-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RfuRUkSDN9hOAThdN4yd8fktM7KLUEVjTDk7lbHFjOSzmRqzA3Bhl762HDJNGMB9 ZT4GBtCQWaWmu8akrPj/VQ== 0000790650-97-000006.txt : 19970321 0000790650-97-000006.hdr.sgml : 19970321 ACCESSION NUMBER: 0000790650-97-000006 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970320 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORP CENTRAL INDEX KEY: 0000790650 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 061157778 STATE OF INCORPORATION: CT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: 1934 Act SEC FILE NUMBER: 001-09157 FILM NUMBER: 97560076 BUSINESS ADDRESS: STREET 1: 227 CHURCH ST CITY: NEW HAVEN STATE: CT ZIP: 06510 BUSINESS PHONE: 2037715200 MAIL ADDRESS: STREET 1: 227 CHURCH STREET CITY: NEW HAVEN STATE: CT ZIP: 06510 10-K405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 1996. 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 1-9157 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION (Exact name of registrant as specified in its charter) Connecticut 06-1157778 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 227 Church Street, New Haven, CT 06510 (Address of principal executive offices) (Zip Code) (203) 771-5200 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered Common stock-par value $1 New York and Pacific Stock Exchanges per share Rights to purchase common stock New York and Pacific Stock Exchanges (Currently traded with common stock) 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 X. 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 registrant's 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. X At February 28, 1997, 65,793,847 common shares were outstanding. At February 28, 1997, the aggregate market value of the voting stock held by non-affiliates was $2,383,418,614. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's combined 1996 Annual Report to Shareholders and Proxy Statement dated March 20, 1997 issued in connection with the 1997 Annual Meeting of Shareholders [Part II and Part III] 1 TABLE OF CONTENTS Item Page PART I 1. Business.......................................................... 3 2. Properties........................................................ 11 3. Legal Proceedings................................................. 12 4. Submission of Matters to a Vote of Security Holders............... 12 PART II 5. Market for the Registrant's Common Stock and Related Stockholder Matters............................................ 14 6. Selected Financial Data.......................................... 14 7. Management's Discussion and Analysis of Financial Condition and Operating Results........................................... 14 8. Financial Statements and Supplementary Data...................... 14 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure............................. 14 PART III 10. Directors and Executive Officers of the Registrant............... 14 11. Executive Compensation........................................... 14 12. Security Ownership of Certain Beneficial Owners and Management... 14 13. Certain Relationships and Related Transactions................... 14 PART IV 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.. 15 See page 13 for "Executive Officers of the Registrant" 2 PART I Item 1. Business GENERAL Southern New England Telecommunications Corporation ("Corporation") was incorporated in 1986 under the laws of the State of Connecticut and has its principal executive offices at 227 Church Street, New Haven, Connecticut 06510 (telephone number (203) 771-5200). The Corporation is a holding company engaged through its subsidiaries in operations principally in Connecticut with expanded cellular services in Rhode Island and certain areas in Massachusetts. The Corporation has business units in the following telecommunications product groups: wireline; wireless; and information and entertainment. Wireline includes The Southern New England Telephone Company's telecommunications services; SNET America, Inc. (providing national and international long-distance services to Connecticut customers); and SNET Diversified Group, Inc. (providing premium telecommunications services and the selling and leasing of communications equipment to residential and business customers). Wireless includes SNET Cellular, Inc., SNET Mobility, Inc. and, prior to 1996, SNET Paging, Inc. (providing cellular (wholesale and retail), personal communications, equipment sales and paging resale services). Information and entertainment includes publishing, internet and SNET Personal Vision, Inc. (providing cable television service starting in 1997). Other activities include SNET Real Estate, Inc. (engaging in leasing commercial real estate) and the holding company (engaging in financial and strategic planning). WIRELINE The Southern New England Telephone Company's Telecommunications Services The Southern New England Telephone Company ("Telephone Company"), a local exchange carrier ("LEC"), was incorporated in 1882 under the laws of the State of Connecticut and is engaged in providing telecommunications services in Connecticut, subject to various forms of regulation. These telecommunications services include: local and intrastate toll services; network access service, which links customers' premises to the facilities of other carriers; and other services such as digital transmission of data and transmission of radio and television programs, packet switched data network and private line services. In 1996, approximately 68% of the Corporation's consolidated revenues and sales were derived from the Telephone Company's telecommunications services and approximately 11% were derived from wireless sales. The remainder was derived principally from directory publishing operations, national and international long- distance services, the Corporation's other subsidiaries, and activities associated with the provision of facilities and non- access services to interexchange carriers. About 70% of the operating revenues from the Telephone Company's telecommunications services were attributable to intrastate operations, with the remainder attributable to interstate access services. The Telephone Company's access lines in service grew to 2,163,000 at December 31, 1996 from 2,073,000 at December 31, 1995, an increase of 4.3%. The increase resulted primarily from growth in Centrex business lines and second residential lines. The network access lines provided by the Telephone Company to customers' premises can be interconnected with the access lines of other telephone 3 companies in the United States and with telephone systems in most other countries. The following table sets forth, for the Telephone Company, the number of network access lines in service at the end of each year: Network Access Lines in Service (thousands): 1996 1995 1994 1993 1992 Residence 1,444 1,415 1,379 1,355 1,340 Business 719 658 630 609 597 Total 2,163 2,073 2,009 1,964 1,937 The Telephone Company is subject to the jurisdiction of the Federal Communications Commission ("FCC") with respect to interstate rates, services, access charges and other matters, including the prescription of a uniform system of accounts. The FCC also prescribes the principles and procedures (referred to as "separations procedures") used to separate investments, revenues, expenses, taxes and reserves between the interstate and intrastate jurisdictions. In addition, the FCC has adopted accounting and cost allocation rules for the separation of costs of regulated from non-regulated telecommunications services for interstate ratemaking purposes. The Telephone Company's interstate access services have been subject to price cap regulation since January 1991. Price caps are a form of incentive regulation to limit prices and improve productivity. The price cap plan sets maximum limits on prices and requires LECs to share with customers earnings in excess of authorized levels. The Telephone Company, in providing telecommunications services in Connecticut, is subject to regulation by the Connecticut Department of Public Utility Control ("DPUC"), which has jurisdiction with respect to intrastate rates and services and other matters such as the approval of accounting procedures and the issuance of securities. The DPUC has adopted accounting and cost allocation rules for intrastate ratemaking purposes, similar to those adopted by the FCC, for the separation of costs of regulated from non-regulated activities. The Telephone Company's intrastate services have been subject to the traditional rate of return regulation. Effective April 1, 1996, the DPUC replaced traditional rate of return regulation with alternative (price based) regulation to be employed during the transition to full competition [see State Regulatory Initiatives]. Competition As a result of legislative and regulatory reform, the Corporation continues to experience an increasingly competitive environment with respect to telecommunications services in Connecticut. Competitors include interexchange carriers and competitive access providers with respect to the wireline's (Telephone Company's) existing services. In 1996, major carriers intensified their marketing efforts to sell intrastate long- distance services with full implementation of intrastate equal access. In addition, providers began offering local exchange service to businesses in certain areas of the state. Management supports bringing to customers the benefit of competition and affording all competitors the opportunity to compete fairly under reduced regulation. The competitive environment also provides opportunities for the Corporation to continue to grow its interstate and international long-distance service and to launch its cable television service in 1997. The Telephone Company's currently regulated services are subject to competition from companies and carriers, including competitive access providers, that construct and operate their own communications systems and networks, as well as from companies that resell the telecommunications systems and networks of underlying carriers. Since the introduction of intrastate long- distance toll competition, in excess of 170 telecommunications providers have received approval from the DPUC to offer intrastate 4 long-distance services. In addition, over 50 companies have filed for initial certificates of public convenience and necessity in order to offer intrastate long-distance services and are awaiting DPUC approval. The reduction in intrastate toll rates, and the increasingly competitive intrastate toll market continue to place significant downward pressure on intrastate toll revenues. To provide competitive toll products, wireline led the industry in 1996 by introducing the option of one-second rating for all toll calls so customers only pay for the time they talk. Wireline also successfully promoted the one bill feature of SNET All Distance[R], a seamless toll service product line which provides discount calling plans that include intrastate, interstate and international calling. The migration of Connecticut customers to wireline's bundled calling plans resulted in significant growth for interstate and international long-distance services. Concerning competition for local exchange service, seventeen telecommunications providers have been granted certificates of public convenience and necessity for local service and one additional application is pending before the DPUC. With only a few smaller companies offering local service in 1996, including a cable television company, competition did not have the impact on local service revenues as originally anticipated. Local service competition is expected to grow significantly in 1997; however, the financial impact cannot be predicted at this time. Based on existing state and federal regulations, the Telephone Company expects that many competitors will resell the Telephone Company's network and that increased network access revenues will offset a significant portion of local service revenues lost to competition. The Corporation's ability to compete is dependent upon regulatory reform that will allow pricing flexibility to meet competition and provide a level playing field with similar regulation for similar services and with reduced regulation to reflect an emerging competitive marketplace. Regulatory Matters Federal Regulatory Initiatives On February 8, 1996, Congress passed the Telecommunications Act of 1996 ("Act"). The Act was designed to overhaul U.S. Telecommunication policy by removing barriers to local competition. The Federal Communications Commission's ("FCC") First and Second Report and Order ("Order"), adopted August 1, 1996, implements the Act and contains numerous provisions regarding the interconnection of the Telephone Company's network with those of its competitors. Significant changes to network and data systems will be required for the Telephone Company to comply with the Order. In addition, the Order would require fundamental changes in the development of the prices that the Telephone Company would charge competitors for purchasing regulated network products and services. These decisions are the first of three major rule makings to carry out the Act. Future decisions will include universal service and access charge reform, discussed below. The Order, as well as universal service and access charge reform, could have a material negative impact on the Telephone Company. The Order was appealed and a stay was requested by various local telephone companies, including the Telephone Company, the National Association of Regulatory Utility Commissioners and individual state regulatory commissions. On October 15, 1996, the Eighth Circuit Court of Appeals ("Eighth Circuit") issued a partial stay of the Order, delaying the effectiveness of the pricing provisions and the rule allowing competitors to "pick and choose" isolated terms out of negotiated interconnection agreements. The FCC appealed the Eighth Circuit's decision to stay these rules to the Supreme Court. The Supreme Court, however, subsequently declined to hear the appeal. Oral arguments on the Order were heard by the Eighth Circuit on January 17, 1997. A decision is expected in the first half of 1997. In the 5 meantime, the Telephone Company has proceeded to negotiate several interconnection agreements with other carriers in accordance with the FCC's directives not affected by the Eighth Circuit's stay. In accordance with the Act, the Federal-State Joint Board adopted a Recommended Decision on Universal Service on November 7, 1996. The recommendation addresses the universal service provisions of the Act and proposes that one federal fund be established to provide support for universal service. The proposal calls for interstate telecommunications service providers to contribute to the fund based on their telecommunications revenue, net of payments to other carriers. The revenue to be assessed may either be total interstate and intrastate revenue, or interstate revenue only. By May 1997, the FCC is required to issue an order implementing the universal service section of the Act. On December 24, 1996, the FCC also released a Notice For Proposed Rule Making, seeking comments on proposed changes to the way the Telephone Company recovers interstate access charges from interstate toll providers, including SNET America, Inc. Implications of the FCC's proposal indicate that the industry could experience reduced access revenues. The Telephone Company provided comments to the FCC proposal on January 27, 1997. A decision from the FCC regarding this matter is expected in April or May 1997. The Telephone Company's 1996 annual interstate access tariff filing included a 4.0% productivity factor and allowed a 12.25% interstate rate of return. The filing is anticipated to decrease interstate network access rates by $2.3 million for the period July 1, 1996 to June 30, 1997. Management expects this decrease to be offset by increased demand. As of December 31, 1996, the Telephone Company's interstate rate of return was below the 12.25% threshold. The Telephone Company's 1995 annual interstate access tariff filing under price cap regulation incorporated rate reductions of approximately $10 million in decreased interstate network access revenues for the period August 1, 1995 to June 30, 1996. The decrease was offset by increased demand. The calendar year 1995 interstate rate of return of 11.58%, which was below the 12.25% threshold, was reported to the FCC. The Telephone Company will file its 1997 annual interstate access tariff in April 1997 to become effective July 1, 1997. The filing will adjust interstate access rates for an experienced rate of inflation, the FCC's productivity target and exogenous cost changes, if any. The Telephone Company does not anticipate changing its 4.0% productivity factor election. Since January 1, 1988, the Telephone Company has utilized an FCC approved, company-specific Cost Allocation Manual ("CAM"), which apportions costs between regulated and non-regulated activities, and describes the nature of the transactions between the Telephone Company and its affiliates. In addition, the FCC requires larger LECs, including the Telephone Company, to undergo an annual independent audit to determine whether the LEC is in compliance with its approved CAM. The Telephone Company has received audit reports for 1988 through 1995 indicating it is in compliance with its CAM, and is currently undergoing an audit for the year 1996. State Regulatory Initiatives In compliance with the Act, the Telephone Company has filed with the DPUC numerous cost studies supporting its proposed wholesale (i.e., resale) and unbundled rates for interconnection services. In light of the Order, on March 4, 1997, the DPUC issued a second draft decision setting a 17.8% discount rate for local residence service. A final decision is expected in late March 1997. 6 The DPUC's review of the Telephone Company's cost studies related to unbundled elements is still pending. Hearings were held the first week in February 1997, with a final decision expected in April 1997. This decision is expected to address the Telephone Company's offerings of unbundled elements of its facilities and associated interconnection arrangements. In March 1996, the DPUC replaced traditional rate of return regulation with alternative (price based) regulation, effective April 1, 1996, during the transition to full competition. The decision contains the following major items: price cap regulation for non-competitive services; a five year monitoring period on financial results; and a price cap formula on services categorized as non-competitive (utilizing an inflation factor, a 5% productivity offset, a narrowly defined exogenous factor, a potential service quality adjustment and various pricing bands). In addition, basic local service rates for residence, business and coin may not be raised above current levels until January 1, 1998, at which time the price cap formula becomes effective for these services, unless they have been reclassified into the emerging competitive or competitive categories. The decision also authorized a rate of return on the Telephone Company's common equity of 11.90% during the monitoring period. The impact of these changes on the Telephone Company's operating results will depend on the timing of classifying the various products and services into categories (non-competitive, emerging competitive and competitive) for pricing (banding) changes. As of December 31, 1996, the Telephone Company's rate of return was 7.95%. On November 27, 1996, the DPUC granted the Telephone Company's request to reclassify message toll and calling card services from the non-competitive category to competitive in its entire service territory. Reclassification provides the Telephone Company with the opportunity to gain additional promotional and pricing flexibility for its products and services, and to operate under regulatory guidelines similar to its competitors. On January 24, 1997, the Corporation filed a proposal with the DPUC outlining steps to structure its wireline business, including the Telephone Company, into separate retail and wholesale subsidiaries. Under the proposal, the new retail organization, a competitive local exchange carrier, will compete under the same regulations as all other retail telecommunications providers in the state and will bring innovative packages of products and services to the consumer. The LEC, primarily the Telephone Company's wholesale business, will provide network services and functionality to retail providers, including the Corporation's new retail business, on neutral terms. The directory publishing operations will also be structured as a separate subsidiary of the Corporation. A decision is expected in late June 1997. SNET America, Inc. SNET America, Inc. ("SNET America") was incorporated in 1993 under the laws of the State of Connecticut. SNET America resells a complete range of interstate and international long-distance services to Connecticut customers, including calling card and "800" service, along with volume discount plans such as SNET All Distance Simple Solutions, a calling plan for small business and residence customers. SNET America and the Telephone Company jointly sell toll services. This enables the Corporation to satisfy its customers' long-distance calling needs with a single point of contact through SNET All Distance, a seamless toll service product line which provides discount calling plans that include intrastate, interstate and international calling. The joint marketing as SNET All Distance has produced such features as one- second rating and one bill for all toll calls. [See Competition]. 7 SNET Diversified Group, Inc. SNET Diversified Group, Inc. ("Diversified") was incorporated in 1986 under the laws of the State of Connecticut in order to identify and develop new, non-regulated business opportunities. The majority of Diversified's activities is the offering of premium services, such as information and enhanced network- related services. Another activity is leasing and selling customer premises equipment ("CPE") to residential and small business customers. Key telephone systems and related products are offered and maintained which are complementary to the Telephone Company's central office-based solutions. Diversified faces significant competition from numerous department store, discount store and business equipment retailers that carry CPE. Diversified has differentiated its product line from its competitors by offering a wide array of quality products including leasing options. WIRELESS The Corporation provides cellular (wholesale and retail), personal communications, equipment sales and paging resale services in Connecticut, Rhode Island and certain areas in Massachusetts, through its subsidiaries SNET Cellular, Inc. ("Cellular"), SNET Mobility, Inc. ("Mobility") and, prior to 1996, SNET Paging, Inc. ("Paging"). SNET Cellular, Inc. Cellular was incorporated in 1985 under the laws of the State of Connecticut. In 1990, Cellular formed the Springwich Cellular Limited Partnership ("Springwich") with four other partners. Springwich is authorized to provide wholesale cellular radio telecommunications services in the Hartford, New Haven, New London, and Fairfield, Connecticut New England County Metropolitan Areas ("NECMAs") and in the Springfield, Massachusetts NECMA. Springwich also is licensed to provide cellular wholesale service in three Rural Service Areas, Windham and Litchfield Counties in Connecticut and Franklin County in Massachusetts. In July 1995, Cellular purchased from Bell Atlantic Corporation ("Bell Atlantic"), NYNEX Corporation ("NYNEX") and Richmond Telephone Company, for approximately $456 million in aggregate, certain cellular properties in Rhode Island and New Bedford and Pittsfield, Massachusetts, and an increased interest in Springwich. In total, these acquisitions expanded Cellular's service area by approximately 2.3 million POPs (population equivalents) to approximately 5.5 million POPs along the Boston to New York corridor. Under the new partnership structure, Cellular holds a 98.6% partnership interest in Springwich. Cellular has "roamer agreements" with other carriers which allow the carriers' subscribers access to Cellular's network and allow Cellular's subscribers access to other networks throughout the United States and Canada. Cellular is currently subject to FCC jurisdiction. In November 1996, the DPUC opened an investigation to determine whether wireless service was a replacement for landline telephone service. The DPUC will review number administration, Connecticut market conditions, intrastate land line local and toll usage, and cellular intrastate usage. If wireless service is determined to be a replacement for land line service, the DPUC plans to petition the FCC for rate regulation authority. During 1994, the FCC issued a spectrum plan allocating radio spectrum to be licensed for the provision of new personal communications services ("PCS"). As a result of the plan, licenses for separate blocks of spectrum were auctioned to potential PCS providers in geographic areas of the United States through 8 1996. Various telecommunications groups, including primarily all the nation's largest telephone companies, competed for licenses to offer PCS in markets including Cellular's coverage area. These blocks of spectrum could be used to provide a range of wireless services including advanced paging, wireless data services and two-way voice communications. The Corporation did not participate in these auctions since it had adequate spectrum to provide competitive services. In July 1995, Bell Atlantic and NYNEX completed the merger of their cellular service properties. This combination created the largest wireless service provider on the East Coast and the second largest provider in the United States. Cellular expects increasing competition from new alliances and the impact from auctions of PCS licenses. A purchaser of PCS spectrum is expected to launch the first digital service in Connecticut during 1997, creating a third major wireless provider in the state. Cellular has made and will continue to make investments in network expansion and enhancements. SNET Mobility, Inc. Mobility was incorporated in 1985 under the laws of the State of Connecticut under its predecessor's name SNET MobileCom, Inc. Mobility purchases wholesale cellular communications service from Springwich and resells cellular communications service to the retail market under the registered trademark LINX[R] in Springwich's service area. During 1996, Mobility launched SNET Personal Phone Service[SM], a Local Service Area concept where subscribers may choose their county of service at a favorable rate in contrast to traditional cellular service, which is made available at peak and offpeak rates for entire cellular markets. Mobility is the first provider of this service in its franchise area. Mobility markets its services through its internal sales force and through agreements with third-party distributors and dealers. Mobility anticipates continuing competition from local, regional and national resellers. Over the past few years, intense competition for new subscribers has led to increases in the market and increases in selling and promotional costs. In response to this competition, Mobility continues to evaluate the quality of its distribution channels, price aggressively, bundle with other telecommunications services and introduce both creative customer acquisition programs and differentiated value- added services. SNET Paging, Inc. Paging was incorporated in February 1990 under the laws of the State of Connecticut and launched service on April 1, 1991. On June 30, 1995, Paging and a subsidiary completed the sale of substantially all of its paging network assets and the subsidiary's reseller accounts, to Paging Network of New York, Inc. Paging was merged into Mobility on May 30, 1996, with Mobility retaining the Paging retail accounts and continuing, as a reseller, to market paging services under the Page 2000[R] brand name. INFORMATION AND ENTERTAINMENT Publishing Operations The Telephone Company's publishing operations produces and distributes traditional paper products including White and Yellow Pages directories throughout Connecticut and adjacent communities. To strategically widen its business focus and position itself for the future, the publishing operations 9 introduced electronic publishing services, such as SNET Access[SM], Consumer Tips and Electronic Yellow Pages. The Connecticut advertising marketplace is undergoing major structural changes and is becoming increasingly more fragmented and competitive. The publishing division faces increased competition from traditional directory publishers and non- traditional services such as on-line services, desktop publishing, electronic shopping services, CD-ROM and the expansion of cable television. Furthermore, additional competition may arise from the Regional Bell Operating Companies' ability to offer information services. SNET Personal Vision, Inc. On September 6, 1996, SNET Personal Vision, Inc. ("Personal Vision") received an 11 year license from the DPUC to operate a community antenna television system that will serve the entire state of Connecticut. Personal Vision also became a partner in the americast joint venture with The Walt Disney Company, Ameritech Corporation, BellSouth Corporation, SBC Communications Inc. and GTE Corporation. The partnership will provide a full range of americast[TM] programming and marketing services and access to the joint venture's innovative technology. Personal Vision will launch its cable service, SNET americast, in the spring of 1997. Internet Service On January 31, 1996, the Corporation launched SNET Internet[SM] access service, which allows all subscribers in the state of Connecticut to access the Internet with a local phone call. OTHER SERVICES SNET Real Estate, Inc. SNET Real Estate, Inc. ("Real Estate") was incorporated in 1983 under the laws of the State of Connecticut. Real Estate is the owner of commercial property which it leases under operating leases and is a 99% partner in a limited liability company that also leases commercial property. Currently, Real Estate is managing its existing portfolio and is not actively pursuing additional real estate investments. Real Estate faces a risk that real estate markets in which its properties are located, primarily Connecticut, may deteriorate from their current value. This risk is minimized by the conservative nature of Real Estate's portfolio, a majority of which is leased to affiliates. Holding Company On February 15, 1995, the DPUC provided the Corporation greater flexibility to diversify into new markets by lifting to 40% a nine-year-old restriction that prevented the Corporation from investing more than 25% of its total assets in unregulated diversified activities without approval of the DPUC. In January 1997, the Corporation requested the DPUC to completely lift the restriction. A decision is expected in late June 1997. EMPLOYEE RELATIONS The Corporation and its subsidiaries employed approximately 9,350 persons at February 28, 1997, of whom approximately 65% are represented by the Connecticut Union of Telephone Workers, Inc. ("CUTW"), an unaffiliated union. 10 On April 12, 1995, a new labor contract was ratified by members of the Connecticut Union of Telephone Workers, Inc. ("CUTW"). As part of the new contract, a voluntary Early Out Offer, which provided incentives in the form of enhanced pension benefits, was available to bargaining-unit employees during July 1995. Approximately 2,700 bargaining-unit employees accepted the offer at that time and left the Corporation by June 1996. CUTW members who remained with the Corporation received a combination of basic wage and lump sum increases to their wages or cash balance pension plan account totaling 4.0% in January 1996 and 3.0% in January 1997. In January 1998, they will receive a combination of basic wage and lump sum increases totaling 3.0%. In addition, the contract also provided a sign-on bonus and health benefit and pension enhancements. The new labor agreement will expire on August 8, 1998. The contract is intended to keep layoffs to a minimum while enabling the Corporation to position itself to meet increasing competition. Item 2. Properties The principal properties of the Corporation do not lend themselves to a detailed description by character and location. The majority of telecommunications property, plant and equipment of the Corporation is owned by the Telephone Company. Of the Corporation's investment in telecommunications property, plant and equipment at December 31, 1996, central office equipment represented 41%; connecting lines not on customers' premises, the majority of which are over or under public roads, highways or streets and the remainder over or under private property, represented 35%; land and buildings (occupied principally by central offices) represented 12%; telephone instruments and related wiring and equipment, including private branch exchanges, substantially all of which are on the premises of customers, represented 1%; and other, principally vehicles and general office equipment, represented 11%. Substantially all of the central office equipment installations and administrative offices are located in Connecticut in buildings owned by the Telephone Company situated on land which it owns in fee. Many garages, service centers and some administrative offices are located in rented quarters. The Corporation has a significant investment in the properties, facilities and equipment necessary to conduct its business with the overwhelming majority of this investment relating to telephone operations. Management believes that the Corporation's facilities and equipment are suitable and adequate for the business. Capital Expenditures The Corporation has been making, and expects to continue to make, significant capital expenditures to meet the demand for telecommunications services and to further improve such services. The total gross investment in property, plant and equipment increased from approximately $4.0 billion at December 31, 1991 to approximately $4.7 billion at December 31, 1996, after giving effect to retirements, but before deducting accumulated depreciation at either date. Since 1992, cash expended for capital additions was as follows: Dollars in Millions, 1996 1995 1994 1993 1992 For the Years Ended Cash Expended for Capital Additions $367 $354 $282 $267 $290 In 1996, the Corporation funded its cash expenditures for capital additions entirely through cash flows from operations. In 1997, capital additions are expected to be approximately $435 million, including 11 estimated additions of $262 to the wireline network. The Corporation expects to fund substantially all of its 1997 capital additions through cash flows from operations. The buildout of I-SNET, a $4.5 billion investment, is expected to be completed by 2007. I-SNET, a statewide telephony and information superhighway, is an advanced network capable of delivering voice, video and a full range of information and interactive multimedia services. I-SNET passed approximately 234,000 households by December 1996 and is expected to pass approximately 334,000 households by December 1997. The Telephone Company plans to support this investment primarily through increased productivity from the new technology deployed, ongoing cost-reduction initiatives and customer demand for the new services offered, including SNET americast. Item 3. Legal Proceedings The Corporation and certain of its subsidiaries are involved in various claims and lawsuits that arise in the normal conduct of their business. In the opinion of management, upon advice of counsel, these claims will not have a material adverse effect on the financial position, operating results or cash flows of the Corporation or its subsidiaries. Item 4. Submission of Matters to a Vote of Security Holders No matter was submitted to a vote of security holders in the fourth quarter of the fiscal year covered by this report. 12 Executive Officers of the Registrant (1) (as of February 28, 1997) Executive Officer Name Age(2) Position Since Daniel J. Miglio 56 Chairman, President and Chief Executive Officer 1/86 Jean M. LaVecchia 44 Senior Vice President- Organization Development 8/94 Fred T. Page 50 Senior Vice President- Network Services 2/96 Ronald M. Serrano 41 Senior Vice President- Communication, Information and Entertainment Group 1/93 Donald R. Shassian 41 Senior Vice President and Chief Financial Officer 12/93 (1) Executive officers subject to Section 16 of the Securities Exchange Act of 1934. (2) As of December 31, 1996. Mr. Miglio, Ms. LaVecchia and Mr. Page have held high level managerial positions with the Corporation or its subsidiaries for more than the past five years. Mr. Serrano was a Vice President of Mercer Management Consulting, Inc., (formerly Strategic Planning Associates) for more than five years prior to joining the Corporation. Mr. Shassian was a partner with Arthur Andersen & Co., independent accountants, for more than five years prior to joining the Corporation. 13 PART II Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters The common stock of the Corporation is listed on the New York and Pacific stock exchanges and the number of holders of record, computed on the basis of registered accounts, was 50,458 as of February 28, 1997. Information with respect to the quarterly high, low and closing sales price for the Corporation's common stock and quarterly cash dividends declared is included in the registrant's Annual Report to Shareholders on page 30 under the caption "Market and Dividend Data" and is incorporated herein by reference pursuant to General Instruction G(2). Items 6 through 8. Information required under Items 6 through 8 is included in the registrant's combined 1996 Annual Report to Shareholders and Proxy Statement dated March 20, 1997 on pages 6 through 29 in their entirety and is incorporated herein by reference pursuant to General Instruction G(2). The Corporation will adopt Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings Per Share," in fiscal year 1998. SFAS No. 128 establishes standards for computing and presenting earnings per share. Management does not expect the adoption of SFAS No. 128 to have a material impact on the earnings per share calculation. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure No changes in or disagreements with accountants on any accounting or financial disclosure occurred during the period covered by this report. PART III Items 10 through 13. Information required under Items 10 through 13 is included in the registrant's combined 1996 Annual Report to Shareholders and 1997 Proxy Statement dated March 20, 1997 on pages 35 through 44. Such information is incorporated herein by reference pursuant to General Instruction G(3). Information regarding executive officers of the registrant required by Item 401(b) and (e) of Regulation S-K is included in Part I of this Annual Report on Form 10-K, following Item 4. 14 PART IV Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K (a) Documents filed as part of the report: Page (1) Report of Management * Report of Independent Accountants * Consolidated Financial Statements: Consolidated Statements of Income (Loss) - for the years ended December 31, 1996, 1995 and 1994 * Consolidated Balance Sheets - as of December 31, 1996 and 1995 * Consolidated Statements of Changes in Shareholders' Equity - for the years ended December 31, 1996, 1995 and 1994 * Consolidated Statements of Cash Flows - for the years ended December 31, 1996, 1995 and 1994 * Notes to Consolidated Financial Statements * (2) Consolidated Financial Statement Schedule for the year ended December 31, 1996 Report of Independent Accountants 20 II - Valuation and Qualifying Accounts 21 Schedules other than those listed above have been omitted because the required information is contained in the financial statements and notes thereto, or because such schedules are not applicable. * Incorporated herein by reference to the appropriate portions of the registrant's combined 1996 Annual Report to Shareholders and 1997 Proxy Statement dated March 20, 1997 [see Part II]. 15 (3) Exhibits: Exhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. Exhibits numbered 10(iii)(A)1 through 10(iii)(A)16 are management contracts or compensatory plans required to be filed as exhibits pursuant to Item14(c) of Form 10-K. Exhibit Number 3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3-A to Form SE dated 3/15/91, File No. 1-9157). 3b By-Laws of the registrant as amended and restated through October 10, 1990 (Exhibit 3 to Form 8-K dated 10/10/90, File No. 1-9157). 4a Rights Agreement dated December 11, 1996 between Southern New England Telecommunications Corporation and State Street Bank and Trust Company, as Rights Agent (Exhibit 4 to Form 8-K dated 12/11/96, File No. 1-9157). 4b Indenture dated December 13, 1993 between The Southern New England Telephone Company and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $200,000,000 of 6 1/8% Medium-Term Notes, Series C, due December 15, 2003 and $245,000,000 of 7 1/4% Medium-Term Notes, Series C, due December 15, 2033 (Exhibit 4b to 1994 Form 10-K dated 3/10/95, File No. 1-9157). 4c Indenture dated July 10, 1991 between the registrant and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $100,000,000 of 6 1/2% Medium-Term Notes, Series 2, due August 15, 2000 and $200,000,000 of 7% Medium-Term Notes, Series 2, due August 15, 2005 (Exhibit 4c to 1995 Form 10-K dated 3/20/96, File No. 1-9157). 10(iii)(A)1 SNET Short Term Incentive Plan as amended February 8, 1995 (Exhibit 10(iii)(A)1 to 1994 Form 10-K dated 3/10/95, File No. 1-9157). 10(iii)(A)2 SNET Long Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)2 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)3 SNET Financial Counseling Program as amended January 1987 (Exhibit 10-D to Form SE dated 3/23/87-1, File No. 1-9157). 10(iii)(A)4 Group Life Insurance Plan and Accidental Death and Dismemberment Benefits Plan for Outside Directors of SNET as amended July 1, 1986 (Exhibit 10-E to Form SE dated 3/23/87-1, File No. 1-9157). 16 (3) Exhibits (continued): Exhibit Number 10(iii)(A)5 SNET Pension Benefit Plan as amended November 1, 1991 (Exhibit 10-A to Form SE dated 3/20/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10(iii)(A)5 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). Amendment dated February 8, 1995 (Exhibit 10(iii)(A)5 to 1994 Form 10-K dated 3/10/95, File No. 1-9157). Amendments effective December 13, 1995 and January 1, 1996 (Exhibit 10(iii)(A)5 to 1995 Form 10-K dated 3/20/96, File No. 1-9157). 10(iii)(A)6 SNET Management Pension Plan as amended March 31, 1995. Amendments effective December 20, 1995 through April 1, 1996 (Exhibit 10(iii)(A)6 to 1995 Form 10-K dated 3/20/96, File No. 1-9157). Amendments effective April 1, 1996 through December 18, 1996. 10(iii)(A)7 SNET Incentive Award Deferral Plan as amended March 1, 1993 (Exhibit 10(iii)(A)7 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)8 SNET Mid-Career Pension Plan as amended November 1, 1991 (Exhibit 10-D to Form SE dated 3/20/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)8 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). 10(iii)(A)9 SNET Deferred Compensation Plan for Non-Employee Directors as amended January 1, 1993 (Exhibit 10(iii)(A)9 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)10 Change-in-Control Agreements (Exhibit 10-F to Form SE dated 3/15/91, File No. 1-9157). 10(iii)(A)11 SNET 1986 Stock Option Plan as amended March 1, 1993 (Exhibit 10(iii)(A)11 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)12 SNET Retirement and Disability Plan for Non- Employee Directors as amended April 14, 1993 (Exhibit 10(iii)(A)12 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). Amendment dated February 14, 1996. 10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration No. 33-51055 on Form S-8, File No. 1-9157). 10(iii)(A)14 Description of SNET Executive Retirement Savings Plan (Exhibit 10(iii)(A)14 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). 10(iii)(A)15 SNET 1995 Stock Incentive Plan (Exhibit 4.4 to Registration No. 33-64975, File No. 1-9157). 10(iii)(A)16 SNET Non-Employee Director Stock Plan effective June 1, 1996 (Exhibit 4.2 to Registration No. 333- 05757 on Form S-8, File No. 1-9157). 17 (3) Exhibits (continued): Exhibit Number 12 Computation of Ratio of Earnings to Fixed Charges. 13 Pages 6 through 30 of the registrant's 1996 Annual Report to Shareholders for the fiscal year ended December 31, 1996. 21 Subsidiaries of the Corporation. 23 Consent of Independent Accountants. 24a Powers of Attorney. 24b Board of Directors' Resolution. 27 Financial Data Schedule. 99a Annual Report on Form 11-K for the plan year ended December 31, 1996 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1997. 99b Annual Report on Form 11-K for the plan year ended December 31, 1996 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1997. The Corporation will furnish, without charge, to a shareholder upon request a copy of the combined 1996 Annual Report to Shareholders and Proxy Statement, portions of which are incorporated by reference, and will furnish any other exhibit at cost. (b) Reports on Form 8-K: On October 22, 1996, the Corporation and the Telephone Company filed, separately, reports on Form 8-K, dated October 22, 1996 announcing the Corporation's financial results for the third quarter of 1996. The Corporation's Form 8-K also announced the acquisition of Woodbury Telephone Company [see Note 2]. On December 13, 1996, the Corporation filed a report on Form 8-K, dated December 11, 1996 announcing the renewal of the existing shareholder rights plan and declaring a dividend of one preference share purchase right for each outstanding share of the Corporation's common stock [see Note 12]. On January 21, 1997, the Corporation and the Telephone Company filed, separately, reports on Form 8-K, dated January 21, 1997, announcing the Corporation's 1996 financial results. 18 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION By /s/ Donald R. Shassian Donald R. Shassian, Senior Vice President and Chief Financial Officer March 20, 1997 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated. PRINCIPAL EXECUTIVE OFFICER: Daniel J. Miglio* Chairman, President, Chief Executive Officer and Director PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER: Donald R. Shassian By /s/ Donald R. Shassian Senior Vice President (Donald R. Shassian, as attorney- and Chief Financial Officer in fact and on his own behalf) DIRECTORS: William F. Andrews* Richard H. Ayers* Zoe Baird* Robert L. Bennett* Barry M. Bloom* March 20, 1997 Frank J. Connor* William R. Fenoglio* Claire L. Gaudiani* James R. Greenfield* Ira D. Hall* Burton G. Malkiel* Frank R. O'Keefe, Jr.* * by power of attorney 19 REPORT OF INDEPENDENT ACCOUNTANTS To the Shareholders of Southern New England Telecommunications Corporation: Our report on the consolidated financial statements of Southern New England Telecommunications Corporation has been incorporated by reference in this Form 10-K from the combined Proxy Statement and 1996 Annual Report to Shareholders of Southern New England Telecommunications Corporation on page 13 therein. In connection with our audits of such financial statements, we have also audited the related financial statement schedule for each of the three years in the period ended December 31, 1996 listed in Item 14 (a) (2) of this Form 10-K. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein. Hartford, Connecticut COOPERS & LYBRAND L.L.P. January 21, 1997 20 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (Dollars in Millions) COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E Additions Balance at Balance beginning of Charged to Charged to at end Description period expense other accounts Deductions of period Allowance for Uncollectible Accounts Receivable: Year 1996 $34.2 $42.6 $5.1 (a) $54.5 (b) $27.4 Year 1995 29.8 23.1 3.6 (a) 22.3 (b) 34.2 Year 1994 27.9 20.7 7.5 (a) 26.3 (b) 29.8 Allowance for Uncollectible Direct-Financing Lease Notes Receivable: Year 1996 $ 9.7 $ 1.8 $ - $ 0.5 (b) $11.0 Year 1995 8.4 1.4 - 0.1 (b) 9.7 Year 1994 11.7 1.7 - 5.0 (b) 8.4 Restructuring Charge: Year 1996 $ 77.0 $ - $ - $ 45.5 (c) $ 31.5 Year 1995 264.9 - - 187.9 (c) 77.0 Year 1994 355.0 - - 90.1 (c) 264.9 (a) Includes amounts previously written off that were credited directly to this account when recovered and miscellaneous amounts. (b) Includes amounts written off as uncollectible. 1996 also includes fully reserved amounts written off of $17.8 as a result of a revised procedure to write off uncollectible accounts receivable within a shorter time frame. (c) Includes non-cash net pension and postretirement settlement gain charged against the restructuring reserve of $65.1 in 1996 and curtailment losses of $102.2 and $14.2 in 1995 and 1994, respectively. 21 EXHIBIT INDEX Exhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. Exhibit Number 3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3-A to Form SE dated 3/15/91, File No. 1-9157). 3b By-Laws of the registrant as amended and restated through October 10, 1990 (Exhibit 3 to Form 8-K dated 10/10/90, File No. 1-9157). 4a Rights Agreement dated December 11, 1996 between Southern New England Telecommunications Corporation and State Street Bank and Trust Company, as Rights Agent (Exhibit 4 to Form 8-K dated 12/11/96, File No. 1-9157). 4b Indenture dated December 13, 1993 between The Southern New England Telephone Company and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $200,000,000 of 6 1/8% Medium-Term Notes, Series C, due December 15, 2003 and $245,000,000 of 7 1/4% Medium-Term Notes, Series C, due December 15, 2033 (Exhibit 4b to 1994 Form 10-K dated 3/10/95, File No. 1-9157). 4c Indenture dated July 10, 1991 between the registrant and Fleet National Bank of Connecticut, Trustee, issued in connection with the sale of $100,000,000 of 6 1/2% Medium-Term Notes, Series 2, due August 15, 2000 and $200,000,000 of 7% Medium-Term Notes, Series 2, due August 15, 2005 (Exhibit 4c to 1995 Form 10-K dated 3/20/96, File No. 1-9157). 10(iii)(A)1 SNET Short Term Incentive Plan as amended February 8, 1995 (Exhibit 10(iii)(A)1 to 1994 Form 10-K dated 3/10/95, File No. 1-9157). 10(iii)(A)2 SNET Long Term Incentive Plan as amended March 1, 1993 (Exhibit 10(iii)(A)2 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)3 SNET Financial Counseling Program as amended January 1987 (Exhibit 10-D to Form SE dated 3/23/87-1, File No. 1-9157). 10(iii)(A)4 Group Life Insurance Plan and Accidental Death and Dismemberment Benefits Plan for Outside Directors of SNET as amended July 1, 1986 (Exhibit 10-E to Form SE dated 3/23/87-1, File No. 1-9157). 10(iii)(A)5 SNET Pension Benefit Plan as amended November 1, 1991 (Exhibit 10-A to Form SE dated 3/20/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10(iii)(A)5 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). Amendment dated February 8, 1995 (Exhibit 10(iii)(A)5 to 1994 Form 10-K dated 3/10/95, File No. 1-9157). Amendments effective December 13, 1995 and January 1, 1996 (Exhibit 10(iii)(A)5 to 1995 Form 10-K dated 3/20/96, File No. 1-9157). 10(iii)(A)6 SNET Management Pension Plan as amended March 31, 1995. Amendments effective December 20, 1995 through April 1, 1996 (Exhibit 10(iii)(A)6 to 1995 Form 10-K dated 3/20/96, File No. 1-9157). Amendments effective April 1, 1996 through December 18, 1996. 10(iii)(A)7 SNET Incentive Award Deferral Plan as amended March 1, 1993 (Exhibit 10(iii)(A)7 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)8 SNET Mid-Career Pension Plan as amended November 1, 1991 (Exhibit 10-D to Form SE dated 3/20/92, File No. 1-9157). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)8 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). 10(iii)(A)9 SNET Deferred Compensation Plan for Non-Employee Directors as amended January 1, 1993 (Exhibit 10(iii)(A)9 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)10 Change-in-Control Agreements (Exhibit 10-F to Form SE dated 3/15/91, File No. 1-9157). 10(iii)(A)11 SNET 1986 Stock Option Plan as amended March 1, 1993 (Exhibit 10(iii)(A)11 to 1992 Form 10-K dated 3/23/93, File No. 1-9157). 10(iii)(A)12 SNET Retirement and Disability Plan for Non- Employee Directors as amended April 14, 1993 (Exhibit 10(iii)(A)12 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). Amendment dated February 14, 1996. 10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration No. 33-51055 on Form S-8, File No. 1-9157). 10(iii)(A)14 Description of SNET Executive Retirement Savings Plan (Exhibit 10(iii)(A)14 to 1993 Form 10-K dated 3/23/94, File No. 1-9157). 10(iii)(A)15 SNET 1995 Stock Incentive Plan (Exhibit 4.4 to Registration No. 33-64975, File No. 1-9157). 10(iii)(A)16 SNET Non-Employee Director Stock Plan effective June 1, 1996 (Exhibit 4.2 to Registration No. 333- 05757 on Form S-8, File No. 1-9157). 12 Computation of Ratio of Earnings to Fixed Charges. 13 Pages 6 through 30 of the registrant's 1996 Annual Report to Shareholders for the fiscal year ended December 31, 1996. 21 Subsidiaries of the Corporation. 23 Consent of Independent Accountants. 24a Powers of Attorney. 24b Board of Directors' Resolution. 27 Financial Data Schedule. 99a Annual Report on Form 11-K for the plan year ended December 31, 1996 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1997. 99b Annual Report on Form 11-K for the plan year ended December 31, 1996 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1997. EX-10.1 2 SNET MANAGEMENT PENSION PLAN A summary of amendments to the SNET Management Pension Plan ("Plan") is as follows: Effective April 1, 1996: An annuitant of any former employee who received a disability pension on or after January 1, 1976 and is receiving an annuitant pension as of April 1, 1996 shall be eligible to receive this pension payable from the trust fund instead of SNET operating funds. Effective June 1, 1996: The termination of employees who received benefits under the SNET Management Severance Pay Plan shall not be considered as a temporary layoff for purposes of this Pension Plan. If such an employee is rehired, except as provided in Sec. 6, Paragraph 4, the continuity of service shall be deemed to have been broken for all purposes and such employee shall not receive service credit under the Sec. 6, Paragraph 6 of the Pension Plan. However, this amendment shall have no effect to any employee who was offered the Severance Pay Plan prior to June 1, 1996 and left SNET with Severance Plan benefits on or after June 1, 1996 and prior to January 1, 1997. Effective September 15, 1996: Employees can no longer submit written direction that any death benefit be payable to a qualified beneficiary in monthly installments. Surviving spouses of terminated employees may elect to defer receipt of their pension benefits until a later date, up to when the employee would have reached age 65. Effective October, 1996 and later: For purposes of determining the maximum pension benefit payable and distributed under this Plan under the IRC Section 415(b)(2)(E), the interest and mortality provisions of the Uruguary Round Agreement Act (GATT) which provided for the use of the 30-Year Treasury rate and the table prescribed by the Secretary of the Treasury under Code Section 417(e)(3) are repealed and the interest and mortality rate assumptions previously in effect prior to the adoption of GATT have been reinstated. Effective December 18, 1996: The "Consent to Receive Distributions" provisions of the Plan are amended to provide that if the employee notifies SNET in writing of his election to begin receiving his pension payments after the 90-day election period, the monthly pension payments shall be payable beginning the day SNET receives the election form, unless the Secretary is made aware in writing during the 90-day election period of a pending divorce action which may assign pension benefits to the Alternate Payee, or is made aware by the employee in writing after the 90-day election period that such employee did not receive such written explanation of election and consent as provided in Paragraph (4)(B) of this Article VII, or the Secretary is made aware by the Employee in writing during the 90-day election period that such employee has notified the Company that he or she is contesting his or her termination of employment from SNET or a Participating Company through a grievance, arbitration, lawsuit or complaint with an administrative agency with appropriate jurisdiction and the secretary approves, in his or her discretion, monthly pension payments when elected within the 90 day election period begin the day following the Employee's termination of employment date or such other pension distribution options, including the lump sum distribution option, otherwise available only upon termination of employment. EX-10.2 3 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION Amendment of Retirement and Disability Plan for Non-Employee Directors. On February 14, 1996, the Retirement and Disability Plan for Non-Employee Directors of Southern New England Telecommunications Corporation (the "Plan") was amended to provide that eligibility for benefits under the Plan shall be limited to those participants as of February 14, 1996, that the amount of accrued pension benefits for participants shall be frozen as of May 31, 1996 and that benefits payable to participants shall continue to be paid under the terms of the Plan until such benefit obligations are satisfied whereupon the Plan shall terminate. EX-12 4 EXHIBIT 12 1996 Form 10-K Southern New England Telecommunications Corporation Computation of Ratio of Earnings to Fixed Charges Dollars in Millions, For the Year Ended December 31, 1996 Income before income taxes $300.4 Add: Interest on indebtedness 88.2 Portion of rents representative of the interest factor 7.0 Earnings before fixed charges and income taxes (1) $395.6 Fixed charges Interest charges $ 95.4 Portion of rents representative of the interest factor 7.0 Fixed charges (2) $102.4 Ratio of earnings to fixed charges [(1) divided by (2)] 3.86 EX-13 5 SNET LOGO Southern New England Telecommunications Corporation 227 Church Street New Haven, Connecticut 06510 - ------------------------------------------------------------------------------- 1996 ANNUAL REPORT & 1997 PROXY STATEMENT - ------------------------------------------------------------------------------- WIRELINE WIRELESS INFORMATION AND ENTERTAINMENT TABLE OF CONTENTS FINANCIAL INFORMATION Financial Highlights 1 Year in Review 2 Letter to Shareowners 3 Financial Commentary 6 Report of Management 13 Report of Independent Accountants 13 Statements of Income (Loss) 14 Balance Sheets 15 Statements of Changes in Shareholders' Equity 16 Statements of Cash Flows 17 Notes to Consolidated Financial Statements 18 Financial and Statistical Data (Unaudited) 29 Investor Information 30 Other Information 31 NOTICE OF ANNUAL MEETING 33 PROXY STATEMENT Proxy Information 35 Beneficial Ownership of Common Stock 35 Election of Directors (Proposal 1) 36 Nominees for Election as Directors 36 Directors Continuing in Office 36 Compensation and Other Information Regarding Directors 38 Committees of the Board 38 Ratification of Appointment of Auditors (Proposal 2) 39 Submission of Shareholder Proposals 39 Other Matters to Come Before the Meeting 39 Report of Personnel Resources Committee of the Board of Directors on Executive Compensation 39 1996 Executive Compensation 39 CEO Compensation 40 Summary Compensation Table 41 Option/SAR Grants in the Last Fiscal Year 42 Aggregated Option/SAR Exercises in Last Fiscal Year and Fiscal Year End Option/SAR Values 43 Pension Plan 43 Change-in-Control Agreements 44 Certain Transactions 44 Performance Graph 44 Financial Statements 44 WHO WE ARE SNET is a Connecticut-based company reaching beyond its traditional borders to offer wireline, wireless and information and entertainment services, including local, national and international calling; mobile communications; and publishing, information and advertising. The company is building I-SNET(SM), a statewide, information superhighway that brings to customers a full array of information, communications and entertainment services. SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION FINANCIAL HIGHLIGHTS
Dollars in Millions, Except as Noted 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------- Operating Results Revenues and Sales $1,941.9 $1,816.4 $1,717.8 Annual Growth 6.9% 5.7% 3.6% Costs and Expenses(1) $1,203.6 $1,121.6 $1,014.9 Operating Cash Flow(2) $ 738.3 $ 694.8 $ 702.9 Net Income (Loss)(3) $ 192.8 $ (518.3) $ 177.6 - --------------------------------------------------------------------------------------------------------------- Per Common Share (dollars) Income Before Extraordinary Charge $ 2.94 $ 2.60 $ 2.77 Net Income (Loss)(3) $ 2.94 $ (7.99) $ 2.77 Dividends Declared $ 1.76 $ 1.76 $ 1.76 Market Price (year-end) $ 38.875 $ 39.750 $ 32.375 - --------------------------------------------------------------------------------------------------------------- At Year-End Total Assets $2,671.0 $2,724.2 $3,504.6 Debt Ratio(4) 74.9% 80.0% 51.0% Telephone Company Wireline Employees 8,167 7,742 8,604 Total Employees 9,441 9,070 9,797 - --------------------------------------------------------------------------------------------------------------- Statistical Data Network Access Lines in Service (thousands) 2,163 2,073 2,009 Annual Growth 4.3% 3.2% 2.3% Second Residential Network Access Lines in Service (thousands) 97 75 60 Annual Growth 29.3% 25.0% 27.7% Network Interstate Access Minutes of Use (millions) 7,906 7,298 6,917 Annual Growth 8.3% 5.5% 6.1% Cellular Subscribers (thousands)(5) 392 323 166 Annual Growth(5) 21.4% 94.6% 88.6% - --------------------------------------------------------------------------------------------------------------- Other Data Telephone Company Wireline Cost Per Access Line (dollars)(6) $ 332 $ 320 $ 340 Net Cash Provided by Operating Activities $ 470.2 $ 439.2 $ 422.6 Cash Expended for Capital Additions $ 366.6 $ 354.0 $ 282.3 Cash Dividends Paid $ 100.2 $ 98.0 $ 97.2 - --------------------------------------------------------------------------------------------------------------
(1) Excludes depreciation and amortization. (2) Represents operating income before depreciation and amortization. Operating cash flow is not a generally accepted accounting principle measurement. Management provides this measurement for informational purposes only. (3) 1995 includes a $1,202.6 before-tax extraordinary charge for the discontinuance of SFAS No. 71, "Accounting for the Effects of Certain Types of Regulation," that reduced net income and earnings per share by $687.1 and $10.59, respectively. (4) Excluding the effect of the non-cash extraordinary charge related to the discontinuance of SFAS No. 71, the 1995 debt ratio would have been 57.6%. Excluding the combined effect of the charge related to SFAS No. 71 and the debt issued to acquire the cellular properties, the 1995 debt ratio would have been 48.0%. (5) Excluding the subscribers from the acquired cellular properties, cellular subscribers would have increased 51.1% to 251,000 subscribers in 1995. (6) Excludes depreciation and amortization, property and other taxes, publishing and bad debt expenses. SNET Annual Report 1 YEAR IN REVIEW o We earned a record $2.94 per share for 1996, up 8%. o Our wireline business reported record growth in access lines, and Connecticut added an area code to accommodate burgeoning demand for telephone numbers. o Our wireless business continued robust growth -- revenues up 27% -- with improved margins. o We became the number two long-distance provider in Connecticut, as interstate/international revenues more than doubled. o We continued to build I-SNET(sm), our broadband, full-service network. Successful tests of telephony applications expanded to 2,000 customers. o We obtained the first ever, statewide cable-TV franchise and joined the americast partnership to gain world-class programming and technology. o We entered the Internet access business and leaped to the number two position in Connecticut. o We led the industry in offering billing to the nearest second so customers pay only for the time they talk on long-distance calls. o We challenged the FCC's interconnection order and gained a court stay of onerous provisions. o We signed a definitive agreement to acquire Woodbury Telephone, the only other independent telephone company in Connecticut. 2 SNET Annual Report LETTER TO SHAREOWNERS To Our Shareowners: Trailblazing is an SNET tradition. Our drive to take customers beyond the call is the reason behind our industry "firsts" and our finest accomplishments. SNET is now an information, communications and entertainment company well positioned for the 21st century. In this transitional era of converging technologies and markets, we are broadening and integrating our product lines, pursuing new growth opportunities and proving to be a very scrappy competitor. We are pioneering new broadband technology through a hybrid fiber/coaxial cable design that is less expensive than an all-fiber network and just as effective. This is creating a platform for further growth as we introduce and package an array of desirable information, communications and entertainment products. Our proven ability to compete in wireless and long distance prepares us for local telephone competition, which will heat up in 1997, and for expansion into the cable-TV market. In all of the following ways we have significant competitive strengths on which to build: o a strong brand name o a superior local presence and knowledge of customers o the broadest product line in the industry o an experienced, diverse and battle-tested management team o an employee team dedicated to quality and service o a versatile landline network throughout Connecticut o a wireless network covering Connecticut, Rhode Island and portions of Massachusetts o nimbleness of size: the ability to act and react quickly. Stock Price Disappointing Through the middle of 1996, our stock was doing relatively well, up about 4 percent. Beginning in July, the price declined with increasing investor uncertainty about the effects of local competition. Investor confidence plummeted further when the Federal Communications Commission (FCC) issued its Interconnection Order in August, a topic to which [Picture of Chairman] DANIEL J. MIGLIO Chairman and Chief Executive Officer I'll return. On top of those industry-wide developments, our margins were squeezed in the fourth quarter as costs rose to maintain service quality in the face of skyrocketing demand. We're taking aggressive steps to regain investor interest. We've challenged the FCC's decision and are committed to improving margins in 1997. Others in the industry will soon face the competition that we are succeeding against and our record will compare favorably. I believe investors will view our performance positively in the future and that our strong competitive position and growth prospects will be reflected in our stock price. Earnings Growth Continues Net income for 1996 was $193 million or $2.94 per share. This represents an 8 percent gain over the prior year's operating earnings before one-time items, including an extraordinary non-cash charge for a change in accounting method. Our strong revenues -- up 7 percent to $1,942 million -- reflect our ability to capitalize on growth opportunities in long distance and wireless. Our wireline business grew 6 percent as interstate/international long-distance revenues more than doubled. We led the industry in introducing billing to the nearest second and initiated a very effective campaign promoting the advantages of our single bill, which enabled us to capture a substantial SNET Annual Report 3 share of the long-distance market. In addition, access lines grew at a healthy clip -- a record 90,000 new lines, up 4.3 percent, fueled by booming demand for business and second residential lines. Additional strong growth came from vertical services like SNET SmartLink(R). We also continued double-digit growth in our wireless business while improving operating margins. Revenues climbed 27 percent to $219 million, due partly to the cellular acquisitions we made in July, 1995. Wireless margins were significantly better than a year ago and will be improving further in 1997 as we push to achieve industry norms. Information and Entertainment revenues were up 2 percent to $184 million. Consolidated operating expenses for the year were up 8 percent. Wireline expenses increased 12 percent to support growth in interstate/international toll, for aggressive marketing and for bad debts. In addition, weather conditions, unparalleled demand for new lines and workforce inexperience caused cost per access line to increase in 1996, counter to our long-term downward trend. This year, we will be back on track with overall cost per line decreasing once again. Wireless expenses, even including the cellular acquisitions, were flat for the year. Information and Entertainment expenses were down 6 percent for 1996 compared with 1995 when we trialed cable-TV and video-on-demand services to gain valuable marketing and operational experience. Depreciation and amortization expenses were up 3 percent for the year as was interest expense. Finally, certain true-ups and credits resulted in lower state taxes. This past year was clearly one of marketing successes and positioning for the future. We incurred significant costs not only to meet unprecedented demand and competition, but also to prepare for integrated marketing and product packaging. This year, we will continue to position SNET as we prepare for our exciting entry into cable TV, implement requirements of the Federal Telecommunications Act and reprogram computers for the year 2000. That reprogramming comes after a detailed examination of the implications of the year 2000 for our computer systems and business processes. We estimate that related expenses will be in the $15 million to $20 million range for 1997 as we revise and test over 30 million lines of computer code. In our business, revenues derive from a very high volume of date-sensitive transactions. So, we are pursuing this proactively, well in advance, to assure that there will be no glitches at the turn of the century. We're Pursuing New Growth Opportunities As we continue to advance through turbulent, uncharted waters made murkier by regulatory uncertainties, we are poised to take full advantage of growth opportunities that change offers. For instance, we just proposed to the Department of Public Utility Control (DPUC) that we separate our business into wholesale and retail subsidiaries, formalizing the internal separation that already exists between our wholesale and retail units. This new operating model will unleash the growth potential of each arm of our business, and provide the singularity of focus each needs to compete most effectively. Importantly, the retail subsidiary will compete under the same rules as other providers of telecommunications services in Connecticut to bring consumers an ever increasing array of innovative products and services. Our wholesale strategy is to remain the preeminent network by marketing our transport, switching and processing capabilities to retail-service providers in Connecticut and beyond. We offer sophisticated, feature-rich capabilities unparalleled in quality. For instance, our network is so reliable that customers experienced less than one minute on average of downtime in 1996. We are constantly improving and replacing our network, aiming for the year 2007 when every inch of it will be an information superhighway that reaches all households and businesses in Connecticut. On the retail side, our aim is to be the hometown team of choice. We will grow and retain our customer base by building lasting, multiple-product relationships across a broad range of information, communications and entertainment services. You can see how we're executing that strategy through the exciting initiatives we have under way or are about to launch. Our new statewide cable-TV franchise will put us in a strong marketing position that we intend to use to its fullest potential. One of our competitors attempted to slow the launch of our new cable venture by alleging that the back-up network powering design isn't safe. This contention is unfounded. We would never put our employees or anyone else at risk. However, rather than engage in a prolonged appeal process dealing with a minor technicality we are modifying our power-cable design to conform with the current national code. This will not delay our entry into the cable-TV business. We will launch SNET americast on schedule. 4 SNET Annual Report In the long-distance business, we've set our sights on becoming the market-share leader in Connecticut. Likewise, for Internet services, which continue to grow geometrically. We are honing our competitive edge by continuing to develop employee capabilities and by reshaping a monopoly culture to one that is riveted on customers and encourages an adaptive, creative work atmosphere and mentality. And we're forging alliances that will leverage our strengths, improve margins and add value. An example is our partnership with Disney through americast. This gives us access to high-quality programming at competitive prices and capitalizes on pooled resources to develop the next generation of television. Legal Initiative Results In Important Partial Stay Of FCC Order The 1994 landmark state statute that brought choice to consumers for telecommunications services came far ahead of the 1996 federal legislation. But the new federal law did give us an opportunity to enter the cable-TV business in a big way, which we acted on quickly. The FCC's first major interpretation of the new federal law was its interconnection order. That order would have imposed unrealistic pricing methodologies and pulled the rug out from under our pricing negotiations with competitors. SNET took a leadership role in mounting a legal challenge to the order. We won an important partial stay, and the appeal process is under way. We're Reaping Success In An Explosive Growth Industry The companies that prevail will be those that are adaptable and invest in their future while they remain their customers' most compelling choice for products, price and service. We're right on track at SNET. We have come a long way very fast. I've been in this business for many years, and I know that SNET has the means and the will to reap continued success in an explosive growth industry. I am confident about our ability to capture that potential for you. /s/ DAN MIGLIO - ------------------------------------ Daniel J. Miglio Chairman and Chief Executive Officer February 12, 1997 SNET Annual Report 5 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION FINANCIAL COMMENTARY (Dollars in Millions, Except Per Share Amounts) Southern New England Telecommunications Corporation ("Corporation") has business units in the following telecommunications product groups: wireline; wireless; and information and entertainment. Wireline includes telephone related services, premium services and equipment sales. Wireless consists of cellular services and equipment sales and paging services; and information and entertainment includes publishing, internet and multimedia services. Other activities, such as real estate and holding company operations, are included with eliminations and other sales. Operating Results Income before extraordinary charge was $192.8, $168.8 and $177.6 in 1996, 1995 and 1994, respectively. The corresponding earnings per share for those years were $2.94, $2.60 and $2.77. The financial results are summarized as follows: For the Years Ended December 31, 1996 1995 1994 - ----------------------------------------------------------------- Income before extraordinary charge $ 192.8 $ 168.8 $177.6 Extraordinary charge, net of tax -- (687.1) -- - ----------------------------------------------------------------- Net Income (Loss) $ 192.8 $(518.3) $177.6 ================================================================= Earnings (Loss) Per Share: Income before extraordinary charge $ 2.94 $ 2.60 $ 2.77 Extraordinary charge -- (10.59) -- - ----------------------------------------------------------------- Earnings (Loss) Per Share $ 2.94 $ (7.99) $ 2.77 ================================================================= Income before extraordinary charge increased $24.0 in 1996 due to strong revenues, primarily in interstate and international toll and wireless, offset partially by an increase in wireline expenses. Income before extraordinary charge decreased $8.8 in 1995 due primarily to the impact of the cellular acquisitions completed in July 1995 of approximately $19, or $.29 per share dilution. Stronger operating cash flow in the wireline business partially offset this decrease. Also included in 1995 was an $11.0 charge, $6.3 after-tax or $.10 per share, associated primarily with a court ruling on the Corporation and The Southern New England Telephone Company's ("Telephone Company") labor practices [see Note 9]. In 1995, the Corporation recorded a non-cash extraordinary charge of $1,202.6, $687.1 after-tax or $10.59 per share, related to the discontinuance of Statement of Financial Accounting Standards ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation" for financial reporting purposes. This non-cash extraordinary charge consisted of the elimination of net regulatory assets and the recognition of depreciation reserve deficiencies [see Note 3]. The Telephone Company determined that due to emerging competition and the change in its regulatory environment, it would change from the methodology under SFAS No. 71, which specifies accounting standards required for public utilities and certain other regulated companies, to one which is more appropriate for a competitive environment. As a result of this charge, net loss for 1995 was $518.3, or $7.99 per share. Revenues and Sales Revenues and sales increased $125.5, or 6.9%, in 1996 and $98.6, or 5.7%, in 1995. The components of revenues and sales by product group are summarized as follows: For the Years Ended December 31, 1996 1995 1994 - ----------------------------------------------------------- --------- Wireline: Local service $ 673.7 $ 641.6 $ 618.8 Network access 388.1 369.4 354.5 Intrastate toll 251.2 266.4 295.4 Interstate and international toll 101.2 42.1 10.0 Premium services and equipment sales 107.6 104.9 103.2 Other revenues 50.1 57.0 45.6 - --------------------------------------------------------------------- Total Wireline 1,571.9 1,481.4 1,427.5 - --------------------------------------------------------------------- Wireless: Cellular service 203.0 153.1 97.0 Cellular equipment sales 10.1 7.8 4.5 Paging 6.1 12.2 17.8 - --------------------------------------------------------------------- Total Wireless 219.2 173.1 119.3 - --------------------------------------------------------------------- Information and Entertainment 184.2 180.9 180.5 Eliminations and Other Sales (33.4) (19.0) (9.5) - --------------------------------------------------------------------- Total Revenues and Sales $1,941.9 $1,816.4 $1,717.8 ===================================================================== WIRELINE Local service revenues, derived from providing local exchange, advanced calling features and local private line services, increased $32.1, or 5.0%, in 1996 and $22.8, or 3.7%, in 1995. Growth in 1996 and 1995 was primarily attributable to increases of 4.3% and 3.2%, respectively, in access lines in service. The increases included significant growth in Centrex business lines in 1996, and second residential lines in both years. The 1996 increase of 90,012 access lines was the largest annual increase experienced by the Telephone Company. Local service revenues also increased due to growth in subscriptions to SmartLink(R) vertical calling services, including Caller ID, missed call dialing, call blocking and call tracing. Management expects competition to impact local service revenues in 1997 as other telecommunications providers offer local service [see Competition]. Network access charges are assessed on interexchange carriers and end users for access to the local exchange network. In 1996, network access revenues increased $18.7, or 5.1%, compared with an increase of $14.9, or 4.2%, in 1995. The increases in 1996 and 1995 were due primarily to continued growth in interstate minutes of use of approximately 8% and 6%, respectively, and increases in access lines in service 6 SNET Annual Report discussed previously. Partially offsetting the impact of the increase in minutes of use was a decrease in rates due to discount plans and reduced access tariffs [see Regulatory Matters]. In addition, intrastate access revenues increased due primarily to an increase in intrastate minutes of use by competitive providers of intrastate long-distance service. In 1996, intrastate toll revenues, which include primarily revenues from toll and WATS "800" services, decreased $15.2, or 5.7%, compared with a decrease of $29.0, or 9.8%, in 1995. Reduced intrastate toll rates due to the migration of customers to several of the Corporation's discount calling plans was the primary factor in the decrease in both years. Also contributing to the decreases was a reduction in toll message volume of approximately 1% and 2% in 1996 and 1995, respectively. In 1996, increased volume in the first half of the year from higher customer demand during inclement weather was offset by decreased volume in the second half of the year as a result of the increasingly competitive toll market. Customer migration to discount calling plans and increasing competition will continue to place downward pressure on intrastate toll revenues. Interstate and international toll services provided to Connecticut based customers increased $59.1 in 1996 and $32.1 in 1995. Interstate and international access line subscriptions more than doubled in both years to approximately 758,000 access lines at year-end 1996. The increase in 1996 was the result of customers' response to SNET All Distancer(R), a simple, competitively priced product providing one-second rating on intrastate, interstate and international toll services, along with local service on one bill. Other wireline revenues, which include primarily services rendered on behalf of interexchange carriers, rent and late fee revenues, decreased $6.9 in 1996 compared with an increase of $11.4 in 1995. The 1996 decrease was due primarily to the discontinuance of the provision of billing services for a major long-distance carrier. Higher billing service and late payment fee revenues contributed to the increase in 1995. WIRELESS Cellular service revenues increased $49.9, or 32.6%, in 1996 and $56.1, or 57.8%, in 1995. The increase in 1996 was due mainly to strong growth of 21.4% in the subscriber base in response to competitive marketing and pricing strategies. Also contributing to the increase was the impact from the first full year of revenues from the cellular acquisitions completed in July 1995 [see Note 2]. The 1995 increase was due primarily to growth of 94.6% in the subscriber base, including the new subscribers from the expanded cellular area. Average usage per subscriber continued to decline in 1996 and 1995, in line with a nationwide trend, as lower volume users made up a larger portion of the subscriber base. Paging sales decreased $6.1 in 1996 and $5.6 in 1995. The impact of the sale of paging network assets in June 1995 contributed to the reduction in sales [see Note 2]. Wireless continues, as a reseller, to market paging services under the Page 2000(R) brand name. INFORMATION AND ENTERTAINMENT Information and entertainment revenues increased $3.3 in 1996 due primarily to growth in yellow page advertising, while revenues remained relatively flat in 1995. Internet sales, a new service offered in 1996, also contributed to the increase. The introduction of cable television service is anticipated to have a positive impact on revenues in 1997. Costs and Expenses Total costs and expenses increased $92.1, or 6.3%, in 1996 and $124.1, or 9.2%, in 1995. Total costs and expenses are summarized as follows: For the Years Ended December 31, 1996 1995 1994 - -------------------------------------------------------------------- Operating $ 777.9 $ 732.3 $ 633.4 Maintenance 371.1 332.8 325.3 - -------------------------------------------------------------------- Total Operating Costs 1,149.0 1,065.1 958.7 Depreciation and amortization 356.1 346.0 328.6 Taxes other than income 54.6 56.5 56.2 - -------------------------------------------------------------------- Total Costs and Expenses $1,559.7 $1,467.6 $1,343.5 ==================================================================== Total operating costs consist primarily of employee-related expenses, including wages and benefits. Cost of goods sold and general and administrative expenses, including marketing, represent the remaining portion of these expenses. Total operating costs increased $83.9, or 7.9%, in 1996 compared with an increase of $106.4, or 11.1%, in 1995. Management expects to incur computer system related costs in order to avoid complications with the recognition of the year 2000. These costs will be incurred over the next three to four years, with related expenses estimated to be approximately $15 to $20 in 1997. WIRELINE Wireline operating costs increased $99.9, or 11.6%, in 1996 and $16.0, or 1.9%, in 1995. The increase in 1996 was due primarily to the direct costs of providing an increased volume of interstate and international toll services. Also contributing to the increase were higher contract services, bad debt and marketing expenses. The increase in contract services was due primarily to outsourcing certain functions which experienced lower work force levels, including the data processing, network and collection areas. Wireline bad debt expenses increased primarily from higher credit risk in a competitive environment and reduced collection efforts. The residential and business collection efforts were negatively impacted during a period of transition when employees departed under the early-out offer ("EOO") and most of the collection function was outsourced to an external agency. Employee-related expenses were relatively flat in 1996. Savings from the EOO and severance programs SNET Annual Report 7 under the 1993 restructuring program [see Note 6] were offset partially by the costs from a higher work force level in the second half of the year. The Telephone Company wireline work force increased to 8,167 employees at year-end 1996, primarily in the network area to meet increased service demands. Also offsetting the savings were higher pension and postretirement expenses (excluding net settlement gains and curtailment losses), annual compensation increases and additional overtime. In 1995, the direct costs of providing an increased volume of interstate and international toll services and the previously discussed labor practice charge were offset partially by lower employee-related expenses, including pension income. Work force levels decreased during 1995 due primarily to the EOO and severance programs. The Telephone Company's wireline work force decreased to 7,742 employees at year-end 1995, compared with 8,604 employees at year-end 1994. WIRELESS Wireless operating costs were relatively flat in 1996 compared with an increase of $79.3, or 76.9%, in 1995. Costs from the first full year of the expanded cellular area in 1996 were offset by lower customer acquisition costs and roaming fraud due to preventive control programs. The 1995 increase was due primarily to costs associated with an expanding preacquisition subscriber base, the operation of the cellular acquisitions in the second half of the year and increased roaming fraud. INFORMATION AND ENTERTAINMENT Information and entertainment operating costs decreased $4.4, or 5.6%, in 1996 compared with an increase of $12.5, or 19.0%, in 1995. The 1996 decrease was due primarily to the discontinuance of the multimedia trial, offset partially by costs of providing internet service and development costs associated with the commercial deployment of the Corporation's cable offering. Costs of the multimedia trial, offset partially by lower publishing expenses, contributed to the increase in 1995. Management expects information and entertainment operating costs to increase in 1997 as the Corporation launches SNET americast, its cable television service. DEPRECIATION AND AMORTIZATION In 1996, depreciation and amortization expense increased $10.1, or 2.9%, compared with an increase of $17.4, or 5.3%, in 1995. The 1996 and 1995 increases were due primarily to the amortization of assets acquired in the cellular acquisitions, primarily cellular licenses. An increase in the average depreciable telecommunications property, plant and equipment also contributed to the increase. The 1995 increase also resulted from revised depreciation rate schedules for the Telephone Company's intrastate plant, as approved by the Connecticut Department of Public Utility Control ("DPUC"), effective January 1, 1995. RESTRUCTURING CHARGE In December 1993, the Corporation recorded a restructuring charge to provide for a comprehensive restructuring program designed to reduce costs and improve delivery of service. The restructuring charge of $355.0 before-tax was comprised of $170.0 in employee separation costs, $145.0 in process and systems reengineering costs and $40.0 in exit and other costs. Specifically, the program included costs to be incurred to facilitate employee separations as well as incremental costs of implementing appropriate reengineering solutions, including designing and developing new processes and tools [see Note 6]. Beginning in 1997, the Corporation anticipates annual savings of approximately $100 from reduced employee-related expenses, net of costs for provisional employees. These anticipated savings will be offset by growth in the business. Interest Expense For the Years Ended December 31, 1996 1995 1994 - --------------------------------------------------------------- Interest Expense $88.7 $85.9 $74.9 =============================================================== Interest expense increased $2.8, or 3.3%, in 1996 and $11.0, or 14.7%, in 1995. The issuance of commercial paper and medium-term notes in connection with the cellular acquisitions was the primary contributor to the increases in both years [see Note 2]. In 1996, the increase was offset partially by lower average interest rates and capitalized interest of $7.2 due to a change in the reporting of capitalized interest as a reduction of interest expense. Prior to the discontinuance of SFAS No. 71, capitalized interest was reported as a component of other income, net. Other Income, net For the Years Ended December 31, 1996 1995 1994 - ------------------------------------------------------------- Other Income, net $6.9 $15.5 $.1 ============================================================= Other income, net is comprised primarily of interest income, income from investments and gains or losses on the disposition of non-telephone property. The 1996 decrease was due primarily to the absence of income from the disposition of a real estate partnership in 1995, lower interest income and the change in the classification of capitalized interest from other income, net to interest expense discussed previously. Other income, net increased in 1995 due primarily to an increase in partnership income, interest income and a gain on the disposal of non-telephone property. Income Taxes For the Years Ended December 31, 1996 1995 1994 - -------------------------------------------------------------- Income Taxes $107.6 $109.6 $121.9 ============================================================== The combined federal and state effective tax rate in 1996 was 35.8% compared with 39.4% in 1995 and 40.7% in 1994. The lower 1996 effective tax rate was due primarily to a higher level of state tax credits. The 8 SNET Annual Report recognition of state tax credits relating to certain personal property taxes lowered the effective tax rate in 1995 when compared with 1994. A reconciliation of these effective tax rates to the statutory tax rates is disclosed in Note 5. Competition As a result of unprecedented legislative and regulatory reform, the Corporation continues to experience an increasingly competitive environment with respect to telecommunications services in Connecticut. Competitors include interexchange carriers and competitive access providers with respect to the wireline's (Telephone Company's) existing services. In 1996, major carriers intensified their marketing efforts to sell intrastate long-distance services with full implementation of intrastate equal access. In addition, providers began offering local exchange service to businesses in certain areas of the state. Management supports bringing to customers the benefit of competition and affording all competitors the opportunity to compete fairly under reduced regulation. The competitive environment also provides opportunities for the Corporation to continue to grow its interstate and international long-distance service and to launch its cable television service in 1997. On September 6, 1996, SNET Personal Vision, Inc. ("Personal Vision") received an 11 year license from the DPUC to operate a community antenna television system that will serve the entire state of Connecticut. Personal Vision also became a partner in the americast joint venture with The Walt Disney Company, Ameritech Corporation, BellSouth Corporation, SBC Communications Inc. and GTE Corporation. The partnership will provide a full range of americast(TM) programming and marketing services and access to the joint venture's innovative technology. Personal Vision will launch its cable service, SNET americast, in the spring of 1997. To provide competitive toll products, wireline led the industry in 1996 by introducing the option of one-second rating for all toll calls so customers only pay for the time they talk. Wireline also successfully promoted the one bill feature of SNET All Distance, a seamless toll service product line which provides discount calling plans that include intrastate, interstate and international calling. The migration of Connecticut customers to wireline's bundled calling plans resulted in significant growth for interstate and international long-distance services. Concerning competition for local exchange service, seventeen telecommunications providers have been granted certificates of public convenience and necessity for local service and one additional application is pending before the DPUC. With only a few smaller companies offering local service in 1996, including a cable television company, competition did not have the impact on local service revenues as originally anticipated. Local service competition is expected to grow; however, the timing and financial impact cannot be predicted at this time. Based on existing state and federal regulations, the Telephone Company expects that many competitors will resell the Telephone Company's network and that increased network access revenues will offset a significant portion of local service revenues lost to competition. The Corporation's ability to compete in providing all of its products and services is dependent upon regulatory reform that will allow pricing flexibility to meet competition and provide a level playing field with similar regulation for similar services and with reduced regulation to reflect an emerging competitive marketplace. Regulatory Matters On February 8, 1996, Congress passed the Telecommunications Act of 1996 ("Act"). The Act was designed to overhaul U.S. Telecommunications policy by removing barriers to local competition. The Federal Communications Commission's ("FCC") First and Second Report and Order ("Order"), adopted August 1, 1996, implements the Act and contains numerous provisions regarding the interconnection of the Telephone Company's network with those of its competitors. Significant changes to network and data systems will be required for the Telephone Company to comply with the Order. In addition, the Order would require fundamental changes in the development of the prices that the Telephone Company would charge competitors for purchasing regulated network products and services. These decisions are the first of three major rule makings to carry out the Act. Future decisions will include universal service and access charge reform, discussed below. The Order, as well as universal service and access charge reform, could have a material negative impact on the Telephone Company. The Order was appealed and a stay was requested by various local telephone companies, including the Telephone Company, the National Association of Regulatory Utility Commissioners and individual state regulatory commissions. On October 15, 1996, the Eighth Circuit Court of Appeals ("Court") issued a stay delaying the effectiveness of the pricing provisions and the "pick and choose" rule of the Order. The FCC appealed the Court's decision to stay these rules to the Supreme Court. The Supreme Court, however, subsequently declined to hear the appeal. Oral arguments on the Order were heard by the Court on January 17, 1997. A decision is expected in the first half of 1997. In the meantime, the Telephone Company has proceeded to negotiate several interconnection agreements with other carriers in accordance with the FCC's directives not affected by the Court's stay. In accordance with the Act, the Federal-State Joint Board adopted a Recommended Decision on Universal SNET Annual Report 9 Service on November 7, 1996. The recommendation addresses the universal service provisions of the Act and proposes that one federal fund be established to provide support for universal service. The proposal calls for interstate telecommunications service providers to contribute to the fund based on their telecommunications revenue, net of payments to other carriers. The revenue to be assessed may either be total interstate and intrastate revenue, or interstate revenue only, depending on further discussion of these issues. By May 1997, the FCC is required to issue an order implementing the universal service section of the Act. On December 24, 1996, the FCC also released a Notice For Proposed Rule Making, seeking comments on proposed changes to the way the Telephone Company recovers interstate access charges from interstate toll providers, including SNET America, Inc. A full analysis of the implications of the FCC's proposal has not yet been completed. However, the industry could experience reduced access revenues. The Telephone Company provided comments to the FCC proposal on January 27, 1997. A decision from the FCC regarding this matter is expected in April or May 1997. In compliance with the Act, the Telephone Company has filed with the DPUC numerous cost studies supporting its proposed wholesale (i.e., resale) and unbundled rates for interconnection services. In light of the Order, on January 9, 1997, the DPUC issued a draft decision setting a 17.8% discount rate for local residence service. The Telephone Company filed its written exceptions and a request seeking clarification of, among other things, the applicability of the 17.8% discount. A second draft decision is expected in the first quarter of 1997. In March 1996, the DPUC issued a final decision that replaces traditional rate of return regulation with alternative (price based) regulation to be employed, effective April 1, 1996, during the transition to full competition. The decision contains the following major items: price cap regulation for non-competitive services; a five year monitoring period on financial results; and a price cap formula on services categorized as non-competitive (utilizing an inflation factor, a 5% productivity offset, a narrowly defined exogenous factor, a potential service quality adjustment and various pricing bands). In addition, basic local service rates for residence, business and coin may not be raised above current levels until January 1, 1998, at which time the price cap formula becomes effective for these services, unless they have been reclassified into the emerging competitive or competitive categories. The impact of these changes on the Telephone Company's operating results will depend on the timing of classifying the various products and services into categories (non-competitive, emerging competitive and competitive) for pricing (banding) changes. On November 27, 1996, the DPUC issued a final decision granting the Telephone Company's request to reclassify message toll and calling card services from the non-competitive category to competitive in its entire service territory. Reclassification provides the Telephone Company with the opportunity to gain additional promotional and pricing flexibility for its products and services, and to operate under regulatory guidelines similar to its competitors. On June 24, 1996, the FCC approved the Telephone Company's 1996 annual interstate access tariff filing. These tariffs became effective July 1, 1996. The Telephone Company again elected a 4.0% productivity factor and will be allowed to earn up to a 12.25% interstate rate of return annually before any sharing. The filing is anticipated to decrease interstate network access revenues by $2.3 for the period July 1, 1996 to June 30, 1997. Management expects this decrease to be offset by increased demand. As of December 31, 1996, the Telephone Company's interstate rate of return was below the 12.25% threshold. Employee Relations On April 12, 1995, a new labor contract was ratified by members of the Connecticut Union of Telephone Workers, Inc. ("CUTW"). As part of the new contract, a voluntary EOO, which provided incentives in the form of enhanced pension benefits, was available to bargaining-unit employees during July 1995. Approximately 2,700 bargaining-unit employees accepted the offer at that time and left the Corporation by June 1996. CUTW members who remained with the Corporation received a combination of basic wage and lump sum increases to their wages or cash balance pension plan account totaling 4.0% in January 1996 and 3.0% in January 1997. In January 1998, they will receive a combination of basic wage and lump sum increases totaling 3.0%. In addition, the contract also provided a sign-on bonus and health benefit and pension enhancements. The new labor agreement will expire on August 8, 1998. The contract is intended to keep layoffs to a minimum while enabling the Corporation to position itself to meet increasing competition. Liquidity and Capital Resources OPERATING ACTIVITIES The Corporation generated cash flows from operations of $470.2 during 1996 compared with $439.2 during 1995 and $422.6 during 1994. Cash flows from operations increased in 1996 compared with 1995 due primarily to strong growth in revenues. In 1996, the consolidated balance sheet changed as a result of operating activities. Even though revenues increased 6.9%, accounts receivable and the related allowance for uncollectibles decreased due primarily to higher write-offs in 1996. The higher write-offs reflect the impact of an increasingly competitive environment 10 SNET Annual Report and reduced collection efforts discussed previously. As a result of the changing environment, management revised its procedure to write-off uncollectible accounts within a shorter time frame. In addition, management enhanced its evaluation of the adequacy of the allowance for uncollectibles by placing additional emphasis on the risks associated with a competitive environment. Other balance sheet changes included a decrease in the current portion of deferred income taxes due primarily to costs incurred in 1996 under the restructuring program and a decrease in accrued postretirement benefit obligation as a result of favorable investment returns and increased funding to the trust. The decrease in other liabilities and deferred credits was attributable to a pension settlement gain. Cash outlays relating to the Corporation's restructuring charge recorded in December 1993 totaled $110.6, $89.1 and $63.6 in 1996, 1995 and 1994, respectively. Costs incurred for employee separations of $20.0 in 1996, $9.0 in 1995 and $27.6 in 1994 included primarily payments for severance and unused vacation. Incremental costs of $83.1 in 1996, $74.2 in 1995 and $35.0 in 1994 were incurred for executing numerous reengineering programs. In addition, exit and other costs were $7.5 in 1996, $5.9 in 1995 and $1.0 in 1994 and included expenses relating to the reduction of overall corporate space requirements. All cash expenditures were funded with cash flows from operations. Management anticipates that cash expenditures in connection with the restructuring program will approximate $15 in 1997 and will be funded from operations. INVESTING ACTIVITIES The primary use of corporate funds continued to be capital expenditures. Cash expended for capital additions was $366.6, $354.0 and $282.3 in 1996, 1995 and 1994, respectively. Capital additions for all years were funded entirely from cash flows from operations. The majority of these additions was for construction of the wireline network. Capital additions also included incremental capital additions under the restructuring program and improvements to wireless cell sites. Management anticipates that total capital expenditures for consolidated telecommunications plant will approximate $435 in 1997 and will be funded from cash flows from operations. Included in total capital expenditures in 1997 are estimated additions of $262 to the wireline network as compared with actual 1996 expenditures of approximately $251. These additions include expenditures relating to I-SNET(sm), a statewide telephony and information superhighway. Since 1994, the wireline business has been replacing its existing network of twisted copper wire with low maintenance fiber-optic and coaxial cable. The buildout of I-SNET, a $4.5 billion investment, is expected to be completed by 2007. This advanced network is capable of delivering voice, video and a full range of information and interactive multimedia services. I-SNET passed approximately 234,000 households as of December 1996, and is expected to pass approximately 334,000 households by December 1997. The support of this investment will be primarily through increased productivity from the new technology deployed and customer demand for the new services offered. Incremental capital expenditures relating to the restructuring program approximated $28, $29 and $20 in 1996, 1995 and 1994, respectively. In July 1995, the Corporation completed the acquisitions of certain cellular properties and an increased interest in an existing partnership for approximately $456 [see Note 2]. The properties increased wireless' service area by 2.3 million POPs (population equivalents) along the communication intensive Boston to New York corridor. The purchases were financed with short-term debt of approximately $456, of which $300.0 was subsequently replaced with medium-term notes in August 1995. During 1995, the Corporation completed the sale of substantially all of the paging network assets [see Note 2]. In addition, as a part of the Corporation's reengineering solutions, certain real estate properties were sold during the year to reduce office space. Proceeds of $74.0 primarily from these transactions were used to repay debt associated with these assets. FINANCING ACTIVITIES In September 1996, a total of $20.0 of 7.61% medium-term notes matured and were satisfied with the issuance of short-term debt. In July 1995, the Corporation filed a shelf registration statement with the Securities and Exchange Commission ("SEC") to sell up to $470.0 in medium-term notes. Pursuant to the registration statement, $300.0 of unsecured notes were sold in August 1995 with interest rates ranging from 6.50% to 7.00%. The proceeds of the sale were used to replace a portion of short-term debt and to establish permanent financing for the cellular acquisitions discussed previously. In September 1995, the Corporation's 7.66% medium-term notes of $20.0 matured and were satisfied with the issuance of short-term debt. The Corporation also repaid long-term debt of $88.3 with proceeds from the sale of paging and real estate assets and the issuance of short-term debt. Dividends paid totaled $100.2, $98.0 and $97.2 in 1996, 1995 and 1994, respectively. The quarterly dividend rate of $.44 per share has remained unchanged for the past seven years. On February 4, 1997, the Corporation issued $100.0 of 6.50% medium-term notes due 2002. The issuance replaced a portion of short-term debt related to the cellular acquisitions discussed previously. On February 18, 1997, the Corporation redeemed $80.0 of 8.70% medium-term notes due 2031, which were satisfied with the issuance of short-term debt. The SNET Annual Report 11 early extinguishment of debt will result in an extraordinary charge to the Corporation's first quarter 1997 earnings of approximately $3.7 after-tax, or $.06 per share. ESOP In connection with the establishment of the Employee Stock Ownership Plan ("ESOP") in 1990, the Corporation loaned the ESOP $10.0 and guaranteed a $110.0 loan to the ESOP by a third party. The Corporation has committed to make cash contributions to the ESOP that, together with dividends received on shares held by the ESOP, will enable the ESOP to make its principal and interest payments on both loans. Both loans mature in the year 2000. In 1996, the Corporation made cash payments to the ESOP for debt service of $13.5 and anticipates making equivalent cash payments during 1997. DEBT RATIO The Corporation's ratio of debt to total capitalization at year-end 1996 was 74.9% compared with 80.0% at year-end 1995 and 51.0% at year-end 1994. The increase in 1995 was due primarily to the combined effect of the non-cash extraordinary charge related to the discontinuance of SFAS No. 71 and the debt issued to acquire the cellular properties in July 1995. The ESOP represented 2.7% of the debt ratio at December 31, 1996 compared with 3.4% and 3.8% at December 31, 1995 and 1994, respectively. CAPITAL RESOURCES The Corporation maintains bank lines of credit to facilitate the issuance of commercial paper. As part of this credit facility, the Corporation has obtained contractual commitments to $300.0 in lines of credit provided by a syndicate of banks. The annual commitment fee is currently .05% on the lines of credit. As of December 31, 1996, the entire $300.0 was available. As of December 31, 1996, the Corporation and the Telephone Company had $225.0 and $95.0, respectively, of unissued, unsecured debt securities registered with the SEC. Subsequent to year-end, the Corporation's total decreased to $125.0 with the February 1997 issuance of $100.0 of 6.50% medium-term notes due 2002. Additional notes may be sold in one or more issues from time to time as market conditions warrant. Management believes that the Corporation has sufficient internal and external resources to finance the anticipated requirements of business development. Capital additions and dividends are expected to be funded primarily with cash from operations during 1997. The purchase of Woodbury Telephone Company will be funded through the issuance of treasury stock [see Note 2]. The Corporation also has access to external resources including committed lines of credit and unissued debt securities registered with the SEC. 12 SNET Annual Report SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION Report of Management The Corporation's consolidated financial statements have been prepared in conformity with generally accepted accounting principles. The Corporation is responsible for the preparation and reliability of the data in these consolidated financial statements, including estimates and judgments relating to matters not concluded by year-end. To this end, the Corporation maintains a highly developed system of internal controls and supports an extensive program of internal auditing to monitor compliance with the system. Management believes that this system provides reasonable, but not absolute, assurance at a reasonable cost that the transactions of the Corporation are executed in accordance with management's authorizations and are recorded properly. This system requires that the recorded assets be compared with existing assets at reasonable intervals and it provides reasonable assurance that access to assets is permitted only in accordance with management's authorization. The Corporation further seeks to assure the reliability of these consolidated financial statements by the careful selection of its managers, by organizational arrangements that provide appropriate division of responsibility and by communication and inspection programs aimed at assuring understanding of and compliance with its policies, standards and managerial authorities. The Audit Committee of the Board of Directors, which consists of five non-employee directors, meets periodically with the Corporation's financial management, audit services and independent accountants (Coopers & Lybrand L.L.P.) to review their work and the relationships between them in whatever depth considered necessary to fulfill the Committee's responsibilities. Both audit services and the independent accountants meet privately with and have unrestricted access to the Audit Committee. /s/ DONALD R. SHASSIAN Donald R. Shassian Senior Vice President and Chief Financial Officer January 21, 1997 Report of Independent Accountants To the Shareholders of Southern New England Telecommunications Corporation: We have audited the consolidated balance sheets of Southern New England Telecommunications Corporation as of December 31, 1996 and 1995, and the related consolidated statements of income (loss), changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Southern New England Telecommunications Corporation as of December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 3 to the consolidated financial statements, the Corporation discontinued accounting for the operations of its telephone subsidiary in accordance with Statement of Financial Accounting Standards No. 71, "Accounting for the Effects of Certain Types of Regulation," effective January 1, 1996. /s/ COOPERS & LYBRAND L.L.P. Coopers & Lybrand L.L.P. Hartford, Connecticut January 21, 1997 SNET Annual Report 13 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION Consolidated Statements of Income (Loss) Dollars in Millions, Except Per Share Amounts, For the Years Ended December 31, 1996 1995 1994 - -------------------------------------------------------------------------------- REVENUES AND SALES $1,941.9 $1,816.4 $1,717.8 - -------------------------------------------------------------------------------- COSTS AND EXPENSES Operating 777.9 732.3 633.4 Maintenance 371.1 332.8 325.3 Depreciation and amortization 356.1 346.0 328.6 Taxes other than income 54.6 56.5 56.2 - -------------------------------------------------------------------------------- Total Costs and Expenses 1,559.7 1,467.6 1,343.5 - -------------------------------------------------------------------------------- OPERATING INCOME 382.2 348.8 374.3 Interest expense 88.7 85.9 74.9 Other income, net 6.9 15.5 .1 - -------------------------------------------------------------------------------- INCOME BEFORE INCOME TAXES 300.4 278.4 299.5 Income taxes 107.6 109.6 121.9 - -------------------------------------------------------------------------------- INCOME BEFORE EXTRAORDINARY CHARGE 192.8 168.8 177.6 Extraordinary charge, net of tax -- (687.1) -- - -------------------------------------------------------------------------------- NET INCOME (LOSS) $ 192.8 $ (518.3) $ 177.6 ================================================================================ Weighted Average Common Shares Outstanding (thousands) 65,589 64,888 64,209 ================================================================================ EARNINGS (LOSS) PER SHARE Income before extraordinary charge $ 2.94 $ 2.60 $ 2.77 Extraordinary charge -- (10.59) -- - -------------------------------------------------------------------------------- EARNINGS (LOSS) PER SHARE $ 2.94 $ (7.99) $ 2.77 ================================================================================ The accompanying notes are an integral part of these financial statements. 14 SNET Annual Report SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION Consolidated Balance Sheets Dollars in Millions, At December 31, 1996 1995 - ---------------------------------------------------------------------------- ASSETS Cash and temporary cash investments $ 9.0 $ 11.1 Accounts receivable, net of allowance for uncollectibles of $27.4 and $34.2, respectively 323.3 347.3 Materials, supplies and inventories 27.4 26.1 Prepaid publishing 35.2 37.3 Deferred income taxes 45.4 66.8 Other current assets 27.7 46.3 - ---------------------------------------------------------------------------- Total Current Assets 468.0 534.9 Property, plant and equipment, net 1,597.0 1,565.2 Intangible assets, net 400.3 414.9 Deferred income taxes 91.2 92.0 Leases and other assets 114.5 117.2 - ---------------------------------------------------------------------------- Total Assets $2,671.0 $2,724.2 ============================================================================ LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable and accrued expenses $ 252.0 $ 261.9 Short-term debt 215.2 232.2 Advance billings and customer deposits 60.9 58.0 Accrued compensated absences 31.9 36.6 Restructuring charge 14.5 59.0 Other current liabilities 92.5 87.9 - ---------------------------------------------------------------------------- Total Current Liabilities 667.0 735.6 Long-term debt 1,169.7 1,182.4 Accrued postretirement benefit obligation 288.9 310.8 Unamortized investment tax credits 15.5 17.6 Other liabilities and deferred credits 66.9 124.9 - ---------------------------------------------------------------------------- Total Liabilities 2,208.0 2,371.3 - ---------------------------------------------------------------------------- Common stock; $1.00 par value; 300,000,000 shares authorized; 68,407,669 and 67,881,159 issued, respectively 68.4 67.9 Proceeds in excess of par value 602.8 697.9 Retained deficit (55.7) (249.5) Treasury stock; 2,758,512 shares, at cost (104.7) (104.7) Unearned compensation related to ESOP (47.8) (58.7) - ---------------------------------------------------------------------------- Total Shareholders' Equity 463.0 352.9 - ---------------------------------------------------------------------------- Total Liabilities and Shareholders' Equity $2,671.0 $2,724.2 ============================================================================ The accompanying notes are an integral part of these financial statements. SNET Annual Report 15 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION Consolidated Statements of Changes in Shareholders' Equity
Unearned Compen- Total Common Stock Issued Proceeds in Retained sation Share- Dollars in Millions, ---------------------- Excess of Earnings Treasury Related holders' Except Per Share Amounts Number Par Value Par Value (Deficit) Stock to ESOP Equity - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT JANUARY 1, 1994 66,608,360 $66.6 $656.7 $ 315.7 $(104.7) $(79.7) $854.6 - --------------------------------------------------------------------------------------------------------------------------------- Net income 177.6 177.6 Common stock issued, at market: Dividend reinvestment plan 474,441 .5 15.2 15.7 Savings and incentive plans 181,634 .2 5.9 6.1 Dividends declared ($1.76 per share) (113.0) (113.0) Reduction of ESOP debt 10.1 10.1 Tax benefit of dividends declared on unallocated shares held in ESOP 1.5 1.5 ESOP earned compensation accrual .3 .3 - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1994 67,264,435 67.3 677.8 381.8 (104.7) (69.3) 952.9 - --------------------------------------------------------------------------------------------------------------------------------- Net loss (518.3) (518.3) Common stock issued, at market: Dividend reinvestment plan 466,498 .5 15.4 15.9 Savings and incentive plans 150,226 .1 4.7 4.8 Dividends declared ($1.76 per share) (114.2) (114.2) Reduction of ESOP debt 11.0 11.0 Tax benefit of dividends declared on unallocated shares held in ESOP 1.2 1.2 ESOP earned compensation accrual (.4) (.4) - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1995 67,881,159 67.9 697.9 (249.5) (104.7) (58.7) 352.9 - --------------------------------------------------------------------------------------------------------------------------------- Net income 192.8 192.8 Common stock issued, at market: Dividend reinvestment plan 367,183 .4 14.3 14.7 Savings and incentive plans 159,327 .1 5.8 5.9 Dividends declared ($1.76 per share) (115.2) (115.2) Reduction of ESOP debt 12.1 12.1 Tax benefit of dividends declared on unallocated shares held in ESOP 1.0 1.0 ESOP earned compensation accrual (1.2) (1.2) - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 68,407,669 $68.4 $602.8 $ (55.7) $(104.7) $(47.8) $463.0 =================================================================================================================================
The accompanying notes are an integral part of these financial statements. 16 SNET Annual Report
SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION Consolidated Statements of Cash Flows Dollars in Millions, For the Years Ended December 31, 1996 1995 1994 ---------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income (loss) $ 192.8 $(518.3) $ 177.6 Tax benefit of dividends on shares held in ESOP 1.0 1.2 1.5 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization 356.1 346.0 328.6 Extraordinary charge, net of tax -- 687.1 -- Provision for uncollectible accounts 44.4 25.9 23.0 Restructuring payments (110.6) (89.1) (63.6) Increase in deferred income taxes 22.2 30.7 30.0 Decrease in investment tax credits (2.1) (6.9) (7.9) Changes in operating assets and liabilities, net (30.3) (34.0) (74.1) Other, net (3.3) (3.4) 7.5 ---------------------------------------------------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 470.2 439.2 422.6 ---------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Cash expended for capital additions (366.6) (354.0) (282.3) Purchase of cellular properties -- (455.6) -- Proceeds from asset sales 10.8 74.0 -- Other, net 16.6 16.5 27.3 ---------------------------------------------------------------------------------------------------------------------------- Net Cash Used by Investing Activities (339.2) (719.1) (255.0) ---------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Repayments of long-term debt (34.9) (108.3) (294.7) Proceeds from long-term debt -- 300.0 -- Cash dividends paid (100.2) (98.0) (97.2) Net proceeds of commercial paper 2.0 192.9 6.3 Other, net -- (2.3) (.1) ---------------------------------------------------------------------------------------------------------------------------- Net Cash (Used) Provided by Financing Activities (133.1) 284.3 (385.7) ---------------------------------------------------------------------------------------------------------------------------- (Decrease) Increase in Cash and Temporary Cash Investments (2.1) 4.4 (218.1) Cash and temporary cash investments at beginning of year 11.1 6.7 224.8 ---------------------------------------------------------------------------------------------------------------------------- Cash and Temporary Cash Investments at End of Year $ 9.0 $ 11.1 $ 6.7 ============================================================================================================================
The accompanying notes are an integral part of these financial statements. SNET Annual Report 17 SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Millions, Except Per Share Amounts) NOTE 1: Summary of Significant Accounting Policies BASIS OF PRESENTATION The consolidated financial statements of Southern New England Telecommunications Corporation ("Corporation") are in conformity with generally accepted accounting principles ("GAAP"). Effective January 1, 1996, the Corporation's telephone operating subsidiary, The Southern New England Telephone Company ("Telephone Company"), discontinued using Statement of Financial Accounting Standard ("SFAS") No. 71, "Accounting for the Effects of Certain Types of Regulation" [see Note 3]. The consolidated financial statements include the accounts of the Corporation, all wholly-owned subsidiaries and partnerships in which the Corporation effectively has control. All significant intercompany transactions and accounts have been eliminated. The Corporation derives substantially all of its revenues from the telecommunications service industry by providing wireline, wireless and information and entertainment services, including local, national and international communications; network services; mobile communications; and advertising. The Corporation's operations and customers are located primarily in Connecticut. The 1995 and 1994 consolidated financial statements have been reclassified to conform to the current year presentation. USE OF ESTIMATES The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. As a result of the increasingly competitive environment, management revised its procedure to write-off uncollectible accounts receivable within a shorter time frame in 1996. In addition, management enhanced its evaluation of the adequacy of the allowance for uncollectibles by placing additional emphasis on the risks associated with an increasingly competitive environment. CASH AND TEMPORARY CASH INVESTMENTS Cash and temporary cash investments include all highly liquid investments, with original maturities of three months or less. The Corporation records payments made by draft as accounts payable until the banks honoring the drafts have presented them for payment. At December 31, 1996 and 1995, accounts payable included drafts outstanding of $41.4 and $45.9, respectively. MATERIALS, SUPPLIES AND INVENTORIES Materials and supplies, which are carried at original cost, are primarily for the construction and maintenance of telephone plant. Inventories, principally telephone sets, wireless equipment and telephone systems, are carried at the lower of weighted average cost or market value. PROPERTY, PLANT AND EQUIPMENT Property, plant and equipment is stated at cost. Depreciation is calculated on telephone plant using either the equal life group straight-line depreciation method or the composite vintage group method. Property and equipment other than telephone plant is depreciated primarily using the straight-line method. As a result of the discontinuance of SFAS No. 71, the Corporation is using estimated useful lives, effective January 1, 1996, that are shorter than the economic lives historically prescribed by regulators. A comparison of average asset lives before and after the discontinuance of SFAS No. 71, for the most significantly affected categories of telephone plant, is as follows: Asset Category Before After - ----------------------------------------------------------- Digital Switch 17 10.5 Digital Circuit 11.5 8.2 Conduit 55 55 Copper 22-26 10.5-16 Fiber 32-40 30 =========================================================== Under the composite group method, the cost of depreciable telephone plant retired, net of removal costs and salvage (i.e., gains or losses), is charged to accumulated depreciation. When depreciable property and equipment other than telephone plant are sold or retired, the resulting gain or loss is recognized currently as an element of income. All long-lived assets are reviewed for impairment whenever events or changes in circumstance indicate that the carrying amount may not be recoverable, and any necessary adjustment is made. Replacements, renewals and betterments that materially increase an asset's useful or remaining life are capitalized. Minor replacements and all repairs and maintenance are charged to expense. INTANGIBLE ASSETS Intangible assets consist primarily of cellular licenses, customer lists and goodwill resulting from the cellular acquisitions completed in July 1995. The intangible assets are stated at cost and are being amortized using the straight-line method over periods ranging from 5 to 40 years. Accumulated amortization was $27.6 and $10.9 as of December 31, 1996 and 1995, respectively. Intangible assets are reviewed for impairment whenever events or changes in circumstance indicate that the carrying amount may not be recoverable, and any necessary adjustment is made. 18 SNET Annual Report LEASE NOTES RECEIVABLE Direct-financing and leveraged lease contracts are accounted for by recording the total minimum lease payments receivable, plus the estimated residual value, less the unearned lease income and, for leveraged leases, less the associated aggregate non-recourse debt obligation. The unearned lease income for direct-financing leases represents the excess of total minimum lease payments, plus estimated residual value expected to be realized, over the cost of the related equipment. For leveraged leases, the unearned income reflects the net positive cash flow to be generated from the lease. EMPLOYEE STOCK OWNERSHIP PLAN The Corporation accounts for its Employee Stock Ownership Plan ("ESOP") in accordance with Statement of Position 76-3, as amended. Accordingly, compensation expense is measured as the cost of shares allocated from the trust, plus the amount required to purchase any additional shares allocated to employee accounts, less a percentage of dividends received by the plan. Dividends on stock held by the ESOP are recorded as a reduction of retained earnings, and all ESOP shares are treated as outstanding for earnings per share calculations. Debt of the ESOP that has been guaranteed by the Corporation is recorded as long-term debt and as a reduction of shareholders' equity. As the ESOP repays the debt, a corresponding reduction in long-term debt and an increase in shareholders' equity is recorded. REVENUE RECOGNITION Revenues are recognized when earned regardless of the period in which billed. Revenues for directory advertising are recognized over the life of the related directory, normally one year. CAPITALIZED INTEREST COST Upon the discontinuance of SFAS No. 71, effective January 1, 1996, the Telephone Company reports capitalized interest as a cost of telephone plant and a reduction in interest expense, in accordance with SFAS No. 34, "Capitalization of Interest Cost." Prior to the discontinuance of SFAS No. 71, the Telephone Company included in its telephone plant accounts an imputed cost of debt and equity for funds used during the construction of telephone plant. The Corporation's other subsidiaries account for capitalized interest in accordance with SFAS No. 34. ADVERTISING COSTS Costs for advertising products and services or corporate image are expensed as incurred. COMPUTER SOFTWARE COSTS The Telephone Company capitalizes initial operating systems for central office switching equipment. Right-to-use fees, additions, upgrades and modifications to operating software programs and applications are expensed. Computer software acquired or developed for internal use by all other subsidiaries are expensed when incurred. INCOME TAXES The Corporation files a consolidated federal income tax return and, where allowable, combined state income tax returns. The Corporation computes income taxes under SFAS No. 109, "Accounting for Income Taxes." Deferred tax assets and liabilities are determined based on all temporary differences between the financial statement and tax bases of assets and liabilities using the currently enacted rates. Additionally, the Corporation will recognize deferred tax assets if it is more likely than not that the related benefit will be realized. Investment tax credits realized in prior years by the Telephone Company are being amortized as a reduction to the provision for income taxes over the life of the related plant. EARNINGS PER SHARE Earnings per common share are computed by dividing net income by the weighted average number of common stock and common stock equivalents outstanding during the period. NOTE 2: Acquisitions and Sale of Assets On October 22, 1996, the Corporation entered into a definitive agreement to acquire the remaining 63.5% of Woodbury Telephone Company ("Woodbury") which it does not already own. Under the terms of the agreement, common shareholders of Woodbury will exchange each outstanding share of Woodbury common stock for an amount of the Corporation's common stock having a market value of $43 per share at the closing of the transaction, subject to certain conditions. The acquisition will be accounted for under the purchase method, and is expected to close in mid-1997, pending approval by regulatory agencies. Woodbury has approximately 19,000 access lines, all in Connecticut, and reported 1995 net income of $1.8 on $12.6 in revenue. In July 1995, the Corporation purchased from Bell Atlantic Corporation, NYNEX Corporation and Richmond Telephone Company, for approximately $456 in the aggregate, certain cellular properties in Rhode Island and New Bedford and Pittsfield, Massachusetts, and an increased interest in Springwich Cellular Limited Partnership ("Springwich"). In total, these acquisitions expanded wireless' service area by 2.3 million POPs (population equivalents) along the Boston to New York corridor. The cellular acquisitions were financed with approximately $456 of short-term debt issued in June 1995. Short-term debt of $300.0 was replaced with medium-term notes in the third quarter of 1995. The acquisitions were accounted for under the purchase method. Accordingly, the operating results of the cellular properties and the increased interest in Springwich were included in the consolidated financial statements subsequent to the acquisition date. The excess of the purchase price over the estimated fair value of the net assets acquired of approximately $24 was assigned to goodwill with an amortization period of 15 years. SNET Annual Report 19 In June 1995, the Corporation completed the sale, for approximately $25, of substantially all of its paging network assets to Paging Network of New York, Inc. Wireless continues, as a reseller, to market paging services under the Page 2000(RM) brand name. The net loss from the sale represented costs incurred as a direct result of exiting the paging network business and was charged against the restructuring reserve [see Note 6]. NOTE 3: Discontinuance of SFAS No. 71 In the fourth quarter 1995, the Telephone Company determined it was no longer eligible for application of SFAS No. 71, which specifies accounting standards required for public utilities and certain other regulated companies. Effective January 1, 1996, the Telephone Company follows accounting principles which are more appropriate for a competitive environment. This determination was made based on the significant changes in technology and the increase in telecommunications competition in Connecticut brought about by legislative and regulatory policy changes. This accounting change is for financial reporting purposes only and does not affect the Telephone Company's accounting and reporting for regulatory purposes. As a result of the discontinued use of SFAS No. 71, in accordance with the provisions of SFAS No. 101, "Accounting for the Discontinuance of Application of FASB Statement No. 71," the Corporation recorded a non-cash, extraordinary charge of $687.1, or $10.59 per share, net of applicable tax benefits of $515.5, in the fourth quarter of 1995. The following table is a summary of 1995's extraordinary charge: Before-tax After-tax - ------------------------------------------------------------ Adjustment to net telephone plant $(1,178.0) $(703.9) Elimination of net regulatory assets (24.6) (14.3) Tax-related net regulatory liabilities -- 20.1 Accelerated amortization of investment tax credits -- 11.0 - ------------------------------------------------------------ Total Non-cash, Extraordinary Charge $(1,202.6) $(687.1) ============================================================ The adjustment of $1,178.0 to net telephone plant was necessary since estimated useful lives and depreciation methods historically prescribed by regulators did not reflect the rapid pace of technological development and differed significantly from those economic useful lives used by unregulated companies. Plant balances were adjusted by increasing the accumulated depreciation reserve. The increase to the accumulated depreciation reserve was determined by a discounted cash flow analysis which considered technological replacement and the estimated impact of future competition. To support this analysis, a depreciation reserve study was also performed that identified, by asset categories, inadequate accumulated depreciation levels (i.e., deficiencies) that had developed over time. The discontinuance of SFAS No. 71 also required the Corporation to eliminate from its consolidated balance sheet, prepared for financial reporting purposes, the effects of any actions of regulators that had been recognized as assets and liabilities pursuant to SFAS No. 71, but would not have been recognized as assets and liabilities by unregulated companies. The elimination of net regulatory assets relates principally to vacation pay costs and gross earnings tax which were being amortized as they were recognized in the ratemaking process. Additionally, upon the discontinuance of SFAS No. 71, the tax-related regulatory assets and liabilities were eliminated and the related deferred tax balances were adjusted to reflect application of SFAS No. 109, consistent with other unregulated companies. As asset lives were shortened, the related investment tax credits associated with those assets were also adjusted for the shortened lives and the result ($11.0) was included in the extraordinary charge as a credit to income, net of associated deferred income taxes. NOTE 4: Employee Benefits SEPARATION OFFERS In April 1995, the Corporation ratified a contract with the Connecticut Union of Telephone Workers, Inc. which included a voluntary early-out offer ("EOO"). The EOO provided enhanced pension benefits by adding six years to the age and to the length of service of employees for purposes of determining pension and postretirement health care benefits eligibility. The employees also had the option to select a pension distribution method (i.e., lump-sum, monthly pension or a combination of both) at the time of separation. The EOO was available to the bargaining-unit work force during July 1995 and approximately 2,700 employees, or 40.7% of the total bargaining-unit work force, accepted the offer and left the Corporation through June 1996. In addition, approximately 500 management employees accepted a severance plan with enhanced benefits during 1996. The 1996 net settlement gains and the 1995 net curtailment losses related to these separation offers were recorded to the restructuring reserve in the respective years [see Note 6]. PENSION PLANS The Corporation sponsors several non-contributory, defined benefit pension plans: one for management employees and one for bargaining-unit employees; and one supplementary non-qualified, unfunded plan for all employees. The supplementary non-qualified plan provides a benefit equal to any pension amount above which would otherwise be payable under the defined benefit pension plans in the absence of Internal Revenue Code limitations. Prior to July 1, 1995, benefits for bargaining-unit employees were based on years of service and pay during 1987 to 1991 as well as a cash balance component. Prior to 1996, benefits for management employees were based on an adjusted career average pay plan. The bargaining-unit and management pension plans were converted to cash balance plans effective July 1, 1995 and January 1, 1996, respectively. Accordingly, pension benefits are determined as a single account balance 20 SNET Annual Report and grow each year with pay and interest credits. Prior to the conversion to the cash balance plans, the benefits for the employees' supplementary plans were based on years of service and average eligible pay. Effective with the conversion to the cash balance plans, the benefits are based on pay and interest credits. The supplementary non-qualified, unfunded plan for non-employee directors was terminated in 1996 with pension benefits payable only to current and retired directors and with the amount of accrued pension benefits being frozen. Funding of the management and bargaining-unit plans is achieved through irrevocable contributions made to a trust fund. Plan assets consist primarily of listed stocks, corporate and governmental debt and real estate. The Corporation's policy is to fund the pension cost for these plans in conformity with the Employee Retirement Income Security Act of 1974 using the aggregate cost method. For purposes of determining contributions, the assumed investment earnings rate on plan assets was 9.5% in 1996 and declines to 7.5% in 1998. Pension (income) cost for all plans, computed using the projected unit credit actuarial method, includes the following components: For the Years Ended December 31, 1996 1995 1994 - -------------------------------------------------------------------- Service cost $ 20.2 $ 22.1 $ 30.9 Interest cost on projected benefit obligation 96.3 113.5 107.0 Amortizations and deferrals, net 65.8 249.6 (136.4) Actual return on plan assets (177.6) (393.3) 1.0 - -------------------------------------------------------------------- Net Pension Cost (Income) Recorded to Expense 4.7 (8.1) 2.5 - -------------------------------------------------------------------- Settlement gain (76.1) (76.0) -- Costs relating to special termination benefits -- 137.5 -- Curtailment loss 10.8 16.8 13.4 - -------------------------------------------------------------------- Net (Settlement Gain) Curtailment Loss (65.3) 78.3 13.4 - -------------------------------------------------------------------- Net Pension (Income) Cost $ (60.6) $ 70.2 $ 15.9 ==================================================================== The 1996 net settlement gain and the 1995 and 1994 net curtailment losses were associated with the severance programs and were recorded to the restructuring reserve in the respective years [see Note 6]. The 1996 increase in net pension cost (income) recorded to expense was due primarily to lower returns on plan assets, reflecting a combination of a lower asset base and a generally weaker capital market return when compared with 1995. The following table sets forth the plans' funded status: At December 31, 1996 1995 - -------------------------------------------------------------------- Actuarial Present Value of Accumulated Benefit Obligation, including vested benefits of $1,253.3 and $1,405.8, respectively $ 1,289.3 $ 1,475.6 ==================================================================== Plan assets at fair value $ 1,690.3 $ 1,847.8 Actuarial present value of projected benefit obligation (1,337.3) (1,565.2) ==================================================================== Assets in Excess of Projected Benefit Obligation 353.0 282.6 Unrecognized prior service costs 129.2 151.7 Unrecognized transition asset (98.4) (130.5) Unrecognized net gain (401.3) (383.4) Adjustment required to recognize minimum liability (3.2) (2.7) - -------------------------------------------------------------------- Accrued Pension Cost $ (20.7) $ (82.3) ==================================================================== Assumptions used to calculate the plans' funded status: At December 31, 1996 1995 1994 - ----------------------------------------------------------------- Discount rate for projected benefit obligation 7.5% 7.0% 8.0% Expected rate of increase in future management compensation levels 4.5% 4.5% 4.5% Expected long-term rate of return on plan assets 8.0% 8.0% 8.0% ================================================================= The Corporation periodically amends the benefit formulas under its pension plans. Accordingly, pension cost has been determined in such a manner as to anticipate that modifications to the pension plans would continue in the future. POSTRETIREMENT HEALTH CARE BENEFITS The Corporation provides health care and life insurance benefits for retired employees. Substantially all of the Corporation's employees may become eligible for these benefits if they meet certain age and service requirements. In addition, an employee's spouse and dependents may be eligible for health care benefits. Effective July 1, 1996, all bargaining-unit employees who retire after December 31, 1989 and all management employees who retire after December 31, 1991 may have to share with the Corporation the premium costs of postretirement health care benefits if these costs exceed certain limits. The Corporation funds trusts for postretirement health insurance benefits using Voluntary Employee Beneficiary Association. Plan assets consist primarily of investments in domestic corporate equity and government and corporate debt securities. SNET Annual Report 21 The Corporation's postretirement benefit cost includes the following components: For the Years Ended December 31, 1996 1995 1994 - ------------------------------------------------------------- Service cost $ 4.4 $ 4.4 $ 5.4 Interest cost of accumulated benefit obligation 37.6 33.4 32.2 Amortizations and deferrals, net 19.8 21.0 (5.4) Actual return on plan assets (30.9) (31.5) (2.6) - ------------------------------------------------------------- Net Postretirement Benefit Cost Recorded to Expense 30.9 27.3 29.6 - ------------------------------------------------------------- Costs relating to special termination benefits -- 11.0 -- Curtailment loss .2 12.9 .8 - ------------------------------------------------------------- Net Curtailment Loss .2 23.9 .8 - ------------------------------------------------------------- Net Postretirement Benefit Cost $ 31.1 $ 51.2 $30.4 ============================================================= The 1996, 1995 and 1994 net curtailment losses were associated with the severance programs and were recorded to the restructuring reserve in the respective years [see Note 6]. The following table sets forth the plans' funded status: At December 31, 1996 1995 - ------------------------------------------------------------- Accumulated postretirement benefit obligation: Retirees $(458.6) $(447.5) Fully eligible active plan participants (15.5) (21.1) Other active plan participants (66.3) (74.2) - ------------------------------------------------------------- Total Accumulated Postretirement Benefit Obligation (540.4) (542.8) Plan assets at fair value 229.4 178.6 - ------------------------------------------------------------- Accumulated Postretirement Benefit Obligation in Excess of Plan Assets (311.0) (364.2) Unrecognized net (gain) loss (11.9) 16.7 Unrecognized prior service cost 13.6 16.3 - ------------------------------------------------------------- Accrued Postretirement Benefit Obligation $(309.3) $(331.2) ============================================================= Assumptions used to calculate the plans' funded status: At December 31, 1996 1995 1994 - ------------------------------------------------------------- Discount rate for projected benefit obligation 7.5% 7.0% 8.0% Expected rate of increase in future compensation levels 4.5% 4.5% 4.5% Expected long-term rate of return on plan assets: Management health trust 7.0% 7.0% 7.0% Bargaining-unit health trust 7.5% 7.5% 7.5% Retiree life insurance trust 7.5% 7.5% 7.5% - ------------------------------------------------------------- The assumed health care cost trend rate used to measure the expected cost of these benefits for 1997 was 6.9% and declines to 3.8% by 2001. A one percentage point increase in the assumed health care cost trend rate would have increased the estimated aggregate service and interest cost components of the 1996 net postretirement benefit cost by approximately $2 and the accrued postretirement benefit obligation by approximately $24 as of December 31, 1996. EMPLOYEE STOCK OWNERSHIP PLAN The Corporation has established a leveraged ESOP for substantially all employees as part of its existing savings plans. Under the ESOP, the Corporation's matching contributions are invested entirely in common stock of the Corporation and are held by the ESOP. In January 1990, the Corporation loaned the ESOP $10.0 and in February 1990, the ESOP borrowed an additional $110.0, which the Corporation guaranteed, through a third party. The proceeds of the $10.0 loan were used to acquire shares of the Corporation's common stock through open market purchases. The proceeds of the $110.0 loan were used to purchase shares of both unissued common stock and treasury stock from the Corporation. All shares purchased by the ESOP were originally pledged as collateral for its debt. The Corporation periodically makes cash payments to the ESOP that, together with dividends received on shares held by the ESOP, are used to make interest and principal payments on both loans. As these payments are made, shares are released from collateral and made available for distribution to employees' accounts, based on the proportion of debt service paid in the year. ESOP expense and ESOP trust activity are as follows: For the Years Ended December 31, 1996 1995 1994 - ----------------------------------------------------------- Compensation expense(1) $11.0 $14.7 $14.3 Interest expense incurred(1) 4.4 5.1 5.9 Interest income earned (.5) (.6) (.7) - ----------------------------------------------------------- Total Expense $14.9 $19.2 $19.5 =========================================================== Dividends Used for Debt Service $ 5.1 $ 5.3 $ 5.3 Cash Contributions Used for Debt Service $13.5 $13.3 $13.2 =========================================================== (1) Net of applicable dividends used for debt service. ESOP shares outstanding are as follows: In Thousands, At December 31, 1996 1995 1994 - ----------------------------------------------------------- Allocated shares 1,389.1 1,508.0 1,164.4 Unreleased shares 1,206.4 1,301.5 1,809.6 - ----------------------------------------------------------- Total ESOP Shares 2,595.5 2,809.5 2,974.0 =========================================================== 22 SNET Annual Report NOTE 5: Income Taxes Income tax expense includes the following components: For the Years Ended December 31, 1996 1995 1994 - ----------------------------------------------------------- Federal Current $ 79.4 $ 62.4 $ 74.7 Deferred 16.1 27.4 19.5 Investment tax credits, net (2.1) (6.9) (7.9) - ----------------------------------------------------------- Total Federal 93.4 82.9 86.3 - ----------------------------------------------------------- State Current 9.8 17.3 31.1 Deferred 4.4 9.4 4.5 - ----------------------------------------------------------- Total State 14.2 26.7 35.6 - ----------------------------------------------------------- Total Income Taxes $107.6 $109.6 $121.9 =========================================================== Deferred income tax expense resulted primarily from restructuring program costs incurred in 1996, 1995 and 1994. In April 1995, new Connecticut state income tax rates were enacted to accelerate the reduction of current rates. The 1996 Connecticut state income tax rate of 10.75% will gradually decrease to 7.5% in 2000. Income taxes in 1995 included a provision to adjust deferred tax balances for the effect of the change in state income tax rates. A reconciliation between income taxes and taxes computed by applying the statutory federal income tax rate to pre-tax income is as follows: For the Years Ended December 31, 1996 1995 1994 - ----------------------------------------------------------- Statutory Federal Income Tax Rate 35.0% 35.0% 35.0% =========================================================== Federal income taxes at statutory rate $105.1 $ 97.4 $104.8 State income taxes, net of federal income tax effect 9.2 17.4 23.1 Depreciation of telephone plant construction cost previously deducted for tax purposes(1) -- 5.1 5.1 Amortization of investment tax credits(1) (2.1) (6.9) (7.9) Other differences, net (4.6) (3.4) (3.2) - ----------------------------------------------------------- Income Taxes $107.6 $109.6 $121.9 =========================================================== Effective Tax Rate 35.8% 39.4% 40.7% =========================================================== (1) Telephone Company only. Consolidated deferred income tax assets (liabilities) are comprised of the following: At December 31, 1996 1995 - ----------------------------------------------------------- Postretirement benefits other than pensions $124.8 $124.1 Software 13.9 15.1 Compensated absences 13.1 12.4 Restructuring charge 12.8 32.1 Allowance for uncollectibles 11.9 14.5 Pension 9.2 31.3 Other 10.6 (2.2) Depreciation and amortization (29.3) (34.8) Leveraged leases (28.3) (30.4) Valuation allowance (2.1) (3.3) - ----------------------------------------------------------- Deferred Income Taxes $136.6 $158.8 =========================================================== The 1996 decrease in the valuation allowance was due primarily to the disposition of certain nonregulated operations. The allowance will continue to be evaluated based on evidence of realization of all deferred tax assets. NOTE 6: Restructuring Charge In December 1993, the Corporation recorded a restructuring charge of $355.0, $204.2 after-tax or $3.21 per share, to provide for a comprehensive restructuring program. The charge included: $170.0 for employee separation costs; $145.0 for process and systems reengineering; and $40.0 for exit and other costs. Costs incurred for employee separations included payments for severance, unused vacation and health care continuation, as well as non-cash net pension and postretirement settlement gains of $65.1 in 1996 and curtailment losses of $102.2 and $14.2 in 1995 and 1994, respectively. Process and systems reengineering costs included incremental costs incurred in connection with the execution of numerous reengineering programs. Exit and other costs included expenses related to the reduction of overall corporate space requirements and the cost incurred as a direct result of exiting the paging network business [see Note 2]. A summary of costs incurred under the restructuring program is as follows: For the Years Ended December 31, 1996 1995 1994 - ------------------------------------------------------------- Employee separation (gains) costs $(45.1) $111.2 $41.8 Process and systems reengineering 83.1 74.2 35.0 Exit and other costs 7.5 2.5 13.3 - ------------------------------------------------------------- Total Costs Incurred $ 45.5 $187.9 $90.1 ============================================================= Total employee separations under the restructuring program approximated 4,300 employees utilizing the EOO and severance plans: 970 employees through the end of 1994; 2,195 employees in 1995; and 1,135 employees in 1996. Total employee separations were substantially offset by an increase in provisional employees to support greater demand for services and expanding businesses. The hiring of provisional employees also provides flexible work force levels as business needs change in the future. The Telephone Company has implemented network operations, customer service, repair and support programs and developed new processes to reduce the costs of business while improving quality and customer service. These new integrated processes have enabled the Telephone Company to increase its responsiveness to customer specific needs and to eliminate certain current labor-intensive interfaces between the existing systems. As of December 31, 1996, the restructuring reserve balance of $31.5 is adequate for the future residual costs under the 1993 restructuring program, primarily exit costs relating to the delayed reduction of overall corporate space requirements and timing of remaining charges. SNET Annual Report 23 NOTE 7: Short-term Debt Short-term debt, which includes commercial paper used to meet temporary cash needs and long-term debt maturing within one year, consists of the following: At December 31, 1996 1995 - --------------------------------------------------------- Commercial paper $201.9 $199.9 Current maturities of long-term debt 13.3 32.3 - --------------------------------------------------------- Total Short-term Debt $215.2 $232.2 - --------------------------------------------------------- Weighted Average Interest Rate on Commercial Paper at Year-End 5.8% 5.8% ========================================================= The Corporation maintained bank lines of credit to facilitate the issuance of commercial paper. As part of these credit facilities, the Corporation has obtained a contractual commitment to $300.0 in lines of credit provided by a syndicate of banks. At December 31, 1996, the entire line remained available. The annual commitment fee is currently .05% of the total lines of credit. NOTE 8: Long-term Debt The components of long-term debt are as follows: At December 31, Maturing 1996 1995 - ------------------------------------------------------------- Unsecured notes: 6.13%-8.00% 1996-2007 $ 720.0 $ 740.0 7.25%-8.70% 2031-2033 325.0 325.0 Guaranteed ESOP: 9.35% 1996-2000 56.4 67.5 Debentures: 4.38% 2001 45.0 45.0 Bank notes: 10.00%-10.50% 1996-2009 24.4 24.9 Mortgage notes: 9.14%-9.90% 1996-2000 17.2 17.9 - ------------------------------------------------------------- Total Long-term Debt 1,188.0 1,220.3 Unamortized discount and premium, net (5.1) (5.7) Capital lease obligations .1 .1 Current maturities (13.3) (32.3) - ------------------------------------------------------------- Long-term Debt $1,169.7 $1,182.4 ============================================================= Scheduled maturities of total long-term debt include $13.3 in 1997, $41.8 in 1998, $16.9 in 1999, $125.1 in 2000, $66.2 in 2001 and $924.7 thereafter. At December 31, 1996, the Corporation and the Telephone Company had remaining securities registered with the Securities and Exchange Commission to issue up to $225.0 and $95.0, respectively, of medium-term unsecured notes through shelf registrations. Subsequent to year-end, the Corporation's total decreased to $125.0 as a result of the February 4, 1997 issuance of $100.0 of 6.50% medium-term notes due 2002. The proceeds from the issuance were used to replace a portion of short-term debt related to the cellular acquisitions discussed previously. On February 18, 1997, the Corporation redeemed $80.0 of 8.70% medium-term notes due 2031, which were satisfied with the issuance of short-term debt. The early extinguishment of debt will result in an extraordinary charge to the Corporation's first quarter 1997 earnings of approximately $3.7 after-tax, or $.06 per share. NOTE 9: Commitments and Contingencies The Corporation has entered into both operating and capital leases for facilities and equipment used in its operations. Rental expense under operating leases was $21.0, $23.7 and $24.4 for 1996, 1995 and 1994, respectively. Future minimum rental commitments under third-party, noncancelable operating leases include $15.3 in 1997, $14.9 in 1998, $13.2 in 1999, $11.2 in 2000, $5.6 in 2001 and $14.1 thereafter, for a total of $74.3. Capital leases were not significant. The Corporation expects total capital expenditures of approximately $435 for additions to property, plant and equipment during 1997. In connection with the capital program, the Corporation has made certain commitments for the purchase of material and equipment. In June 1995, a U.S. District Court decision was issued in favor of the Department of Labor against the Corporation and the Telephone Company. The decision held that the Corporation and the Telephone Company violated certain sections of the Fair Labor Standards Act and was liable for back wages and liquidating damages. The Corporation and the Telephone Company are appealing this decision. The Telephone Company recorded a liability of $11.0 as its anticipated cost of total damages for this and other litigation matters, which was recorded to expenses in 1995. NOTE 10: Financial Instruments FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it was practicable to estimate that value: Cash and Temporary Cash Investments The carrying amount approximates fair value because of the short maturity of those instruments. Long-term Investments The fair value of equity investments was estimated based on quoted market prices for those or similar investments. Debt The carrying amount of the Corporation's short-term debt approximates fair value because of the short maturity of those instruments. The fair value of long-term debt (excluding capital leases) was estimated based on the quoted market prices for the same or similar issues or on the current rates offered to the Corporation for debt of the same remaining maturities. 24 SNET Annual Report The carrying amount and estimated fair value of the Corporation's financial instruments are as follows: At December 31, 1996 1995 - --------------------------------------------------------------------- Carrying Fair Carrying Fair Amount Value Amount Value - --------------------------------------------------------------------- Cash and Temporary Cash Investments $ 9.0 $ 9.0 $ 11.1 $ 11.1 Long-term Investments $ 4.1 $ 13.2 $ 4.1 $ 9.6 Debt $(1,384.8) $(1,381.0) $(1,414.5) $(1,474.4) ===================================================================== CONCENTRATIONS OF CREDIT RISK Financial instruments that potentially subject the Corporation to concentrations of credit risk consist primarily of temporary cash investments and trade receivables. The Corporation places its temporary cash investments primarily with one financial institution, a New England regional bank. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers in the Corporation's customer base. NOTE 11: Lease Notes Receivable Lease notes receivable includes, on an investment basis, a portfolio of leveraged and direct-financing leases. The gross investment in these leases has been recorded on the consolidated balance sheet in leases and other assets. Investments in leveraged leases are in a coal-fired, electric generating facility and other equipment. The investment in direct-financing leases are in a commercial aircraft and other equipment. The components of the lease notes receivable are as follows: At December 31, 1996 1995 - ----------------------------------------------------------------- Direct- Direct- Financing Leveraged Financing Leveraged Leases Leases Leases Leases - ----------------------------------------------------------------- Minimum rentals receivable $ 61.7 $ 25.4 $ 70.1 $ 25.3 Unearned income (26.9) (14.0) (30.2) (15.7) Estimated, unguaranteed residual value of leased assets 10.3 30.6 10.3 31.5 Initial direct costs .2 -- .3 -- Allowance for losses (11.0) -- (9.7) -- - ----------------------------------------------------------------- Lease Notes Receivable $ 34.3 42.0 $ 40.8 41.1 ====== ====== Deferred taxes arising from leveraged leases (28.3) (30.4) - ----------------------------------------------------------------- Net Investment in Leveraged Leases $ 13.7 $ 10.7 ================================================================= Future minimum receipts under third-party direct-financing leases include $4.1 in 1997, $4.1 in 1998, $4.8 in 1999, $3.1 in 2000, $3.8 in 2001 and $41.8 thereafter. NOTE 12: Shareholders' Equity COMMON, PREFERRED AND PREFERENCE SHARES The Corporation is authorized to issue up to 300,000,000 shares of common stock at a par value of $1.00 per share ("Common Stock") as well as 2,000,000 preferred shares at a par value of $50.00 per share and 50,000,000 preference shares at a par value of $1.00 per share. No preferred or preference shares have been issued pursuant to these authorizations. DIVIDENDS DECLARED The 1996 dividends were declared out of proceeds in excess of par value, while 1995 and 1994 dividends were declared out of retained earnings. SHAREHOLDERS' RIGHTS PLAN On December 11, 1996, the Board of Directors approved the 1997 shareholders' rights plan ("Rights Plan") which became effective February 11, 1997 upon the expiration of the previous plan. Under the 1997 Rights Plan, each share of Common Stock has a purchase right that entitles the holder to purchase 1/100 of a preference share (equivalent of one share of Common Stock) at an exercise price of $180.00. The rights are not exercisable or transferable apart from the Common Stock until a person or group has acquired, or has made an offer for, 20% or more of the outstanding Common Stock. In the event that a person or group acquires 20% or more of the outstanding Common Stock, each outstanding right, other than those held by the 20% acquirer, is entitled to purchase, at the exercise price of the rights, a number of shares of Common Stock having a market value of two times the exercise price of the right. The Board also may exchange the rights generally at an exchange ratio of one share of Common Stock per right. The Rights Plan may be amended by the Board of Directors to reduce the threshold at which the rights are triggered to not less than 10% of the then outstanding Common Stock. Additionally, if the person or group acquires the Corporation in a merger or other business combination transaction, each right will entitle the owner to purchase common stock of the acquirer having a market value of two times the exercise price of the right. The rights are redeemable at one cent each prior to public announcement that a person or group has acquired beneficial ownership of 20% or more of the outstanding Common Stock. The rights expire on February 11, 2007. NOTE 13: Stock-Based Compensation Plans During 1996, the Corporation sponsored two employee stock option plans, and a restricted stock plan for non-employee directors. The SNET 1986 Stock Option Plan ("1986 Plan") provided stock options to certain key employees at the discretion of a committee of the Board of Directors ("Committee"). Options are no longer granted under the 1986 Plan, as it expired on June 30, 1996. The SNET 1995 Stock Incentive Plan is a stock-based compensation plan which enables the awarding of incentive compensation, including stock options, to all employees at the discretion of the Board of Directors or the Committee. Under both plans, the exercise price of each option may not be less than 100% of the fair market value of the shares on the date of grant. All options are exercisable no earlier than one year after the date of grant, with most options vesting ratably over two or four years, and have a maximum life of ten years. SNET Annual Report 25 The plans allow stock appreciation rights ("SARs") to be granted in tandem with the related stock option. No SARs have been granted since 1992 and the Corporation presently does not intend to grant additional SARs in the future. The Corporation has elected to continue following Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its employee stock-based compensation plans. Accordingly, no compensation cost has been recognized for the plans. Had the Corporation adopted the cost recognition method provided under SFAS No. 123, "Accounting for Stock-Based Compensation" for 1996 and 1995, the Corporation's net income (loss) and earnings (loss) per share would approximate the pro forma amounts below: For the Years Ended December 31, 1996 1995 - --------------------------------------------------------------- As Pro As Pro Reported Forma Reported Forma - --------------------------------------------------------------- Net Income (Loss) $192.8 $189.4 $(518.3) $(518.9) Earnings (Loss) Per Share $ 2.94 $ 2.90 $ (7.99) $ (8.00) =============================================================== The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. SFAS No. 123 does not apply to awards prior to 1995, and additional awards in future years are anticipated. The Black-Scholes option pricing model was used to estimate the options' grant date fair value with the following assumptions: 20% volatility; risk free interest rate ranging from 5.2% to 7.9%; dividends of $1.76 per share per year; and an estimated period to exercise of three or five years. The weighted average fair value of options granted during the year was $7.85 and $6.13 in 1996 and 1995, respectively. Information with respect to plan activity is as follows: Options Shares Available Under Average for Grant Option SARs Price - ------------------------------------------------------------- Balance at 1/1/94 1,112,200 544,025 172,600 $34.20 Granted (360,500) 360,500 -- $31.86 SARs exercised -- (8,100) (8,100) $29.82 Options exercised -- (1,100) -- $24.69 Canceled 33,600 (33,600) (1,800) $34.78 - --------------------------------------------------- Balance at 12/31/94 785,300 861,725 162,700 $33.25 - --------------------------------------------------- Approved for grant 4,600,000 -- -- -- Granted (2,535,950) 2,535,950 -- $37.59 SARs exercised -- (41,475) (41,475) $28.44 Options exercised -- (15,775) -- $30.86 Canceled 34,500 (34,500) -- $33.15 - --------------------------------------------------- Balance at 12/31/95 2,883,850 3,305,925 121,225 $36.65 - --------------------------------------------------- 1986 Plan unused (65,525) -- -- -- Granted (223,500) 223,500 -- $42.48 SARs exercised -- (66,975) (66,975) $32.60 Options exercised -- (53,625) -- $33.37 Canceled 364,725 (364,725) -- $38.04 - --------------------------------------------------- BALANCE AT 12/31/96 2,959,550 3,044,100 54,250 $37.05 ============================================================= Options exercisable were 1,334,388, 403,850 and 310,475 at December 31, 1996, 1995 and 1994, respectively. The respective weighted average exercise prices were $36.72, $33.67 and $32.74. All outstanding SARs were exercisable at each year-end. The following table summarizes information with regard to stock options outstanding and exercisable by ranges of exercise prices: Weighted Weighted Average Average Remaining Exercise Contractual At December 31, 1996 Shares Price Life - ----------------------------------------------------------- Stock Options Outstanding: $24.69 to $35.99 1,035,500 $33.21 7.4 years $36.00 to $43.38 2,008,600 $39.03 8.7 years - ------------------------------------ $24.69 to $43.38 3,044,100 $37.05 8.3 years =========================================================== Stock Options Exercisable: $24.69 to $35.99 416,950 $32.80 -- $36.00 to $39.00 917,438 $38.50 -- - ------------------------------------ $24.69 to $39.00 1,334,388 $36.72 -- =========================================================== The 1994 SNET Non-Employee Director Stock Plan ("1994 Plan"), which was terminated upon ratification of the 1996 Non-Employee Director Stock Plan ("1996 Plan"), allowed each director to receive between 25% and 100% of their annual retainer in shares of Common Stock. The 1996 Plan, approved on May 8, 1996, provides each non-employee director with 300 shares of Common Stock in lieu of cash compensation. A director may also elect to receive up to 100% of his or her cash retainer in shares. All shares distributed have voting and dividend rights, and are subject to restrictions on transferability. Upon granting of the shares, compensation expense is recorded in the amount of the market value of the shares. A summary of restricted stock activity is as follows: At December 31, 1996 1995 1994 - ----------------------------------------------------------- Shares available for grant, beginning of period 143,852 147,152 -- New shares approved for issuance 200,000 -- 150,000 1994 Plan unused (141,619) -- -- Shares granted (5,833) (3,300) (2,848) - ----------------------------------------------------------- Shares Available for Grant, End of Period 196,400 143,852 147,152 =========================================================== Weighted Average Market Value of Stock on Grant Date $41.21 $35.02 $29.91 Compensation Expense Recorded for Restricted Stock Grants $ .2 $ .1 $ .1 =========================================================== 26 SNET Annual Report NOTE 14: Supplemental Financial Information SUPPLEMENTAL INCOME STATEMENT INFORMATION For the Years Ended December 31, 1996 1995 1994 - ------------------------------------------------------------ Advertising Expense $ 42.1 $ 38.8 $ 32.4 ============================================================ Depreciation and amortization: Depreciation $331.1 $328.1 $ 320.6 Amortization 25.0 17.9 8.0 - ------------------------------------------------------------ Total Depreciation and Amortization $356.1 $346.0 $ 328.6 ============================================================ Taxes other than income: Property $ 48.0 $ 43.7 $ 45.5 Other 6.6 12.8 10.7 - ------------------------------------------------------------ Total Taxes Other Than Income $ 54.6 $ 56.5 $ 56.2 ============================================================ Interest expense: Long-term debt $ 83.0 $ 74.7 $ 70.3 Short-term debt 10.0 8.5 2.2 Capitalized interest (7.2) -- -- Other 2.9 2.7 2.4 - ------------------------------------------------------------ Total Interest Expense $ 88.7 $ 85.9 $ 74.9 ============================================================ During 1996, 1995 and 1994, revenues earned from providing services to AT&T Corp. accounted for 7.9%, 9.2% and 10.2%, respectively, of total revenues and sales. SUPPLEMENTAL BALANCE SHEET INFORMATION At December 31, 1996 1995 - ------------------------------------------------------------ Materials, supplies and inventories: Materials and supplies $ 14.3 $ 10.6 Inventories 13.1 15.5 - ------------------------------------------------------------ Total Materials, Supplies and Inventories $ 27.4 $ 26.1 ============================================================ Property, plant and equipment, at cost: Telephone plant: Land $ 16.8 $ 17.5 Buildings 386.4 396.2 Central office equipment 1,743.0 1,657.2 Outside plant facilities and equipment 1,732.4 1,640.3 Furniture and office equipment 310.0 310.6 Station equipment and connections 22.5 22.7 Plant under construction 98.0 122.4 Telecommunications property and equipment 398.2 365.2 - ------------------------------------------------------------ Total Property, Plant and Equipment, at cost 4,707.3 4,532.1 Accumulated Depreciation (3,110.3) (2,966.9) - ------------------------------------------------------------ Total Property, Plant and Equipment, net $ 1,597.0 $1,565.2 ============================================================ Leases and other assets: Lease notes receivable $ 76.3 $ 81.9 Prepaid pension cost 7.3 -- Other assets 30.9 35.3 - ------------------------------------------------------------ Total Leases and Other Assets $ 114.5 $ 117.2 ============================================================ Other current liabilities: Dividends payable $ 28.9 $ 28.7 Accrued postretirement benefit obligation 20.4 20.4 Accrued interest 19.2 19.8 Other current liabilities 24.0 19.0 - ------------------------------------------------------------ Total Other Current Liabilities $ 92.5 $ 87.9 ============================================================ Other liabilities and deferred credits: Accrued pension cost $ 28.0 $ 82.3 Restructuring charge 17.0 18.0 Other liabilities 21.9 24.6 - ------------------------------------------------------------ Total Other Liabilities and Deferred Credits $ 66.9 $ 124.9 ============================================================ SUPPLEMENTAL CASH FLOW INFORMATION For the Years Ended December 31, 1996 1995 1994 - ------------------------------------------------------------ Interest Paid, net of amounts capitalized $ 89.2 $ 79.7 $ 81.2 ============================================================ Income Taxes Paid $ 84.0 $ 87.8 $109.5 ============================================================ Changes in operating assets and liabilities, net: Increase in accounts receivable, net $(18.5) $(78.3) $(48.9) Increase in materials, supplies and inventories (1.2) (.1) (4.9) (Decrease) increase in accounts payable, accrued expenses and compensated absences (18.2) 65.0 11.0 Changes in other assets and liabilities, net 7.6 $(20.6) (31.3) - ------------------------------------------------------------ Changes in Operating Assets and Liabilities, net $(30.3) $(34.0) $(74.1) ============================================================ OPERATING CASH FLOW(1) The following unaudited financial data on the Corporation's product groups is not required by generally accepted accounting principles and is provided for informational purposes only: For the Years Ended December 31, 1996 1995 1994 - ------------------------------------------------------------ Wireline(2) $564.8 $569.0 $531.3 Wireless(3) 31.3 (10.8) 14.8 Information and Entertainment(4) 110.2 102.6 114.7 Other(5) 32.0 34.0 42.1 - ------------------------------------------------------------ Total Operating Cash Flow $738.3 $694.8 $702.9 =========================================================== (1) Represents operating income before depreciation and amortization. Operating cash flow is not a generally accepted accounting principle measurement. (2) Includes Telephone Company's telecommunications operations, SNET Diversified Group, Inc. and SNET America, Inc. (3) Includes the wholesale and retail cellular operations, SNET Cellular, Inc. and SNET Mobility, Inc., net of cellular intercompany amounts. Also includes paging operations which have changed from a network-based service to a resale service in 1995. (4) Includes publishing and SNET Personal Vision, Inc. (5) Includes SNET Real Estate, Inc. and holding company operations. SNET Annual Report 27
NOTE 15: Quarterly Financial Information (Unaudited) 1st QTR 2nd QTR 3rd QTR 4th QTR Full Year - ----------------------------------------------------------------------------------------------------------------------------- 1996 - ---- Revenues and Sales $474.0 $487.8 $488.2 $ 491.9 $1,941.9 Operating Income $102.1 $100.2 $ 90.5 $ 89.4 $ 382.2 Net Income $ 52.2 $ 50.5 $ 45.8 $ 44.3 $ 192.8 Earnings Per Share $ .80 $ .77 $ .70 $ .67 $ 2.94 ============================================================================================================================= 1995 - ---- Revenues and Sales $440.4 $447.5 $464.9 $ 463.6 $1,816.4 - ----------------------------------------------------------------------------------------------------------------------------- Operating Income $ 93.7 $ 86.0 $ 83.4 $ 85.7 $ 348.8 - ----------------------------------------------------------------------------------------------------------------------------- Income before extraordinary charge $ 46.7 $ 40.1 $ 41.3 $ 40.7 $ 168.8 Extraordinary charge [see Note 3] -- -- -- (687.1) (687.1) - ----------------------------------------------------------------------------------------------------------------------------- Net Income (Loss) $ 46.7 $ 40.1 $ 41.3 $ (646.4) $ (518.3) - ----------------------------------------------------------------------------------------------------------------------------- Earnings (Loss) Per Share: Income before extraordinary charge $ .72 $ .62 $ .64 $ .62 $ 2.60 Extraordinary charge(1) -- -- -- (10.54) (10.59) - ----------------------------------------------------------------------------------------------------------------------------- Earnings (Loss) Per Share $ .72 $ .62 $ .64 $ (9.92) $ (7.99) =============================================================================================================================
(1) Earnings (loss) per share is computed independently for the quarter based on weighted average common shares outstanding for the quarter. The calculations resulted in a difference of $.05 between loss per share for the quarter and for the year. 28 SNET Annual Report
SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION FINANCIAL AND STATISTICAL DATA (UNAUDITED) Dollars in Millions, Except as Noted 1996 1995 1994 1993 1992 - ------------------------------------------------------------------------------------------------------------------------ Financial Data Revenues and sales $ 1,942 $ 1,816 $ 1,718 $ 1,657 $ 1,629 Costs and expenses(1) $ 1,204 $ 1,121 $ 1,015 $ 1,361 $ 1,004 Interest expense $ 89 $ 86 $ 75 $ 91 $ 97 Income taxes $ 108 $ 110 $ 122 $ (44) $ 110 Income (loss) from continuing operations(2) $ 193 $ 169 $ 178 $ (44) $ 159 Net income (loss) $ 193 $ (518) $ 178 $ (318) $ 151 Earnings (loss) per share (dollars): From continuing operations(2) $ 2.94 $ 2.60 $ 2.77 $ (.68) $ 2.56 Net income (loss) $ 2.94 $ (7.99) $ 2.77 $ (4.99) $ 2.44 Dividends declared per share (dollars) $ 1.76 $ 1.76 $ 1.76 $ 1.76 $ 1.76 Net cash provided by operating activities $ 470 $ 439 $ 423 $ 479 $ 504 Cash expended for capital additions $ 367 $ 354 $ 282 $ 267 $ 290 Depreciation and amortization $ 356 $ 346 $ 329 $ 291 $ 250 Property, plant and equipment, net $ 1,597 $ 1,565 $ 2,712 $ 2,770 $ 2,767 Total assets $ 2,671 $ 2,724 $ 3,505 $ 3,762 $ 3,485 Shareholders' equity $ 463 $ 353 $ 953 $ 855 $ 1,254 Long-term debt $ 1,170 $ 1,182 $ 952 $ 984 $ 1,048 ======================================================================================================================== Statistical Data Network access lines in service (thousands) 2,163 2,073 2,009 1,964 1,937 Annual growth 4.3% 3.2% 2.3% 1.4% .8% Network interstate access minutes of use (millions) 7,906 7,298 6,917 6,522 6,230 Annual growth 8.3% 5.5% 6.1% 4.7% 4.0% Cellular subscribers (thousands) 392 323 166 88 68 Annual growth 21.4% 94.6% 88.6% 29.4% 19.3% Operating cash flow(3) $ 738 $ 695 $ 703 $ 296 $ 625 Telephone Company wireline cost per access line (dollars)(4) $ 332 $ 320 $ 340 $ 365 $ 359 Return on average total capital 15.9% --(5) 12.8% --(6) 10.3% Return on average equity 45.6% --(5) 19.4% --(6) 12.5% Debt ratio(7) 74.9% 80.0% 51.0% 59.9% 47.4% Pre-tax interest coverage (times) 4.1 4.2 5.0 .1 3.8 Average total debt cost 6.6% 6.9% 6.8% 7.7% 7.8% Current ratio (times) .70 .73 .88 .82 .84 Average dividend yield 4.4% 5.1% 5.4% 4.9% 5.4% Payout ratio 59.9% --(5) 63.5% --(6) 72.1% Market price per share (dollars): High $45.500 $40.250 $36.250 $38.375 $38.000 Low $36.000 $31.750 $28.250 $33.625 $28.250 Book value per share (dollars) $ 7.05 $ 5.42 $ 14.77 $ 13.38 $ 19.79 Average market price per share (dollars) $ 40.07 $ 34.47 $ 32.63 $ 35.70 $ 32.70 Average book value per share (dollars) $ 6.44 $ 15.14 $ 14.26 $ 17.69 $ 19.49 Average price/earnings ratio (times) 14 --(5) 12 --(6) 13 Average trading volume 105,028 91,797 59,437 79,086 60,360 Number of shareholders 50,917 53,332 55,693 57,352 59,089 Telephone Company wireline employees 8,167 7,742 8,604 9,087 9,532 Total employees 9,441 9,070 9,797 10,476 11,216 ========================================================================================================================
Certain amounts have been restated to conform to the current year presentation. (1) Excludes depreciation and amortization. 1993 includes a charge of $355.0, $204.2 after-tax or $3.21 per share, for restructuring. (2) 1995 excludes an extraordinary charge of $687.1, or $10.59 per share, related to the discontinuance of SFAS No. 71. 1993 includes the after-tax restructuring charge and excludes discontinued operations of $10.3, or $.16 per share, an extraordinary charge of $44.0, or $.69 per share and the cumulative effect of accounting changes of $220.2, or $3.46 per share. (3) Represents operating income before depreciation and amortization. Operating cash flow is not a generally accepted accounting principle measurement. Management provides this measurement for informational purposes only. Excluding the impact of the 1993 before-tax restructuring charge, operating cash flow would have been $650 in 1993. (4) Excludes depreciation and amortization, property and other taxes, publishing and bad debt expenses. 1993 also excludes the before-tax restructuring charge. (5) Not presented for 1995 based upon a loss per share. A return on average total capital of 11.6%, a return on average equity of 17.2%, a payout ratio of 67.7% and an average price/earnings ratio of 13 were calculated excluding the loss per share impact of the extraordinary charge of $10.59. (6) Not presented for 1993 based upon a loss per share. A return on average total capital of 10.4%, a return on average equity of 12.3%, a payout ratio of 69.6% and an average price/earnings ratio of 14 were calculated excluding the loss per share impact of the restructuring charge of $3.21, discontinued operations of $.16, extraordinary charge of $.69 and the cumulative effect of accounting changes of $3.46. (7) Excluding the effect of the non-cash extraordinary charge related to the discontinuance of SFAS No. 71, the 1995 debt ratio would have been 57.6%. Excluding the combined effect of the charge related to SFAS No. 71 and the debt issued to acquire the cellular properties, the 1995 debt ratio would have been 48.0%. SNET Annual Report 29
SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION INVESTOR INFORMATION Corporate Information - --------------------------------------------------------------------------------------------------------------------- Executive Office: Stock Exchange Listings: Auditors: SNET New York Stock Exchange Coopers & Lybrand L.L.P. 227 Church Street Pacific Stock Exchange Independent Accountants New Haven, CT 06510 Symbol: SNG 100 Pearl Street (203) 771-5200 Hartford, CT 06103 Shareholder Information - --------------------------------------------------------------------------------------------------------------------- Annual Meeting of Shareholders: The Form 10-K may be obtained For Shareholder Information May 14, 1997, 10:00 a.m. by contacting the Transfer Agent including quarterly results, Oakdale Theatre and Registrar: latest recorded news 95 South Turnpike Road State Street Bank and Trust Company and information, call Wallingford, CT 06492 P.O. Box 8200 1-800-SNG-6220 or visit Boston, MA 02266-8200 our Internet web site From anywhere in the continental at www.snet.com U.S.: 1-800-243-1110 Security Analysts and Dividend Reinvestment Portfolio Managers and Stock Purchase Plan - --------------------------------------------------------------------------------------------------------------------- Direct inquiries to: All owners of common stock are Shareholders do not pay any Mr. James A. Magrone eligible for the plan, which allows brokerage or administrative fees Director-Investor Relations participants to apply dividends and/or when purchasing additional shares 227 Church Street optional cash payments toward through the plan. You can obtain a New Haven, CT 06510 increased investment in the prospectus and enrollment forms by (203) 771-4662 Corporation. contacting State Street Bank and Trust Company, Plan Administrator. Market and Dividend Data - --------------------------------------------------------------------------------------------------------------------- Market information was obtained Market Price from the composite tape, which ---------------------------------------------------------------------------------- encompasses trading on the 1996 1995 principal U.S. stock exchanges Quarter High Low Close Quarter High Low Close as well as offboard trading. Cash ---------------------------------------------------------------------------------- dividends of $.44 per share were First $43.750 $37.500 $40.250 First $34.500 $31.750 $33.375 declared for each quarter in 1996 Second $45.500 $40.500 $42.000 Second $35.500 $32.375 $35.250 and 1995. The number of holders Third $42.750 $36.750 $36.875 Third $36.125 $32.625 $35.375 of SNET stock at February 28, Fourth $41.125 $36.000 $38.875 Fourth $40.250 $35.125 $39.750 1997 was 50,458.
30 SNET Annual Report
SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION OTHER INFORMATION Executive Officers of the Corporation - --------------------------------------------------------------------------------------------------------------------- Daniel J. Miglio Chairman and Chief Executive Officer Jean M. LaVecchia Senior Vice President--Organization Development Fred T. Page Senior Vice President--Network Services Ronald M. Serrano Senior Vice President--Communication, Information and Entertainment Group Donald R. Shassian Senior Vice President and Chief Financial Officer Representative Servicemarks and Trademarks - --------------------------------------------------------------------------------------------------------------------- SNET(r) is a registered trademark We Go Beyond The Call(r), SmartLink(r) americast is a trademark of the and I-SNET is a servicemark of and All Distance(r) are registered trademarks americast partnership. Southern New England of The Southern New England Telephone Telecommunications Corporation. Company. Page 2000(r) is a registered trademark of SNET Mobility, Inc.
SNET Annual Report 31 EX-21 6 Southern New England Telecommunications Corporation Subsidiaries of the Registrant Name State of Incorporation The Southern New England Telephone Company Connecticut SNET America, Inc. Connecticut SNET Cellular, Inc. Connecticut SNET Mobility, Inc. Connecticut SNET Diversified Group, Inc. Connecticut SNET Real Estate, Inc. Connecticut SNET Credit, Inc. Connecticut SNET Personal Vision, Inc. Connecticut EX-23 7 Coopers Coopers & Lybrand L.L.P. & Lybrand a professional services firm CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference of our reports dated January 21, 1997, which include an explanatory paragraph related to the discontinuance of SFAS No. 71, "Accounting for Certain Types of Regulation," effective January 1, 1996, on our audits of the consolidated financial statements and financial statement schedule of Southern New England Telecommunications Corporation as of December 31, 1996 and 1995 and for each of the three years in the period ended December 31, 1996, included or incorporated by reference in this Annual Report on Form 10-K, in the following documents filed by Southern New England Telecommunications Corporation: Registration Statement No. 33-59713 on Form S-3 relating to the Shareholder Dividend Reinvestment and Stock Purchase Plan. Post-Effective Amendment No. 3 to Registration Statement No. 33-6326 on Form S-8 relating to the SNET Bargaining Unit Retirement Savings Plan. Post-Effective Amendment No. 2 to Registration Statement No. 33-6325 on Form S-8 relating to the SNET Management Retirement Savings Plan. Registration Statement No. 33-19058 on Form S-8 relating to the SNET 1986 Stock Option Plan. Registration Statement No. 33-41237 on Form S-3 relating to the registration of $165 million of Debt Securities. Registration Statement No. 33-51055 on Form S-8 relating to the SNET Non-Employee Director Stock Plan. Registration Statement No. 33-64975 on Form S-8 relating to the SNET 1995 Stock Incentive Plan. Registration Statement No. 33-60133 on Form S-3 relating to the registration of $470 million of Debt Securities. Registration Statement No. 333-05757 on Form S-8 relating to the SNET 1996 Non-Employee Director Stock Plan. Registration Statement No. 333-22841 on Form S-4 relating to the proposed acquisition of the Woodbury Telephone Company. /s/ Coopers & Lybrand L.L.P. Hartford, Connecticut Coopers & Lybrand L.L.P. March 20, 1997 EX-24.1 8 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS: WHEREAS, Southern New England Telecommunications Corporation, a Connecticut corporation (hereinafter referred to as the "Corporation"), proposes to file shortly with the Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, an annual report on Form 10-K; and WHEREAS, each of the undersigned is an officer or director, or both, of the Corporation, and holds the office, or offices, in the Corporation herein below indicated under his or her name; NOW, THEREFORE, the undersigned, and each of them, hereby constitutes and appoints Donald R. Shassian their attorney-in-fact for them and in their name, place and stead, and in each of their offices and capacities with the Corporation, to execute and file such annual report, and thereafter to execute and file any amendment or amendments thereto, hereby giving and granting to said attorney full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in and about the premises, as fully, to all intents and purposes, as the undersigned might or could do, if personally present at the doing thereof, hereby ratifying and confirming all that said attorney may or shall lawfully do, or cause to be done, by virtue hereof. IN WITNESS WHEREOF each of the undersigned has executed this Power of Attorney this 12th day of March 1997. Principal Executive Officer: Directors: /s/ Daniel J. Miglio Daniel J. Miglio Chairman, President, Chief Executive Officer and Director /s/ William F. Andrews William F. Andrews, Director /s/ Richard H. Ayers Richard H. Ayers, Director /s/ Zoe Baird Zoe Baird, Director /s/ Robert L. Bennett Robert L. Bennett, Director /s/ Barry M. Bloom Barry M. Bloom, Director /s/ Frank J. Connor Frank J. Connor, Director /s/ William R. Fenoglio William R. Fenoglio, Director /s/ James R. Greenfield James R. Greenfield, Director /s/ Ira D. Hall Ira D. Hall, Director /s/ Burton G. Malkiel Burton G. Malkiel, Director /s/ Frank R. O'Keefe, Jr. Frank R. O'Keefe, Jr., Director POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENTS: WHEREAS, Southern New England Telecommunications Corporation, a Connecticut corporation (hereinafter referred to as the "Corporation"), proposes to file shortly with the Securities and Exchange Commission, under the provisions of the Securities Exchange Act of 1934, as amended, an annual report on Form 10-K; and WHEREAS, the undersigned is a director of the Corporation; NOW, THEREFORE, the undersigned hereby constitutes and appoints Donald R. Shassian her attorney-in-fact for her and in her name, place and stead, and in her capacity as director of the Corporation, to execute and file such annual report, and thereafter to execute and file any amendment or amendments thereto, hereby giving and granting to said attorney full power and authority to do and perform each and every act and thing whatsoever requisite and necessary to be done in and about the premises, as fully, to all intents and purposes, as the undersigned might or could do, if personally present at the doing thereof, hereby ratifying and confirming all that said attorney may or shall lawfully do, or cause to be done, by virtue hereof. IN WITNESS WHEREOF the undersigned has executed this Power of Attorney this 17th day of March 1997. /s/ Claire L. Gaudiani Claire L. Gaudiani, Director EX-24.2 9 C E R T I F I C A T E This is to certify that at a regular meeting of the Board of Directors of Southern New England Telecommunications Corporation held on March 12, 1997, the following vote was adopted and, as of the date of this Certificate, has not been amended, modified or rescinded and is in full force and effect: "VOTED: That the Chief Executive Officer and the Chief Financial Officer are, or either one of them is, authorized to execute, personally or by attorney, in the name and on behalf of the Company, and to cause to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934, as amended, the Company's Annual Report on Form 10-K, for the fiscal year ended December 31, 1996, in substantially the form submitted to this meeting, but with such changes, additions and revisions as the officer executing the same shall approve, such approval to be conclusively evidenced by such execution and thereafter to execute personally, and to cause to be filed, any amendments or supplements to such report and to do any other acts and to execute and deliver any other documents necessary or advisable in connection with the foregoing." Attest: /s/ Paula M. Anderson Paula M. Anderson Assistant Secretary New Haven, Connecticut March 20, 1997 EX-27 10
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE 1996 ANNUAL REPORT ON FORM 10-K OF SOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1,000 YEAR DEC-31-1996 JAN-01-1996 DEC-31-1996 9,000 0 350,700 27,400 27,400 468,000 4,707,300 3,110,300 2,671,000 667,000 1,169,700 0 0 68,400 394,600 2,671,000 0 1,941,900 0 1,559,700 (6,900) 0 88,700 300,400 107,600 192,800 0 0 0 192,800 2.94 2.94
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