BellSouth's Health Problems

Accounting changes for health-care costs will be a drag on the telco's earnings through the rest of this year and in 2005

By Brian Grow

Even as companies attempt to pare back the soaring cost of employee benefits, health care remains a problem. That's the case at BellSouth (BLS ). A new labor contract is expected to hike retiree health-coverage costs by $3.3 billion and push down earnings in the fourth quarter, the Atlanta-based regional telecom said on Aug. 18.

The scaleback comes in the wake of a new agreement concluded on Aug. 7 with the Communications Workers of America (CWA), which covers some 45,000 BellSouth workers. Under previous contracts, BellSouth had waived attempts to collect additional premiums when health-care costs topped caps. And BellSouth accounted for its retiree medical obligations based on the terms of CWA contracts, which meant the amounts were fixed for each financial period.


  Now, "the recent tentative agreement with the CWA includes an increase in the amount of the caps," BellSouth said in a statement. "With this increase, BellSouth will begin recording retiree medical costs as if there were no caps in future periods."

BellSouth is matching rivals such as SBC (SBC ) and Verizon (VZ ) by recognizing the potential increases in the costs of retiree medical benefits in current accounting periods, according to Richard G. Klugman, telecom analyst at Jefferies & Co. in New York. "While this won't change BellSouth's cash obligation for retirees, upfront recognition...of [such] costs leads to a $3.3 billion increase to the company's benefit obligation," Klugman wrote in a note to investors on Aug. 18.

Like most other major corporations, BellSouth is bracing for an expected 10.4% rise in health-care costs this year, according to the Kaiser Family Foundation. The telecom expects its total health-care bill to jump to about $1.1 billion in 2004 -- and even higher next year. While analysts believe the accounting change won't have a major impact on earnings -- and indeed, it was expected -- the timing is somewhat unfortunate, as BellSouth has been gaining traction in the sluggish telecom market.


  Operating in 13 Southeastern states, BellSouth has turned in solid profits in recent quarters as margins have improved, and it has attracted customers willing to pay as much as $54.95 per month for high-speed Internet access. On July 26, it reported income from continuing operations of $939 million, up 3.4% from the same period a year ago. And in June, it raised its dividend 8%.

The hike in BellSouth's retiree medical costs, which will be recognized over the average remaining service period for employees, is expected to reduce fourth-quarter earnings by 3 cents to 4 cents per share. The company is still calculating what the effect of new accounting for those benefits will be in 2005.

"There will be some impact," says BellSouth spokesman Jeffrey Battcher. Analysts polled by Thomson First Call prior to the announcement had expected BellSouth to earn 50 cents per share in the fourth quarter ending Dec. 31. BellSouth shares were down 5 cents, to close at $27.15 in New York Stock Exchange trading on Aug. 18. While the market didn't seem to take the matter much to heart, even a small drag on earnings can't be happy news for investors.

Grow is a correspondent in BusinessWeek's Atlanta bureau

Edited by Patricia O'Connell

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