<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1995
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-8609
PACIFIC TELESIS GROUP
I.R.S. Employer No. 94-2919931
A Nevada Corporation
130 Kearny Street, San Francisco, California 94108
Telephone - Area Code (415) 394-3000
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 .
--- ---
At October 31, 1995, 428,434,672 common shares were outstanding.
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
TABLE OF CONTENTS
Page
Number
------
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
Review Report of Independent Accountants .............. 1
Condensed Consolidated Statements of Income ........... 2
Condensed Consolidated Balance Sheets ................. 4
Condensed Consolidated Statements of
Shareowners' Equity ............................... 5
Condensed Consolidated Statements of Cash Flows ....... 6
Notes to Condensed Consolidated Financial Statements .. 8
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition .................... 15
PART II. OTHER INFORMATION
- --------------------------
Item 6. Exhibits and Reports on Form 8-K......................... 38
SIGNATURE......................................................... 39
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowners of Pacific Telesis Group:
We have reviewed the accompanying condensed consolidated balance sheet of
Pacific Telesis Group and Subsidiaries as of September 30, 1995 and the
related condensed consolidated statements of income for the three- and nine-
month periods ended September 30, 1995 and 1994, and the condensed
consolidated statements of shareowners' equity and cash flows for the nine-
month periods ended September 30, 1995 and 1994. These financial statements
are the responsibility of the Corporation's management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
for them to be in conformity with generally accepted accounting principles.
As discussed in Note C on page 9, the Corporation's Pacific Bell subsidiary
discontinued application of Statement of Financial Accounting Standards No. 71
effective third quarter 1995.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Pacific Telesis Group and
Subsidiaries as of December 31, 1994, and the related consolidated statements
of income, shareowners' equity, and cash flows for the year then ended (not
presented herein); and in our report dated February 23, 1995, we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 1994, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
/s/Coopers & Lybrand L.L.P.
San Francisco, California
November 14, 1995
1
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
(Dollars in millions, ---------------------- ----------------------
except per share amounts) 1995 1994 1995 1994
- ----------------------------------------------------------------------------
OPERATING REVENUES
Local service....................$ 963 $ 875 $ 2,858 $2,576
Network access:
Interstate..................... 427 400 1,297 1,209
Intrastate..................... 180 192 525 534
Toll service..................... 311 498 926 1,502
Other service revenues........... 394 364 1,154 1,058
------- ------ ------- ------
TOTAL OPERATING REVENUES......... 2,275 2,329 6,760 6,879
------- ------ ------- ------
OPERATING EXPENSES
Cost of products and services.... 403 464 1,329 1,415
Customer operations and
selling expenses............... 477 452 1,352 1,336
General, administrative, and
other expenses................. 348 314 990 956
Property and miscellaneous taxes. 46 46 146 140
Depreciation and amortization.... 471 450 1,405 1,334
------- ------ ------- ------
TOTAL OPERATING EXPENSES......... 1,745 1,726 5,222 5,181
------- ------ ------- ------
OPERATING INCOME................. 530 603 1,538 1,698
Interest expense................. 117 107 350 336
Miscellaneous income............. 21 12 65 36
------- ------ ------- ------
INCOME FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM 434 508 1,253 1,398
Income taxes..................... 159 194 436 524
------- ------ ------- ------
INCOME FROM CONTINUING OPERATIONS
BEFORE EXTRAORDINARY ITEM....... 275 314 817 874
Income from spun-off operations,
net of tax (Note B)............ - - - 23
------- ------ ------- ------
INCOME BEFORE EXTRAORDINARY ITEM 275 314 817 897
Extraordinary item, net of tax
(Note C)....................... (3,360) - (3,360) -
-------- ------ -------- ------
NET INCOME (LOSS)................
$(3,085) $ 314 $(2,543) $ 897
======== ====== ======== ======
(Continued on next page)
2
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Continued)
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
(Dollars in millions, ---------------------- ----------------------
except per share amounts) 1995 1994 1995 1994
- ----------------------------------------------------------------------------
Earnings (loss) per share:
Income from continuing
operations before
extraordinary item............ $ 0.64 $ 0.74 $ 1.92 $ 2.06
Income from spun-off
operations.................... - - - 0.06
------ ------ ------ ------
Income before extraordinary
item.......................... 0.64 0.74 1.92 2.12
Extraordinary item............. (7.86) - (7.90) -
------- ------ ------ ------
Net income (loss).............. $(7.22) $ 0.74 $(5.98) $ 2.12
======= ====== ======= ======
Dividends per share............. $0.545 $0.545 $1.635 $1.635
Average shares outstanding
(thousands)................... 427,421 424,065 425,184 423,937
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
3
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
ASSETS: (Unaudited)
Cash and cash equivalents................... $ 72 $ 135
Accounts receivable -(net of allowances for
uncollectibles of $137 and $134 in 1995 and
1994, respectively)....................... 1,516 1,557
Prepaid expenses and other current assets... 1,079 1,206
------- -------
Total current assets........................ 2,667 2,898
------- -------
Property, plant, and equipment - at cost.... 26,913 26,565
Less: accumulated depreciation........... (15,785) (10,451)
------- -------
Property, plant, and equipment - net........ 11,128 16,114
------- -------
Deferred charges and other noncurrent assets 1,806 1,127
------- -------
TOTAL ASSETS................................ $15,601 $20,139
======= =======
LIABILITIES AND SHAREOWNERS' EQUITY:
Accounts payable and accrued liabilities.... $ 1,833 $ 1,907
Debt maturing within one year............... 881 246
Other current liabilities................... 1,178 1,330
------- -------
Total current liabilities................... 3,892 3,483
------- -------
Long-term obligations....................... 5,232 4,897
------- -------
Deferred income taxes....................... - 1,673
------- -------
Other noncurrent liabilities and
deferred credits.......................... 4,304 4,853
------- -------
Commitments and contingencies (Note D)......
Total shareowners' equity................... 2,173 5,233
------- -------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY... $15,601 $20,139
======= =======
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
4
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(Unaudited)
For the 9 Months Ended
September 30,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
COMMON STOCK
Balance at beginning of period...................... $ 43 $ 43
------ ------
Balance at end of period............................ 43 43
------ ------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period...................... 3,493 6,372
Spin-off stock distribution (Note B)................ - (2,901)
Issuance of shares.................................. - 22
Acquisition of wireless cable company (Note E)...... (9) -
Other changes....................................... 10 (4)
------ ------
Balance at end of period............................ 3,494 3,489
------ ------
REINVESTED EARNINGS
Balance at beginning of period...................... 2,257 2,040
Net income (loss)................................... (2,543) 897
Dividends declared.................................. (696) (693)
Other changes....................................... 2 (12)
------ ------
Balance at end of period............................ (980) 2,232
------ ------
TREASURY STOCK
Balance at beginning of period...................... (254) (283)
Issuance of shares.................................. - 29
Acquisition of wireless cable company (Note E)...... 126 -
------ ------
Balance at end of period............................ (128) (254)
------ ------
DEFERRED COMPENSATION - LESOP TRUST
Balance at beginning of period...................... (306) (386)
Cost of trust shares allocated to employee accounts. 50 56
------ ------
Balance at end of period............................ (256) (330)
------ ------
TOTAL SHAREOWNERS' EQUITY ............................ $2,173 $5,180
====== ======
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
5
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 9 Months Ended
September 30,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES:
Net income (loss)................................. $(2,543) $ 897
Adjustments to net income (loss):
(Income)from spun-off operations (Note B)....... - (23)
Extraordinary item (Note C)..................... 3,360 -
Depreciation and amortization................... 1,405 1,334
Deferred income taxes........................... 50 (3)
Changes in operating assets and liabilities:
Accounts receivable........................... 43 (12)
Prepaid expenses and other current assets..... (46) 17
Deferred charges and other noncurrent assets.. 135 2
Accounts payable and accrued liabilities...... 4 104
Other current liabilities..................... 23 (4)
Noncurrent liabilities and deferred credits... (438) (66)
Other adjustments, net.......................... (11) (84)
------ ------
Cash from continuing operations................... 1,982 2,162
Cash from spun-off operations..................... - 18
------ ------
Cash from operating activities.................... 1,982 2,180
------ ------
CASH FROM (USED FOR) INVESTING ACTIVITIES:
Additions to property, plant, and equipment....... (1,308) (1,060)
Investment in PCS licenses........................ (656) -
Other investing activities, net................... (13) 27
------ ------
Cash used by continuing operations................ (1,977) (1,033)
Cash used by spun-off operations.................. - (332)
------ ------
Cash used for investing activities ............... (1,977) (1,365)
------ ------
(Continued on next page)
6
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Continued)
For the 9 Months Ended
September 30,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) FINANCING ACTIVITIES:
Proceeds from issuance of common and treasury shares.. 67 124
Proceeds from issuance of long-term debt.............. - 10
Retirements of long-term debt......................... (261) (1)
Dividends paid........................................ (693) (676)
Increase (Decrease) in short-term borrowings, net..... 821 (588)
Other financing activities, net....................... (2) (16)
----- -----
Cash used by continuing operations.................... (68) (1,147)
Cash from spun-off operations......................... - 39
----- -----
Cash used for financing activities.................... (68) (1,108)
----- -----
Net cash used for all activities...................... (63) (293)
Less spun-off operations.............................. - (275)
----- -----
Decrease in cash and cash equivalents................. (63) (18)
Cash and cash equivalents at January 1................ 135 69
----- -----
Cash and cash equivalents at September 30............. $ 72 $ 51
===== =====
Cash payments for:
Interest............................................ $ 382 $ 371
Income taxes........................................ $ 359 $ 527
- ----------------------------------------------------------------------------
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
7
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION
The Condensed Consolidated Financial Statements include the accounts of
Pacific Telesis Group (the "Corporation") and its wholly and majority
owned subsidiaries. The Corporation includes a holding company,
Pacific Telesis; its telephone subsidiaries: Pacific Bell (and its
subsidiaries, Pacific Bell Directory, Pacific Bell Information Services,
Pacific Bell Mobile Services, and Pacific Bell Internet Services) and
Nevada Bell (the "Telephone Companies"); and several other units.
The Condensed Consolidated Financial Statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission ("SEC") applicable to interim financial information. Certain
information and footnote disclosures included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted in these interim statements pursuant to such
SEC rules and regulations. Management recommends that these interim
financial statements be read in conjunction with both the Corporation's
1994 annual report on Form 10-K and its 1995 Proxy Statement that
includes the audited 1994 financial statements. Effective third quarter
1995, the Corporation's Pacific Bell subsidiary discontinued accounting
under Statement of Financial Accounting Standards No. 71 ("SFAS 71"),
"Accounting for the Effects of Certain Types of Regulation." The
Corporation's Nevada Bell subsidiary continues to apply SFAS 71
accounting. (See Note C - "Discontinuance of Regulatory Accounting -
SFAS 71" on page 9.)
In management's opinion, the Condensed Consolidated Financial Statements
include all adjustments (consisting of only normal recurring adjustments,
except for the extraordinary charge of $3.4 billion associated with the
discontinuance of SFAS 71 at Pacific Bell as stated in Note C on page 9)
necessary to present fairly the financial position and results of
operations for each interim period shown. The Condensed Consolidated
Financial Statements have been reviewed by Coopers & Lybrand L.L.P.,
independent accountants. Their report is on page 1.
The Corporation's previous interest in the operating results of wireless
operations which were spun off effective April 1, 1994, is reported
separately as "spun-off operations." (See Note B - "Spun-off Operations"
following.) These operations are excluded from the prior year amounts
reported for the Corporation's revenues and expenses which reflect
"continuing operations." The Corporation's prior year statement of cash
flows has been reclassified to include separately the cash flows of spun-
off operations to conform to the current presentation. Amounts presented
for spun-off operations have been prepared solely for the purpose of
reporting Pacific Telesis Group results.
8
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (CONTINUED)
Intangible Assets and Capitalized Interest
Included in deferred charges and other noncurrent assets is $696 million
representing the amounts paid for two Personal Communications Services
("PCS") licenses recorded at cost. Interest related to these licenses is
capitalized as part of their cost. In addition, costs to relocate
incumbent microwave users will be capitalized as part of the license
acquisition cost. These costs will be amortized over 40 years once the
PCS system is in service. Management anticipates a widespread offering
of PCS services in early 1997.
B. SPUN-OFF OPERATIONS
Effective April 1, 1994, the Corporation spun off to shareowners its
domestic and international cellular, paging, and other wireless
operations in a one-for-one stock distribution of its 86 percent interest
in AirTouch Communications, Inc. A stock distribution payable was
recorded during first quarter 1994 as a stock dividend from paid-in
capital at the carrying amount of the net assets of spun-off operations.
As a result, the Corporation's shareowners' equity was reduced by
$2.9 billion in the first quarter of 1994. The stock distribution itself
was a noncash transaction which did not affect the Corporation's cash
flow statement.
C. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71
Effective third quarter 1995, the Corporation's Pacific Bell subsidiary
discontinued its application of SFAS 71 in accordance with the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 101,
"Accounting for the Discontinuance of Application of FASB Statement
No. 71." As a result, the Corporation recorded a non-cash, extraordinary
charge of $3.4 billion, or $7.86 per share, during third quarter which is
net of a deferred income tax benefit of $2.4 billion. The charge
includes a write-down of net telephone plant and the elimination of net
regulatory assets as summarized in the following table.
($ millions) Pre-Tax After-Tax
------------------------------------------------------------------------
Increase in telephone plant and equipment
accumulated depreciation............... $4,819 $2,714
Elimination of net regulatory assets..... 962 646
------ ------
Total.................................... $5,781 $3,360
========================================================================
9
<PAGE>
C. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71 (continued)
The Telephone Companies have historically accounted for the economic
effects of regulation in accordance with the provisions of SFAS 71.
Under SFAS 71, the Telephone Companies have depreciated telephone plant
using lives prescribed by regulators and, as a result of actions of
regulators, have deferred recognizing certain costs or have recognized
certain liabilities (referred to as "regulatory assets" and "regulatory
liabilities").
Effective third quarter 1995, management determined that, for external
financial reporting purposes, it is no longer appropriate for
Pacific Bell to use the special SFAS 71 accounting rules for entities
subject to traditional regulation. Management's decision to change to
the general accounting rules used by competitive enterprises was based
upon an assessment of the emerging competitive environment in California.
Pacific Bell's prices for its products and services are being driven
increasingly by market forces instead of regulation.
The $4.8 billion increase in Pacific Bell's accumulated depreciation for
its telephone plant reflects the adoption of new, shorter depreciation
lives. The estimated useful lives historically prescribed by regulators
did not keep up with the rapid pace of technology. Pacific Bell's
previous and new asset lives are compared in the following table.
Asset Lives (in years)
--------------------------------------------------------------------
Old New
--- ---
Copper............................................. 19-26 14
Digital Switches................................... 16.5 10
Digital Circuits...................................9.6-11.5 8
Fiber.............................................. 28-30 20
Conduit............................................ 59 50
=======================================================================
10
<PAGE>
C. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71 (continued)
The discontinuance of SFAS 71 for external financial reporting purposes
also required the elimination of Pacific Bell's net regulatory assets,
which totaled $962 million. Regulators sometimes include costs in
allowable costs for ratemaking purposes in a period other than the period
in which those costs would be charged to expense under general accounting
rules. The accounting for these timing differences created regulatory
assets and regulatory liabilities on Pacific Bell's balance sheet.
Details of Pacific Bell's net regulatory assets which have been
eliminated are displayed in the following table.
($ millions)
------------------------------------------------------------------------
Regulatory assets (liabilities) due to:
Deferred pension costs*.................. $460
Unamortized debt redemption costs**...... 337
Deferred compensated absence costs*...... 206
Unamortized purchases of property, plant,
and equipment under $500............. 82
Deferred income taxes***................. (159)
Other.................................... 36
----
Total.................................... $962
========================================================================
* Previously included primarily in "deferred charges and other
noncurrent assets" in the Corporation's balance sheets.
** Previously included in "long-term obligations."
*** Previously included in "other current liabilities" and "other
noncurrent liabilities and deferred credits."
The $460 million regulatory asset for deferred pension costs reflected an
order by the California Public Utilities Commission ("CPUC") requiring
Pacific Bell to use the "aggregate cost method" for regulatory accounting
purposes for its intrastate operations. This regulatory asset
represented differences between Pacific Bell's intrastate pension costs
calculated using this actuarial method, subject to Internal Revenue
Service and other limitations, and costs determined under the provisions
of SFAS No. 87, "Employers' Accounting for Pensions," and SFAS No. 88,
"Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits."
Previously, when debt was refinanced before maturity, Pacific Bell had
amortized to expense any difference between net book value and redemption
price evenly over the term of the replacing issue in accordance with the
ratemaking treatment of such costs by regulators. The above unamortized
debt redemption costs of $337 million represented costs deferred in
accordance with the previous ratemaking treatment. The elimination of
the $337 million unamortized debt redemption costs balance for external
reporting purposes has resulted in a corresponding increase in the
Corporation's reported amount of long-term obligations.
11
<PAGE>
C. DISCONTINUANCE OF REGULATORY ACCOUNTING - SFAS 71 (continued)
In prior years, the CPUC and the Federal Communications Commission
("FCC") changed the required accounting for the costs of compensated
absences, such as vacation days, from a cash basis to an accrual basis. A
transition liability for earned but unused compensated absence days was
being amortized to expense over periods prescribed by each regulator.
However, the CPUC had required Pacific Bell to recognize certain
compensated absence costs on a cash basis for ratemaking. The above
regulatory asset of $206 million for compensated absences reflected those
costs which were deferred in accordance with this ratemaking treatment.
In 1989 and 1990, respectively, the FCC and the CPUC increased the
threshold for directly expensing purchases of property, plant, and
equipment from $200 to $500. Purchases of less than $500 which were
previously capitalized were being amortized to expense over periods
prescribed by regulators.
Specific provisions of SFAS No. 109, "Accounting for Income Taxes,"
requires regulated companies to record a regulatory asset or a regulatory
liability when recognizing deferred income taxes if it is probable that
these deferred taxes would be reflected in future rates. The net
regulatory liability for deferred income taxes reflected this regulatory
treatment.
Due to its discontinued application of SFAS 71, Pacific Bell will no
longer account for the economic effects of regulation for external
financial reporting purposes. Pacific Bell's reported depreciation
expense will be based on estimated economic asset lives. Pension costs
for both intrastate and interstate operations will be determined under
SFAS No. 87 and SFAS No. 88. Capitalized interest cost will be reported
as a cost of telephone plant and equipment and a reduction in interest
expense, as required by SFAS No. 34, "Capitalization of Interest Cost."
Prior to the discontinuance of SFAS 71, Pacific Bell recorded an
allowance for funds used during construction, which included both
interest and equity return components, as a cost of plant and as an item
of miscellaneous income. Pacific Bell's accounting and reporting for
regulatory purposes are not affected by the discontinued application of
SFAS 71 for external financial reporting purposes.
D. COMMITMENTS AND CONTINGENCIES
Broadband Network
In December 1994, Pacific Bell contracted for the purchase of up to
$2 billion of broadband network facilities which will incorporate
emerging technologies. Pacific Bell is committed to purchase these
facilities in 1998 if they meet certain quality and performance criteria.
12
<PAGE>
D. COMMITMENTS AND CONTINGENCIES (continued)
Revenues Subject to Refund
In 1992, the CPUC issued a decision adopting, with modification,
SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other
than Pensions," for regulatory accounting purposes. Annual price cap
decisions by the CPUC granted Pacific Bell $100 million in each of the
years 1995 and 1994 for partial recovery of higher costs under
SFAS No. 106. However, the CPUC in October 1994 reopened the proceeding
to determine the criteria for exogenous cost treatment and whether
Pacific Bell should continue to recover these costs. The CPUC's order
held that related revenues collected after October 12, 1994 are subject
to refund.
Beginning August 1, 1995, approximately $25 million annually of 1993-94
postretirement benefits costs are being recovered subject to potential
refund in the interstate jurisdiction. The FCC is examining the
appropriateness of this cost recovery in a new proceeding. Management
believes postretirement benefits costs are appropriately recoverable in
Pacific Bell's price cap filings, but is unable to predict the outcome of
the CPUC's or FCC's proceedings.
Purchase Options
In June 1990, Prime Cable of Chicago, Inc. ("Prime Cable"), acquired
certain Chicago cable television properties from Group W. The
Corporation, through its PTCB subsidiary, holds options to purchase a
75 percent interest in Prime Cable. TC Cable, Inc. ("TC Cable") now
holds this interest. PacTel Capital Funding, a wholly owned subsidiary
of the Corporation, has guaranteed bank financing used by TC Cable and
its parent corporation to acquire this interest. The guarantees cover
initial loan amounts of $60 million as well as interest accruing on the
loans which will be added to the outstanding loan balances up to an
aggregate of $136 million. In management's opinion, the likelihood that
the Corporation will be required to pay principal or interest on this
debt under these guarantees is remote.
13
<PAGE>
PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
E. ACQUISITIONS
In July 1995, the Corporation acquired 100 percent of the stock of
Cross Country Wireless Inc. ("CCW") to provide wireless cable service in
southern California. The Corporation now has existing wireless cable
operations with over 40,000 video customers in Riverside, California and
holds licenses and rights to provide wireless video services in
Los Angeles, Orange County, and San Diego. The transaction involved the
exchange of approximately $120 million of Pacific Telesis Group treasury
stock, or about 4.4 million shares, for the outstanding stock of CCW.
The Corporation also assumed approximately $55 million of CCW debt that
was retired during the third quarter of 1995. By the end of 1996, the
Corporation plans to offer more than 100 channels of digital programming
in the Los Angeles, Orange County, and San Diego areas which can deliver
high quality digital picture with CD-quality sound to approximately five
million households. The actual number of subscribers cannot be predicted
at this time.
F. SUBSEQUENT EVENT
On October 17, 1995, Pacific Telesis Financing I, II and III (the
"Trusts") were established as Delaware statutory business trusts. All of
the common securities of the Trusts will be directly or indirectly owned
by the Corporation. In October 1995, the Corporation and the Trusts
filed a shelf registration with the SEC to sell up to $1 billion of the
Trusts' preferred securities to the public. The Trusts' preferred
securities are subject to a guarantee from the Corporation as described
in the registration statement. Each Trust was formed for the exclusive
purpose of issuing preferred and common securities representing undivided
beneficial interests in the Trusts and investing the proceeds from the
sale of the preferred securities in unsecured subordinated debt
securities of the Corporation. The registration statement has not yet
been declared effective by the SEC. Such offerings will be made only by
means of a prospectus and the proceeds will be used for general corporate
purposes.
14
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESULTS OF OPERATIONS
The following discussions and data compare the results of operations of
Pacific Telesis Group (the "Corporation") for the three- and nine-month
periods ended September 30, 1995 to the same periods in 1994. The
Corporation's previous interests in the operating results of wireless
operations which were spun off to shareowners on April 1, 1994 are
classified separately as "spun-off operations" in the accompanying financial
statements. (See Note A - "Basis of Presentation" on page 8.) The spun-off
operations are excluded from the reported amounts of the Corporation's
revenues and expenses. The Corporation's "continuing operations" include
Pacific Bell and Nevada Bell (the "Telephone Companies"), along with several
other units. Results for the first nine months of 1995 may not be
indicative of results for the full year.
A summary of selected operating data is shown below:
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
% %
Selected Operating Data* 1995 1994 Change 1995 1994 Change
----------------------------------------------------------------------------
Return on shareowners'
equity (%)................. -246.3 24.1 - -64.5 22.7 -
Operating ratio (%).......... 76.7 74.1 - 77.3 75.3 -
Revenues per average employee
($ thousands).............. 45 44 2.3 133 128 3.9
Total employees
at September 30.............49,976 53,162 -6.0 - - -
Telephone Companies employees per
ten thousand access lines
at September 30**.......... 29.8 32.8 -9.1 - - -
----------------------------------------------------------------------------
* continuing operations
** excludes Pacific Bell Directory and Pacific Bell Mobile Services
employees
Earnings
--------
The Corporation reported losses for the three- and nine-months ended
September 30, 1995 of $3,085 and $2,543 million, respectively, or losses per
share of $7.22 and $5.98, respectively. The reported losses reflect a non-
cash, extraordinary charge to net income during third quarter of
$3.4 billion, after taxes, or $7.86 per share. The charge results from the
discontinued application by the Corporation's Pacific Bell subsidiary of
special accounting rules for entities subject to traditional regulation and
its change to the general accounting rules used by competitive enterprises.
As a result of this extraordinary charge, the Corporation expects to record
a net loss for the year. (See "Extraordinary Item" on page 23.)
15
<PAGE>
Earnings for the first nine months of 1995 decreased $3.4 billion in
comparison to the same period last year reflecting this year's one-time,
extraordinary third quarter charge. Revenue shortfalls also contributed to
the decline in earnings. Demand growth as a result of the January 1995
intra-service area toll ("local toll") price reductions fell far short of
the level anticipated by the California Public Utilities Commission
("CPUC"). As a result, the revenue neutrality intended by the CPUC's price
rebalancing order was not achieved. Price cap revenue reductions ordered by
the CPUC and the Federal Communications Commission ("FCC") further reduced
earnings. Additional pressure on earnings resulted from incremental labor
expense associated with the severe storms in early 1995. Last year's results
included a one-time after-tax charge of about $29 million for a CPUC refund
order. Management believes 1995 earnings without one-time charges could be
about ten percent less than 1994 due primarily to the revenue rebalancing
shortfall. (See "Revenue Rebalancing Shortfall Filing" on page 31.)
Volume Indicators
------------------
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- -----------------------
% %
Volume Indicators 1995 1994 Change 1995 1994 Change
---------------------------------------------------------------------------
Customer switched access
lines in service at
September 30 (thousands). 15,640 15,223 2.7 - - -
Carrier access minutes-
of-use (millions)........ 15,037 13,554 10.9 44,083 39,968 10.3
Interstate............... 8,252 7,982 3.4 24,505 23,693 3.4
Intrastate............... 6,785 5,572 21.8 19,578 16,275 20.3
Toll messages (millions)... 1,243 1,137 9.3 3,639 3,355 8.5
---------------------------------------------------------------------------
The total number of access lines in service grew to 15,640 thousand, an
increase of 2.7 percent for the twelve months ended September 30, 1995.
This is slightly below the 2.8 percent increase for the same period last
year. The growth rate in business access lines was 4.4 percent this year,
up from 4.1 percent last year. The growth in business access lines reflects
increased employment levels in California. Pacific Bell's business Centrex
lines grew 12.1 percent during the same period as businesses continued to
link multiple locations and improve disaster preparedness. The number of
ISDN lines in service for the Telephone Companies grew to 43,195, an
increase of 125.4 percent for the twelve months ended September 30, 1995, as
customers demanded faster data transmission and Internet access. The
residential access line growth rate declined to 1.8 percent for the twelve
months ended September 30, 1995, from 2.0 percent last year. Last year's
figure included the results of a second line sales promotion. The lower
residential growth rate compared to the business growth rate reflects weak
residential construction in California.
16
<PAGE>
Access minutes-of-use represent the volume of traffic carried by
interexchange carriers over the Telephone Companies' local networks. Total
access minutes-of-use for the nine months ended September 30, 1995 increased
by 10.3 percent over the same period last year. The increase in access
minutes-of-use was primarily attributable to economic growth and the effect
of toll services competition. In California, the official introduction of
toll services competition in January 1995 had the effect of increasing
intrastate access minutes-of-use. Pacific Bell provides access service to
competitors who complete local toll calls over Pacific Bell's network.
Toll messages are comprised of Message Telecommunications Service, Optional
Calling Plans, WATS and terminating 800 messages. For the nine months ended
September 30, 1995, toll messages increased by 8.5 percent compared to an
increase of 4.6 percent for the corresponding period in 1994. The increase
was driven primarily by economic growth as well as lower prices. In
California on January 1, 1995, Pacific Bell lowered the price of its local
toll services by an average of 40 percent. Pacific Bell also began offering
new discount calling plans. Residential customers receive an automatic
15 percent off toll charges above five dollars per month while businesses
receive an automatic 20 percent off toll charges over $15 per month. High
volume customers can receive even larger discounts. Price decreases have
stimulated demand slightly but the increase falls far short of levels
included in the CPUC's order. (See also "Competitive Risk" on page 35.)
Operating Revenues
------------------
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
($ millions) 1995 1994 Change 1995 1994 Change
----------------------------------------------------------------------------
Total operating revenues.. $2,275 $2,329 -$54 $6,760 $6,879 -$119
-2.3% -1.7%
----------------------------------------------------------------------------
Revenues for the three- and nine-months ended September 30, 1995, were
reduced from the same periods last year primarily because demand growth as a
result of lower prices was lower than assumed in the CPUC-ordered price
rebalancing. Revenues were also reduced because of price cap revenue
reductions ordered by the CPUC under incentive-based regulation and the
effects of toll services competition.
17
<PAGE>
Effective January 1, 1995, the CPUC allowed long-distance companies and
others to officially compete with Pacific Bell in providing local toll
services in California. That decision also rebalanced prices for most of
Pacific Bell's regulated services so that Pacific Bell could remain
competitive in the new environment. The CPUC intended this decision to be
initially revenue neutral. Revenue reductions due to lower prices were
intended to be offset by other price increases and by increased network
usage generated by the lower prices. Although Pacific Bell observed some
increased usage during the three- and nine-months ended September 30, 1995,
calling volumes were far below levels forecasted by the CPUC and far below
levels necessary to achieve revenue neutrality. (See "Revenue Rebalancing
Shortfall Filing" on page 31.)
The decreases in total operating revenues from price rebalancing and price
cap orders for the three- and nine-months ended September 30, 1995, compared
to 1994, were partially offset by $92 million and $237 million,
respectively, in revenues from increased customer demand. The increase in
customer demand resulted both from general economic growth and the effect of
price rebalancing.
The revenue decreases were also partially offset by a CPUC-ordered refund in
the second quarter of 1994 related to past problems with Pacific Bell's
payment processing system. Due to the 1994 refund, miscellaneous other
service revenues for the nine-month period ending September 30, 1995,
increased $27 million compared to last year. Factors affecting revenue
changes are summarized in the following tables.
Third Quarter 1995 versus Third Quarter 1994
----------------------------------------------
Total
Price change
Price Cap Customer from
($ millions) rebalancing order Misc. demand 1994
----------------------------------------------------------------------------
Local service............. $ 87 -$31 $25 $ 7 $88
Network access
Interstate.............. 3 -18 18 24 27
Intrastate.............. -48 -3 -15 54 -12
Toll service.............. -154 -12 -10 -11 -187
Other service revenues.... 4 -1 9 18 30
----- ----- ----- ----- -----
Total operating revenues.. -$108 -$65 $27 $92 -$54
============================================================================
18
<PAGE>
First 9 Months 1995 versus First 9 Months 1994
----------------------------------------------
Total
Price change
Price Cap Customer from
($ millions) rebalancing order Misc. demand 1994
-----------------------------------------------------------------------
Local service............. $289 -$ 93 $ 62 $ 24 $282
Network access
Interstate.............. 16 -18 31 59 88
Intrastate.............. -171 -12 13 161 -9
Toll service.............. -454 -37 -23 -62 -576
Other service revenues.... 12 -1 30 55 96
----- ----- ----- ----- -----
Total operating revenues.. -$308 -$161 $113 $237 -$119
=======================================================================
The increases in revenues due to customer demand in the above tables reflect
growth in key volume indicators. The increases in customer demand for
local service revenues is the result of growth in access lines and custom
calling services generated by the improved economy in California.
Increases in interstate network access revenues due to customer demand
reflect increased interexchange carrier access minutes-of-use, as well as
increased access lines. Demand-related increases in intrastate network
access revenues also result from growth in access minutes-of-use. At
Pacific Bell, the official introduction of competition in the local toll
market in January 1995 had the effect of increasing access usage revenues.
The decreases in customer demand-related toll service revenues primarily
results from competition (see "Competitive Risk" on page 35). In addition,
Pacific Bell has lost and continues to lose WATS and 800 service business to
interexchange carriers who have the competitive advantage of being able to
offer these services both within and between service areas. Partially
offsetting these reductions for the three- and nine-month periods were
increased usage revenues resulting from general economic growth.
Demand-related increases in other service revenues reflect the continuing
success of the Telephone Companies' voice mail products and directory
operations.
19
<PAGE>
Operating Expenses
- ------------------
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ---------------------
($ millions) 1995 1994 Change 1995 1994 Change
- -------------------------------------------------------------------------
Total operating expenses.. $1,745 $1,726 $19 $5,222 $5,181 $41
1.1% 0.8%
- -------------------------------------------------------------------------
Total operating expenses for the three- and nine-months ended September 30,
1995, increased when compared with 1994 reflecting increased depreciation
expense, costs resulting from severe storm damage in early 1995, and increased
customer education and software expenses. These expenses were partially
offset by the Corporation's continuing cost reduction efforts and reduced
settlements expense as displayed in the tables below.
Third Quarter 1995 versus Third Quarter 1994
---------------------------------------------
Pacific Bell Expenses
(excluding subsidiaries)
--------------------------------- Total
Other Change
Salaries Employee Settle- PTG From
($ millions) & Wages Benefits ments Misc. Entities 1994
- ---------------------------------------------------------------------------
Cost of products &
services............... -$22 -$13 -$23 -$ 9 $ 6 -$61
Customer operations &
selling expenses....... -6 - - 34 -3 25
General, admin. & other
expenses............... -8 11 - -17 48 34
Property & misc. taxes... - - - 1 -1 -
Depreciation &
amortization........... - - - 17 4 21
----- ----- ----- ----- ----- -----
Total operating expenses. -$36 -$ 2 -$23 $26 $54 $ 19
===========================================================================
20
<PAGE>
First 9 Months 1995 versus First 9 Months 1994
----------------------------------------------
Pacific Bell Expenses
(excluding subsidiaries)
--------------------------------- Total
Other Change
Salaries Employee Settle- PTG From
($ millions) & Wages Benefits ments Misc. Entities 1994
- ---------------------------------------------------------------------------
Cost of products &
services............... -$ 4 -$20 -$58 -$14 $10 -$86
Customer operations &
selling expenses....... -7 -13 - 29 7 16
General, admin. & other
expenses............... -24 14 - -12 56 34
Property & misc. taxes... - - - 6 - 6
Depreciation &
amortization........... - - - 66 5 71
----- ----- ----- ----- ----- -----
Total operating expenses. -$35 -$19 -$58 $75 $78 $41
===========================================================================
Pacific Bell's salary and wage expense for the three- and nine-month periods
ending September 30, 1995, decreased compared to the same periods in 1994
primarily due to force reduction. Force reduction savings were partially
offset by higher overtime expense for storm and flood repairs in the first
half of 1995. Pacific Bell's lower employee benefits expense for the three-
and nine-month periods in 1995 compared to 1994 was primarily due to the
Corporation's ongoing health care cost-reduction efforts. Certain
nonrecurring adjustments in the third quarter of 1994 partially offset these
decreases.
Pacific Bell's settlements expense for the three- and nine-month periods in
1995 compared to 1994 decreased primarily due to the CPUC-ordered price
rebalancing which eliminated reimbursements to certain other local exchange
carriers for calls terminating in their territories.
Pacific Bell's miscellaneous customer operations and selling expenses for the
three- and nine-month periods in 1995 compared to 1994 increased primarily due
to customer education expenses in the third quarter of 1995.
Pacific Bell's depreciation expense increased for the three- and nine-month
periods in 1995 compared to 1994 primarily due to higher depreciation rates
ordered by the CPUC effective January 1, 1995, and higher telephone plant
balances.
The Corporation's other entities' general and administrative expense increased
for the three- and nine-month periods in 1995 compared to 1994 primarily due
to increased software expense in the third quarter of 1995.
21
<PAGE>
Interest Expense
- ----------------
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
($ millions) 1995 1994 Change 1995 1994 Change
- ---------------------------------------------------------------------------
Interest expense.......... $117 $107 $10 $350 $336 $14
9.3% 4.2%
- ---------------------------------------------------------------------------
Interest expense increased for the three- and nine-month periods in 1995
compared to 1994 primarily due to interest adjustments on capital leases and
the discontinuance of the amortization of gains on certain investments. These
increases were partially offset by interest expense associated with the
retirement of medium term notes in 1995 and last year's interest expense
associated with a CPUC refund order.
Miscellaneous Income
- --------------------
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
($ millions) 1995 1994 Change 1995 1994 Change
- ----------------------------------------------------------------------------
Miscellaneous Income..... $21 $12 $9 $65 $36 $29
75.0% 80.6%
- ----------------------------------------------------------------------------
Miscellaneous income increased for the three-month period in 1995 compared to
1994 primarily due to a change in the FCC calculation of "Allowance for Funds
Used During Construction" and unrealized gains on trust assets under an
executive compensation deferral plan. These unrealized gains will fluctuate
throughout the year and may be offset by unrealized losses depending on market
conditions. The increase for the nine-month period in 1995 compared to 1994
included interest income of $25 million from a tax refund received in first
quarter 1995 related to prior years. These increases were partially offset by
the Corporation's equity losses of its joint ventures.
Income Taxes
- ------------
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
($ millions) 1995 1994 Change 1995 1994 Change
- ----------------------------------------------------------------------------
Income Taxes............. $159 $194 -$35 $436 $524 -$88
-18.0% -16.8%
- -----------------------------------------------------------------------------
The decrease in income tax expense for the three- and nine-month periods in
1995 compared to 1994 was primarily due to lower pre-tax income and a tax
refund received in first quarter 1995.
22
<PAGE>
Extraordinary Item
- ------------------
The Telephone Companies historically have accounted for the economic effects
of regulation in accordance with the provisions of Statement of Financial
Accounting Standards No. 71 ("SFAS 71"), "Accounting for the Effects of
Certain Types of Regulation." Under SFAS 71, the Telephone Companies have
depreciated telephone plant using lives prescribed by regulators and, as a
result of other actions of regulators, have deferred recognizing certain costs
or have recognized certain liabilities (referred to as "regulatory assets" and
"regulatory liabilities").
Effective third quarter 1995, management determined that, for external
financial reporting purposes, it is no longer appropriate for Pacific Bell to
continue to use the special SFAS 71 accounting rules for entities subject to
traditional regulation. Management's decision to change to the general
accounting rules used by competitive enterprises was based upon an assessment
of the emerging competitive environment in California. Pacific Bell's prices
for its products and services are being driven increasingly by market forces
instead of regulation.
The discontinued application of SFAS 71 required Pacific Bell, for external
financial reporting purposes, to write down the carrying amount of its
telephone plant and to eliminate its regulatory assets and liabilities. As a
result, the Corporation recorded in third quarter 1995 a non-cash,
extraordinary charge of $3.4 billion, or $7.86 per share, which is net of a
deferred income tax benefit of $2.4 billion. The telephone plant write-down
portion of the charge reflects a pre-tax increase in Pacific Bell's
accumulated depreciation of approximately $4.8 billion to recognize shorter
estimated lives in a competitive market. The extraordinary charge also
includes a pre-tax adjustment of $962 million to eliminate Pacific Bell's
regulatory assets and liabilities. The discontinuance of SFAS 71 for
Pacific Bell was made in accordance with Statement of Financial Accounting
Standards No. 101, "Accounting for the Discontinuance of Application of
FASB Statement No. 71." The Corporation's Nevada Bell subsidiary continues to
apply SFAS 71 accounting. If Nevada Bell were to discontinue SFAS 71, the
financial impact would not have a material effect on the Corporation's
earnings. (See also Note C - "Discontinuation of Regulatory Accounting -
SFAS 71" on page 9.)
In future years, the discontinuance of SFAS 71 by Pacific Bell is not expected
to materially affect the Corporation's depreciation expense, net income or
cash flow. This action will not affect Pacific Bell's planned network
investments. The discontinuance of SFAS 71 by Pacific Bell is a change for
external financial reporting purposes only and has no effect on its customers.
23
<PAGE>
Status of Reserves
- ------------------
As previously reported, Pacific Bell established a restructuring reserve at
the end of 1993 to provide for the incremental cost of force reductions and
other related costs to restructure its internal business processes through
1997. After new hires, net force loss for Pacific Bell (excluding
subsidiaries) was approximately 1,700 for the first nine months of 1995. A
total of $215 million was charged to the reserve in the first nine months of
1995 primarily for reengineering projects. As of September 30, 1995, a
balance of $619 million remained in the restructuring reserve.
Pacific Bell continues to refine its reengineering and force reduction plans
in order to maximize cost savings. Management expects fourth quarter 1995
charges to the reserve to exceed the $108 million charged in the third
quarter. Actual charges to the reserve in 1995 are not expected to differ
materially from the previous estimate of $386 million.
During the second quarter of 1995, Pacific Bell announced that it will further
consolidate its network operations centers to two by first quarter 1996,
rather than four centers as previously announced. This move is expected to
result in investment savings of $20 million during 1995 without affecting
customer service.
In December 1994, the Corporation's real estate subsidiary sold substantially
all of its assets for approximately $160 million which included $43 million in
notes secured by four of the properties. In March and April of 1995, defaults
on the secured notes resulted in the return of the four properties to the
Corporation. The Corporation is in the process of selling the returned
properties. Management believes the $46 million reserve balance at September
30, 1995 is adequate to cover potential losses on the disposal of the
remaining assets.
LIQUIDITY AND FINANCIAL CONDITION
The Corporation defines liquidity as its ability to generate resources to
finance business expansion, construct capital assets, pay its current
obligations, and pay dividends. The Corporation has been meeting most of its
liquidity needs from internally generated funds. The Corporation expects to
continue to meet the majority of its liquidity needs from internally generated
funds, but can also obtain external financing through the issuance of common
stock and short- and long-term debt, if needed.
Short-term borrowings are available under a commercial paper program and
through uncommitted unused lines of credit. These lines of credit are subject
to continued review by the lending banks. At September 30, 1995, the unused
lines of credit available totaled approximately $2.6 billion.
24
<PAGE>
For longer term borrowings, Pacific Bell has remaining authority from the CPUC
to issue up to $1.25 billion of long- and intermediate-term debt. The
proceeds may be used to redeem maturing debt and to refinance other debt
issues. Pacific Bell has remaining authority from the Securities and Exchange
Commission ("SEC") to issue up to $650 million of long- and intermediate-term
debt through a shelf registration filed in April 1993. In addition, the
Corporation's PacTel Capital Resources ("PTCR") subsidiary may issue up to
$192 million of medium-term notes through a shelf registration on file with
the SEC.
In October 1995, the Corporation and Pacific Telesis Financing I, II and III
(the "Trusts"), each Trust a Delaware statutory business trust, filed a shelf
registration with the SEC to sell up to $1 billion of the Trusts' preferred
securities to the public. The Trusts' preferred securities are subject to a
guarantee from the Corporation as described in the registration statement.
(See Note F - "Subsequent Event" on page 14.) Each Trust was formed for the
exclusive purpose of issuing preferred and common securities representing
undivided beneficial interests in the Trusts and investing the proceeds from
the sale of the preferred securities in unsecured subordinated debt securities
of the Corporation. The registration statement has not yet been declared
effective by the SEC. Such offerings will be made only by means of a
prospectus and the proceeds will be used for general corporate purposes. In
November 1995, Standard & Poor's Corporation ("S&P") and Moody's Investors
Services, Inc. ("Moody's") assigned preliminary ratings of Single-A ("A") and
(P) "al", respectively to the preferred securities.
In October 1995, the Corporation and the Los Angeles Times announced that the
two companies will discontinue their equally owned joint venture, ESS
Ventures. The joint venture was created to explore and offer electronic
shopping services. The Corporation and the Los Angeles Times have decided to
independently develop their own services. The financial impact of the
discontinuance of ESS Ventures will not have a material effect on the
Corporation's earnings.
In July 1995, the Corporation acquired 100 percent of the stock of
Cross Country Wireless ("CCW") to provide wireless cable service in
Southern California. The Corporation now has existing wireless cable
operations with over 40,000 video customers in Riverside, California and holds
licenses and rights to provide wireless video services in Los Angeles,
Orange County, and San Diego. The transaction involved the exchange of
approximately $120 million of Pacific Telesis Group treasury stock, or about
4.4 million shares, for the outstanding stock of CCW. The Corporation also
assumed approximately $55 million of CCW debt that was retired during the
third quarter of 1995. By the end of 1996, the Corporation plans to offer
more than 100 channels of digital programming in the Los Angeles,
Orange County, and San Diego areas which can deliver high quality digital
picture with CD-quality sound to approximately five million households. The
actual number of subscribers cannot be predicted at this time. The
Corporation continues to evaluate opportunities to expand its wireless video
services offerings.
25
<PAGE>
In September 1995, management announced a strategy whereby the Corporation
will focus on wireless digital television in Southern California, where
wireline video technology construction will slow, and accelerate construction
of its advanced communication network in the San Francisco Bay Area. The plan
will reduce capital needs by as much as $1 billion over the next five years.
In September 1995, TELE-TV, of which the Corporation is a one-third owner,
announced it had selected Thomson Consumer Electronics as its wireless set-top
box supplier. The contract will include building three million set-top boxes,
valued at more than $1 billion over the course of three years.
In June 1995, the Corporation paid the remaining $557 million balance for the
two licenses it had acquired to offer personal communications services ("PCS")
in California and Nevada. The licenses totaled $696 million of which
20 percent had been paid by March 1995 including a $56 million deposit made in
1994. These payments were made from a combination of internally generated
funds and external financing. The Corporation anticipates financing the
build-out of the PCS network, including a five year, $300 million agreement
with Ericsson for network equipment, from a combination of internally
generated funds and external financing.
In May 1995, Duff and Phelps, Inc. lowered the rating of Pacific Bell's bonds
from Double-A ("AA") to Double-A-Minus ("AA-"). At September 30, 1995,
Pacific Bell had approximately $5 billion of long- and intermediate-term debt
outstanding. The rating action reflected price cap revenue reductions, toll
services competition, and proposed interim rules on local services
competition. The rating action also reflected the expected financing
requirements of the Corporation's broadband and PCS networks. In addition,
Moody's has changed its outlook on the long-term debt of Pacific Bell to
"negative" from "stable," citing concerns about risks associated with
deployment of the broadband network and potential pressure on the financial
profile and performance of Pacific Bell. Moody's also expressed concerns
about the timetable for the introduction of competition for all
telecommunications services in California and the risk that the rules
governing the competitive environment will be unbalanced.
In August 1995, S&P removed bond and commercial paper ratings of the
Corporation, PacTel Capital Resources, and Pacific Bell from "CreditWatch,"
where they were placed in May 1995 following the release by the CPUC of its
proposed interim rules on local services competition. S&P stated that the
long-term rating outlook for the above entities is negative.
Cash from continuing operations for operating activities decreased
$180 million for the nine months ended September 30, 1995, compared to the
same period in 1994. The decrease was primarily due to timing differences in
the payment of accounts payable and other liabilities and the trend in lower
revenues. The decrease in cash flow was partially offset by tax refunds of
$152 million received in 1995.
26
<PAGE>
Cash used by continuing operations for investing activities increased
$944 million for the nine months ended September 30, 1995, compared to the
same period in 1994. The increase was primarily due to payments of
$656 million on the PCS licenses and the associated capitalized interest in
1995. In addition, the increase also reflects the Corporation's 1995
investments in the TELE-TV joint venture with Bell Atlantic and NYNEX and the
recently disbanded LA Times joint venture. The Telephone Companies invested
about $1.2 billion for their networks for the first nine months of 1995 and
now expect to invest about $1.8 billion for the year excluding broadband
costs.
Cash used by continuing operations for financing activities decreased
$1,079 million for the nine months ended September 30, 1995, compared to the
same period in 1994. The decrease primarily reflects reduced payments of
short-term borrowings in 1995 and an increase in short-term borrowings of
approximately $820 million. In 1994, the Corporation substantially repaid its
balance of short-term borrowings during the first half of the year. These
decreases were partially offset by the retirement, primarily by PTCR, of
approximately $260 million of long-term debt in 1995.
Significant changes in certain balance sheet items occurred primarily due to
the discontinuance of SFAS 71. (See NOTE C - "Discontinuance of Regulatory
Accounting - SFAS 71" on page 9.) Accumulated depreciation on telephone plant
increased due to the discontinuance of SFAS 71. A portion of the deferred
income tax benefit associated with the SFAS 71 charge increased deferred
charges and other noncurrent assets along with the reclassification of certain
other deferred taxes. Deferred charges and other noncurrent assets also
increased due to the Corporation's investment in PCS licenses (see Note A
under "Intangible Assets and Capitalized Interest" on page 9). Offsetting
these increases was the elimination of regulatory assets due to SFAS 71.
Long-term obligations increased primarily due to the elimination of
unamortized debt redemption costs associated with the discontinuance of
SFAS 71. Shareowners' equity and the Corporation's deferred income taxes
liability decreased due to the extraordinary charge associated with SFAS 71
net of related tax benefit.
The Corporation's debt ratio changed to 73.8 percent at September 30, 1995,
from 49.6 percent at December 31, 1994, primarily due to the extraordinary
charge, which decreased shareowners' equity, and increases in short-term
borrowings of approximately $820 million in 1995. Pre-tax interest coverage
was negative for the first nine months in 1995 compared to 5.2 times for the
same period in 1994. This decrease was due primarily to the Corporation's
reported loss in third quarter 1995.
For third quarter 1995, the Pacific Telesis Group Board of Directors
maintained the Corporation's dividend at $0.545 per share.
27
<PAGE>
LABOR AGREEMENT
On August 8, 1995, the Telephone Companies reached a tentative three-year
agreement with the Communications Workers of America which represents about
33,000 employees. The agreement was ratified by the union membership in
September 1995. The new agreement features a 10.5 percent wage increase over
three years, a 14 percent pension increase, a $16 million training and
retraining program, a new voluntary early retirement option, continued
employment security and improved health benefits. Agreements were also
reached with two other unions. Management estimates that the agreements will
result in increased costs of approximately $550 million over three years.
This estimate does not include savings which may result from future force
reductions. In October 1995, the Corporation began offering the new voluntary
early retirement option to certain non-management employees.
PENDING REGULATORY ISSUES
Telecommunications Legislation
- ------------------------------
In June 1995, the U.S. Senate approved a telecommunications bill which would
ease certain restrictions imposed by the Communications Act of 1934, the
1982 Consent Decree and the 1984 Cable Act. Among the provisions, the bill
would allow telephone companies and cable television companies to compete in
each others' markets. In August 1995, similar legislation was passed by the
House of Representatives. In October 1995, the bills went to conference to
reconcile the differences. Management believes that the telecommunications
reform legislation pending before Congress is a balanced plan that, after
reconciliation and if enacted, would begin to offer consumers the benefits of
real competition. The President of the U. S. has indicated that he may veto
the legislation unless certain changes are made.
Calling Party Identification
- ----------------------------
In May 1995, the FCC established national rules affecting how telephone
companies, including the Telephone Companies, may offer calling party
identification services ("Caller ID"). Caller ID displays the telephone
number of the calling party on a device that attaches to a customer's
telephone unless it is blocked by the calling party. Caller ID is already
available in most other states but has not been offered in California due to
CPUC blocking requirements that make the service uneconomic to provide. The
FCC ruling preempts certain of the CPUC's restrictions which made providing
Caller ID uneconomic. In June 1995, the CPUC appealed the FCC's ruling to the
U.S. Court of Appeals for the Ninth Circuit. The appeal is pending.
28
<PAGE>
FCC Regulatory Framework Review
- --------------------------------
In March 1995, the FCC adopted new interim price cap rules that govern the
prices that the larger local exchange carriers ("LECs"), including the
Telephone Companies, charge interexchange carriers ("IECs") for access to
local telephone networks.
The interim rules require LECs to adjust their maximum prices for changes in
inflation, productivity and certain costs beyond the control of the LEC.
Under the interim plan, LECs may choose from three productivity factors: 4.0,
4.7, or 5.3 percent. Election of the 5.3 percent productivity factor permits
the LEC to retain all of its earnings whereas the other lower productivity
factors require earnings to be shared with customers. In adopting the interim
plan, the FCC required LECs to prospectively reduce their price caps by
0.7 percent for each year the LEC elected the lower 3.3 percent productivity
factor during 1991-94. For Pacific Bell this resulted in a 2.1 percent
reduction. Likewise, Nevada Bell will have a 1.4 percent reduction due to
selecting the 3.3 percent productivity factor in two prior years. The
Telephone Companies have formally contested these reductions as well as other
adjustments associated with the interim plan in the U.S. Court of Appeals for
the District of Columbia (the "Court"). In August 1995, the Court agreed to
expedite review of these adjustments.
The FCC plans to adopt permanent rules in 1996 following a rulemaking
proceeding. Management continues to believe that the FCC should adopt pure
price cap regulation and eliminate the productivity factor, sharing, and
earnings caps.
The Telephone Companies' 1995 annual access filings implementing the interim
rules took effect August 1, 1995. As a result, the Telephone Companies'
revenues were reduced by approximately $126 million through June 30, 1996. Of
this amount, $72 million was reflected in the Corporation's 1994 financials.
The Telephone Companies chose the 5.3 percent productivity factor that enables
them to retain all of their earnings after July 1, 1995. The higher
productivity factor was chosen because management believes that it will be
more than offset by elimination of the sharing mechanism.
Video Dialtone Applications Approval
- ------------------------------------
In July 1995, the FCC approved Pacific Bell's applications for authority to
offer video dialtone services in specific locations in four of its service
areas. The approval allows Pacific Bell to begin installing the video-
specific components of its advanced communications network. Construction of
the video-specific elements of the network will give customers access to such
interactive services as movies and television shows on demand, interactive
news, tele-education, home shopping, video games, community information
listings, high-speed Internet access and broadcast programming. Construction
of the telephone portion of the network began in May 1994.
29
<PAGE>
In September 1995, management announced it would concentrate deployment of the
advanced communications network in the San Francisco Bay Area, one of
Pacific Bell's most competitive markets. Management had previously planned to
build an advanced communications network simultaneously in Southern
California. The Corporation's acquisition of Cross Country Wireless Inc., a
company with rights to deliver wireless digital television to more than five
million homes, allows the Corporation to introduce services more rapidly in
Southern California without the immediate deployment of wireline video
technology.
Pacific Bell's approved video dialtone applications, filed in late
December 1993, cover approximately 1.3 million homes throughout California.
With this approval, Pacific Bell is on track to be the first company in the
United States to offer a single full service network, supporting telephony,
data, and video. Technology trials will be conducted during the second half
of 1995 in the San Francisco Bay Area, with paying customers connected early
next year. Interactive services will be offered to consumers beginning mid-
1996.
Pacific Bell has selected the state-of-the-art hybrid fiber/coaxial cable
architecture. The technology is cost effective to deploy and operate, and
allows Pacific Bell to achieve significant operational savings. Furthermore,
the architecture is flexible enough to meet customer needs today while network
capacity can be expanded easily as demand grows.
There are still critical regulatory issues to resolve before Pacific Bell can
deliver the full benefits of the "communications superhighway." The FCC must
resolve the issue of whether programming affiliates of the video dialtone
providers will be regulated under cable television rules. While a cable
television system allows the owner sole discretion to determine programming, a
video dialtone platform is a common carrier platform open to any programmer.
Management believes that telephone companies providing video dialtone should
be regulated solely as common carriers even if they provide some programming
on the video dialtone platform.
30
<PAGE>
CPUC Annual Price Cap Filing
- ----------------------------
In October 1995, Pacific Bell filed its annual, mandated price cap advice
letter filing for 1996 with the CPUC. However, this year's filing was
complicated by the fact that the CPUC has not adopted a productivity factor
for Pacific Bell for 1996 for use in the price cap formula. As a result, and
solely at the CPUC's request, Pacific Bell included in its price cap filing,
"for illustrative purposes only", the revenue decrease that would result using
the productivity factor of five percent that had been adopted for use in 1994
and 1995. The resulting "illustrative" revenue decrease from our price cap
filing would be $63 million, consisting of an illustrative revenue reduction
of $116 million due to the "inflation minus productivity" portion of the price
cap formula and a proposed revenue increase of $53 million due to other
partially offsetting items. The CPUC is currently examining whether to modify
or eliminate the "inflation minus productivity" portion of the price cap
formula and has indicated that it could reach a decision by the end of 1995.
(See "CPUC Regulatory Framework Review" below.)
Uniform Systems of Account ("USOA") Turnaround Adjustment
- ---------------------------------------------------------
In May 1995, Pacific Bell filed an application with the CPUC to eliminate the
USOA Turnaround Adjustment effective January 1, 1995. This Turnaround
adjustment is a vestige of traditional rate-of-return regulation and has been
in effect since 1988. Because of the adjustment, Pacific Bell's revenues have
been reduced by approximately $23 million each year since 1988. These
adjustments were intended to reflect annual revenue requirement reductions
resulting from the CPUC's adoption of a capital-to-expense accounting change
in 1988. The CPUC held evidentiary hearings in September 1995 addressing
whether the USOA Turnaround adjustment should be eliminated. Pacific Bell has
strongly recommended that this adjustment be discontinued effective January 1,
1995, which would result in a one-time revenue increase to Pacific Bell of
$23 million for 1995. The CPUC's Division of Ratepayer Advocates has proposed
that Pacific Bell be ordered to permanently reduce its revenues by
$106 million effective January 1, 1996. AT&T Corp. has proposed that
Pacific Bell should be ordered to reduce its revenues permanently by
$112 million over the next ten years and reduce its revenues by an additional
$43 million on January 1, 1996. Management is unable to predict the outcome
of this matter.
Revenue Rebalancing Shortfall Filing
- ------------------------------------
In September 1995, Pacific Bell filed for $214 million of revenue increases.
The request was to address the revenue shortfall as a result of the CPUC price
rebalancing decision which was intended to be revenue neutral. Management
cannot predict the outcome of this matter.
31
<PAGE>
CPUC Regulatory Framework Review
- --------------------------------
In June 1995, Pacific Bell filed an emergency petition with the CPUC
requesting an expeditious review of its current regulatory framework. In
July 1995, the CPUC granted Pacific Bell's request and announced the first
phase of the review which is addressing three issues:
1. Should the inflation minus productivity portion of the price cap formula
be modified or eliminated?
2. Should the price cap formula be applied to all of the services placed in
the categories for non-competitive and partially competitive services or
only to services placed in the category for non-competitive services?
3. Should any modifications to the regulatory framework be ordered in
stages, contingent on reviewing milestones?
Management believes that the inflation minus productivity factor portion of
the price cap formula should be eliminated. As Pacific Bell operates under an
increasingly competitive environment, competition itself replaces the need for
formula based adjustments to rates. The CPUC has indicated that it wishes to
conclude the first phase of its review by the end of 1995. Management cannot
predict the future effect of the CPUC's review on revenues.
Depreciation Filing
- -------------------
The CPUC evaluates and prescribes depreciation rates each year. In June 1995,
Pacific Bell requested technical changes which would result in a $34 million
decrease in annual depreciation expense. This request was not related to
management's decision to discontinue accounting under SFAS 71 for external
financial reporting purposes. In November 1995, the CPUC granted
Pacific Bell's request with new depreciation rates to become effective
January 1, 1996.
Local Services Competition
- --------------------------
In July 1995, the CPUC issued initial rules opening the local exchange market
to competition. Facilities-based competitive local carriers ("CLCs") are
authorized to begin providing local phone service beginning January 1, 1996.
Those companies leasing lines for resale will be able to offer phone service
by March 1, 1996. No CLC may begin operating until all certification
requirements are satisfied and the CPUC grants a certificate of public
convenience and necessity. As of October 1995, 67 companies had filed with
the CPUC for authority to offer local phone service in Pacific Bell's service
areas.
32
<PAGE>
The CPUC expects to resolve remaining issues and issue final rules for
implementing full competition in all California telecommunications markets by
January 1, 1997. The CPUC has been taking testimony and is holding
evidentiary hearings on specific unresolved issues related to local
competition. These issues include LEC pricing flexibility, resale terms and
conditions including prices, points of network interconnection, prices for
interim number portability and whether the rules provide the LECs with an
opportunity to earn a fair rate of return.
In October 1995 Pacific Bell filed proposed guidelines for selling network
services and capabilities to CLCs. The proposal outlines plans for wholesale
pricing, universal service funding, joint marketing and other concerns which
management believes must be addressed before local competition can be
introduced next year. Pacific Bell has also filed testimony showing that the
effect of the CPUC's initial local competition rules, taken together with
possible unfavorable decisions on other pending regulatory issues, would
deprive Pacific Bell of the opportunity to earn a fair rate of return. The
CPUC denied Pacific Bell's Application for Rehearing of the initial rules.
Although management supports the expansion of local telephone competition, it
is concerned that under the CPUC's initial rules competitors will be able to
package and resell local phone service together with long-distance service,
while Pacific Bell will still not be able to offer customers the same array of
services. This would be a significant competitive disadvantage to Pacific
Bell since it is prohibited by the 1982 Consent Decree from providing long-
distance service between service areas.
Universal Service
- -----------------
In July 1995, in connection with its local services competition decision, the
CPUC affirmed its commitment to universal service and proposed rules to assure
the continuation of affordable, high quality service in the coming competitive
local phone services market. Universal service issues are fundamental to the
ongoing CPUC proceeding to allow local and long-distance companies to compete
in providing basic local phone services, just as they already compete in
providing local toll services.
The CPUC has stated that companies that want to compete in the local phone
services market will have the opportunities as well as the obligations
associated with universal service. Hearings have been held to seek public
comment on universal service in California. Management believes that
universal service issues should be resolved before resale competition is
authorized. Resale competition is currently scheduled to begin March 1, 1996.
33
<PAGE>
Revenues Subject to Refund
- --------------------------
In 1992, the CPUC issued a decision adopting, with modification, SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other than Pensions," for
regulatory accounting purposes. Annual price cap decisions by the CPUC
granted Pacific Bell $100 million in each of the years 1995 and 1994 for
partial recovery of higher costs under SFAS No. 106. However, the CPUC in
October 1994 reopened the proceeding to determine the criteria for exogenous
cost treatment and whether Pacific Bell should continue to recover these
costs. The CPUC's order held that related revenues collected after
October 12, 1994 are subject to refund.
Beginning August 1, 1995, approximately $25 million annually of 1993-94
postretirement benefits costs are being recovered subject to potential refund
in the interstate jurisdiction. The FCC is examining the appropriateness of
this cost recovery in a new proceeding. Management believes postretirement
benefits costs are appropriately recoverable in Pacific Bell's price cap
filings, but is unable to predict the outcome of the CPUC's or FCC's
proceedings.
Public Service Commission of Nevada ("PSCN") Regulatory Review
- --------------------------------------------------------------
On April 24, 1995, the PSCN issued a rule redesigning telecommunications
regulation in the state of Nevada. This rule includes many reforms initiated
by an industry coalition which includes Nevada Bell, Nevada IECs and other
Nevada LECs. The rule includes compromises reached with other parties,
including the cable industry and the state Office of Consumer Advocate. The
new rule will remove barriers to toll and local competition in Nevada but will
also allow Nevada Bell to keep any productivity gains by eliminating the
current customer sharing provision. The new plan is optional and will require
a rate case to determine initial pricing. After adoption, pricing flexibility
is based on the nature and competitive environment of the service. Prices for
basic service are capped during a three or five year period based on the
company's election. The plan does not prohibit or require presubscription and
allows interconnection where technologically feasible. Nevada Bell
anticipates a complete rate redesign as part of a rate case which it will file
in first quarter of 1996, for rates effective in the latter part of 1996 when
the current plan expires. Nevada Bell cannot predict the outcome of the
proceeding but believes that competition and increased productivity will
result in price reductions for customers.
34
<PAGE>
Property Taxes
- --------------
In 1992, a settlement agreement was reached between the State Board of
Equalization, all California counties, the State Attorney General, and
28 utilities, including Pacific Bell, on a specific methodology for valuing
utility property for property tax purposes. The CPUC opened an investigation
to determine if any resulting property tax savings should be returned to
customers. Intervenors have asserted that as much as $20 million of annual
property tax savings should be treated as an exogenous cost reduction in
Pacific Bell's annual price cap filings. These intervenors have also asserted
that past property tax savings totaling as much as $60 million plus interest
should be returned to customers. Management believes that under the CPUC's
regulatory framework, any property tax savings should only be treated as a
component of the calculation of shareable earnings. In an Interim Opinion
issued in June 1995, the CPUC decided to defer a final decision on this matter
pending resolution of the criteria for exogenous cost treatment under its
regulatory framework. The criteria are being considered in a separate
proceeding initiated for rehearing of the CPUC's postretirement benefits other
than pensions decision.
DISPOSITION OF BELLCORE
In April 1995, Bellcore announced a decision by its owners to pursue the
disposition of their interests in Bellcore. Bellcore is a leading provider of
communications software and consulting services. It is owned by Pacific Bell
and six of the telephone regional holding companies formed at the divestiture
of AT&T Corp. in 1984. A final decision regarding the disposition of
interests and the structure of such a transaction has yet to be determined.
Any transaction will be subject to necessary approvals.
COMPETITIVE RISK
Regulatory, legislative and judicial actions, as well as advances in
technology, have expanded the types of available communications products and
services and the number of companies offering such services. Various forms of
competition are growing steadily and are already having an effect on the
Corporation's earnings. An increasing amount of this competition is from
large companies with substantial capital, technological, and marketing
resources. Currently, competitors primarily consist of interexchange
carriers, competitive access providers and wireless companies. Soon the
Corporation will also face competition from cable television companies and
others.
35
<PAGE>
Effective January 1, 1995, the CPUC authorized toll services competition.
Toll service revenues represented approximately 14 percent of Pacific Bell's
total operating revenues for the first nine months of 1995. In May 1995, the
CPUC issued a decision that requires Pacific Bell to permit Centrex customers
who purchase certain optional routing features to route intra-service area
calls to the toll carrier of their choice. Since the official introduction of
competition in January 1995, management estimates that Pacific Bell lost about
five to six percent of the total local toll services market to other providers
by the end of third quarter 1995. Management estimates that, as a result of
official competition and unofficial competitive losses in prior years,
Pacific Bell currently serves less than 60 percent of the business toll
market. Changes contemplated by the CPUC and the effects of pending
legislation make it too early to predict when, or at what level, market share
loss will stabilize.
The CPUC has also ordered Pacific Bell to offer expanded interconnection to
competitive access providers. These competitors are allowed to carry the
intrastate portion of long-distance and local toll calls between
Pacific Bell's central offices and long-distance carriers. As a result of the
CPUC order, competitors may choose to locate their transmission facilities
within or near Pacific Bell's central offices. Intrastate access revenues
subject to increased competition represent about five percent of
Pacific Bell's total revenues.
In addition, the CPUC has issued initial rules to open the local exchange
market to competition beginning January 1, 1996. (See "Local Services
Competition" on page 32.) Local service revenues represented approximately
42 percent of Pacific Bell's total operating revenues for the first nine
months of 1995. Local exchange competition will also affect network access
revenues as CLCs provide access services.
Because of the unique characteristics of the California market, Pacific Bell
is vulnerable to competition. Pacific Bell's business and residence revenues
and profitability are highly concentrated among a portion of its customer base
and geographic areas. Competitors need only serve portions of our service
area to compete for the majority of Pacific Bell's business and residence
usage revenues. High-margin customers are clustered in high density areas
such as Los Angeles and Orange County, the San Francisco Bay Area, San Diego
and Sacramento.
Competitors can be expected to target the high-usage, high-profit customers
and can do this by targeting only a small part of our geographic area and a
small part of our customer base. Large and well-capitalized long-distance
carriers, wireless companies, competitive access providers and cable
television companies are preparing to compete in major local exchange markets.
In some cases they are already deploying switches and other facilities. In
California, cable television companies currently pass more than 90 percent of
Pacific Bell's residential customers. Cable television companies have already
announced plans for major build-outs to compete in the local exchange market.
All of Pacific Bell's customers have already chosen a long-distance company,
and there is more advertising from long-distance companies than from
traditional local exchange companies including Pacific Bell.
36
<PAGE>
Market research has shown that a substantial majority of residence customers
prefer using one company for all telecommunications services. This is a
significant competitive disadvantage to Pacific Bell since it is prohibited by
the 1982 Consent Decree from providing long-distance service between service
areas. Similar market research shows that a substantial majority of business
customers would select one of the major long-distance companies over a
combination of Pacific Bell and a long-distance company because using one
carrier would permit them to apply all of their traffic toward volume discount
plans offered by the long-distance companies.
For these reasons, management believes that implementation of local exchange
competition prior to the Telephone Companies being allowed to enter the long-
distance market would provide already strong competitors an unfair advantage.
Management also believes that a truly open competitive market would allow for
the simultaneous entry of all telecommunications competitors into each others'
markets on an equal footing. Although the Telephone Companies are facing
increasing competition for all of their services, management believes that a
truly open competitive market, in which the Telephone Companies can compete
without restrictions, offers long-term opportunity to grow the business.
37
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibits identified as on file with the SEC are incorporated herein by
reference as exhibits hereto.
Exhibit
Number Description
- ------- -----------
4a Rights Agreement, dated as of September 22, 1989, between
Pacific Telesis Group and The First National Bank of Boston, as
successor Rights Agent, which includes as Exhibit B thereto the form of
Rights Certificate (Exhibits 1 and 2 to Form SE filed September 25,
1989 as part of Form 8-A, File No. 1-8609).
4b No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Telesis Group or its subsidiaries is
filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A).
Pursuant to this regulation, Pacific Telesis Group hereby agrees to
furnish a copy of any such instrument to the SEC upon request.
11 Computation of Earnings per common share.
15 Letter re unaudited interim financial information.
27 Article 5 FDS for 3rd Quarter 1995 Form 10-Q.
The Corporation will furnish to a security holder upon request a copy of any
exhibit at cost.
(b) Reports on Form 8-K.
--------------------
Form 8-K, Date of Report September 7, 1995, was filed with the SEC,
under Item 5, announcing the discontinuance of SFAS 71.
38
<PAGE>
FORM 10-Q
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Pacific Telesis Group
BY /s/ W. E. Downing
--------------------------
W. E. Downing
Executive Vice President -
Chief Financial Officer & Treasurer
November 14, 1995
39
<PAGE>
EXHIBIT INDEX
Exhibits identified as on file with the SEC are incorporated herein by
reference as exhibits hereto. All other exhibits are provided as part of the
electronic transmission.
Exhibit
Number Description
- ------- -----------
4a Rights Agreement, dated as of September 22, 1989, between
Pacific Telesis Group and The First National Bank of Boston, as
successor Rights Agent, which includes as Exhibit B thereto the form
of Rights Certificate (Exhibits 1 and 2 to Form SE filed September 25,
1989 as part of Form 8-A, File No. 1-8609).
4b No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Telesis Group or its subsidiaries is
filed herewith pursuant to Regulation S-K, Item 601(b)(4)(iii)(A).
Pursuant to this regulation, Pacific Telesis Group hereby agrees to
furnish a copy of any such instrument to the SEC upon request.
11 Computation of Earnings per common share.
15 Letter re unaudited interim financial information.
27 Article 5 FDS for 3rd Quarter 1995 Form 10-Q.
40
<PAGE>
Exhibit 11
----------
PACIFIC TELESIS GROUP AND SUBSIDIARIES
COMPUTATION OF EARNINGS (LOSS) PER SHARE
(Dollars in millions, except per share amounts; shares in thousands)
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
1995 1994 1995 1994
---------------------- ----------------------
Net income (loss) ........ $(3,085) $ 314 $(2,543) $ 897
======== ======== ======= ========
Weighted average number
of common shares
outstanding ............. 427,421 424,065 425,184 423,937
Common stock equivalent
shares applicable to
stock options............ 376 1,268 429 1,277
-------- -------- ------- --------
Total number of shares
for computing primary
earnings (loss) per share 427,797 425,333 425,613 425,214
Incremental shares for
computing fully diluted
earnings (loss) per share 202 0 149 0
-------- -------- ------- --------
Total number of shares
for computing fully
diluted earnings (loss)
per share............... 427,999 425,333 425,762 425,214
======== ======== ======== ========
Earnings (loss) per
common share
(as reported)........... $ (7.22) $ 0.74 $ (5.98) $ 2.12
Primary earnings (loss)
per share............... $ (7.21) $ 0.74 $ (5.97) $ 2.11
Fully diluted earnings
(loss) per share........ $ (7.21) $ 0.74 $ (5.97) $ 2.11
Earnings (loss) per share amounts for the three- and nine-month periods ended
September 30, 1995 and 1994, as reported in the Condensed Consolidated
Statements of Income, were based on the weighted average number of common
shares outstanding for the respective periods. Primary and fully diluted
earnings (loss) per share amounts were not shown in the Condensed Consolidated
Statements of Income, as they differ from the reported earnings per share
amounts by less than three percent.
<PAGE>
Exhibit 15
----------
COOPERS & LYBRAND L.L.P.
November 14, 1995
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
Re: Pacific Telesis Group
Registrations on Forms S-3, Form S-4, and Forms S-8
---------------------------------------------------
We are aware that our report dated November 14, 1995 on our review of the
interim financial information of Pacific Telesis Group and Subsidiaries for
the three- and nine-month periods ended September 30, 1995 and included in
this Form 10-Q is incorporated by reference in the Corporation's registration
statements as follows:
Form S-3: PacTel Capital Resources $500,000,000 Debt Securities and
Guarantee thereof by Pacific Telesis Group
Form S-3: Secondary Offering of 137,504 shares of Pacific Telesis Group
Common Stock
Form S-3: Shareowner Dividend Reinvestment and Stock Purchase Plan
Form S-3: Pacific Telesis Group and Pacific Telesis Financing I, II, and
III filed to sell up to $1 billion of Trusts' preferred
securities
Form S-4: ABI American Businessphones, Inc. Merger
Form S-8: Nonemployee Director Stock Option Plan
Form S-8: Supplemental Retirement and Savings Plan for Salaried
Employees
Form S-8: Supplemental Retirement and Savings Plan for Nonsalaried
Employees
Form S-8: Stock Option and Stock Appreciation Rights Plan
Form S-8: Stock Incentive Plan
Pursuant to Rule 436(c) under the Securities Act of 1933, this report should
not be considered a part of the registration statements prepared or certified
by us within the meaning of Sections 7 and 11 of that Act.
Very truly yours,
/s/ Coopers & Lybrand L.L.P.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<FISCAL-YEAR-END> DEC-31-1995
<PERIOD-START> JAN-01-1995
<PERIOD-END> SEP-30-1995
<PERIOD-TYPE> 9-MOS
<CASH> 72
<SECURITIES> 0
<RECEIVABLES> 1,516
<ALLOWANCES> 137
<INVENTORY> 0
<CURRENT-ASSETS> 2,667
<PP&E> 26,913
<DEPRECIATION> 15,785
<TOTAL-ASSETS> 15,601
<CURRENT-LIABILITIES> 3,892
<BONDS> 5,232
<COMMON> 43
0
0
<OTHER-SE> 2,130
<TOTAL-LIABILITY-AND-EQUITY> 15,601
<SALES> 0
<TOTAL-REVENUES> 6,760
<CGS> 0
<TOTAL-COSTS> 5,222
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 350
<INCOME-PRETAX> 1,253
<INCOME-TAX> 436
<INCOME-CONTINUING> 17
<DISCONTINUED> 0
<EXTRAORDINARY> 3,360
<CHANGES> 0
<NET-INCOME> 2,543
<EPS-PRIMARY> 5.98
<EPS-DILUTED> 5.98
</TABLE>
