price of $27.88. Excludes shares purchased from employees to pay taxes related to the exercise of stock options. |
(2) | Our publicly announced stock repurchase program expired pursuant to its terms on December 31, 2003. |
Stock Transfer Agent and Registrar
Mellon Investor Services, LLC is our stock transfer agent and registrar.
The comparability of the following Selected Financial and Operating Data is significantly impacted by various changes in accounting principle and merger, acquisition and disposition activity. The more significant items include the formation of Cingular in October 2000, which resulted in a reduction in revenues and expenses caused by the contribution of our wireless operations to Cingular; the adoption of Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002, which resulted in the cessation of amortization of goodwill; and the adoption of SFAS No. 143, Accounting for Asset Retirement Obligations, effective January 1, 2003, which resulted in a reduction in depreciation expense.
At December 31 or for the year ended | 2000 | 2001 | 2002 | 2003 | 2004 | ||||||||||||||||||
Income Statement Data:
|
|||||||||||||||||||||||
Operating revenues
|
$ | 23,245 | $ | 21,211 | $ | 20,207 | $ | 20,341 | $ | 20,300 | |||||||||||||
Operating expenses
|
16,663 | 15,339 | 15,753 | 14,784 | 15,011 | ||||||||||||||||||
Operating income
|
6,582 | 5,872 | 4,454 | 5,557 | 5,289 | ||||||||||||||||||
Income from continuing operations before
discontinued operations and cumulative effect of changes in
accounting principle
|
4,236 | 2,786 | 3,475 | 3,488 | 3,394 | ||||||||||||||||||
Income (loss) from discontinued operations, net
of tax
|
(118 | ) | (339 | ) | (867 | ) | 101 | 1,364 | |||||||||||||||
Income before cumulative effect of changes in
accounting principle
|
4,118 | 2,447 | 2,608 | 3,589 | 4,758 | ||||||||||||||||||
Cumulative effect of changes in accounting
principle, net of tax
|
| | (1,285 | ) | 315 | | |||||||||||||||||
Net income
|
4,118 | 2,447 | 1,323 | 3,904 | 4,758 | ||||||||||||||||||
Operating income margin
|
28.3% | 27.7% | 22.0% | 27.3% | 26.1% | ||||||||||||||||||
Diluted earnings per share of common stock:
|
|||||||||||||||||||||||
Income before discontinued operations and
cumulative effect of changes in accounting principle
|
$ | 2.24 | $ | 1.48 | $ | 1.85 | $ | 1.88 | $ | 1.85 | |||||||||||||
Income before cumulative effect of changes in
accounting principle
|
$ | 2.18 | $ | 1.30 | $ | 1.39 | $ | 1.94 | $ | 2.59 | |||||||||||||
Net income
|
$ | 2.18 | $ | 1.30 | $ | 0.71 | $ | 2.11 | $ | 2.59 | |||||||||||||
Other Financial Data:
|
|||||||||||||||||||||||
Diluted weighted-average shares of common
stock
outstanding (millions) |
1,893 | 1,888 | 1,876 | 1,852 | 1,836 | ||||||||||||||||||
Dividends declared per share of common stock
|
$ | 0.76 | $ | 0.76 | $ | 0.79 | $ | 0.92 | $ | 1.06 | |||||||||||||
Total assets
|
$ | 50,925 | $ | 52,046 | $ | 49,479 | $ | 49,702 | $ | 59,496 | |||||||||||||
Long-term debt
|
12,463 | 15,014 | 12,283 | 11,489 | 15,108 | ||||||||||||||||||
Shareholders equity
|
16,993 | 18,758 | 17,906 | 19,712 | 23,066 | ||||||||||||||||||
Construction and capital expenditures
|
$ | 6,169 | $ | 5,495 | $ | 3,536 | $ | 2,926 | $ | 3,193 | ||||||||||||
Book value per common share
|
$ | 9.08 | $ | 9.99 | $ | 9.63 | $ | 10.77 | $ | 12.60 | ||||||||||||
Ratio of earnings to fixed charges
|
5.36 | 3.98 | 5.03 | 5.68 | 6.00 | |||||||||||||||||
Debt ratio
|
54.0 | 51.7 | 49.2 | 43.1 | 47.1 | |||||||||||||||||
Operating Data:
|
||||||||||||||||||||||
Access lines in service (in thousands)
|
24,546 | 23,824 | 23,005 | 22,263 | 21,356 | |||||||||||||||||
Retail long distance customers (in thousands)
|
| | 1,002 | 3,960 | 6,130 | |||||||||||||||||
DSL customers (in thousands)
|
215 | 621 | 1,021 | 1,462 | 2,096 | |||||||||||||||||
Cingular Wireless customers (in thousands)
|
18,555 | 21,596 | 21,925 | 24,027 | 49,109 | |||||||||||||||||
Number of employees
|
103,916 | 87,875 | 77,020 | 75,743 | 62,564 | |||||||||||||||||
See Managements Discussion and Analysis of Financial Condition and Results of Operations Consolidated Results of Operations for a discussion of unusual items affecting the results for 2002, 2003 and 2004.
BELLSOUTH CORPORATION
Overview
We are a Fortune 100 company with annual revenues of over $20 billion. Our core business is wireline communications and our largest customer segment is the retail consumer. We have interests in wireless communications through our ownership of approximately 40% of Cingular Wireless (Cingular), the nations largest wireless company based on number of customers. We also operate one of the largest directory advertising businesses in the United States. The great majority of our revenues are generated based on monthly recurring services.
INDUSTRY DYNAMICS
The communications industry has experienced a very difficult period of contraction brought on by over-investment in the late 1990s that created significant excess capacity with many companies competing for the same business. Demand in the traditional voice business has been negatively impacted by the proliferation of wireless services led by one-rate pricing plans that include a large bucket of minutes and free roaming and long-distance, the popularity of e-mail and instant messaging, technological advances such as cable and DSL, that obviate the need for additional telephone lines, and stagnant job growth. After a period of significant growth in the 1990s, access lines, a key driver of our business, have declined steadily since 2001.
REGULATION AND COMPETITION
Our wireless and wireline business are subject to vigorous competition. In addition, both are subject to regulation.
ACQUISITIONS AND DISPOSITIONS
On October 26, 2004, Cingular completed its previously announced acquisition of AT&T Wireless. With the close of the transaction, Cingular management moved immediately to begin integrating the two companies. Key focus areas included customer communications, immediate training for all sales and service personnel, relaunch of the Cingular brand, transitioning to a common order system, and beginning the work that over time will integrate support systems and network functions. This acquisition will substantially increase BellSouths participation in the domestic wireless industry.
BELLSOUTH CORPORATION
January 2005, we closed on the sale of the remaining properties in Argentina and Chile.
HIGHLIGHTS AND OUTLOOK
Consolidated revenues for 2004 were down slightly compared to 2003 reflecting top line pressures caused by the loss of 1.2 million retail access lines to UNE-P competitors and technology substitution, primarily wireless. Revenue contraction due to line loss and pricing pressures was substantially offset by revenue growth from long distance and DSL services. During 2004 we added approximately 2.2 million long distance customers to total 6.1 million at December 31, 2004, while net new DSL subscriber additions of 634 thousand brought our total to 2.1 million. We anticipate a continuation of these trends in 2005.
Consolidated Results of Operations
Key financial and operating data for the three years ended December 31, 2002, 2003 and 2004 are set forth below. All references to earnings per share are on a diluted basis. The following consolidated Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with results by segment directly following this section.
Following generally accepted accounting principles (GAAP), our financial statements reflect results for the Latin American operations as Discontinued Operations. The operational results and other activity associated with the Latin American segment have been presented on one line item in the income statement separate from Continuing Operations.
Percent Change | ||||||||||||||||||||||
2003 vs. | 2004 vs. | |||||||||||||||||||||
2002 | 2003 | 2004 | 2002 | 2003 | ||||||||||||||||||
Results of operations: | ||||||||||||||||||||||
Operating revenues
|
$ | 20,207 | $ | 20,341 | $ | 20,300 | 0.7 | (0.2 | ) | |||||||||||||
Operating expenses
|
||||||||||||||||||||||
Cost of services and products
|
6,670 | 6,991 | 7,520 | 4.8 | 7.6 | |||||||||||||||||
Selling, general, and administrative expenses
|
3,891 | 3,777 | 3,816 | (2.9 | ) | 1.0 | ||||||||||||||||
Depreciation and amortization
|
4,202 | 3,811 | 3,636 | (9.3 | ) | (4.6 | ) | |||||||||||||||
Provision for restructuring and asset impairments
|
990 | 205 | 39 | (79.3 | ) | (81.0 | ) | |||||||||||||||
Total operating expenses
|
15,753 | 14,784 | 15,011 | (6.2 | ) | 1.5 | ||||||||||||||||
Operating income
|
4,454 | 5,557 | 5,289 | 24.8 | (4.8 | ) | ||||||||||||||||
Interest expense
|
1,066 | 947 | 916 | (11.2 | ) | (3.3 | ) | |||||||||||||||
Net (losses) earnings of equity affiliates
|
542 | 452 | 68 | (16.6 | ) | (85.0 | ) | |||||||||||||||
Gain on sale of operations
|
1,335 | | 462 | * | * | |||||||||||||||||
Other income (expense), net
|
102 | 362 | 283 | 254.9 | (21.8 | ) | ||||||||||||||||
Income from continuing operations before income
taxes, discontinued operations and cumulative effect of changes
in accounting principle, net of tax
|
5,367 | 5,424 | 5,186 | 1.1 | (4.4 | ) | ||||||||||||||||
Provision for income taxes
|
1,892 | 1,936 | 1,792 | 2.3 | (7.4 | ) | ||||||||||||||||
Income from continuing operations before
discontinued operations and cumulative effect of changes in
accounting principle
|
3,475 | 3,488 | 3,394 | 0.4 | (2.7 | ) | ||||||||||||||||
Income (loss) from discontinued operations, net
of tax
|
(867 | ) | 101 | 1,364 | 111.6 | * | ||||||||||||||||
Income before cumulative effect of changes in
accounting principle
|
2,608 | 3,589 | 4,758 | 37.6 | 32.6 | |||||||||||||||||
Cumulative effect of changes in accounting
principle, net of tax
|
(1,285 | ) | 315 | | 124.5 | * | ||||||||||||||||
Net income
|
$ | 1,323 | $ | 3,904 | 4,758 | 195.1 | 21.9 |
Summary results of discontinued operations: | ||||||||||||||||||||
Operating revenues
|
2,233 | 2,294 | 2,459 | 2.7 | 7.2 | |||||||||||||||
Operating Income
|
292 | 349 | 647 | 19.5 | 85.4 | |||||||||||||||
Income (loss) from discontinued operations
|
(867 | ) | 101 | 1,364 | 111.6 | * |
* Not meaningful
2004 compared to 2003
OPERATING REVENUES
Consolidated revenues declined $41 in 2004 as compared to 2003. Communications group revenues decreased $16 compared to 2003 reflecting the impact of revenue declines associated with competitive line losses and related pricing pressures substantially offset by growth in DSL and long distance products. Revenues from DSL and long distance combined increased $893 in 2004 compared to 2003. In addition, 2004 was negatively affected by a $50 customer refund accrual associated with a settlement agreement with the South Carolina Consumer Advocate. A decline in revenue for the exit of the payphone business was offset by higher revenues from the sale of wholesale long distance. Advertising & Publishing group revenues were down $28 in 2004 compared to 2003 because of a reduction in print revenues due to lower overall spending by our advertisers. Revenue trends are discussed in more detail in the Communications group and Advertising & Publishing group segment results sections.
BELLSOUTH CORPORATION
OPERATING EXPENSES
Total operating expenses increased $227 in 2004 as compared to the prior year. The most significant expense change driver was increased labor costs of $464, which includes incremental overtime related to service restoration and network repairs due to the four major hurricanes that hit during the third quarter of 2004, higher expense associated with pension and postretirement benefit plans (pension and retiree medical costs) driven by changes associated with the recent contract agreement with the CWA. The most significant changes were the change in the calculation of the obligation for non-management retiree medical costs as if there were no caps and lower contractual limits on life insurance coverage, increases in annual salary and wage rates, higher incentive compensation and adjustments to workers compensation and long-term disability accruals partially offset by lower average employees due to continued workforce reductions. In addition to higher labor costs, costs of goods sold increased $213 primarily for the provision of long distance services associated with the growth in subscribers and information technology expenses and contract services increased $63 in connection with more project-related spending.
INTEREST EXPENSE
For the Year Ended | |||||||||||||||
December 31, | |||||||||||||||
2003 | 2004 | Change | |||||||||||||
Interest expense debt
|
$ | 836 | $ | 864 | $ | 28 | |||||||||
Interest expense other
|
111 | 52 | (59 | ) | |||||||||||
Total interest
|
$ | 947 | $ | 916 | $ | (31 | ) | ||||||||
Average debt balances(1)
|
$ | 14,193 | $ | 15,458 | $ | 1,265 | |||||||||
Effective rate
|
5.9 | % | 5.6 | % | (30 | ) bps | |||||||||
(1) | Average debt balances exclude amounts related to discontinued operations. |
Interest expense decreased $31 in 2004 compared to 2003. Interest expense associated with interest-bearing debt was up $28 for 2004 compared to 2003 reflecting higher average debt balances impacted by higher incremental borrowings associated with our equity contributions to Cingular to fund its acquisition of AT&T Wireless. The lower effective interest rate is due to our interest rate swap program and refinancing higher-rate debt with lower-rate debt, offset partially by an increase in commercial paper rates. The change in interest expense-other relates primarily to the reversal of interest accruals related to tax contingencies based on audit settlements.
NET EARNINGS (LOSSES) OF EQUITY AFFILIATES
For the Year Ended | ||||||||||||||
December 31, | ||||||||||||||
2003 | 2004 | Change | ||||||||||||
Cingular
|
$ | 408 | $ | 24 | $ | (384 | ) | |||||||
Other equity investees
|
44 | 44 | | |||||||||||
Total
|
$ | 452 | $ | 68 | $ | (384 | ) | |||||||
Earnings from Cingular in the 2004 periods were lower compared to the same periods in 2003 primarily due to impacts of the AT&T Wireless acquisition, which included integration costs and higher depreciation expense associated with increased capital investments and a reduction in the useful life of TDMA assets.
GAIN (LOSS) ON SALE OF OPERATIONS
The gain on sale of operations in 2004 relates to the sale of our interest in Danish wireless provider, Sonofon, for 3.68 billion Danish Kroner to Telenor ASA. As a result of the sale, we recorded a gain of $462, or $295 net of tax, which included the recognition of cumulative foreign currency translation gains of $13.
OTHER INCOME (EXPENSE), NET
For the Year Ended | ||||||||||||||
December 31, | ||||||||||||||
2003 | 2004 | Change | ||||||||||||
Interest Income
|
$ | 316 | $ | 300 | $ | (16 | ) | |||||||
Foreign currency transaction gains (losses)
|
39 | (1 | ) | (40 | ) | |||||||||
Loss on early extinguishment of debt
|
(18 | ) | (14 | ) | 4 | |||||||||
Other, net
|
25 | (2 | ) | (27 | ) | |||||||||
Total Other Income (Expense), net
|
$ | 362 | $ | 283 | $ | (79 | ) | |||||||
PROVISION FOR INCOME TAXES
For the Year Ended | ||||||||||||||
December 31, | ||||||||||||||
2003 | 2004 | Change | ||||||||||||
Provision for income taxes
|
$ | 1,936 | $ | 1,792 | $ | (144 | ) | |||||||
Effective tax rate
|
35.7 | % | 34.6 | % | (110 | ) bps | ||||||||
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX
Income (loss) from discontinued operations, net of tax, increased $1,263 in 2004 compared to the same period in 2003 primarily due to the sale of eight of the ten Latin American properties, which resulted in a $850 gain, net of tax. Other net income increases include a $336 tax benefit related to excess tax basis over book basis in our Latin America investments, $177 for the cessation of depreciation beginning in the second quarter of 2004, a $234 loss on the sale of our interests in two Brazilian wireless companies in 2003, and higher revenues. Partially offsetting the increases to net income were the $190 charge related to the settlement of arbitration in Venezuela, foreign exchange gain decreases of $99, and a $33 loss in the second quarter of 2004 related to the purchase of additional ownership share in Argentina.
CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLE
Asset retirement obligations
Effective January 1, 2003, we adopted SFAS No. 143, Accounting for Asset Retirement Obligations (SFAS No. 143). In connection with the adoption of this standard, we recorded the cumulative effect of accounting change that increased 2003 net income by $816.
Revenue recognition for publishing revenues
Effective January 1, 2003, we changed our method for recognizing revenues and expenses related to our directory publishing business from the publication and delivery method to the deferral method. The cumulative effect of the change in accounting method is reflected in the income statement as a decrease to 2003 net income of $501.
2003 compared to 2002
OPERATING REVENUES
Consolidated revenues increased $134 in 2003 as compared to 2002. The increase in total operating revenues is attributable to revenue growth in long distance and DSL, which together generated nearly $800 in new revenue in 2003. Growth from these new products was substantially offset by lower voice revenues caused by the loss of 1.5 million retail access lines to UNE-P competitors and technology substitution. Voice revenues were also impacted by pricing strategies in our effort to remain competitive. Revenues from the sale of wholesale data transport services, including long distance and Competitive Local Exchange Carriers, declined 7.8% in 2003 primarily due to reductions in leased circuits by large inter-exchange carriers as they rationalized their capacity needs in relation to current demand. The exit from our payphone business and the elimination of certain products within the wholesale long distance portfolio also negatively impacted year-over-year comparisons.
OPERATING EXPENSES
Operating expenses declined by nearly $1 billion in 2003 driven by:
| $785 in lower charges related to restructuring and asset impairments as we rationalized our business in 2002; | |
| $391 of lower depreciation expense associated with the declines in capital expenditures and a change in accounting for plant retirements; | |
| $272 of improvements in uncollectibles expense due to a steadily improving economy, lower bankruptcy rates and operational improvements; | |
| $86 of lower cost of goods related to equipment sales in the Communications Group due to a change in the presentation for drop shipments from gross to net, which had no impact on operating margin, and paging and equipment costs decreased $53 driven by lower volumes; and | |
| $121 in lower labor related costs in the Communications Group due to a nearly 12% reduction in our workforce since the beginning of 2002 driven by weak demand and increased productivity. |
BELLSOUTH CORPORATION
These decreases were partially offset by:
| $379 of incremental expense associated with pension and postretirement benefits plans (pension and retiree medical costs) driven by rising health care costs, unfavorable returns on pension assets due to weak capital markets over the past few years, changes to plan assumptions regarding expected asset returns, and a lower discount rate used to calculate service and interest cost; | |
| $350 of customer acquisition costs related to competitive response in the Communications Group; and | |
| $108 of variable cost of goods for the provision of long distance service in the Communications Group. |
We have made adjustments to our business model to address changes in our economic, regulatory, and competitive environment, and as a result we have incurred charges in each of the years presented. The provision for restructuring and asset impairments of $205 in 2003 includes $153 of charges associated with workforce reductions (including $47 of pension settlement losses) and a $52 charge for an abandoned software project. The provision of $990 in 2002 includes $635 of charges associated with workforce reductions (including $167 of pension settlement losses) and a $221 charge for the impairment of MMDS spectrum license and charges of $134 associated with the elimination of certain services including wholesale long distance and e-business services.
INTEREST EXPENSE
For the Year Ended | |||||||||||||||
December 31, | |||||||||||||||
2002 | 2003 | Change | |||||||||||||
Interest expense debt
|
$ | 953 | $ | 836 | $ | (117 | ) | ||||||||
Interest expense other
|
113 | 111 | (2 | ) | |||||||||||
Total interest
|
$ | 1,066 | $ | 947 | $ | (119 | ) | ||||||||
Average debt balances(1)
|
$ | 16,525 | $ | 14,193 | $ | (2,332 | ) | ||||||||
Effective rate
|
5.8 | % | 5.9 | % | 10 bps | ||||||||||
(1) | Average debt balances exclude amounts related to discontinued operations. |
GAIN ON SALE OF OPERATIONS
The gain in 2002 of $1,335 related to the sale of our investment in E-Plus, a German wireless carrier.
NET EARNINGS (LOSSES) OF EQUITY AFFILIATES
For the Year Ended | ||||||||||||||
December 31, | ||||||||||||||
Equity in Earnings | 2002 | 2003 | Change | |||||||||||
Cingular
|
$ | 497 | $ | 408 | $ | (89 | ) | |||||||
Other equity investees
|
45 | 44 | (1 | ) | ||||||||||
Total
|
$ | 542 | $ | 452 | $ | (90 | ) | |||||||
Earnings from Cingular in 2003 declined compared to 2002 primarily due to significant growth in customers and the costs related to that growth and due to slightly lower average revenue per customer. See Managements Discussion and Analysis of Financial Condition and Results of Operations Results by Segment Domestic Wireless for further discussion of Cingular results.
OTHER INCOME (EXPENSE), NET
For the Year Ended | |||||||||||||||
December 31, | |||||||||||||||
Gain (loss) on sales and impairments of cost
method investments:
|
|||||||||||||||
Qwest
|
$ | (336 | ) | $ | | $ | 336 | ||||||||
Other
|
| (9) | (9 | ) | |||||||||||
Subtotal
|
(336 | ) | (9) | 327 | |||||||||||
Interest Income
|
460 | 316 | (144 | ) | |||||||||||
Loss on early extinguishment of debt
|
(40 | ) | (18) | 22 | |||||||||||
Foreign currency gain/loss
|
16 | 39 | 23 | ||||||||||||
Other
|
2 | 34 | 32 | ||||||||||||
Total Other Income (Expense), net
|
$ | 102 | $ | 362 | $ | 260 | |||||||||
PROVISION FOR INCOME TAXES
For the Year Ended | ||||||||||||||
December 31, | ||||||||||||||
2002 | 2003 | Change | ||||||||||||
Provision for income taxes
|
$ | 1,892 | $ | 1,936 | $ | 44 | ||||||||
Effective tax rate
|
35.3 | % | 35.7 | % | 40 bps | |||||||||
The effective tax rate increased slightly to 35.7% in 2003 from 35.3% in 2002, primarily driven by state income tax activity. A reconciliation of the statutory federal income
tax rate to the effective income tax rate for each period is included in Note J to our consolidated financial statements.
INCOME (LOSS) FROM DISCONTINUED OPERATIONS, NET OF TAX
Income (loss) from discontinued operations, net of tax, improved $968 in comparison to the prior year principally driven by foreign currency transaction activity and a $263 after-tax loss recorded in 2002 related to the recognition of other-than-temporary impairments related to our Brazilian wireless affiliate. Currency gains were recorded in 2003 for the improvement in the Argentine Peso and the Chilean Peso. For 2002, the devaluation of the Argentine Peso resulted in losses of $584. During 2003, we recognized a loss of $234 on the sale of our interests in two Brazilian wireless companies. During 2002, we recognized a loss of $51 on the sale of Listel, our Brazilian advertising and publishing company. Additionally, Latin America experienced a nearly 3% growth in revenue in 2003 driven by the addition of over 1.5 million net customers and steady average revenue per customer. Operating expenses remained flat.
Results by Segment
Our reportable segments reflect strategic business units that offer similar products and services and/or serve similar customers. We have three reportable operating segments:
| Communications Group; | |
| Domestic Wireless; and | |
| Advertising & Publishing Group. |
Management evaluates the performance of each business unit based on net income, exclusive of internal charges for use of intellectual property and adjustments for unusual items that may arise. Unusual items are transactions or events that are included in reported consolidated results but are excluded from segment results due to their nonrecurring or nonoperational nature. In addition, when changes in our business affect the comparability of current versus historical results, we adjust historical operating information to reflect the current business structure. See Note P to our consolidated financial statements for a reconciliation of segment results to the consolidated financial information.
BELLSOUTH CORPORATION
The Communications Group includes our core domestic businesses including: all domestic wireline voice, data, broadband, e-commerce, long distance, Internet services and advanced voice features. The group provides these services to an array of customers, including residential, business and wholesale.
During 2003 and 2004, the Communications Group emphasized interLATA long distance and BellSouth® FastAccess® DSL, encouraging customers to purchase packages containing multiple communications services. We continue to experience retail access line market share loss due to competition and technology substitution, and we expect these trends to continue into 2005.
Percent Change | ||||||||||||||||||||||||
2003 vs. | 2004 vs. | |||||||||||||||||||||||
2002 | 2003 | 2004 | 2002 | 2003 | ||||||||||||||||||||
Segment operating revenues:
|
||||||||||||||||||||||||
Voice
|
$ | 12,559 | $ | 12,702 | $ | 12,609 | 1.1 | (0.7 | ) | |||||||||||||||
Data
|
4,269 | 4,353 | 4,518 | 2.0 | 3.8 | |||||||||||||||||||
Other
|
1,661 | 1,393 | 1,325 | (16.1 | ) | (4.9 | ) | |||||||||||||||||
Total segment operating revenues
|
18,489 | 18,448 | 18,452 | (0.2 | ) | 0.0 | ||||||||||||||||||
Segment operating expenses:
|
||||||||||||||||||||||||
Cost of services and products
|
6,464 | 6,755 | 7,108 | 4.5 | 5.2 | |||||||||||||||||||
Selling, general, and administrative expenses
|
2,948 | 3,079 | 3,123 | 4.4 | 1.4 | |||||||||||||||||||
Depreciation and amortization
|
4,161 | 3,771 | 3,593 | (9.4 | ) | (4.7 | ) | |||||||||||||||||
Total segment operating expenses
|
13,573 | 13,605 | 13,824 | 0.2 | 1.6 | |||||||||||||||||||
Segment operating income
|
4,916 | 4,843 | 4,628 | (1.5 | ) | (4.4 | ) | |||||||||||||||||
Segment net income
|
$ | 2,751 | $ | 2,829 | $ | 2,727 | 2.8 | (3.6 | ) | |||||||||||||||
Segment net income including unusual items
|
$ | 2,237 | $ | 3,505 | $ | 2,567 | 56.7 | (26.8 | ) | |||||||||||||||
Key Indicators:(000s except where
noted)
|
||||||||||||||||||||||||
Switched Access lines:
|
||||||||||||||||||||||||
Residence retail:
|
||||||||||||||||||||||||
Primary
|
13,242 | 12,466 | 11,771 | (5.9 | ) | (5.6 | ) | |||||||||||||||||
Additional
|
1,926 | 1,601 | 1,346 | (16.9 | ) | (15.9 | ) | |||||||||||||||||
Total Retail Residence
|
15,168 | 14,067 | 13,117 | (7.3 | ) | (6.8 | ) | |||||||||||||||||
Residential wholesale:
|
||||||||||||||||||||||||
Resale
|
342 | 177 | 116 | (48.2 | ) | (34.5 | ) | |||||||||||||||||
UNE-P
|
934 | 1,696 | 1,972 | 81.6 | 16.3 | |||||||||||||||||||
Total Wholesale Residence
|
1,276 | 1,873 | 2,088 | 46.8 | 11.5 | |||||||||||||||||||
Total residence
|
16,444 | 15,940 | 15,205 | (3.1 | ) | (4.6 | ) | |||||||||||||||||
Business retail
|
5,687 | 5,417 | 5,245 | (4.7 | ) | (3.2 | ) | |||||||||||||||||
Business wholesale:
|
||||||||||||||||||||||||
Resale
|
85 | 73 | 58 | (14.1 | ) | (20.5 | ) | |||||||||||||||||
UNE-P
|
607 | 686 | 750 | 13.0 | 9.3 | |||||||||||||||||||
Total wholesale business
|
692 | 759 | 808 | 9.7 | 6.5 | |||||||||||||||||||
Total business
|
6,379 | 6,176 | 6,053 | (3.2 | ) | (2.0 | ) | |||||||||||||||||
Other retail/wholesale lines (primarily public)
|
182 | 147 | 98 | (19.2 | ) | (33.3 | ) | |||||||||||||||||
Total switched access lines
|
23,005 | 22,263 | 21,356 | (3.2 | ) | (4.1 | ) | |||||||||||||||||
ISDN line equivalents
|
||||||||||||||||||||||||
Residence
|
18 | 13 | 9 | (27.8 | ) | (30.8 | ) | |||||||||||||||||
Business
|
1,580 | 1,453 | 1,459 | (8.0 | ) | 0.4 | ||||||||||||||||||
Total ISDN Adjusted Access Lines in Service
|
24,603 | 23,729 | 22,824 | (3.6 | ) | (3.8 | ) | |||||||||||||||||
DSL customers (retail and wholesale)
|
1,021 | 1,462 | 2,096 | 43.2 | 43.4 | |||||||||||||||||||
Retail long distance customers
|
1,002 | 3,960 | 6,130 | 295.2 | 54.8 | |||||||||||||||||||
Switched access and local minutes of use
(millions)
|
96,755 | 82,101 | 70,061 | (15.1 | ) | (14.7 | ) | |||||||||||||||||
Retail long distance minutes of use
|
1,816 | 10,039 | 21,109 | * | 110.3 | |||||||||||||||||||
Total access minutes of use (millions)
|
98,571 | 92,141 | 91,170 | (6.5 | ) | (1.1 | ) | |||||||||||||||||
Capital expenditures
|
$ | 3,337 | $ | 2,824 | $ | 3,018 | (15.4 | ) | 6.9 | |||||||||||||||
* | Not meaningful |
2004 compared to 2003
SEGMENT OPERATING REVENUES
Voice
Voice revenues decreased $93 during 2004 compared to 2003 driven primarily by continued access line loss offset by the growth in interLATA long distance. Total switched access lines declined 907,000, or 4.1%, for the period with retail line losses being slightly offset by increases in wholesale lines. The access line decline was the result of continued share loss and technology substitution, primarily wireless.
Data
Data revenues increased $165 in 2004 when compared to 2003. Data revenues were driven by strong growth from the sale of BellSouth® FastAccess® DSL service partially offset by decreases in revenue from other data products. Combined wholesale and retail DSL revenues were up $241 in 2004 when compared to 2003 due primarily to a larger customer base. As of December 31, 2004, we had almost 2.1 million DSL customers, an increase of 634 thousand customers compared to December 31, 2003.
BELLSOUTH CORPORATION
designed to increase long-term market penetration. Retail FastAccess customer additions were offset somewhat by wholesale DSL disconnects as we continue to see a shift in customer mix to retail. Revenue from other retail data products was flat for 2004 when compared to 2003.
Other
Other revenues decreased $68 in 2004 when compared to 2003. This decrease reflects decreases in revenues from the payphone business of $77 and billing and late payment fees of $29, partially offset by increases in equipment revenues of $33 and increases in wholesale long distance revenues of $12. Increases in equipment revenues reflect increased demand due to improved economic conditions and customer upgrades to newer technology.
SEGMENT OPERATING EXPENSES
Cost of services and products
Cost of services and products of $7,108 in 2004 increased $353 from 2003. The cost of services increase was impacted by: increases of $213 in costs of goods sold principally driven by increases in the provision of long distance service volumes; increases of $104 in labor costs impacted by pay increases driven by union contract raises and higher costs from retiree and medical benefits slightly offset by lower average workforce; increases of $39 in contract services related to network planning projects and equipment installations; and increases in materials and supplies of $39 associated with increased utilities usage, partially offset by decreases of $95 in access fees due to volume declines, settlements and significant reductions in charges associated with access to other carriers customer name databases; and by decreases in rent of $22 related to real estate consolidation.
Selling, general, and administrative expenses
Selling, general, and administrative expenses of $3,123 in 2004 increased $44 from 2003. The selling, general, and administrative expense reflected represents an increase of $133 in labor costs driven by higher costs from retiree and medical benefits, incentive awards, reduced use of contractors and pay increases partially offset by lower headcount. Also included in the labor increase was a $38 increase in an annual adjustment to the workers compensation and long-term disability accruals. In addition to labor increases, information technology costs increased $24 during 2004 compared to 2003.
Depreciation and amortization
Depreciation and amortization expense decreased $178 during 2004 when compared to 2003. The primary driver of the decline in depreciation expense relates to lower depreciation rates under the group life method of depreciation. The lower depreciation rates were precipitated primarily by the reductions in capital expenditures over the past several years. Amortization expense increased due to higher levels of capitalized software.
UNUSUAL ITEMS EXCLUDED FROM SEGMENT NET INCOME
Unusual items that were excluded from this segments net income consisted of the following: for 2004, unusual items of $(160) for the South Carolina regulatory settlement, lease termination fees, severance and hurricane-related costs; for 2003, unusual items of $676 for the cumulative effect of change in accounting principle related to the adoption of FAS 143 offset by restructuring charges, costs associated with the early extinguishment of debt, and an asset impairment.
2003 compared to 2002
SEGMENT OPERATING REVENUES
Voice
Voice revenues increased $143 driven by significant growth in interLATA long distance substantially offset by continued access line share loss and conversion to wholesale lines. Total switched access lines declined 3.6% with retail line losses being partially offset by increases in wholesale lines. The access line decline was the result of share loss, technology substitution and a continued weak economy.
in the nine southeastern states we serve. At December 31, 2003, we had nearly 4 million long distance customers, a penetration rate of 28% of primary residential access lines and 39% of mass-market small business accounts. Earlier in 2003, we began offering unlimited long distance to reduce competitive churn and increase retention and reacquisition of residential customers. We recorded $71 in complex long distance revenue in 2003 compared to $3 in 2002. Revenue from wholesale long-distance services provided to Cingular increased $47 in 2003. This increase was caused by higher volumes associated with the proliferation of wireless long distance plans.
Data
Data revenues increased $84 in 2003. The overall growth was driven by revenues from the sale of BellSouth® FastAccess® DSL service. Combined wholesale and retail DSL revenues were up $248 in 2003 due to a larger customer base. As of December 31, 2003, we had over 1.46 million DSL customers, an increase of 441,000 customers compared to December 31, 2002.
Other
Other communications revenue decreased $268 primarily due to a decline of $123 in sales to second and third tier long distance carriers due to our decision to eliminate certain products within the wholesale long distance portfolio and due to the continuing phase-out of our payphone business which created a decline of $59. We completed our exit of the payphone business as of December 31, 2003. Other revenues decreased $86 due to a change in the presentation for drop shipments of equipment from gross to net, which lowered both revenues and expenses.
SEGMENT OPERATING EXPENSES
Cost of services and products
Cost of services and products increased $291 compared to the same periods in 2002. The increase reflects higher pension and retiree medical costs of $315. Costs of service associated with providing retail interLATA long distance increased $183 driven by higher volumes related to more customers while costs associated with the provision of long distance services to Cingular increased $34 driven by higher volumes. In addition, installation and activation expense increased $239 as compared to the prior period reflecting lower expense deferrals related to lower installation and activation service revenue.
Selling, general, and administrative expenses
Selling, general, and administrative expenses increased $131 in 2003 compared to 2002. The periods presented were impacted by increases in advertising of $111 associated with higher spending related to a more competitive environment and increases in outside sales commissions of $55 primarily related to the long distance launch. The periods presented were also impacted by increased pension and retiree medical costs of $33.
BELLSOUTH CORPORATION
Depreciation and amortization
Depreciation and amortization expense decreased $390. The primary driver of the year-over-year decline in depreciation expense relates to lower depreciation rates under the group life method of depreciation. The lower rates were caused primarily by the significant reductions in capital expenditures over the past several years. In addition, depreciation expense was lower due to the adoption of SFAS No. 143. In connection with the adoption of this standard, we no longer accrue for net cost of removal in our depreciation rates causing lower depreciation expense. Amortization expense increased slightly due to higher levels of capitalized software.
UNUSUAL ITEMS EXCLUDED FROM SEGMENT NET INCOME
Unusual items which were excluded from this segments results consisted of the following: in 2003, $676 for the cumulative effect of a change in accounting principle related to the adoption of FAS 143 offset by restructuring charges, costs associated with the early extinguishment of debt, and an asset impairment; in 2002, $(514) related to restructuring costs, including pension settlements, costs associated with the early extinguishment of debt, costs associated with service curtailments and asset impairments and refund of customer late fees in Florida.
Domestic Wireless
We own an approximate 40% economic interest in Cingular, a joint venture with SBC. Because we exercise influence over the financial and operating policies of Cingular, we use the equity method of accounting for this investment. Under the equity method of accounting, we record our proportionate share of Cingulars earnings in our consolidated statements of income. These earnings are included in the caption Net earnings (losses) of equity affiliates. For management purposes, we evaluate our Domestic Wireless segment based on our proportionate share of Cingulars results. Accordingly, results for our Domestic Wireless segment reflect the proportional consolidation of approximately 40% of Cingulars financial results.
Percent Change | ||||||||||||||||||||||||
2003 vs. | 2004 vs. | |||||||||||||||||||||||
2002 | 2003 | 2004 | 2002 | 2003 | ||||||||||||||||||||
Segment operating revenues:
|
||||||||||||||||||||||||
Service revenues
|
$ | 5,569 | $ | 5,689 | $ | 6,989 | 2.2 | 22.9 | ||||||||||||||||
Equipment revenues
|
392 | 504 | 785 | 28.6 | 55.8 | |||||||||||||||||||
Total segment operating revenues
|
5,961 | 6,193 | 7,774 | 3.9 | 25.5 | |||||||||||||||||||
Segment operating expenses:
|
||||||||||||||||||||||||
Cost of services and products
|
1,965 | 2,273 | 2,980 | 15.7 | 31.1 | |||||||||||||||||||
Selling, general, and administrative expenses
|
2,170 | 2,170 | 2,826 | 0.0 | 30.2 | |||||||||||||||||||
Depreciation and amortization
|
740 | 835 | 1,232 | 12.8 | 47.5 | |||||||||||||||||||
Total segment operating expenses
|
4,875 | 5,278 | 7,038 | 8.3 | 33.3 | |||||||||||||||||||
Segment operating income
|
1,086 | 915 | 736 | (15.7 | ) | (19.6 | ) | |||||||||||||||||
Segment net income
|
$ | 357 | $ | 261 | $ | 129 | (26.9 | ) | (50.6 | ) | ||||||||||||||
Segment net income including unusual items
|
$ | 301 | $ | 261 | 20 | (13.3 | ) | (92.3 | ) | |||||||||||||||
Key Indicators (100% Cingular):
|
||||||||||||||||||||||||
Cellular/PCS Customers (000s)
|
21,925 | 24,027 | 49,109 | 9.6 | 104.4 | |||||||||||||||||||
Wireless average monthly revenue per
user
Cellular/PCS (whole dollars)(a) |
$ | 52 | $ | 51 | $ | 49 | (1.9 | ) | (3.9 | ) | ||||||||||||||
Capital Expenditures
|
$ | 3,085 | $ | 2,734 | $ | 3,449 | (11.4 | ) | 26.2 | |||||||||||||||
(a) | Management uses average revenue per user (ARPU) as an indicator of operating performance of the business. Wireless ARPU Cellular/PCS is defined as Cellular/PCS service revenues during the period divided by average Cellular/PCS subscribers during the period. This metric is used to compare the recurring revenue amounts being generated on Cingulars network to prior periods and internal targets. We believe that this metric provides useful information concerning the performance of Cingulars initiatives to attract and retain high value customers and the use of its network. |
2004 compared to 2003
SEGMENT OPERATING REVENUES
Cingular had 49.1 million cellular/PCS customers at December 31, 2004, representing growth of 25.1 million in its cellular/PCS customer base from a year ago. This growth was primarily due to a 21.7 million cellular/ PCS customer base increase, related to Cingulars acquisition of AT&T Wireless in October 2004. Additionally, for 2004, Cingulars cellular/ PCS customer net additions were 3.4 million, up from 2.1 million a year ago, with 1.7 million of the current years cellular/ PCS customer net additions occurring in the fourth quarter of the year. This fourth quarter increase represents the highest cellular/ PCS customer net additions total ever when compared with the combined historical results of Cingular and AT&T Wireless. The strong performance in cellular/ PCS customer net additions during the fourth quarter was driven by the re-launch of the Cingular brand, the offering of new common rate plans and the larger distribution network of the newly combined Cingular/ AT&T Wireless company subsequent to the acquisition. Also favorably impacting customer net additions throughout 2004 were the promotion and success of Cingulars new GSM service offerings and the continued promotion of its FamilyTalk® service offering and its Rollover® rate plans. Excluding the impact to the prepaid customer base due to the AT&T Wireless acquisition, the prepaid customer count was reduced from the prior year, in part due to the successful promotion of the postpaid FamilyTalk® plan, which competes for customers at a similar price point but with enhanced services. The increase in reseller customer net additions compared with the prior year can be attributed to continued growth by Cingulars primary reseller.
Service revenues
Service revenue, comprised of local voice and data services, roaming, long distance and other revenue, increased $1,300 in 2004 compared to 2003. The local service component of total service revenue includes recurring monthly access charges, airtime usage, including prepaid service, and charges for optional features and services, such as voice mail, mobile-to-mobile calling, roadside assistance, caller ID, handset insurance and data services. It also includes billings to customers for the Universal Service Fund (USF) and other regulatory fees. The primary driver of the increase in local service revenue for 2004 was the inclusion of the former AT&T Wireless operating results as a result of Cingulars acquisition in late October 2004. Aside from this impact, increases in local service revenue are a function of the higher average customer base partially offset by the impact of a lower Average Revenue Per User (ARPU). Strong growth in data revenue, including the impact of the AT&T wireless acquisition, continues to favorably impact local service revenue driven primarily by increased data service penetration and usage of text messaging and other data services by cellular/PCS customers. Incollect and outcollect roaming revenues were essentially flat, when compared with the corresponding prior year. Roaming revenue continues to be unfavorably impacted by the bundling of free roaming minutes with all-inclusive regional and national rate plans and lower negotiated rates with Cingulars roaming partners. Prior to the acquisition, AT&T Wireless was Cingulars largest national roaming partner. Effective with the acquisition, Cingulars consolidated outcollect revenue reflects elimination of roaming revenue between the now combined Cingular and former AT&T Wireless properties along with a corresponding elimination of incollect roaming costs. Although net income neutral, this elimination will significantly reduce the new combined company outcollect revenue when compared to the combination of prior historical stand-alone results. The increase in long distance revenue compared with 2003 was primarily related to the incremental impact of the additional long distance revenue contributed as a result of the AT&T Wireless acquisition. Higher international long distance revenue in 2004 also contributed, to a lesser extent, to the overall increase compared with the prior year.
BELLSOUTH CORPORATION
Cellular/ PCS ARPU for 2004 was $49.30, a decrease of $2.02, or 3.9%, compared with $51.32 for 2003. Although the contribution of a higher ARPU for the AT&T Wireless customer base for the last 67 days of 2004 had a slightly positive impact on overall 2004 ARPU when compared with 2003, the main drivers of the changes in ARPU remained consistent with prior periods. Continued increases in ARPU related to higher customer usage and increased data revenue and regulatory fee revenue were more than offset by the impact of a larger embedded customer base of postpaid customers on lower ARPU FamilyTalk® rate plans and on all-inclusive rate plans that include more free minutes, thereby reducing overages and other chargeable airtime. Also exerting downward pressure on ARPU compared with the prior year is a change in the mix of the cellular/PCS customer base to include a higher percentage of lower ARPU reseller customers and decreases in roaming revenue, largely as a result of the acquisition of AT&T Wireless. Additionally, as former AT&T Wireless customers migrate to the popular Rollover rate plans, Cingular expects higher revenue deferrals related to unused rollover minutes to have an unfavorable impact on reported ARPU. This effect may be partially offset by the addition of higher ARPU AT&T Wireless subscribers to the customer base.
Equipment revenues
For 2004, equipment sales increased $281 in 2004 compared to 2003, primarily driven by overall higher handset sales including the impact of a significant increase in customer gross additions due to the acquisition of AT&T Wireless. Customer migrations to new Cingular rate plans as a result of the merger also favorably impacted handset upgrade revenue.
SEGMENT OPERATING EXPENSES
Cost of services and products
The cost of services and products increase of $707 for 2004 compared to 2003 was due to increases in local network system costs and in third party system costs (i.e., roaming and long distance costs). Over half of the increase in local network system costs can be attributed to the incremental costs related to the acquired AT&T Wireless network. Excluding this impact, the overall drivers of increased local network costs are primarily related to increased network system usage and associated network system expansion costs. Increased local network system costs in 2004 versus the prior year attributable to historical pre-merger Cingular activities included increased costs billed to its customers related to payments into the USF and certain other regulatory funds and higher costs related to its handset insurance program due to increased claims. For 2004, third party network system costs were lower as continued decreases in incollect roaming costs were partially offset by higher long distance costs. Lower incollect roaming costs were a result of lower negotiated roaming rates with Cingulars roaming partners, which more than offset increased volumes of roaming minutes. Also, as a result of the AT&T Wireless acquisition, Cingulars consolidated incollect expenses reflect elimination of intra-company incollect roaming costs between the now combined Cingular and former AT&T Wireless properties along with a corresponding elimination of outcollect revenue. Although net income neutral, this elimination will significantly reduce the new combined company incollect roaming expenses when compared to the combination of prior historical stand-alone results. The increase in long distance costs was primarily volume driven, impacted by the inclusion of free long distance in many of Cingulars regional and national rate plan offerings. In addition, approximately one-third of the increase in long distance costs versus 2003 was related to the incremental long distance expenses incurred as a result of the AT&T Wireless acquisition. For 2004, the cost of equipment sales increased, primarily driven by overall higher handset sales including the impact of a significant increase in customer gross additions and customer migration to Cingular rate plans due to the acquisition of AT&T Wireless.
Selling, general, and administrative expenses
Selling, general, and administrative expenses for 2004 increased $656 when compared with the prior year, primarily due to the incremental expense impact resulting from the addition of the AT&T Wireless selling, general, and administrative expenses during the fourth quarter of 2004. Selling, general, and administrative expenses in 2004 also included cost increases associated with increased customer gross additions and other customer service and support initiatives. Selling expenses, which include sales, marketing, advertising and commission expenses, increased for 2004 compared with the prior year primarily due to the addition of the incremental AT&T Wireless selling expenses during the fourth quarter of 2004. Higher sales, advertising and promotion costs and commissions expenses were also a function of the increased customer gross additions in 2004. Costs for maintaining and supporting the customer base also increased for 2004 compared with the prior year primarily due to the addition of the AT&T Wireless expenses in the fourth quarter. Costs for maintaining and supporting the customer base were also impacted by higher bad debt expense, customer service expenses to support on-going customer retention and other service improvement initiatives and higher commission expenses associated with handset upgrades. Bad debt expense increased primarily due to higher customer net write-offs as a result of prior relaxed credit policies in selected areas, which have been subsequently changed, as well as residual impacts related to the implementation of wireless local number portability in late 2003. Additionally, 2003 included a net recovery of prior MCI write-offs. Upgrade commission expenses were impacted by over one million customer migrations to new rate plans as a result of the merger.
Depreciation and amortization
Depreciation expense increased by $249 in 2004, compared to 2003, and included an incremental $130 related to assets acquired from AT&T Wireless. Other increases in depreciation expense were primarily due to on-going capital spending, including the GSM/ GPRS/ EDGE network overlay, in addition to increased depreciation on TDMA assets in 2004 as a result of a further review of estimated service lives. Amortization expense increased by $148 in 2004 compared to 2003, and included an incremental $166 in amortization expense as a result of the AT&T Wireless acquisition, primarily related to the amortization of the customer relationship intangible asset. This increase was partially offset by certain historical Cingular finite-lived intangible assets becoming fully amortized during 2004.
UNUSUAL ITEMS EXCLUDED FROM SEGMENT NET INCOME
Unusual items which were excluded from this segments results consisted of the following: in 2004, $(109) related to wireless merger integration costs, fair value adjustment and lease accounting adjustments; in 2003, no unusual items were excluded.
2003 compared to 2002
SEGMENT OPERATING REVENUES
Cellular/PCS customers increased 9.6% during 2003. Net cellular/PCS additions in 2003 increased 1.8 million compared to 2002. Improvement in customer additions was attributable to several business initiatives Cingular implemented earlier in 2003: (1) reorganization of Cingulars marketing, sales and operations activities from a national to a regional basis to more effectively address local market needs; (2) introduction of a more meaningful brand message; (3) increased emphasis on Cingulars affiliation with its parents and co-branding and more effectively utilizing the parents sales channels in those areas where Cingulars wireless markets overlap with the parents wireline markets; and (4) more effective marketing execution such as the Family Talk rate plan offer introduced in the third quarter of 2003. Prepaid subscriber growth was impacted positively in 2003 by the KIC (Keep in Contact) prepaid plan launched in the fourth quarter of 2002. The reseller subscriber base was higher due to aggressive growth by Cingulars primary reseller during 2003 and to a loss of 371,000 MCI reseller customers in 2002, principally when MCI made the decision to exit the wireless reseller business in the second half of 2002. The cellular/PCS churn rate was 2.7% in 2003 compared with a 2.8% churn rate in 2002.
Total segment operating revenues increased $232 during 2003. The growth in total operating revenues was a result of improved service revenues driven by a larger average cellular/PCS customer base, robust growth in data revenues and increased regulatory fee revenues. Strong customer growth and a significant increase in handset upgrade activity in 2003 also contributed to increased equipment revenues.
Service revenues increased $120 in 2003, driven by the 3.6% increase in the average subscriber base, a 14.4% increase in local minutes of use, and a $64 increase over prior year of revenues related to billings to Cingulars customers for the USF and other regulatory fees. Other increases were a result of an increase in data revenues from 2002, reflective of higher penetration and usage of SMS short messaging data services with cellular/PCS customers as well as increased revenue per customer related to the Mobitex data business. Partially offsetting these increases were a decrease in wireless Average Revenue Per User (ARPU), declines in roaming and long distance revenues reflecting the migration of customers to regional and national rate plans and a reduction in roaming rates with major roaming partners to support all-inclusive rate plans. Additionally, the increase was offset partially by the effects of Emerging Issues Task Force Issue No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables, adopted July 1, 2003. Implementation of EITF 00-21 resulted in a reclassification of certain direct channel activation revenues from service revenues to equipment revenues on a prospective basis only. As a result, service revenue growth was reduced by approximately $14 for the year.
BELLSOUTH CORPORATION
SEGMENT OPERATING EXPENSES
Cost of services and products
Cost of services and products primarily includes expenses to monitor, maintain and service Cingulars network, landline facilities expense, incollect roaming charges from other carriers, cost of equipment sales, and long distance expense. Cost of services and products increased $308 during 2003. The primary driver of the increase of cost of services was the increase in the cost of equipment sales of $198. This increase was driven primarily by higher unit sales associated with the large increase in gross customer additions and upgrade unit sales. Overall, the increased cost of equipment sales was also impacted by higher per unit handset costs for upgrade units driven by a shift to more advanced handsets, such as the dual mode TDMA/GSM handsets in use during Cingulars GSM system conversion and newly introduced feature-rich GSM-only handsets. Other increases in cost of services include increases in local system costs of $164, partially offset by decreases in third party system costs. Local systems costs continue to be driven by growth in system minutes of use, system expansion and the increased costs of redundant TDMA and GSM networks required during the current GSM system overlay. System minutes of use increased 19.1% in 2003. The increase in local system costs includes a $64 increase in costs related to payments into the USF and other regulatory funds. The primary contributor to lower third party system costs was a decrease in incollect roaming costs, which decreased $53 in 2003. These reductions were a result of lower negotiated roaming rates and cost reductions associated with the Mobile Telecommunications Sourcing Act.
Selling, general, and administrative expenses
Selling, general, and administrative expenses remained flat in 2003. Increases in Cingulars selling expenses were offset by decreases in costs related to maintaining and supporting its customer base and other administrative costs. Higher commissions and advertising expenses were partially offset by reduced employee-related costs as a result of the sales operation reorganization in 2002.
Depreciation and amortization
Depreciation and amortization increased $95 in 2003. The increase in depreciation expense of $106 was attributable to higher levels of gross property, plant and equipment plus accelerated depreciation on TDMA assets that began in 2003. Amortization expense declined $11 due to certain finite-lived intangibles becoming fully amortized during 2002.
UNUSUAL ITEMS EXCLUDED FROM SEGMENT NET INCOME
Unusual items which were excluded from this segments results consisted of the following: in 2003, no unusual items were excluded; in 2002, $(56) related to impairment losses.
Advertising & Publishing Group
Our Advertising & Publishing Group is comprised of companies in the US that publish, print, sell advertising in and perform related services concerning alphabetical and classified telephone directories and electronic product offerings. In November 2004, BellSouth and SBC created an online Internet yellow pages joint venture that acquired the online directory publisher www.yellowpages.com. This venture is expected to allow us to expand the national advertising base and expand traffic relationships.
In 2003 and early 2004, our Advertising & Publishing Group was negatively affected by weak economic conditions and competition. We expect an improving economy, combined with the execution of our business strategies, to result in moderate revenue growth in 2005.
Percent Change | |||||||||||||||||||||
2003 vs. | 2004 vs. | ||||||||||||||||||||
2002 | 2003 | 2004 | 2002 | 2003 | |||||||||||||||||
Segment operating revenues
|
|||||||||||||||||||||
Advertising & Publishing revenues
|
$ | 2,010 | $ | 1,906 | 1,878 | (5.2 | ) | (1.5 | ) | ||||||||||||
Commission revenues
|
147 | 144 | 141 | (2.0 | ) | (2.1 | ) | ||||||||||||||
Total segment operating revenues
|
2,157 | 2,050 | 2,019 | (5.0 | ) | (1.5 | ) | ||||||||||||||
Segment operating expenses:
|
|||||||||||||||||||||
Cost of services and products
|
351 | 345 | 353 | (1.7 | ) | 2.3 | |||||||||||||||
Selling, general, and administrative expenses
|
879 | 706 | 684 | (19.7 | ) | (3.1 | ) | ||||||||||||||
Depreciation and amortization
|
29 | 26 | 28 | (10.3 | ) | 7.7 | |||||||||||||||
Total segment operating expenses
|
1,259 | 1,077 | 1,065 | (14.5 | ) | (1.1 | ) | ||||||||||||||
Segment operating income
|
898 | 973 | 954 | 8.4 | (2.0 | ) | |||||||||||||||
Segment net income
|
$ | 545 | $ | 600 | 583 | 10.1 | (2.8 | ) | |||||||||||||
Segment net income including unusual items
|
$ | 428 | $ | 96 | 583 | (77.6 | ) | * | |||||||||||||
Capital Expenditures
|
$ | 29 | $ | 28 | 29 | (3.4 | ) | 3.6 | |||||||||||||
* | Not meaningful |
2004 compared to 2003
SEGMENT OPERATING REVENUES
Segment operating revenues decreased $31 in 2004 compared to 2003. The decreases include a reduction in print revenues, partially offset by an increase in electronic media revenues. Sales agency commission revenues declined $3 in 2004 compared to 2003.
SEGMENT OPERATING EXPENSES
Cost of services and products increased $8 in 2004 compared to 2003 driven by the impact of increased distribution. Selling, general, and administrative expenses decreased $22 in 2004 compared to 2003 driven primarily by a $49 decrease in uncollectible expense, the result of improved collection performance between periods. Variable costs associated with selling also decreased as a result of the reduction in revenues. Partially offsetting these decreases were increases in employee healthcare, pension and post-retirement medical costs, as well as increased spending for advertising in response to a more competitive environment. Depreciation and amortization expense increased $2 during 2004 reflecting an increase in capitalized software.
UNUSUAL ITEMS EXCLUDED FROM SEGMENT NET INCOME
Unusual items that were excluded from this segments net income consisted of the following: in 2004 there were no unusual items; in 2003, unusual items of $(504) included the cumulative effect of change in accounting principle and severance and pension costs.
2003 compared to 2002
SEGMENT OPERATING REVENUES
Segment operating revenues decreased $107 from 2002 to 2003. The decrease included a reduction in print revenues due to lower overall spending by our advertisers. The decline in print revenue was partially offset by an increase in revenues from electronic media offerings, resulting from increased penetration of the print customer base. Sales agency commission revenues decreased slightly as the result of a discontinued line of business.
BELLSOUTH CORPORATION
clined when compared to their 2002 issues attributable to the factors discussed previously. Approximately 50% of the decline was recognized in the segments 2003 income statement, with the remainder to be recognized in 2004.
SEGMENT OPERATING EXPENSES
Cost of services and products decreased $6 in 2003, primarily reflecting the impact of manufacturing cost reduction efforts. Selling, general, and administrative expenses decreased $173 in 2003. Uncollectible expense was the primary driver of the reductions, decreasing $141. The decrease reflects the impact of improved collection performance in 2003. In addition, variable costs associated with selling decreased as the result of the reduction in revenues. Depreciation and amortization expenses were relatively flat in 2003.
UNUSUAL ITEMS EXCLUDED FROM SEGMENT NET INCOME
Unusual items which were excluded from this segments results consisted of the following: in 2003, $(504) included the cumulative effect of a change in accounting principle and severance and pension costs; in 2002, $(117) related to an unbilled receivable adjustment, severance costs and employee benefits related to workforce reduction.
Liquidity and Financial Condition
DESCRIPTION OF CASH FLOWS
Percent Change | |||||||||||||||||||||
2003 vs. | 2004 vs. | ||||||||||||||||||||
Net cash provided by (used for): | 2002 | 2003 | 2004 | 2002 | 2003 | ||||||||||||||||
Continuing Operations
|
|||||||||||||||||||||
Operating activities
|
$ | 7,712 | $ | 7,883 | $ | 6,801 | 2.2 | (13.7 | ) | ||||||||||||
Investing activities
|
(1,912 | ) | (2,706 | ) | (13,560 | ) | * | * | |||||||||||||
Financing activities
|
(4,443 | ) | (4,679 | ) | 5,071 | (5.3 | ) | * | |||||||||||||
Discontinued Operations
|
72 | 428 | (579 | ) | * | * | |||||||||||||||
* | Not meaningful |
Continuing Operations
NET CASH PROVIDED BY OPERATING ACTIVITIES
Cash generated by operations decreased $1,082 in 2004 compared to the prior year due primarily to a $601 increase in income tax payments in 2004, a previously accrued payment of approximately $81 to MCI related to its bankruptcy settlement, a $77 payment associated with the ratification of our contract with CWA, $160 of cash expenses due to the hurricanes in 2004, and lower operating margins before depreciation and amortization in the Communications group. Operating income excluding depreciation and amortization in the Communications group decreased $393 in 2004 compared to the prior year. Partially offsetting these increased payments were decreases over prior year of $141 in other postretirement benefit funding and $45 in severance payments.
NET CASH USED FOR INVESTING ACTIVITIES
Capital expenditures
Capital expenditures consist primarily of (a) gross additions to property, plant and equipment having an estimated service life of one year or more, plus the incidental costs of preparing the asset for its intended use, and (b) gross additions to capitalized software.
Millions | % of Revenue | |||||||||
2000
|
$ | 6,169 | 26.5 | |||||||
2001
|
$ | 5,495 | 25.9 | |||||||
2002
|
$ | 3,536 | 17.5 | |||||||
2003
|
$ | 2,926 | 14.4 | |||||||
2004
|
$ | 3,193 | 15.7 | |||||||
are expected to remain relatively flat as a percent of revenue, we expect a slight shift in the mix of capital expenditures toward broadband and other next-generation technologies, such as fiber optics and DSL.
Other investing activities
During 2004, we contributed $14,410 to Cingular to fund its acquisition of AT&T Wireless. In addition, we loaned Cingular $666 under a revolving credit agreement to fund higher cash needs associated with the initial integration of AT&T Wireless. We received net proceeds of $3,020 in connection with the sale of eight of our Latin American operations. The sale of our investment in Sonofon resulted in proceeds of $634, including the repayment of a shareholder loan. Purchases and sales of short-term investments resulted in a cash inflow of $1,593. Purchases and sales of equity securities, primarily in our grantor trust, resulted in a net cash outlay of $492.
NET CASH USED FOR FINANCING ACTIVITIES
Net borrowings of short-term and long-term debt of $7,057 during 2004 increased $9,337 over 2003, primarily due to financing our share of the purchase price of Cingulars acquisition of AT&T Wireless. Cash used for the purchase of treasury shares declined $712 due to the expiration of the Companys stock repurchase program in December 2003. Dividend payments increased $293 as compared to 2003 due to an increase in the annual dividend rate to $1.04 per share from $.87 per share in 2003. In December 2004, we called $400 of debt, which was redeemed in January 2005.
Discontinued Operations
The following table includes cash flows from our discontinued operations:
2002 | 2003 | 2004 | ||||||||||||
Cash flows from operating activities
|
$ | 534 | $ | 646 | $ | 561 | ||||||||
Cash flows from investing activities
|
(256 | ) | (140 | ) | (997 | ) | ||||||||
Cash flows from financing activities
|
(206 | ) | (78 | ) | (143 | ) | ||||||||
Total cash flows from discontinued operations
|
$ | 72 | $ | 428 | $ | (579 | ) | |||||||
Operating Activity Cash flows from operations declined during 2004 impacted by working capital changes and to a lesser extent by foreign currency translation rate changes on cash balances. Cash flows from operations improved during 2003 reflecting improved margins compared to 2002 driven by growth in Ecuador, Colombia, and the currency recovery in Argentina.
BELLSOUTH CORPORATION
ANTICIPATED SOURCES AND USES OF FUNDS
General
The Communications group and Advertising & Publishing group generate substantially all of our consolidated cash provided by operating activities. These segments generate sufficient cash flow to fund their investing and financing activities. Should other investing opportunities arise, we believe we are well positioned to raise capital in the public debt markets.
Domestic wireless
The Domestic Wireless segment, which consists entirely of our equity investment in Cingular, historically has not relied on BellSouth for funding its operations and capital program but has relied upon the debt capital markets. Effective August 1, 2004, BellSouth and SBC have agreed to finance our respective pro rata shares of Cingulars capital and operating cash requirements based upon Cingulars budget and forecasted cash needs. Cingular also terminated its bank credit facilities and ceased issuing commercial paper and long-term debt. As of December 31, 2004, we had outstanding advances under the line of credit of $666 to fund cash needs associated with the initial integration of AT&T Wireless. During 2005, we expect Cingular to pay down this advance and to distribute additional cash to its parent companies.
Cash management
BellSouths primary source of cash flow is dividends from its subsidiaries. Generally, we do not permit our subsidiaries to accumulate cash, requiring them to pay out either net income or cash flow available in the form of dividends. Any funding requirements for wholly owned domestic subsidiaries are fulfilled by BellSouth Corporation.
Debt instruments
PUBLICLY HELD INDEBTEDNESS
BellSouth and BellSouth Telecommunications currently have debt outstanding under various indentures that we have entered into over the past twelve years. None of these indentures contain any financial covenants. They do contain limitations that restrict the Companys (or the affiliate of the company that is a party to the indenture) ability to create liens on their properties or assets (but not the properties or assets of their subsidiaries) except in specified circumstances. None of these indentures contains any provisions that are tied to the ratings assigned to the company or its affiliates by an external debt rating agency. Further, none of these indentures contains cross-default provisions.
to us or our affiliates by an external debt rating agency. At our election, any outstanding borrowings may be converted to a one-year term loan, in which case the debt of the Company and its consolidated subsidiaries is not permitted to exceed 300% of consolidated earnings before interest, taxes, depreciation and amortization for the preceding four quarters. In addition, the credit facilities prohibit the Company and its significant subsidiaries from permitting liens to be placed on their properties or assets except in specified circumstances. If BellSouth or any of our subsidiaries defaults on any outstanding debt in excess of $200, an event of default will occur under the line of credit.
DISCONTINUED OPERATIONS
As of December 31, 2004, BellSouth Enterprises, a subsidiary of BellSouth, had guaranteed our Chilean operations $180 syndicated loan facility. This guarantee was terminated in January 2005 when we sold our Chilean operations to Telefónica Móviles.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
OFF-BALANCE SHEET ARRANGEMENTS
In most of our sale and divestiture transactions we indemnify the purchaser for various items including labor and general litigation as well as certain tax matters. Generally, the terms last one to five years for general and specific indemnities and for the statutory review periods for tax matters. The events or circumstances that would require us to perform under the indemnity are transaction and circumstance specific. We regularly evaluate the probability of having to incur costs associated with these indemnifications and have accrued for expected losses that are probable. In addition, in the normal course of business, we indemnify counter parties in certain agreements. The nature and terms of these indemnities vary by transaction. Historically, we have not incurred significant costs related to performance under these types of indemnities.
We do not have transactions, arrangements or relationships with special purpose entities, and we do not have any off-balance sheet debt.
CONTRACTUAL OBLIGATIONS
The following table discloses aggregate information about our contractual obligations as of December 31, 2004 and the periods in which payments are due:
Payments Due by Period | |||||||||||||||
Less than | |||||||||||||||
Total | 1 year | 2006-2008 | 2009-2011 | After 2011 | |||||||||||
Debt maturing within 1 year
|
$ | 5,475 | $5,475 | $ | $ | $ | |||||||||
Long-term debt(1)
|
15,453 | | 2,872 | 3,877 | 8,704 | ||||||||||
Interest on long-term debt
|
21,365 | 943 | 2,626 | 2,085 | 15,711 | ||||||||||
Operating leases
|
691 | 136 | 256 | 99 | 200 | ||||||||||
Unconditional purchase obligations(2)
|
3,102 | 723 | 1,599 | 780 | | ||||||||||
Interest rate swaps(3)
|
(2 | ) | (8) | 2 | 4 | | |||||||||
Total contractual cash obligations
|
$ | 46,084 | $7,269 | $7,355 | $6,845 | $24,615 | |||||||||
(1) | The long-term debt amount above excludes $(77) of unamortized discounts and premiums included in long-term debt on the balance sheet as of December 31, 2004. Payments after the year 2011 include the final principal amount of $500 for the Zero-to-Full Debentures due in 2095, which have a carrying value of $232 as of December 31, 2004. | |
(2) | The total unconditional purchase obligation includes $472 related to agreements with Qwest and Accenture that do not stipulate annual minimum purchases. The agreement with Qwest expires in 2010 and the Accenture agreement expires in 2007. Of this amount, $6 is included in the 2006 - 2008 column and $466 is included in the 2009 - 2011 column. | |
(3) | The amounts due for the interest rate swaps and forward contracts are based on market valuations at December 31, 2004. Actual payments, if any, may differ at settlement date. |
Pensions and other retiree benef its
As of December 31, 2004, our defined benefit pension plans were fully funded. Therefore, we do not currently anticipate any cash funding needs to meet minimum required funding thresholds. Over the past three years, funding for other retiree benefits was $493 in 2002, $563 in 2003, and $422 in 2004. We currently expect funding in 2005 to be in the range of $450 to $500.
OTHER POTENTIAL OBLIGATIONS
Several issues of long-term debt included in the table above contain embedded options which may require us to
BELLSOUTH CORPORATION
repurchase the debt or which may alter the interest rate associated with that debt. Please refer to Note I to our consolidated financial statements for further information on these instruments. Those issues, their amounts and the date of the related options, are as follows:
Issue | Amount | Date of Put Option | ||||
20-put-1 Securities | $1,000 | Annually in April | ||||
Putable debentures
|
281 | November 2006 |
RELATED PARTY TRANSACTIONS
We own an approximate 40% interest in Cingular. See Note E to our consolidated financial statements for a description of our relationship with Cingular.
Quantitative and Qualitative Disclosure About Market Risk
DESCRIPTION OF RISK
We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes, changes in equity investment prices and foreign currency exchange rate fluctuations. To manage this exposure, we employ risk management strategies including the use of derivatives such as interest rate swap agreements, foreign currency forwards and currency swap agreements. We do not hold derivatives for trading purposes.
Interest rate risk
Our objective in managing interest rate risk is to maintain a balance of fixed and variable rate debt that will lower our overall borrowing costs within reasonable risk parameters. Interest rate swaps are used to convert a portion of our debt portfolio from a variable rate to a fixed rate or from a fixed rate to a variable rate.
Risk sensitivity
Our use of derivative financial instruments is designed to mitigate foreign currency and interest rate risks, although to some extent they expose us to credit risks. The credit risks associated with these instruments are controlled through the evaluation and continual monitoring of the creditworthiness of the counter parties. In the event that a counter party fails to meet the terms of a contract or agreement, our exposure is limited to the current value at that time of the currency rate or interest rate differential and not the full notional or contract amount. Such contracts and agreements have been executed with credit worthy financial institutions, and as such, we consider the risk of nonperformance to be remote.
The following table provides information, by maturity date, about our interest rate sensitive financial instruments, which consist of fixed and variable rate debt obligations and related interest rate derivatives. Fair values for the majority of our long-term debt obligations are based on quotes from dealers.
Expected Maturity Date | ||||||||||||||||||||||||||||||||||
Fair | ||||||||||||||||||||||||||||||||||
2005 | 2006 | 2007 | 2008 | 2009 | Thereafter | Total | Value | |||||||||||||||||||||||||||
Liabilities | ||||||||||||||||||||||||||||||||||
Long-term debt: | ||||||||||||||||||||||||||||||||||
Fixed Rate
|
$ | 1.867 | $ | 1,299 | $ | 19 | $ | 621 | $ | 1,872 | $ | 10,434 | $ | 16,112 | $ | 17,149 | ||||||||||||||||||
Average interest rate
|
3.1 | % | 5.2 | % | 6.3 | % | 5.7 | % | 4.5 | % | 6.4 | % | 5.7 | % | ||||||||||||||||||||
Variable Rate
|
$ | 335 | $ | 410 | $ | 500 | | | | $ | 1,245 | $ | 1,245 | |||||||||||||||||||||
Average interest rate
|
2.7 | % | 2.9 | % | 3.7 | % | 3.2 | % | ||||||||||||||||||||||||||
Interest Rate Derivatives
|
||||||||||||||||||||||||||||||||||
Interest Rate Swaps: | ||||||||||||||||||||||||||||||||||
Variable to Fixed
|
$ | 1,000 | $ | | $ | | $ | | $ | | $ | | $ | 1,000 | $ | (29 | ) | |||||||||||||||||
Average pay rate
|
5.9 | % | 5.9 | % | ||||||||||||||||||||||||||||||
Average receive rate
|
3.0 | % | 3.0 | % | ||||||||||||||||||||||||||||||
Fixed to Variable
|
| | | $ | 600 | $ | 800 | | $ | 1,400 | $ | 5 | ||||||||||||||||||||||
Average pay rate
|
5.5 | % | 4.8 | % | 5.1 | % | ||||||||||||||||||||||||||||
Average receive rate
|
5.8 | % | 4.8 | % | 5.2 | % | ||||||||||||||||||||||||||||
PROPORTIONAL DEBT
We own an approximate 40% interest in Cingular Wireless, and share joint control of the venture with SBC and, therefore, do not consolidate these operations. Our proportional debt, including our share of the face value of Cingulars non-affiliate debt and capitalized leases at December 31, 2004, is shown in the table below.
Consolidated debt
|
$ | 20,583 | ||||
Plus: 40% of Cingular debt
|
5,099 | |||||
Proportional debt
|
$ | 25,682 | ||||
Operating Environment
DOMESTIC ECONOMIC TRENDS
On average, the economy of our nine-state region tends to closely track the US economy. Real gross domestic product (GDP) grew at an average annual rate of 4.4 percent in 2004, compared with an increase of 3.0 percent in 2003. The improvement in the economy was marked by gains in personal consumption expenditures, residential construction, business investment in equipment and software, federal government spending, and exports. These gains were partly offset by an increase in imports. Nonagricultural employment increased 2.2 million during the year and the unemployment rate dipped to 5.4 percent in December from 5.7 percent a year earlier. The nations economic growth is expected to slow in 2005 to near 3.5 percent. Employment gains are expected to again exceed 2 million with the unemployment rate receding further to 5.2 percent in 2005.
WIRELINE REGULATORY ENVIRONMENT
The FCC regulates rates and other aspects of our provision of interstate telecommunications services, including international rates and interstate access charges. State regulatory commissions have jurisdiction over our provision of intrastate telecommunications services, including local and long distance rates and network access services. Access charges are designed to compensate our wireline subsidiaries for the use of their networks by other carriers. Our future operations and financial results will be substantially influenced by developments in a number of federal and state regulatory proceedings. Adverse results in these proceedings could materially affect our revenues, expenses and ability to compete effectively against other telecommunications carriers.
Regulatory Reform
Because traditional telecommunications providers such as BellSouth are subject to significantly more regulatory requirements than our competitors, we will encourage reform efforts before legislatures and regulatory agencies. As competition increases, our need for regulatory requirements whose burdens more nearly equal those of our competitors increases. We have encouraged both state and federal legislators and regulators to adopt reforms that prevent greater rate and service quality regulation of our services than is imposed on our competitors. In various dockets before the FCC, we have urged it to accord our broadband and Internet Protocol offerings a regulatory treatment more nearly like that it accords broadband offerings by the cable industry, and to forebear from old requirements, such as the Computer Inquiry requirements that require us to tariff and offer separately the telecommunications service portion of any information service we offer and that assume our telecommunications business is a monopoly.
Federal Regulatory Matters
The FCC regulates rates and other aspects of our provision of interstate telecommunications services. In addition, pursuant to the Telecommunications Act of 1996, the FCC has authority to establish policies for pricing and terms of interconnection between local exchange carriers and incumbent local exchange carriers, such as BellSouth. Prior to 1996, this activity had been mostly the exclusive jurisdiction of the state regulatory commissions. The states now set the rates and establish terms for interconnection within the policy framework ordered by the FCC. We expect the FCC to continue policies that promote local service competition.
FCC INTERCONNECTION, UNBUNDLING AND PRICING RULES
Under the 1996 Act, the FCC is required to consider the extent to which we must make elements of our network available to other providers of local service. The FCC can require access to proprietary network elements only when necessary. For non-proprietary network elements, the FCC can order access only when failure to do so will impair the ability of the requesting carrier to provide services. The elements provided under these requirements are known as unbundled network elements, or UNEs. The FCC also establishes the pricing policy for elements. The policy currently in effect is TELRIC (an acronym for Total Element Long-Run Incremental Cost), which assumes a hypothetical, lowest costs, most efficient network for purposes of establishing prices for elements. The states have set prices for elements under this policy since 1996. The FCCs unbundling and pricing requirements have caused us to provide service to competitors at deeply discounted artificial prices, often below actual costs.
BELLSOUTH CORPORATION
their validity, and the courts generally invalidated the unbundling requirements on each occasion.
PRICE REGULATION
The FCC regulates interstate prices using a price regulation plan, which limits aggregate price changes to the rate of inflation, minus a productivity offset, plus or minus other cost changes recognized by the FCC. The productivity factor can vary among services. Interstate prices have been decreasing over the last few years as a result of low inflation in the US economy.
ACCESS CHARGE REFORM
The FCC has favored access reform, through which the historical subsidy for residential local service contained in network access charges paid by long distance carriers is funded instead by the end-user, by universal service funds, or both. As a result of a May 2000 FCC order implementing access charge reform (referred to as the CALLS order), we have reduced the interstate network access charges paid by long distance carriers and increased interstate subscriber line charges paid by end-users. These rate changes better align our cost recovery with the way in which we incur costs.
examination could lead to permanent changes in the way carriers compensate one another and in the way carriers receive compensation from their end-user customer. In February, the FCC announced that it would consider seven policy models submitted by various commenters, each of which would significantly reform intercarrier compensation. We expect the FCC will also reconsider its methodology and rates for reciprocal compensation as part of this comprehensive intercarrier compensation reform. See Reciprocal Compensation below.
UNIVERSAL SERVICE
In 1998, the FCCs universal service order established funding mechanisms for high-cost and low-income service areas. Telecommunications companies are required to pay a specific percentage of their interstate and international revenues into the Universal Service Fund to support the four established programs. All long distance companies, local telephone companies, paging companies, payphone providers and wireless telephone companies must contribute to the Universal Service Fund. We began contributing to the new funds in 1998. During 2004, our wireline operations contributed $307 to the Universal Service Fund. The FCC does not require contributing companies to recover their contributions directly from customers. Like many other companies, however, BellSouth has chosen to recover universal costs directly from end-users.
RECIPROCAL COMPENSATION
Following the enactment of the 1996 Act, our telephone company subsidiary, BST, and various competitive local exchange carriers entered into interconnection agreements providing for, among other things, the payment of reciprocal compensation for local calls initiated by the customers of one carrier that are completed on the network of the other carrier. These agreements were the subject of litigation before various regulatory commissions. After an FCC ruling in April 2001 prescribing new rates, BellSouth settled its claims with competitors for traffic occurring through mid-June 2001, and entered into agreements that contained the FCC rates for traffic occurring from mid-June 2001 forward. The District of Columbia Circuit Court of Appeals, in the second quarter of 2002, remanded the ruling to the FCC to implement a rate methodology consistent with the Courts opinion. Although it has not issued an order responding to the Courts 2002 opinion, the FCC, in October 2004, granted a request by a competitor to forbear from applying certain compensation caps and new market rules required by its April 2001 decision. We expect that the FCC will reconsider the rates and methodology for reciprocal compensation as part of its comprehensive evaluation of intercarrier compensation, and we do not currently expect any change in reciprocal compensation rates to have a material effect on results of operations.
BROADBAND REGULATION
The FCC has pending dockets in which it is considering the regulatory classification of broadband service. Specifically, it is looking at whether broadband service should be deemed a regulated telecommunications service or a non-regulated information service. The FCC and various state public service commissions are considering what rules and regulations should apply to voice over Internet protocol (VoIP) services. We are unable to predict the outcome of these proceedings. Because wireline telephony is transitioning toward broadband services, the materiality of the outcome of these proceedings to us is increasing over time.
SECTION 272 CLAIM
In December 2004, the FCC partially granted and otherwise dismissed July 2004 claims of AT&T that two optional discount special access tariffs violated various provisions of the Communications Act. The FCC held that one of the tariffs, the Transport Savings Plan, was unlawful under Section 272 of the Act, which governs dealings between BST and our long distance affiliate. That tariff, originally filed in 1999, provided an overlay discount for carriers that accepted its terms, which included a five year commitment, a commitment for a defined amount of spending on special access, and shortfall charges if commitments were not met. The FCC held that the discount structure in the tariff was insufficiently related to cost, and unduly favored a class of carriers (including our long distance affiliate) with relatively lower volume special access spending, and discriminated against carriers with relatively higher volumes. The FCC dismissed the other claims associated with the Transport Savings Plan, and dismissed all claims associated with the second tariff. We do not agree with the FCCs finding, and appealed its decision to the D.C. Circuit Court of Appeals. We do not believe that AT&T has suffered any damages, and we
BELLSOUTH CORPORATION
believe that any such claims would be barred in whole or in part by various provisions of law. At this time, however, neither the likely outcome of the appeal nor AT&Ts potential damages claim can be predicted, and therefore no reasonable estimate of loss, if any, can be made.
State Regulatory Matters
We are subject to regulation of our local and intrastate long distance services by a state authority in each state where we provide intrastate telecommunications services. Such regulation covers prices, services, competition and other issues.
PRICE REGULATION
We currently operate under price regulation plans in all states in our wireline territory. Under these plans, the state regulatory commissions or state legislatures have established maximum prices that can be charged for certain telecommunications services. While such plans limit the amount of increases in prices for specific services, they enhance our ability to adjust prices and service options to respond more effectively to changing market conditions and competition. Price regulation also provides an opportunity to benefit more fully from productivity enhancements. The majority of these plans have limitations on raising prices for basic local exchange services during the early years with provisions for inflation-based price increases in later years.
OTHER STATE REGULATORY MATTERS
In each of our states, we are subject to performance measurement plans that measure our service performance to competitors against certain benchmarks and our own retail performance. When we do not meet the relevant standards, we make payments to the competitors or the States treasury. In some states, if we continuously fail to meet certain criteria, we also would suspend our marketing and sale of long distance services. We made immaterial payments in all states in 2003 and 2004, and likely will make immaterial payments in 2005. The plans are reviewed regularly for necessary changes.
WIRELESS REGULATORY ENVIRONMENT
Overview
The FCC regulates the licensing, construction, operation, acquisition and transfer of wireless systems in the US pursuant to the Communications Act of 1934 (Communications Act) and its associated rules, regulations and policies.
| regulate Cingulars ability to acquire and hold radio spectrum licenses or to lease spectrum; |
| impose technical obligations on the operation of Cingulars network; |
| impose requirements on the ways Cingular provides service to and communicates with its customers; |
| regulate the interconnection of Cingulars network with the networks of other carriers; |
| obligate Cingular to permit resale of its services by resellers, if it offers resale opportunities, and to serve roaming customers of other wireless carriers; and |
| impose a variety of fees and charges on Cingulars business that are used to finance numerous regulatory programs and a substantial part of the FCCs budget. |
the Communications Act provides that licenses may be revoked for cause and license renewal applications denied if the FCC determines that a renewal would not serve the public interest. Violations of FCC rules may also result in monetary penalties or other sanctions. FCC rules provide that applications competing with a license renewal application may be considered in comparative hearings and establish the qualifications for competing applications and the standards to be applied in hearings.
Recent Regulatory Developments
The FCC eliminated the rules limiting the amount of spectrum a wireless carrier can own in a market effective January 1, 2003. It has not yet replaced these spectrum limits with published rules or guidelines setting forth how the FCC will review carriers spectrum aggregations. The FCC also eliminated the prohibition on ownership of both cellular licenses by a single entity except it will review on a case-by-case basis applications for authority to own both cellular licenses in a rural area. Certain acquisitions of spectrum would remain subject to approval of the US Department of Justice.
BELLSOUTH CORPORATION
State Regulation and Local Approvals
With the rapid growth and penetration of wireless services has come a commensurate surge of interest on the part of state legislatures and state public utility commissions and local governmental authorities in regulating the domestic wireless industry. This interest has taken the form of efforts to regulate customer billing, termination of service arrangements, advertising, filing of informational tariffs, certification of operation, use of handsets when driving, service quality, sales practices, and many other areas. We anticipate that this trend will continue. It will require Cingular to devote legal and other resources to working with the states to respond to their concerns while minimizing any new regulation that could increase Cingulars costs of doing business.
COMPETITION
There are many competitive forces that impact our businesses. The Telecommunications Act of 1996 removed the regulatory barriers to local service competition in the wireline market and required incumbent carriers such as us to open our networks to other carriers.
| increase its spending to retain customers; | |
| restructure its service packages to include more compelling products and services; | |
| further upgrade its network infrastructure and the handsets Cingular offers; and |
| increase its advertising, promotional spending, commissions and other customer acquisition costs. |
TECHNOLOGY
We are continually upgrading our networks with digital and optical technologies, making them capable of delivering a full complement of voice and data services. This modernization of the network is critical to our success in providing the data connectivity demanded by customers and to compete with fiber networks being constructed or currently utilized by start-ups and cable companies. This continuing effort will require investment of significant amounts of capital in the future.
LEGAL MATTERS
We are involved in numerous legal proceedings associated with state and federal regulatory matters, the disposition of which could materially impact our operating results and prospects. See Note Q to our consolidated financial statements.
NEW ACCOUNTING PRONOUNCEMENTS
See Note B to our consolidated financial statements for a description of new accounting pronouncements.
Critical Accounting Policies
We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used, would have a material impact on our financial condition or results of operations.
DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT
See Note H to our consolidated financial statements for more information regarding costs and assumptions for property, plant and equipment.
Nature of estimates required
We use the group life method to depreciate the assets of our telephone subsidiary. Telephone plant acquired in a given year is grouped into similar categories and depreciated over the remaining estimated useful life of the group. Due to rapid changes in technology and new competitors, selecting the estimated economic life of telecommunications plant and equipment requires a significant amount of judgment. We periodically review data on expected utilization of new equipment, asset retirement activity and net salvage values to determine adjustments to our depreciation rates. We also utilize studies performed by outside consultants to assist us in our determination. We have not made any changes to the lives of assets resulting in a material impact in the three years presented.
Sensitivity analysis
The effect of a one year change in the useful lives of our telephone plant accounts is shown below:
2005 Depreciation Expense | ||||
Higher/(Lower) | ||||
Increasing economic life by one year
|
$(290 | ) | ||
Decreasing economic life by one year
|
360 |
PENSIONS
See Note L to our consolidated financial statements for more information regarding costs associated with employee retirement benefits.
Nature of estimates required
The measurement of our pension obligations, costs and liabilities is dependent on a variety of assumptions including estimates of the present value of projected future pension payments to plan participants, consideration of the likelihood of potential future events such as salary increases and demographic experience. These assumptions may have an effect on the amount and timing of future contributions, if any. Additionally, the plan trustee conducts an independent valuation of the fair value of pension plan assets.
Assumptions and approach used
The assumptions in developing the required estimates include the following key factors:
| Discount rates | |
| Inflation | |
| Salary growth | |
| Expected return on plan assets | |
| Retirement rates | |
| Mortality rates |
BELLSOUTH CORPORATION
The discount rate enables us to state expected future cash flows at a present value on the measurement date. We are required to select a rate that represents the market rate for high-quality fixed income investments and considers the timing and amounts of our expected future benefit payments. A lower discount rate increases the present value of benefit obligations and usually increases expense. However, the expense impact for our plans currently has an opposite impact (lower discount rate decreases expense). This impact occurs because our plan is currently within the specified corridor that under accounting rules does not require us to amortize the discount rate assumption change as it relates to the obligation but we do receive the benefit of lower interest rates in calculating the current period interest component of net periodic pension cost. Our inflation assumption is based on an evaluation of external market indicators. The salary growth assumptions reflect our long-term actual experience, the near-term outlook and assumed inflation. The expected return on plan assets reflects asset allocations, investment strategy and the views of investment managers and other large pension plan sponsors. For 2003, we reduced our estimated return on plan assets to 8.5% reflecting lower expected long-term market returns. Retirement and mortality rates are based primarily on actual plan experience. The effects of actual results differing from our assumptions are accumulated and amortized into the income statement in future periods in accordance with the pension accounting rules.
Sensitivity analysis
The effect of the change in the selected assumptions is shown below:
Percentage | December 31, 2004 | |||||||
Point | Obligation | 2005 Expense | ||||||
Assumption | Change | Higher/(Lower) | Higher/(Lower) | |||||
Discount rate
|
+/- 0.5 pts. | $(454)/$472 | $18/$(21 | ) | ||||
Expected return on assets
|
+/- 1.0 pts. | | (151)/151 |
OTHER POSTRETIREMENT BENEFITS
See Note L to our consolidated financial statements for more information regarding costs associated with postretirement benefits.
Nature of estimates required
We 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. For postretirement benefit plans, the benefit obligation is the accumulated postretirement benefit obligation, the actuarial present value as of a date of all future benefits attributed under the terms of the postretirement benefit plan to employee service rendered to that date. The measurement of our obligations associated with postretirement benefits (e.g., retiree health care) is dependent on a variety of assumptions. This includes estimating the present value of projected future payments to plan participants, net of projected government prescription drug subsidy receipts, and consideration of the likelihood of potential future events such as demographic experience. These assumptions may have an effect on the amount and timing of future payments. Additionally, the plan trustee conducts an independent valuation of the fair value of plan assets.
Assumptions and approach used
Our contract with the CWA provides for contractual limits on the company-funded portion of retiree medical costs (referred to as caps). We have waived the premiums in excess of the caps during the current and past contract periods and, therefore have not collected contributions from those non-management retirees in effect creating a substantive plan. Based on this past practice, we determine the future obligation based on this substantive plan. Accordingly, we calculate the obligation for non-management retiree medical costs as if there were no caps.
| Discount rates | |
| Health care cost trends | |
| Inflation | |
| Expected return on plan assets | |
| Retirement rates | |
| Mortality rates | |
| Actuarial equivalence for purposes of the Medicare Prescription Drug, Improvement and Modernization Act |
The discount rate enables us to state expected future cash flows at a present value on the measurement date. We are required to select a rate that represents the market rate for high-quality fixed income investments and considers the timing and amounts of our expected future benefit payments. A lower discount rate increases the present value of benefit obligations and expense. Our health care cost trend assumptions are developed based on historical cost data, the near-term outlook, and an assessment of likely long-term trends. Our inflation assumption is based on an evaluation of external market indicators. The expected return on plan assets reflects asset allocations, investment strategy and the views of investment managers and other large plan sponsors. Retirement and mortality rates are based primarily on actual plan experience. Actuarial equivalence was based on comparing the Medicare Part D standard drug coverage and premiums to BellSouths retiree prescription drug coverage and premiums. We calculated the actuarial values based on our specific experience combined with published nationwide statistics. The effects of actual results differing from our assumptions are accumulated and amortized into the income statement in future periods in
accordance with the other postretirement benefits accounting rules.
Sensitivity analysis
The effect of the indicated increase/decrease in the selected assumptions is shown below:
Percentage | December 31, 2004 | |||||||||
Point | Obligation | 2005 Expense | ||||||||
Assumption | Change | Higher/(Lower) | Higher/(Lower) | |||||||
Discount rate
|
+/- 0.5 pts. | $(648)/$693 | $(42)/$43 | |||||||
Health care cost trend
|
+/- 1.0 pts. | 1,251/(1,030 | ) | 187/(143 | ) |
OTHER LOSS CONTINGENCIES
Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analysis of multiple forecasts that often depend on judgments about potential actions by third parties such as regulators.
OTHER SIGNIFICANT ACCOUNTING POLICIES
Other significant accounting polices, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the financial statements. Policies related to revenue recognition, stock-based compensation, uncollectible reserves and tax valuation allowances require difficult judgments on complex matters that are often subject to multiple sources of authoritative guidance. Certain of these matters are among topics currently under re-examination by accounting standard setters and regulators. Although no specific conclusions reached by these standard setters appear likely to cause a material change in our accounting policies, outcomes cannot be predicted with confidence. Also see Note A to our consolidated financial statements, which discusses accounting policies that we have selected from acceptable alternatives.
Cautionary Language Concerning
Forward-Looking Statements
In addition to historical information, this document contains forward-looking statements regarding events, financial trends and critical accounting policies that may affect our future operating results, financial position and cash flows. These statements are based on our assumptions and estimates and are subject to risks and uncertainties. For these statements, we claim the protection of the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.
| a change in economic conditions in the markets where we operate or have material investments which could affect demand for our services; | |
| the impact and the success of Cingular Wireless, our wireless joint venture with SBC, including marketing and product development efforts, technological changes and financial capacity; | |
| Cingular Wireless failure to realize, in the amounts and within the timeframe contemplated, the capital and expense synergies and other financial benefits expected from its acquisition of AT&T Wireless as a result of technical, logistical, regulatory and other factors; | |
| changes in laws or regulations, or in their interpretations, which could result in the loss, or reduction in value, of our licenses, concessions or markets, or in an increase in competition, compliance costs or capital expenditures; | |
| continued pressures on the telecommunications industry from a financial, competitive and regulatory perspective; | |
| the intensity of competitive activity and its resulting impact on pricing strategies and new product offerings; | |
| changes in the federal and state regulations governing the terms on which we offer retail and wholesale services; | |
| continued successful penetration of the interLATA long distance market; | |
| the impact on our business of consolidation in the wireline and wireless industries in which we operate; | |
| the issuance by the Financial Accounting Standards Board or other accounting bodies of new accounting standards or changes to existing standards; | |
| changes in available technology that increase the impacts of technology substitution; | |
| higher than anticipated start-up costs or significant up-front investments associated with new business initiatives; | |
| the outcome of pending litigation; and | |
| unanticipated higher capital spending from, or delays in, the deployment of new technologies. |
BELLSOUTH CORPORATION
For the years ended December 31, | ||||||||||||||||
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS) | 2002 | 2003 | 2004 | |||||||||||||
Operating Revenues:
|
||||||||||||||||
Communications Group
|
$ | 18,226 | $ | 18,255 | $ | 18,239 | ||||||||||
Advertising & Publishing Group
|
1,921 | 2,033 | 2,005 | |||||||||||||
All other
|
60 | 53 | 56 | |||||||||||||
Total Operating Revenues
|
20,207 | 20,341 | 20,300 | |||||||||||||
Operating Expenses:
|
||||||||||||||||
Cost of services and products (excludes
depreciation
and amortization shown separately below) |
6,670 | 6,991 | 7,520 | |||||||||||||
Selling, general, and administrative expenses
|
3,891 | 3,777 | 3,816 | |||||||||||||
Depreciation and amortization
|
4,202 | 3,811 | 3,636 | |||||||||||||
Provisions for restructuring and asset impairments
|
990 | 205 | 39 | |||||||||||||
Total Operating Expenses
|
15,753 | 14,784 | 15,011 | |||||||||||||
Operating income
|
4,454 | 5,557 | 5,289 | |||||||||||||
Interest expense
|
1,066 | 947 | 916 | |||||||||||||
Net earnings of equity affiliates
|
542 | 452 | 68 | |||||||||||||
Gain (loss) on sale of operations
|
1,335 | | 462 | |||||||||||||
Other income (expense), net
|
102 | 362 | 283 | |||||||||||||
Income from Continuing Operations Before Income
Taxes, Discontinued Operations and Cumulative Effect of Changes
in Accounting Principle
|
5,367 | 5,424 | 5,186 | |||||||||||||
Provision for Income Taxes
|
1,892 | 1,936 | 1,792 | |||||||||||||
Income from Continuing Operations Before
Discontinued Operations and Cumulative Effect of Changes in
Accounting Principle
|
3,475 | 3,488 | 3,394 | |||||||||||||
Income (Loss) from Discontinued Operations, Net
of Tax
|
(867 | ) | 101 | 1,364 | ||||||||||||
Income Before Cumulative Effect of Changes in
Accounting Principle
|
2,608 | 3,589 | 4,758 | |||||||||||||
Cumulative Effect of Changes in Accounting
Principle, Net of Tax
|
(1,285 | ) | 315 | | ||||||||||||
Net Income
|
$ | 1,323 | $ | 3,904 | $ | 4,758 | ||||||||||
Weighted-Average Common Shares Outstanding:
|
||||||||||||||||
Basic
|
1,870 | 1,848 | 1,832 | |||||||||||||
Diluted
|
1,876 | 1,852 | 1,836 | |||||||||||||
Basic Earnings Per Share:
|
||||||||||||||||
Income from Continuing Operations Before
Discontinued Operations and Cumulative Effect of Changes in
Accounting Principle
|
$ | 1.86 | $ | 1.89 | $ | 1.85 | ||||||||||
Discontinued Operations, net of tax
|
$ | (.46 | ) | $ | .05 | $ | .74 | |||||||||
Cumulative Effect of Accounting Changes, net of
tax
|
$ | (.69 | ) | $ | .17 | $ | | |||||||||
Net Income
|
$ | .71 | $ | 2.11 | $ | 2.60 | ||||||||||
Diluted Earnings Per Share:
|
||||||||||||||||
Income from Continuing Operations Before
Discontinued Operations and Cumulative Effect of Changes in
Accounting Principle
|
$ | 1.85 | $ | 1.88 | $ | 1.85 | ||||||||||
Discontinued Operations, net of tax
|
$ | (.46 | ) | $ | .05 | $ | .74 | |||||||||
Cumulative Effect of Accounting Changes, net of
tax
|
$ | (.68 | ) | $ | .17 | $ | | |||||||||
Net Income*
|
$ | .71 | $ | 2.11 | $ | 2.59 | ||||||||||
Dividends Declared Per Common Share
|
$ | .79 | $ | .92 | $ | 1.06 |
* | Net income per share may not sum due to rounding |
The accompanying notes are an integral part of these consolidated financial statements.
BELLSOUTH CORPORATION
December 31, | ||||||||||
(IN MILLIONS) | 2003 | 2004 | ||||||||
ASSETS
|
||||||||||
Current Assets:
|
||||||||||
Cash and cash equivalents
|
$ | 2,947 | $ | 680 | ||||||
Short-term investments
|
1,609 | 16 | ||||||||
Accounts receivable, net of
allowance for uncollectibles of $496 and $317
|
2,870 | 2,559 | ||||||||
Material and supplies
|
375 | 321 | ||||||||
Other current assets
|
1,048 | 1,055 | ||||||||
Assets of discontinued
operations
|
| 1,068 | ||||||||
Total current
assets
|
8,849 | 5,699 | ||||||||
Investments in and advances to Cingular
|
7,679 | 22,771 | ||||||||
Property, plant and equipment, net
|
23,807 | 22,039 | ||||||||
Other assets
|
6,977 | 7,400 | ||||||||
Intangible assets, net
|
2,297 | 1,587 | ||||||||
Goodwill
|
93 | | ||||||||
Total assets
|
$ | 49,702 | $ | 59,496 | ||||||
LIABILITIES AND SHAREHOLDERS
EQUITY
|
||||||||||
Current Liabilities:
|
||||||||||
Debt maturing within one year
|
$ | 3,491 | $ | 5,475 | ||||||
Accounts payable
|
1,339 | 1,047 | ||||||||
Other current liabilities
|
3,628 | 3,018 | ||||||||
Liabilities of discontinued
operations
|
| 830 | ||||||||
Total current
liabilities
|
8,458 | 10,370 | ||||||||
Long-term debt
|
11,489 | 15,108 | ||||||||
Noncurrent liabilities:
|
||||||||||
Deferred income taxes
|
5,349 | 6,492 | ||||||||
Other noncurrent liabilities
|
4,694 | 4,460 | ||||||||
Total
noncurrent liabilities
|
10,043 | 10,952 | ||||||||
Shareholders equity:
|
||||||||||
Common stock, $1 par value
(8,650 shares authorized;
1,830 and 1,831 shares outstanding) |
2,020 | 2,020 | ||||||||
Paid-in capital
|
7,729 | 7,840 | ||||||||
Retained earnings
|
16,540 | 19,267 | ||||||||
Accumulated other comprehensive
income (loss)
|
(585 | ) | (157 | ) | ||||||
Shares held in trust and
treasury
|
(5,992 | ) | (5,904 | ) | ||||||
Total
shareholders equity
|
19,712 | 23,066 | ||||||||
Total
liabilities and shareholders equity
|
$ | 49,702 | $ | 59,496 | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
BELLSOUTH CORPORATION
For the years ended December 31, | |||||||||||||||
(IN MILLIONS) | 2002 | 2003 | 2004 | ||||||||||||
Cash Flows from Operating
Activities:
|
|||||||||||||||
Income from continuing operations before
discontinued operations and cumulative effect of changes in
accounting principle
|
$ | 3,475 | $ | 3,488 | $ | 3,394 | |||||||||
Adjustments to reconcile income to cash provided
by operating activities from continuing operations:
|
|||||||||||||||
Depreciation and amortization
|
4,202 | 3,811 | 3,636 | ||||||||||||
Provision for uncollectibles
|
795 | 523 | 384 | ||||||||||||
Net losses (earnings) of equity affiliates
|
(542 | ) | (452 | ) | (68 | ) | |||||||||
Deferred income taxes and investment tax credits
|
1,330 | 788 | 1,081 | ||||||||||||
Pension income
|
(825 | ) | (534 | ) | (484 | ) | |||||||||
Pension settlement losses
|
167 | 47 | | ||||||||||||
Stock-based compensation expense
|
161 | 124 | 116 | ||||||||||||
(Gain) loss on sale of operations
|
(1,335 | ) | | (462 | ) | ||||||||||
Net losses (gains) on sale or impairment of
equity securities
|
370 | 7 | 4 | ||||||||||||
Curtailment and termination benefit charges
|
60 | | | ||||||||||||
Unbilled receivable adjustment
|
163 | | | ||||||||||||
Asset impairments
|
302 | 52 | | ||||||||||||
Net change in:
|
|||||||||||||||
Accounts receivable and other current assets
|
(261 | ) | (81 | ) | (419 | ) | |||||||||
Accounts payable and other current liabilities
|
(360 | ) | 55 | (680 | ) | ||||||||||
Deferred charges and other assets
|
46 | 299 | (79 | ) | |||||||||||
Other liabilities and deferred credits
|
10 | (276 | ) | 159 | |||||||||||
Other reconciling items, net
|
(46 | ) | 32 | 219 | |||||||||||
Net cash provided by operating activities from
continuing operations
|
7,712 | 7,883 | 6,801 | ||||||||||||
Cash Flows from Investing
Activities:
|
|||||||||||||||
Capital expenditures
|
(3,536 | ) | (2,926 | ) | (3,193 | ) | |||||||||
Purchase of short-term investments
|
(1,302 | ) | (3,439 | ) | (3,770 | ) | |||||||||
Proceeds from sale of short-term investments
|
841 | 2,291 | 5,363 | ||||||||||||
Proceeds from sale of operations
|
| | 3,392 | ||||||||||||
Proceeds from sale of debt and equity securities
|
1,383 | 27 | 286 | ||||||||||||
Investments in debt and equity securities
|
(36 | ) | (194 | ) | (632 | ) | |||||||||
Proceeds from repayment of loans and advances
|
885 | 1,899 | 129 | ||||||||||||
Net short term advances to Cingular
|
| | (666 | ) | |||||||||||
Settlement of derivatives on advances
|
85 | (352 | ) | (17 | ) | ||||||||||
Investments in and advances to equity affiliates
|
(210 | ) | | (14,445 | ) | ||||||||||
Other investing activities, net
|
(22 | ) | (12 | ) | (7 | ) | |||||||||
Net cash used for investing activities from
continuing operations
|
(1,912 | ) | (2,706 | ) | (13,560 | ) | |||||||||
Cash Flows from Financing
Activities:
|
|||||||||||||||
Net borrowings (repayments) of short-term debt
|
(1,307 | ) | (431 | ) | 1,738 | ||||||||||
Proceeds from the issuance of long-term debt
|
| | 6,078 | ||||||||||||
Repayments of long-term debt
|
(1,149 | ) | (1,849 | ) | (759 | ) | |||||||||
Dividends paid
|
(1,460 | ) | (1,608 | ) | (1,901 | ) | |||||||||
Purchase of treasury shares
|
(591 | ) | (858 | ) | (146 | ) | |||||||||
Other financing activities, net
|
64 | 67 | 61 | ||||||||||||
Net cash used in financing activities from
continuing operations
|
(4,443 | ) | (4,679 | ) | 5,071 | ||||||||||
Net (decrease) increase in cash and cash
equivalents from continuing operations
|
1,357 | 498 | (1,688 | ) | |||||||||||
Net (decrease) increase in cash and cash
equivalents from discontinued operations
|
72 | 428 | (579 | ) | |||||||||||
Net (decrease) increase in cash and cash
equivalents
|
1,429 | 926 | (2,267 | ) | |||||||||||
Cash and cash equivalents at beginning of period
|
592 | 2,021 | 2,947 | ||||||||||||
Cash and cash equivalents at end of period
|
$ | 2,021 | $ | 2,947 | $ | 680 | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
BELLSOUTH CORPORATION
Number of Shares | Amount | |||||||||||||||||||||||||||||||||||||
Accum. | ||||||||||||||||||||||||||||||||||||||
Other | ||||||||||||||||||||||||||||||||||||||
Shares | Compre- | Shares | Guar- | |||||||||||||||||||||||||||||||||||
Held in | hensive | Held in | antee | |||||||||||||||||||||||||||||||||||
Common | Trust and | Common | Paid-in | Retained | Income | Trust and | of ESOP | |||||||||||||||||||||||||||||||
(IN MILLIONS) | Stock | Treasury(a) | Stock | Capital | Earnings | (Loss) | Treasury(a) | Debt | Total | |||||||||||||||||||||||||||||
Balance at December 31, 2001
|
2,020 | (143 | ) | $ | 2,020 | $ | 7,368 | $ | 14,805 | $ | (294 | ) | $ | (4,996 | ) | $ | (145 | ) | $ | 18,758 | ||||||||||||||||||
Net Income
|
1,323 | 1,323 | ||||||||||||||||||||||||||||||||||||
Other comprehensive income, net of tax
|
(446 | ) | (446 | ) | ||||||||||||||||||||||||||||||||||
|
||||||||||||||||||||||||||||||||||||||
Total comprehensive income
|
877 | |||||||||||||||||||||||||||||||||||||
Dividends declared
|
(1,477 | ) | (1,477 | ) | ||||||||||||||||||||||||||||||||||
Share issuances for employee benefit plans
|
5 | (33 | ) | (104 | ) | 197 | 60 | |||||||||||||||||||||||||||||||
Purchase of treasury stock
|
(22 | ) | (591 | ) | (591 | ) | ||||||||||||||||||||||||||||||||
Purchase of stock by grantor trusts
|
(18 | ) | 18 | | ||||||||||||||||||||||||||||||||||
Stock-based compensation
|
171 | 171 | ||||||||||||||||||||||||||||||||||||
Tax benefit related to stock options
|
40 | 40 | ||||||||||||||||||||||||||||||||||||
ESOP activities and related tax benefit
|
2 | 66 | 68 | |||||||||||||||||||||||||||||||||||
Balance at December 31, 2002
|
2,020 | (160 | ) | $ | 2,020 | $ | 7,546 | $ | 14,531 | $ | (740 | ) | $ | (5,372 | ) | $ | (79 | ) | $ | 17,906 | ||||||||||||||||||
Net Income
|
3,904 | 3,904 | ||||||||||||||||||||||||||||||||||||
Other comprehensive income, net of tax
|
155 | 155 | ||||||||||||||||||||||||||||||||||||
|
||||||||||||||||||||||||||||||||||||||
Total comprehensive income
|
4,059 | |||||||||||||||||||||||||||||||||||||
Dividends declared
|
(1,696 | ) | (1,696 | ) | ||||||||||||||||||||||||||||||||||
Share issuances for employee benefit plans
|
5 | (19 | ) | (89 | ) | 169 | 61 | |||||||||||||||||||||||||||||||
Purchase of treasury stock
|
(35 | ) | (858 | ) | (858 | ) | ||||||||||||||||||||||||||||||||
Purchases and sales of treasury stock with
grantor trusts
|
43 | (112 | ) | 69 | | |||||||||||||||||||||||||||||||||
Stock-based compensation
|
137 | 137 | ||||||||||||||||||||||||||||||||||||
Tax benefit related to stock options
|
22 | 22 | ||||||||||||||||||||||||||||||||||||
ESOP activities and related tax benefit
|
2 | 79 | 81 | |||||||||||||||||||||||||||||||||||
Balance at December 31, 2003
|
2,020 | (190 | ) | $ | 2,020 | $ | 7,729 | $ | 16,540 | $ | (585 | ) | $ | (5,992 | ) | $ | | 19,712 | ||||||||||||||||||||
Net Income
|
4,758 | 4,758 | ||||||||||||||||||||||||||||||||||||
Other comprehensive income, net of tax
|
428 | 428 | ||||||||||||||||||||||||||||||||||||
|
||||||||||||||||||||||||||||||||||||||
Total comprehensive income
|
5,186 | |||||||||||||||||||||||||||||||||||||
Dividends declared
|
(1,934 | ) | (1,934 | ) | ||||||||||||||||||||||||||||||||||
Share issuances for employee benefit plans
|
7 | (59 | ) | (94 | ) | 236 | 83 | |||||||||||||||||||||||||||||||
Purchase of treasury stock
|
(6 | ) | (146 | ) | (146 | ) | ||||||||||||||||||||||||||||||||
Purchases and sales of treasury stock with
grantor trusts
|
2 | (2 | ) | | ||||||||||||||||||||||||||||||||||
Stock-based compensation
|
121 | 121 | ||||||||||||||||||||||||||||||||||||
Tax benefit related to stock options
|
39 | 39 | ||||||||||||||||||||||||||||||||||||
Other
|
8 | (3 | ) | 5 | ||||||||||||||||||||||||||||||||||
Balance at December 31, 2004
|
2,020 | (189 | ) | $ | 2,020 | $ | 7,840 | $ | 19,267 | $ | (157 | ) | $ | (5,904 | ) | $ | | $ | 23,066 | |||||||||||||||||||
(a) | Trust and treasury shares are not considered to be outstanding for financial reporting purposes. As of December 31, 2004, there were approximately 26 shares held in trust and 163 shares held in treasury. |
The accompanying notes are an integral part of these consolidated financial statements.
BELLSOUTH CORPORATION
In this report, BellSouth Corporation and its subsidiaries are referred to as we or BellSouth.
ORGANIZATION
We are a communications company headquartered in Atlanta, Georgia. For management purposes, our operations are organized into three reportable segments: Communications Group; Domestic Wireless; and Advertising & Publishing Group.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of BellSouths wholly-owned subsidiaries and subsidiaries in which we have a controlling financial interest. Investments in businesses that we do not control, but have the ability to exercise significant influence over operations and financial policies, are accounted for using the equity method. We report our results on a calendar-year basis, except for our international operations that we report on a one-month lag basis to facilitate timely reporting of the consolidated results of BellSouth. All significant intercompany transactions and accounts have been eliminated. We own an approximate 40% economic interest in Cingular Wireless and we share control with SBC Communications (SBC). Accordingly, we account for this investment under the equity method. Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the current years presentation.
USE OF ESTIMATES
Our consolidated financial statements have been prepared in accordance with Generally Accepted Accounting Principles (US GAAP). We are required to make estimates and assumptions that affect amounts reported in our financial statements and the accompanying notes. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS
We consider all highly liquid investments with an original maturity of three months or less to be cash equivalents. Investments with an original maturity of over three months to one year are not considered cash equivalents and are included as other current assets in the consolidated balance sheets. Interest income on cash equivalents and temporary cash investments was $95 for 2002, $76 for 2003, and $60 for 2004.
SHORT-TERM INVESTMENTS
Short-term investments represent auction rate securities which are highly liquid, variable-rate debt securities. While the underlying security has a long-term nominal maturity, the interest rate is reset through dutch auctions that are typically held every 7, 28 or 35 days, creating a short-term instrument. The securities trade at par and are callable at par on any interest payment date at the option of the issuer. Interest is paid at the end of each auction period.
MATERIAL AND SUPPLIES
New and reusable material held at our telephone subsidiary is carried in inventory, principally at average original cost, except that specific costs are used in the case of large individual items. Non-reusable material is carried at estimated salvage value. Inventories of our other subsidiaries are stated at the lower of cost or market, with cost determined principally on either an average cost or first-in, first-out basis.
PROPERTY, PLANT AND EQUIPMENT
The investment in property, plant and equipment is stated at original cost. For plant dedicated to providing regulated telecommunications services, depreciation is based on the group remaining life method of depreciation and straight-line rates determined on the basis of equal life groups of certain categories of telephone plant acquired in a given year. This method requires the periodic revision of depreciation rates. When depreciable telephone plant is disposed of, the original cost less any net salvage proceeds is charged to accumulated depreciation. We perform inventories of the telephone plant to verify the existence of these assets and reconcile these inventories to our property records. In addition, the inventory reconciliation results allow us to correct our records for investment moved from one location to another and to
account for delayed retirements. The cost of other property, plant and equipment is depreciated using either straight-line or accelerated methods over the estimated useful lives of the assets. Depreciation of property, plant and equipment in continuing operations was $3,718 for 2002, $3,257 for 2003, and $3,039 for 2004.
VALUATION OF LONG-LIVED ASSETS
Long-lived assets, including property, plant and equipment and intangible assets with finite lives are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The communications industry is rapidly evolving and therefore it is reasonably possible that our long-lived assets could become impaired as a result of technological or other industry changes. For assets we intend to hold for use, if the total of the expected future undiscounted cash flows is less than the carrying amount of the asset, we recognize a loss for the difference between the fair value and carrying value of the asset. For assets we intend to dispose of, we recognize a loss for the amount that the estimated fair value, less costs to sell, is less than the carrying value of the assets. We principally use the discounted cash flow method to estimate the fair value of long-lived assets.
FOREIGN CURRENCY
Assets and liabilities of foreign subsidiaries and equity investees with a functional currency other than US Dollars are translated into US Dollars at exchange rates in effect at the end of the reporting period. Foreign entity revenues and expenses are translated into US Dollars at the average rates that prevailed during the period. The resulting net translation gains and losses are reported as foreign currency translation adjustments in shareholders equity as a component of accumulated other comprehensive income (loss). Operations in countries with hyperinflationary economies consider the US Dollar the functional currency.
COST METHOD INVESTMENTS
We have investments in marketable securities, primarily common stocks, which are accounted for under the cost method. Securities classified as available-for-sale under, Accounting for Certain Investments in Debt and Equity Securities, SFAS No. 115 are carried at fair value, with unrealized gains and losses, net of income taxes, recorded in accumulated other comprehensive income (loss) in the statement of changes in shareholders equity and comprehensive income. The fair values of individual investments in marketable securities are determined based on market quotations. Gains or losses are calculated based on the original cost. We periodically review cost method investments for impairment. These reviews are performed to determine whether a decline in the fair value of an investment below its carrying value is deemed to be other than temporary. Equity securities that are restricted for more than one year or not publicly traded are recorded at cost.
DERIVATIVE FINANCIAL INSTRUMENTS
We generally enter into derivative financial instruments only for hedging purposes. In hedging the exposure to variable cash flows or foreign currency impacts on forecasted transactions, deferral accounting is applied when the derivative reduces the risk of the underlying hedged item effectively as a result of high inverse correlation with the value of the underlying exposure. If a derivative instrument either initially fails or later ceases to meet the criteria for deferral accounting, any subsequent gains or losses are recognized currently in income. In hedging the exposure to changes in the fair value of a recognized asset or liability, the change in fair value of both the derivative financial instrument and the hedged item are recognized currently in income. Cash flows resulting from derivative financial instruments are classified in the same category as the cash flows from the items being hedged.
REVENUE RECOGNITION
Revenues are recognized when earned. Certain revenues derived from local telephone services are billed monthly in advance and are recognized the following month when services are provided. Revenues derived from other telecommunications services, principally network access, long distance and wireless airtime usage, are recognized monthly as services are provided. Marketing incentives, including cash coupons, package discounts and free service are recognized as revenue reductions and are accrued in the period the service is provided. With respect to coupons, accruals are based on historical redemption experience. While cash is generally received at the time of sale, revenues from installation and activation activities are
BELLSOUTH CORPORATION
deferred and recognized over the life of the customer relationship, which is generally four years. Print Advertising & Publishing revenues and related directory costs are recognized ratably over the life of the related directory, generally 12 months. Allowances for uncollectible accounts are determined based on analysis of history and future expectations. The provision for such uncollectible accounts in continuing operations was $795 for 2002, $523 for 2003, and $384 for 2004.
DEFERRED ACTIVATION AND INSTALLATION EXPENSES
We defer certain expenses associated with installation and activation activities. Expense is only deferred to the extent associated revenues are deferred. Service costs in excess of revenues are recognized in the period incurred. The deferred costs are recognized over approximately 4 years.
ADVERTISING
We expense advertising costs as they are incurred. These expenses include production, media and other promotional and sponsorship costs. Our total advertising expense in continuing operations was $258 for 2002, $357 for 2003, and $382 for 2004.
INCOME TAXES
The consolidated balance sheets reflect deferred tax balances associated with the anticipated tax impact of future income or deductions implicit in the consolidated balance sheets in the form of temporary differences. Temporary differences primarily result from the use of accelerated methods and shorter lives in computing depreciation for tax purposes.
EARNINGS PER SHARE
Basic earnings per share are computed based on the weighted-average number of common shares outstanding during each year. Diluted earnings per share are based on the weighted-average number of common shares outstanding plus net incremental shares arising out of employee stock options and benefit plans. The earnings amounts used for per-share calculations are the same for both the basic and diluted methods. The following is a reconciliation of the weighted-average share amounts (in millions) used in calculating earnings per share:
2002 | 2003 | 2004 | ||||||||||||
Basic common shares outstanding
|
1,870 | 1,848 | 1,832 | |||||||||||
Incremental shares from stock options and benefit
plans
|
6 | 4 | 4 | |||||||||||
Diluted common shares outstanding
|
1,876 | 1,852 | 1,836 | |||||||||||
Stock options excluded from the computation
|
77 | 92 | 79 | |||||||||||
GOODWILL AND INTANGIBLE ASSETS
Intangible assets consist primarily of capitalized software, wireless licenses and customer related intangibles. Goodwill represents the excess of consideration paid over the fair value of net assets acquired in purchase business combinations. Beginning January 1, 2002 we ceased amortization of goodwill and other indefinite-lived intangible assets in connection with the adoption of SFAS 142, Goodwill and Other Intangible Assets (SFAS No. 142). Customer-related intangible assets represent values placed on customer lists, contracts and non-contractual relationships of acquired businesses and are amortized over periods up to eight years using the sum-of-the-years digits method. Capitalized software costs are being amortized ratably over periods of three to five years. Amortization of intangibles in continuing operations was $484 for 2002, $554 for 2003, and $597 for 2004.
Note B | Recently Issued Accounting Pronouncements |
In December 2004, the FASB issued SFAS No. 123 (Revised 2004), Share-Based Payment. This standard amends and clarifies the accounting for stock compensation plans under SFAS No. 123, Accounting for Stock-Based Compensation, which we adopted effective January 1, 2003. We will adopt this revised statement for our quarter ending September 30, 2005. We do not expect the adoption of this statement to have a material impact on our results of operations, financial position or cash flows.
Note C | Changes in Accounting Principle |
ASSET RETIREMENT OBLIGATIONS
Effective January 1, 2003, we adopted SFAS No. 143, Accounting for Asset Retirement Obligations (SFAS No. 143). This statement provides the accounting for the cost of legal obligations associated with the retirement of
long-lived assets. SFAS No. 143 requires that companies recognize the fair value of a liability for asset retirement obligations in the period in which the obligations are incurred and capitalize that amount as part of the book value of the long-lived asset. SFAS No. 143 also precludes companies from accruing removal costs that exceed gross salvage in their depreciation rates and accumulated depreciation balances if there is no legal obligation to remove the long-lived assets. For our outside plant accounts, such as telephone poles and cable, estimated cost of removal does exceed gross salvage.
REVENUE RECOGNITION FOR PUBLISHING REVENUES
Effective January 1, 2003, we changed our method for recognizing revenues and expenses related to our directory publishing business from the publication and delivery method to the deferral method. Under the publication and delivery method, we recognized 100% of the revenues and direct expenses at the time the directories were published and delivered to end-users. Under the deferral method, revenues and direct expenses are recognized ratably over the life of the related directory, generally 12 months. The change in accounting method is reflected in the 2003 income statement as a cumulative effect of accounting change adjustment and on the balance sheet as a decrease to accounts receivable of $845, increase to other current assets of $166, increase to current liabilities of $129, and a decrease to deferred income taxes of $307. The cumulative effect of the change resulted in a decrease to net income of $501 for 2003. Absent this one-time adjustment, the change in accounting did not materially affect our annual results.
BELLSOUTH CORPORATION
PRO FORMA IMPACT OF ACCOUNTING CHANGES
The following table presents our 2002 results adjusted to reflect the changes in accounting for asset retirement obligations and revenue recognition for publishing revenues:
For the Year Ended December 31, | ||||||||||||||||||
SFAS No. | Directory | 2002 Pro | ||||||||||||||||
2002 | 143 | Publishing | Forma | |||||||||||||||
(As reported) | (Unaudited) | (Unaudited) | (Unaudited) | |||||||||||||||
Total Operating Revenue
|
$ | 20,207 | $ | | $ | 49 | $ | 20,256 | ||||||||||
Operating Expenses
|
||||||||||||||||||
Cost of services and products
|
6,670 | 32 | 37 | 6,739 | ||||||||||||||
Selling, general, and administrative expenses
|
3,891 | | 13 | 3,904 | ||||||||||||||
Depreciation and amortization
|
4,202 | (133 | ) | | 4,069 | |||||||||||||
Provision for restructuring and asset impairments
|
990 | | | 990 | ||||||||||||||
Total operating expenses
|
15,753 | (101 | ) | 50 | 15,702 | |||||||||||||
Operating income
|
4,454 | 101 | (1 | ) | 4,554 | |||||||||||||
Non-operating income (expense), net
|
913 | | | 913 | ||||||||||||||
Income from continuing operations before income
taxes, discontinued operations, and cumulative effect of changes
in accounting principle
|
5,367 | 101 | (1 | ) | 5,467 | |||||||||||||
Provision for income taxes
|
1,892 | 39 | | 1,931 | ||||||||||||||
Income from continuing operations before
discontinued operations and cumulative effect of changes in
accounting principle
|
3,475 | 62 | (1 | ) | 3,536 | |||||||||||||
Income (Loss) from discontinued operations, net
of tax
|
(867 | ) | | | (867 | ) | ||||||||||||
Income before cumulative effect of changes in
accounting principle
|
2,608 | 62 | (1 | ) | 2,669 | |||||||||||||
Cumulative effect of changes in accounting
principle, net of tax
|
(1,285 | ) | | | (1,285 | ) | ||||||||||||
Net Income
|
$ | 1,323 | $ | 62 | $ | (1 | ) | $ | 1,384 | |||||||||
Basic earnings per share*:
|
||||||||||||||||||
Income from continuing operations before
discontinued operations and cumulative effect of changes in
accounting principle
|
$ | 1.86 | $ | 0.03 | $ | 0.00 | $ | 1.89 | ||||||||||
Income before cumulative effect of changes in
accounting principle
|
$ | 1.39 | $ | 0.03 | $ | 0.00 | $ | 1.43 | ||||||||||
Net income
|
$ | 0.71 | $ | 0.03 | $ | 0.00 | $ | 0.74 | ||||||||||
Diluted earnings per share*:
|
||||||||||||||||||
Income from continuing operations before
discontinued operations and cumulative effect of changes in
accounting principle
|
$ | 1.85 | $ | 0.03 | $ | 0.00 | $ | 1.88 | ||||||||||
Income before cumulative effect of changes in
accounting principle
|
$ | 1.39 | $ | 0.03 | $ | 0.00 | $ | 1.42 | ||||||||||
Net income
|
$ | 0.71 | $ | 0.03 | $ | 0.00 | $ | 0.74 |
*Earnings per share amounts do not sum due to rounding.
Note D | Discontinued Operations |
In March 2004, we signed an agreement with Telefónica Móviles, S.A., the wireless affiliate of Telefónica, S.A. (Telefónica), to sell all of our interests in Latin America. Total after-tax proceeds of the sale to Telefónica of the 10 properties, including shareholder loans, were $5.1 billion. The net assets sold to Telefónica included $1.2 billion of cash as part of the Latin American operations, resulting in a net cash inflow to BellSouth related to the Latin American divestitures of approximately $3.9 billion. Based on the net book value of our investment, we recorded after-tax gains totalling approximately $1.2 billion.
SUMMARY OF SALE TRANSACTIONS
After- | |||||||||
Gross | Tax | ||||||||
Proceeds | Gain | ||||||||
For the year ended December 31:
|
|||||||||
2004
|
$ | 4,037 | $ | 850 | |||||
2005
|
$ | 1,079 | $ | 391 | |||||
Total
|
$ | 5,116 | $ | 1,241 | |||||
The 2004 gain includes the recognition of cumulative foreign currency translation losses of $421 and the 2005 gain includes the recognition of cumulative foreign currency translation gains of $77.
SUMMARY FINANCIAL INFORMATION
The assets and liabilities of our remaining Latin American operations (Argentina and Chile) are aggregated and presented as current assets and current liabilities in the consolidated balance sheet at December 31, 2004. Additional detail related to the assets and liabilities of our discontinued operations follows:
At December 31, 2004:
|
|||||
Current assets (excluding cash of $148)
|
$ | 403 | |||
Property, plant and equipment, net
|
387 | ||||
Investments and advances
|
4 | ||||
Intangible assets, net
|
269 | ||||
Other non-current assets
|
5 | ||||
Total Assets
|
$ | 1,068 | |||
Current liabilities
|
$ | 830 | |||
Long-term debt
|
| ||||
Other non-current liabilities
|
| ||||
Total Liabilities
|
$ | 830 | |||
Summarized results for the discontinued operations are as follows:
For the Year Ended | ||||||||||||
December 31, | ||||||||||||
2002 | 2003 | 2004 | ||||||||||
Operating revenue
|
$ | 2,233 | $ | 2,294 | $ | 2,429 | ||||||
Operating income
|
$ | 292 | $ | 349 | $ | 647 | ||||||
Income (loss) before income taxes
|
$ | (951 | ) | $ | 176 | $ | 1,525 | |||||
Provision (benefit) for income taxes
|
$ | (84 | ) | $ | 75 | $ | 161 | |||||
Net income (loss) from discontinued operations
|
$ | (867 | ) | $ | 101 | $ | 1,364 | |||||
TAX OVER BOOK BASIS DIFFERENTIAL
No US tax benefit was previously recognized on losses generated by the Latin American operations due to the essentially permanent duration of those investments. During 2004, we recorded a $336 tax benefit in accordance with SFAS No. 109, Accounting for Income Taxes, relating to excess tax basis over book basis for our Latin American operations. In add