<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 March 31, 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 April 30, 1995, 424,065,165 common shares were outstanding.
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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 ................. 3
Condensed Consolidated Statements of
Shareowners' Equity ............................... 4
Condensed Consolidated Statements of Cash Flows ....... 5
Notes to Condensed Consolidated Financial Statements .. 7
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition .................... 13
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K ........................ 28
SIGNATURE ........................................................ 29
- ---------
<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 March 31, 1995, and the related
condensed consolidated statements of income, shareowners' equity, and cash
flows for the three-month periods ended March 31, 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.
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
May 12, 1995
1
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the 3 Months Ended
March 31,
----------------------
(Dollars in millions, except per share amounts) 1995 1994
- ---------------------------------------------------------------------------
OPERATING REVENUES
Local service........................................... $ 949 $ 856
Network access
Interstate............................................ 442 409
Intrastate............................................ 167 175
Toll service............................................ 319 498
Other service revenues.................................. 377 356
------ ------
TOTAL OPERATING REVENUES................................ 2,254 2,294
------ ------
OPERATING EXPENSES
Cost of products and services........................... 501 476
Customer operations and selling expenses................ 435 422
General, administrative, and other expenses............. 314 360
Property and miscellaneous taxes........................ 47 47
Depreciation and amortization........................... 467 441
------ ------
TOTAL OPERATING EXPENSES................................ 1,764 1,746
------ ------
OPERATING INCOME........................................ 490 548
Interest expense........................................ 117 108
Miscellaneous income.................................... 31 12
------ ------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES... 404 452
Income taxes............................................ 122 170
------ ------
INCOME FROM CONTINUING OPERATIONS....................... 282 282
Income from spun-off operations, net of tax
(Notes A and B)....................................... - 23
----- ------
NET INCOME.............................................. $ 282 $ 305
====== ======
Earnings per share:
Income from continuing operations..................... $ 0.67 $ 0.67
Income from spun-off operations....................... - 0.05
------ ------
Net income............................................ $ 0.67 $ 0.72
====== ======
Dividends per share..................................... $0.545 $0.545
Average shares outstanding (thousands)..................424,065 423,695
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
2
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
ASSETS: (Unaudited)
Cash and cash equivalents...................... $ 106 $ 135
Accounts receivable -(net of allowances for
uncollectibles of $139 and $134 in 1995
and 1994, respectively)...................... 1,366 1,557
Prepaid expenses and other current assets...... 1,234 1,206
------- -------
Total current assets........................... 2,706 2,898
------- -------
Property, plant, and equipment - at cost....... 26,679 26,565
Less: accumulated depreciation.............. (10,699) (10,451)
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Property, plant, and equipment - net........... 15,980 16,114
------- -------
Deferred charges and other noncurrent assets... 1,265 1,127
------- -------
TOTAL ASSETS................................... $19,951 $20,139
======= =======
LIABILITIES AND SHAREOWNERS' EQUITY:
Accounts payable and accrued liabilities....... $ 1,726 $ 1,907
Debt maturing within one year.................. 244 246
Other current liabilities ..................... 1,314 1,330
------- -------
Total current liabilities...................... 3,284 3,483
------- -------
Long-term obligations.......................... 4,898 4,897
------- -------
Deferred income taxes.......................... 1,682 1,673
------- -------
Other noncurrent liabilities and
deferred credits............................. 4,786 4,853
------- -------
Commitments and contingencies (Note C)
Total shareowners' equity...................... 5,301 5,233
------- -------
TOTAL LIABILITIES AND SHAREOWNERS' EQUITY...... $19,951 $20,139
======= =======
==========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
3
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY
(Unaudited)
For the 3 Months Ended
March 31,
----------------------
(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
Other changes....................................... - 1
------ ------
Balance at end of period............................ 3,493 3,494
------ ------
REINVESTED EARNINGS
Balance at beginning of period...................... 2,257 2,040
Net income.......................................... 282 305
Dividends declared.................................. (231) (231)
Other changes....................................... - (7)
------ ------
Balance at end of period............................ 2,308 2,107
------ ------
TREASURY STOCK
Balance at beginning of period...................... (254) (283)
Issuance of shares.................................. - 27
------ ------
Balance at end of period............................ (254) (256)
------ ------
DEFERRED COMPENSATION - LESOP TRUST
Balance at beginning of period...................... (306) (386)
Cost of trust shares allocated to employee accounts. 17 20
------ ------
Balance at end of period............................ (289) (366)
------ ------
TOTAL SHAREOWNERS' EQUITY.............................. $5,301 $5,022
====== ======
==========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
4
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 3 Months Ended
March 31,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES:
Net income............................................. $282 $305
Adjustments to net income:
Income from spun-off operations (Note A)............. - (23)
Depreciation and amortization........................ 467 441
Deferred income taxes................................ (2) (32)
Changes in operating assets and liabilities:
Accounts receivable................................ 192 13
Prepaid expenses and other current assets.......... (120) (7)
Deferred charges and other noncurrent assets....... 11 (29)
Accounts payable and accrued liabilities........... (113) 82
Other current liabilities.......................... (5) (29)
Noncurrent liabilities and deferred credit......... (77) 29
Other adjustments, net............................... 3 (55)
----- -----
Cash from continuing operations........................ 638 695
Cash from spun-off operations.......................... - 18
----- -----
Cash from operating activities......................... 638 713
----- -----
CASH FROM (USED FOR) INVESTING ACTIVITIES:
Additions to property, plant, and equipment............ (335) (347)
Investments in PCS licenses............................ (83) -
Net investment in spun-off operations.................. - 22
Other investing activities, net........................ (12) 23
----- -----
Cash used by continuing operations..................... (430) (302)
Cash used by spun-off operations....................... - (332)
----- -----
Cash used for investing activities..................... (430) (634)
----- -----
(Continued on next page)
5
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Continued)
For the 3 Months Ended
March 31,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) FINANCING ACTIVITIES:
Proceeds from issuance of common and treasury shares.. - 98
Proceeds from issuance of long-term debt.............. - 10
Retirements of long-term debt......................... (2) -
Dividends paid........................................ (231) (214)
Decrease in short-term borrowings, net................ (1) (287)
Other financing activities, net....................... (3) (10)
----- -----
Cash used by continuing operations.................... (237) (403)
Cash from spun-off operations......................... - 39
----- -----
Cash used for financing activities.................... (237) (364)
----- -----
Net cash used for all activities...................... (29) (285)
Less spun-off operations.............................. - (275)
----- -----
Decrease in cash and cash equivalents................. (29) (10)
Cash and cash equivalents at January 1................ 135 69
----- -----
Cash and cash equivalents at March 31................. $106 $ 59
===== =====
Cash payments for:
Interest............................................ $141 $131
Income taxes........................................ $ - $ 33
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
6
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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,
and Pacific Bell Mobile 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.
In management's opinion, the Condensed Consolidated Financial Statements
include all adjustments (consisting of only normal recurring adjustments)
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.
7
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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 are amounts paid
for Personal Communications Services ("PCS") licenses recorded at cost.
Interest related to these licenses are capitalized as part of their cost.
These costs will be amortized once the PCS system is in service.
Management anticipates introducing PCS services in selected areas in late
1996 with a more widespread offering in early 1997.
Accounting Under Regulation
The Telephone Companies account for the economic effects of regulation
under Statement of Financial Accounting Standards No. 71 ("SFAS 71"),
"Accounting for the Effects of Certain Types of Regulation." SFAS 71
requires the Telephone Companies to reflect the rate actions of
regulators in their financial statements when appropriate. Regulators
sometimes include costs in allowable costs for ratemaking in a period
other than the period in which those costs would be charged to expense by
an unregulated enterprise. These timing differences can create
"regulatory assets" or "regulatory liabilities" recorded by the Telephone
Companies. The regulatory assets and liabilities included in the
Corporation's consolidated balance sheets are listed and discussed below:
March 31, December 31,
(Dollars in millions) 1995 1994
----------------------------------------------------------------------
Regulatory assets (liabilities) due to:
Deferred pension costs*..................... $424 $407
Unamortized debt redemption costs**......... 343 346
Deferred compensated absence costs*......... 211 213
Unamortized purchases of property, plant,
and equipment under $500.................. 99 107
Deferred income taxes***.................... (183) (193)
Other....................................... 47 51
---- ----
Total........................................... $941 $931
========================================================================
* Included primarily in "deferred charges and other noncurrent assets" in
the Corporation's balance sheets.
** Reflected as a reduction of "long-term obligations."
*** Included in "other current liabilities" and "other noncurrent
liabilities and deferred credits."
8
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (CONTINUED)
Deferred pension costs above reflect an order by the California Public
Utilities Commission ("CPUC") requiring Pacific Bell to use the
"aggregate cost method" for its intrastate operations. These deferred
costs represent differences between Pacific Bell's intrastate pension
costs calculated using this actuarial method, subject to Internal Revenue
Service ("IRS") and other limitations, and costs determined under the
provisions of Statement of Financial Accounting Standards No. 87 ("SFAS
87"), "Employers' Accounting for Pensions," and No. 88 ("SFAS 88"),
"Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits."
When debt is refinanced before maturity, Pacific Bell amortizes to
expense any difference between net book value and redemption price evenly
over the term of the replacing issue for its intrastate operations, in
accordance with the ratemaking treatment of such costs by the CPUC.
These costs are expensed as incurred for interstate operations.
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
is being amortized to expense over periods prescribed by each regulator.
However, the CPUC continues to require Pacific Bell to recognize certain
compensated absence costs on a cash basis for ratemaking. The above
regulatory asset for compensated absences reflects those costs which have
been deferred in accordance with 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 are being amortized to expense over periods
prescribed by regulators.
Specific provisions of Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes," require regulated companies to
record a regulatory asset or a regulatory liability when recognizing
deferred income taxes if it is probable that these deferred taxes will be
reflected in future rates.
9
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (CONTINUED)
In addition to the regulatory assets and liabilities described above, the
carrying amount of property, plant, and equipment is also affected by the
actions of regulators. Property, plant, and equipment is carried at cost.
The cost of self-constructed plant includes employee wages and benefits,
materials, and other costs. Regulators allow the Telephone Companies to
accrue an allowance for funds used during construction, which includes both
debt and equity components, as a cost of constructing certain plant and as
an item of miscellaneous income. This income is not realized in cash
currently, but is expected to be realized over the service lives of the
related plant. When retired, the original cost of depreciable telephone
plant is charged to accumulated depreciation.
Expenditures in excess of $500 that increase the capacity, operating
efficiency, or useful life of an individual asset are capitalized.
Expenditures for maintenance and repairs are charged to expense. The costs
of computer software purchased or developed for internal use generally are
expensed as incurred. However, initial operating system software costs are
capitalized and amortized over the lives of the associated hardware. Costs
for subsequent additions or modifications to operating system software are
expensed as incurred.
Depreciation of telephone plant is computed essentially by straight-line
depreciation using depreciable lives prescribed periodically by state and
federal regulators. Regulators currently have prescribed the following
depreciable lives for Pacific Bell's property, plant, and equipment:
Depreciable Lives
------------------------------------------------------------------------
(in years)
Buildings................................................. 30 to 57
Cable..................................................... 10 to 30
Central office equipment.................................. 9 to 16.5
Furniture, equipment, and other........................... 5.5 to 20
========================================================================
An unregulated enterprise may have selected shorter depreciable lives for
similar assets. At this time, the Corporation has not determined what
depreciable lives it might otherwise have selected or what the cumulative
effect on its financial statements would have been had shorter lives been
used. Three other telephone regional holding companies ("RHCs") have
discontinued the application of SFAS 71 regulatory accounting and have
adopted shorter depreciable lives and reduced their telephone plant
balances. If Pacific Bell were to discontinue the application of SFAS 71
and compute the effect on its telephone plant in a manner similar to these
other three RHCs, the reduction in the carrying amount of the Corporation's
property, plant, and equipment would be between $3 and $5 billion.
10
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
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. COMMITMENTS AND CONTINGENCIES
Cross Country Wireless Inc.
In April 1995, the Corporation announced plans to provide wireless cable
service in southern California by agreeing to acquire 100 percent of the
stock of Cross Country Wireless Inc. ("CCW"). CCW has existing wireless
cable operations in Riverside, California and holds licenses and rights
to provide wireless video services in Los Angeles, Orange County, and
San Diego. The transaction involves the exchange of approximately
$120 million of Pacific Telesis Group stock and stock purchase warrants
for the outstanding stock and warrants of CCW, and the retirement by the
Corporation of approximately $55 million of CCW debt. Closing is
expected by third quarter 1995, but is subject to a number of conditions
including certain regulatory approvals and completion of a satisfactory
due diligence review by the Corporation. The transaction will be
accounted for by the purchase method.
PCS Licenses
In March 1995, Pacific Telesis Mobile Services a wholly-owned subsidiary
of the Corporation, was the high bidder for two licenses to offer PCS in
California and Nevada at the close of FCC auctions. The bids totaled
$696 million of which the Corporation has paid 20 percent of this
amount. The remaining $557 million is due upon issuance of the PCS
licenses expected by third quarter 1995.
11
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PACIFIC TELESIS GROUP AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
C. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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.
Revenues Subject to Refund
In 1992, the CPUC issued a decision adopting, with modification, Statement
of Financial Accounting Standards No. 106 ("SFAS 106"), "Employers'
Accounting for Postretirement Benefits Other than Pension," 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 106. However, the CPUC in October 1994
reopened the proceeding to determine if 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. The Corporation believes
these costs are appropriately included in Pacific Bell's price cap filings,
but is unable to predict the outcome of the CPUC's proceeding.
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 PacTel Cable 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
$136 million. In the Corporation's opinion, the likelihood that it will be
required to pay principal or interest on this debt under these guarantees
is remote.
12
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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESULTS OF OPERATIONS
The following discussions and data compare the results of operations of
Pacific Telesis Group (the "Corporation") for the three-month period ended
March 31, 1995 to the corresponding period in 1994. The Corporation's
previous interests in the operating results of wireless operations, which were
spun off to shareowners on April 1, 1994, are classified separately as "spun-
off operations" in the accompanying financial statements. (See Note A -
"Basis of Presentation" on page 7.) The spun-off operations are excluded from
the reported amounts of the Corporation's revenues and expenses. The
Corporation's "continuing operations" include Pacific Bell and Nevada Bell
(the "Telephone Companies"), along with several other units. Results for the
first three months of 1995 may not be indicative of results for the full year.
A summary of selected operating data is shown below:
For the 3 Months Ended
March 31,
----------------------
%
Selected Operating Data* 1995 1994 Change
- ----------------------------------------------------------------------------
Return on shareowners' equity (%).................. 21.1 22.3
Operating ratio (%)................................ 78.3 76.1
Total employees at March 31........................ 51,251 53,660 -4.5
Revenues per average employee ($ in thousands) 44 42 4.8
Telephone Companies' employees per ten thousand
access lines**................................... 31.2 34.0 -8.2
- ----------------------------------------------------------------------------
* continuing operations
** excludes Pacific Bell Directory employees
13
<PAGE>
Earnings
- --------
For first quarter 1995, the Corporation reported earnings of $282 million, or
$0.67 per share, the same earnings reported a year ago from continuing
operations. Earnings for 1995 included revenue shortfalls resulting from a
California Public Utilities Commission ("CPUC")-ordered price rebalancing that
accompanied the introduction of toll services competition on January 1, 1995.
Share loss in the toll market has been about as expected. Additional pressure
on earnings resulted from incremental labor expense associated with the severe
storms in 1995. These earnings decreases in 1995 were offset by interest
income and tax refunds received in 1995, Pacific Bell's on-going cost-
reduction efforts, and other items.
The revenue shortfalls occurred because the average 40 percent reduction in
toll prices did not stimulate demand growth to the extent anticipated by the
CPUC to achieve revenue neutrality as intended by the price rebalancing order.
The CPUC price rebalancing order assumed that volume growth would be a key
source of new revenues to offset the price reductions. Results to date
strongly suggest that neither the CPUC's nor management's forecasted growth in
demand will be realized in 1995. Management believes 1995 earnings could be
about ten percent less than 1994 due to this revenue rebalancing shortfall.
Volume Indicators
- ------------------
For the 3 Months Ended
March 31,
----------------------
%
1995 1994 Change
- ---------------------------------------------------------------------------
Customer switched access lines in service at
March 31 (thousands).......................... 15,398 14,986 2.7
Interexchange carrier access minutes-of-use
(millions).................................... 14,381 13,184 9.1
Interstate.................................. 8,130 7,872 3.3
Intrastate.................................. 6,251 5,312 17.7
Toll messages (millions)........................ 1,184 1,096 8.0
- ---------------------------------------------------------------------------
The total number of access lines in service grew to 15,398 thousand, an
increase of 2.7 percent for the twelve months ended March 31, 1995. Although
this is an improvement over the 2.3 percent increase for the same period last
year, access line growth slowed in the first quarter 1995. The residential
access line growth rate increased to 2.0 percent for the twelve months ended
March 31, 1995, from 1.4 percent last year. The growth rate in business
access lines climbed to 4.1 percent this year from 3.9 percent last year.
Pacific Bell's business Centrex lines grew 10.4 percent during the same period
as businesses continued to link multiple locations and improve disaster
preparedness. The number of ISDN lines in service increased 90 percent in the
twelve months ended March 31, 1995 as customers demanded faster data
transmission and Internet access.
14
<PAGE>
Access minutes-of-use represent the volume of traffic carried by interexchange
carriers over the Telephone Companies' local networks. Access minutes-of-use
for the three months ended March 31, 1995 increased by 9.1 percent over the
same period last year. The increase in access minutes-of-use was attributable
to economic growth and price decreases which increased network usage. In
California, the introduction of competition in the intra-service area toll
market that began in January 1995 also had the effect of increasing intrastate
access minutes-of-use. Pacific Bell provides access to other carriers who are
now authorized to complete intra-service area toll calls over Pacific Bell's
local network.
Toll messages are comprised of Message Telecommunications Service, Optional
Calling Plans, WATS and terminating 800 messages. For the three months ended
March 31, 1995, toll messages increased by 8.0 percent compared to an increase
of 5.5 percent for the corresponding period in 1994. The increase was driven
primarily by lower prices as well as economic growth. In California on
January 1, 1995, Pacific Bell lowered the price of its toll services by an
average of 40 percent. Pacific Bell also began offering discount calling
plans. Residential customers receive an additional 15 percent off toll
charges above five dollars per month while businesses receive an additional
20 percent off toll charges over $15 per month. High volume customers can
receive even larger discounts. Price decreases have stimulated demand
slightly but fall short of levels included in the CPUC's order or forecasted
by management. Pacific Bell estimates it lost approximately five percent of
the toll services market to other providers in the first quarter 1995. While
it is too early to estimate where market share loss will stabilize, management
expects it to increase.
Operating Revenues
- ------------------
For the 3 Months Ended
March 31,
---------------------
($ millions) 1995 1994 Change
- ---------------------------------------------------------------------------
Total operating revenues ....................... $2,254 $2,294 -$40
-1.7%
- ---------------------------------------------------------------------------
Revenues for first quarter 1995 were reduced from the same period last year
primarily at Pacific Bell because demand growth was slower than assumed in the
CPUC-ordered price rebalancing, price cap revenue reductions, and the effects
of toll services competition.
15
<PAGE>
Effective January 1, 1995, the CPUC allowed long-distance companies and others
to officially compete with Pacific Bell in providing intra-service area toll
call services in California. The decision rebalanced prices for most of
Pacific Bell's regulated services so it could remain competitive in the new
environment. The CPUC intended this decision to be initially revenue neutral
so that the effect of price decreases would be offset by the effect of price
increases. Increased demand was expected to result from lower prices for
competitive services, partially offsetting the effect of price decreases on
total revenues. Although Pacific Bell observed some increased usage for the
first quarter 1995, calling volumes were below levels envisioned by the CPUC
as necessary to achieve revenue neutrality.
Revenues were also reduced because of price cap revenue reductions ordered by
the CPUC and the Federal Communications Commission ("FCC") under incentive-
based regulation.
Overall, revenue decreases from price rebalancing and price cap orders were
partially offset by $81 million in revenues from increased customer demand.
The increase in customer demand included both general and economic growth and
the result of lower prices. Factors affecting revenue changes are summarized
in the following table.
Total
Price Change
Price Cap Customer From
($ millions) Rebalancing Orders Misc. Demand 1994
- ---------------------------------------------------------------------------
Local service........................ $95 -$31 $15 $14 $93
Network access
Interstate......................... 7 -2 10 18 33
Intrastate......................... -61 -5 -13 71 -8
Toll service......................... -123 -12 -3 -41 -179
Other service revenues............... 4 - -2 19 21
----- ----- ----- ----- ----
Total operating revenues............. -$78 -$50 $ 7 $81 -$40
===========================================================================
The $14 million increase in local service revenues due to customer demand in
the above table reflects increased customer access lines due to economic
recovery.
The $18 million increase in interstate network access revenues due to customer
demand reflects increased interexchange carrier access minutes-of-use, as well
as increased access lines. The $71 million demand related increase in
intrastate network access revenues also reflects growth in interexchange
carrier access minutes-of-use. At Pacific Bell, the introduction of
competition in the intra-service area toll market that began in January 1995
had the effect of increasing access usage revenues.
16
<PAGE>
Decreased customer demand-related revenues for Pacific Bell's toll services,
as displayed in the table above, primarily results from competition.
Pacific Bell lost approximately five percent of the toll services market to
competitors in the first quarter 1995. In addition, Pacific Bell has lost and
continues to lose WATS and 800 service business to interexchange carriers who
have the competitive advantage over the Telephone Companies of being able to
offer these services both within and between service areas.
The increase in other service revenues reflects the continuing success of the
Telephone Companies' voice mail products as well as directory operations.
Operating Expenses
- ------------------
For the 3 Months Ended
March 31,
----------------------
($ millions) 1995 1994 Change
- ---------------------------------------------------------------------------
Total operating expenses....................... $1,764 $1,746 $18
1.0%
- ---------------------------------------------------------------------------
Total operating expenses increased only slightly when compared with 1994
despite a $63 million increase due to severe storm damage in 1995. As
displayed in the table below, increases in salaries and wages, depreciation,
and expenses associated with the Corporation's other entities were partially
offset by miscellaneous general and administrative expense decreases.
Pacific Bell Expenses
(excluding subsidiaries) Total
---------------------------- Other Change
Salaries Employee PTG From
($ millions) & Wages Benefits Misc. Entities 1994
- ---------------------------------------------------------------------------
Cost of products & services....... $25 $2 -$ 8 $ 6 $25
Customer operations & selling
expenses........................ -5 -4 17 5 13
General, admin. & other expenses.. -13 -1 -36 4 -46
Property & misc. taxes.. - - -1 1 -
Depreciation & amortization....... - - 25 1 26
---- ---- ---- --- ---
Total operating expenses.......... $ 7 -$3 -$ 3 $17 $18
===========================================================================
Salary and wage expense increased at Pacific Bell primarily as a result of
1995 storm and flood repairs. This increase was substantially offset by
decreases resulting from Pacific Bell's force reduction programs.
17
<PAGE>
Pacific Bell's miscellaneous general and administrative expenses decreased
primarily because of costs incurred in 1994 for research and development to
support plans to upgrade the core network infrastructure and to begin building
an integrated telecommunications, information, and entertainment network. A
decrease in licensing fees for digital switching software and miscellaneous
benefit adjustments also lowered general and administrative expense.
Pacific Bell's miscellaneous cost of products and services decreased primarily
due to lower settlement payments related to the implementation of toll service
competition. Pacific Bell's depreciation expense increased primarily due to
higher depreciation rates ordered by the CPUC effective January 1, 1995 and
higher telephone plant balances.
Interest Expense
- ----------------
For the 3 Months Ended
March 31,
----------------------
($ millions) 1995 1994 Change
- ---------------------------------------------------------------------------
Interest expense................................... $117 $108 $9
8.3%
- ---------------------------------------------------------------------------
Interest expense for first quarter 1995 increased primarily at Pacific Bell
mostly due to accruals for several regulatory liabilities.
Miscellaneous Income
- --------------------
For the 3 Months Ended
March 31,
----------------------
($ millions) 1995 1994 Change
- ---------------------------------------------------------------------------
Miscellaneous Income................................ $31 $12 $19
158.3%
- ---------------------------------------------------------------------------
Miscellaneous income increased primarily due to interest income of $25 million
from a tax refund received in 1995 related to prior years.
18
<PAGE>
Income Taxes
- ------------
For the 3 Months Ended
March 31,
----------------------
($ millions) 1995 1994 Change
- ---------------------------------------------------------------------------
Income Taxes...................................... $122 $170 -$48
28.2%
- ---------------------------------------------------------------------------
The decrease in income tax expense for first quarter 1995 is primarily due to
lower pre-tax income and a tax refund received in 1995 related to prior years
which decreased income taxes by $20 million. The effective tax rate on pre-tax
income is 30.2 percent for first quarter 1995 compared to 37.6 percent for the
same period last year.
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. A total of 945 employees left Pacific Bell (excluding subsidiaries)
during first quarter 1995. After new hires, the net force loss was
328 employees. A total of $48 million in cash outlays was charged to the
reserve in first quarter 1995. These costs were primarily for force reduction
and information systems reengineering. During first quarter 1995,
Pacific Bell continued its efforts to streamline the service ordering process
and consolidated various activation groups to improve service delivery. The
majority of this year's projected costs are expected to be incurred during the
second half of 1995.
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. Management believes the $48 million reserve balance at March 31,
1995 is adequate to cover potential losses on the disposal of the remaining
assets.
19
<PAGE>
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 unused lines of credit. These lines of credit are subject to
continued review by the lending banks. At March 31, 1995, the unused lines of
credit available totaled approximately $2.6 billion.
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 only 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 subsidiary may issue up to $192 million
of medium-term notes through a shelf registration on file with the SEC.
In April 1995, the Corporation announced plans to provide wireless cable
service in southern California by agreeing to acquire 100 percent of the stock
of Cross Country Wireless Inc. ("CCW"). CCW has existing wireless cable
operations in Riverside, California and holds licenses and rights to provide
wireless video services in Los Angeles, Orange County, and San Diego. The
transaction involves the exchange of approximately $120 million of
Pacific Telesis Group stock and stock purchase warrants for the outstanding
stock and warrants of CCW, and the retirement by the Corporation of
approximately $55 million of CCW debt. Closing is expected by third quarter
1995, but is subject to a number of conditions including certain regulatory
approvals and completion of a satisfactory due diligence review by the
Corporation. Pending the successful completion of the transaction, the
Corporation will manage the Riverside wireless cable service and, by the end
of 1996, plans to offer more than 100 channels of programming in the
Los Angeles, Orange County, and San Diego areas.
In March 1995, the Corporation was the high bidder for two licenses to offer
personal communications services ("PCS") in California and Nevada at the close
of FCC auctions. The bids totaled $696 million of which 20 percent has been
paid to date including a $56 million deposit made in 1994. (See Note C -
"Commitments and Contingencies" on page 11.) The Corporation intends to use a
combination of internally generated funds and external financing to fund the
remaining $557 million which is due upon issuance of the PCS licenses expected
by third quarter 1995.
20
<PAGE>
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 March 31, 1995,
Pacific Bell had approximately $5 billion of long- and intermediate-term debt
outstanding. The rating action reflects price cap revenue reductions, toll
services competition, and proposed interim rules on local services competition
(see "Local Services Competition" on page 23). The rating action also
reflects the expected financing requirements of the Corporation's broadband
and PCS networks. Standard & Poor's Corporation has placed bond and
commercial paper ratings of the Corporation, PacTel Capital Resources, and
Pacific Bell on "CreditWatch," which has negative implications, following the
release by the CPUC of its proposed interim rules on local services
competition. In addition, Moody's Investors Services, Inc. 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.
Cash from continuing operations for operating activities decreased $57 million
for the three months ended March 31, 1995 compared to the same period in 1994.
The decrease was primarily due to timing differences in the payment of
accounts payable net of collections in accounts receivable and a tax refund of
$70 million in 1995 related to prior years.
Cash used by continuing operations for investing activities increased
$128 million for the three months ended March 31, 1995 compared to the same
period in 1994. The increase was primarily due to an $83 million payment on
the PCS licenses in March 1995. In addition, the increase also reflects the
Corporation's 1995 investments in the Bell Atlantic and NYNEX joint venture
and the LA Times joint venture. These joint ventures did not exist in the
first quarter of 1994.
Cash used by continuing operations for financing activities decreased
$166 million for the three months ended March 31, 1995 compared to the same
period in 1994. The decrease primarily reflects reduced payments of short-
term borrowings in 1995. During 1994, the Corporation substantially repaid
its short-term borrowings.
The Corporation's debt ratio improved slightly to 49.2 percent at March 31,
1995 from 49.6 percent at December 31, 1994. Pre-tax interest coverage was
4.5 times for the first three months in 1995 compared to 5.2 times for the
same period in 1994. This decrease was due primarily to lower pre-tax income.
For first quarter 1995, the Pacific Telesis Group Board of Directors
maintained the Corporation's dividend at $0.545 per share.
21
<PAGE>
PENDING REGULATORY ISSUES
Calling Party Identification
- ----------------------------
In May 1995, the FCC established national rules under which 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 restrictions that make the service uneconomic to provide. The
FCC ruling preempts the CPUC's restrictions which made providing Caller ID
uneconomic. Management believes that Caller ID could be an important new
revenue source and plans to provide service by early 1996. The CPUC has
indicated it will appeal the FCC's ruling.
FCC Regulatory Framework Review
- --------------------------------
In March 1995, the FCC adopted a new interim set of rules for 1995 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 LECs charge for the use of their networks when
the IECs connect to local telephone customers.
Under the FCC price cap system of incentive-based regulation, LECs set access
charges by subtracting from the rate of inflation a specified "productivity
factor" intended to account for increasing productivity in the telephone
industry. If the productivity factor exceeds the rate of inflation, LECs must
cut their access charges by an amount equal to the difference. The annual
price adjustments also reflect the effects on the LECs' costs of exogenous
events beyond their control. The rules also contain a sharing provision that
requires LECs to return a percentage of their earnings to their customers
after they achieve a specified rate of return.
The original FCC price cap rules offered LECs a choice of two productivity
factors: either 3.3 percent or 4.3 percent. In its 1994 price cap filing,
Pacific Bell chose a productivity factor of 3.3 percent. Pacific Bell must
share with customers 50 percent of its earnings above a 12.25 rate of return,
and return all earnings to customers above 16.25 percent. Nevada Bell elected
the productivity factor of 4.3 percent. Nevada Bell must share with customers
50 percent of its earnings above a 13.25 percent rate of return, and return
all earnings to customers above 17.25 percent.
22
<PAGE>
The new plan allows LECs to choose among three productivity factors:
4.0 percent, 4.7 percent, or 5.3 percent. LECs electing the 4.0 and
4.7 percent options will share 50 percent of earnings above 12.25 percent in
subsequent year price reductions. In addition, all earnings above 13.25 and
16.25 percent, respectively, will be returned. LECs that choose the
5.3 percent productivity factor can retain all earnings without sharing. In
addition, to modify the FCC's prior methodology, LECs are required to reduce
their 1995 annual access filings by an additional 0.7 percent for each year
they selected a 3.3 percent productivity factor under the old rules, up to
2.8 percent. Pacific Bell will have a 2.1 percent reduction due to selecting
the 3.3 percent productivity factor in three prior years. Likewise, Nevada
Bell will have a 1.4 percent reduction due to selecting the 3.3 percent
productivity factor in two prior years.
The FCC has indicated it will adopt permanent rules in 1995 or 1996.
Management continues to believe that the FCC should adopt pure price cap
regulation including elimination of the productivity factor, sharing, and
earnings caps.
In May 1995, the Telephone Companies submitted their annual access filings
under the interim rules. The Telephone Companies proposed an annual revenue
reduction totaling $126 million effective August 1, 1995. Of this amount
$72 million was reflected in the Corporation's 1994 financials. The Telephone
Companies chose the 5.3 percent productivity factor which will eliminate the
sharing obligation. Management believes that the negative effect of the
higher productivity factor will be more than offset by not having to share
future earnings. If the filing is approved, Pacific Bell's switched access
prices will decrease from approximately 2.2 cents per minute to approximately
1.9 cents per minute.
Local Services Competition
- --------------------------
In December 1994, the CPUC adopted a procedural plan to examine issues related
to opening the local exchange market to competition. Pacific Bell
participated in settlement talks with IECs and other interested parties in an
effort to reach agreement on a number of these issues. Since no agreement was
reached by the March 31, 1995 deadline, the CPUC has begun to address these
issues in formal proceedings.
In April 1995, the CPUC proposed interim rules for local telephone competition
that could begin as early as late 1995. The CPUC's proposal includes
provisions allowing competitors to resell Pacific Bell's services. It also
sets interconnection rules and allows telephone number portability. The
proposal does not resolve the questions of how to maintain affordable
universal service, pricing flexibility, network unbundling, and the future
regulatory framework. If the proposal is adopted in its current form,
Pacific Bell will be at a competitive disadvantage. (See "Competitive Risk"
on page 26.)
23
<PAGE>
In a related action, the CPUC also ordered Pacific Bell to offer expanded
interconnection to allow competitive access providers to carry the transport
portion of switched access between Pacific Bell's central offices and IECs.
Pacific Bell previously proposed to freeze prices of basic services for three
years as part of a comprehensive plan to bring full telecommunications
competition to all Californians. Addressed in its plan are:
1. Universal service, which Pacific Bell would assure to all
Californians
2. A three-year freeze of prices for basic services, which are already
among the lowest in the nation
3. Downward pricing flexibility, so that prices can be lowered to meet
competition
4. Number assignment and portability, maintaining existing calling
areas, so that customers who change their telephone company without
changing location can take their numbers with them
5. Competitive access, allowing competitors access to Pacific Bell's
network at reasonable rates
6. Unbundling of basic elements of the local network
Management believes its customers should have the opportunity to choose their
local telecommunications providers just as they should be able to choose their
cable TV and long-distance providers. At the same time, management believes
customers should have the opportunity to choose Pacific Bell as a complete
local and long-distance telecommunications service provider. 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. The CPUC plans to
issue a decision in mid-1995.
24
<PAGE>
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 January 1996, for rates effective in July 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.
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
as of June 30, 1995 should be returned to customers. Management believes that
under the CPUC's New Regulatory Framework, any property tax savings should
only be treated as a component of the calculation of shareable earnings. A
CPUC decision is pending.
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 other affiliates 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 will be
subject to obtaining satisfactory financing and necessary approvals.
25
<PAGE>
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.
Effective January 1, 1995, the CPUC authorized toll services competition.
Toll service revenues represent approximately 14 percent of Pacific Bell's
total operating revenues. Pacific Bell estimates it lost approximately five
percent of the toll services market to other providers in the first quarter
1995. While it is too early to estimate where market share loss will
stabilize, management expects it to increase. 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. In addition, the CPUC has stated its intention
to open up the local exchange market to competition that could begin as early
as late 1995. Local service revenues represent approximately 42 percent of
Pacific Bell's total operating revenues.
The Corporation recently filed a form 8-K with the SEC detailing competitive
vulnerability. Because of the unique characteristics of the California
market, Pacific Bell is vulnerable to competition should the CPUC adopt local
competition rules that are not fair and even-handed. (See "Local Services
Competition" on page 23.) 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. Customers tend to cluster 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.
26
<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
and that regulators should ensure that the responsibility for universal
service is shared by all telecommunications providers. Management 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 significant opportunity to grow the business.
APPLICABILITY OF REGULATORY ACCOUNTING
The Telephone Companies currently account for the economic effects of
regulation under Statement of Financial Accounting Standards No. 71
("SFAS 71"), "Accounting for the Effects of Certain Types of Regulation." If
it becomes no longer reasonable to assume the Telephone Companies will recover
their costs through rates charged to customers, whether resulting from the
effects of increased competition or specific regulatory actions, SFAS 71 will
no longer apply. The Corporation continues to monitor the effects of
competition and changes in regulation to assess the likelihood the Telephone
Companies will continue to recover their costs. (See "Pending Regulatory
Issues" and "Competitive Risk" beginning on page 22.) Discontinuing the
application of SFAS 71 would require the Telephone Companies to eliminate
their regulatory assets and liabilities and may require a reduction of the
carrying amount of their telephone plant. (See "Accounting Under Regulation"
in Note A on page 8.) Three other telephone regional holding companies
("RHCs") have discontinued the application of SFAS 71 regulatory accounting
and have reduced their telephone plant balances. If Pacific Bell were to
discontinue the application of SFAS 71 and compute the effect on its telephone
plant in a manner similar to these other three RHCs, the reduction in carrying
amount of the Corporation's property, plant, and equipment would be between
$3 and $5 billion.
27
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibits identified in parentheses below 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 1st 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 April 19, 1995, was filed with the SEC,
under Item 5 in connection with a Pacific Bell competitive
vulnerability filing with the CPUC.
28
<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/ R. W. Odgers
--------------------------
R. W. Odgers
Executive Vice President -
General Counsel & External Affairs
May 12, 1995
29
<PAGE>
EXHIBIT INDEX
Exhibits identified in parentheses below 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 1st Quarter 1995 Form 10-Q.
30
<PAGE>
Exhibit 11
----------
PACIFIC TELESIS GROUP AND SUBSIDIARIES
COMPUTATION OF EARNINGS PER SHARE
(Dollars in millions, except per share amounts; shares in thousands)
For the 3 Months Ended
March 31,
-----------------------
1995 1994
-----------------------
Net income............................................ $ 282 $ 305
======= =======
Weighted average number of common shares outstanding.. 424,065 423,695
Common stock equivalent shares applicable to
stock options....................................... 591 1,510
------- -------
Total number of shares for computing primary
earnings per share ................................. 424,656 425,205
Incremental shares for computing fully diluted
earnings per share.................................. 45 0
------- -------
Total number of shares for computing fully diluted
earnings per share.................................. 424,701 425,205
======= =======
Earnings per common share (as reported)............... $ 0.67 $ 0.72
Primary earnings per share............................ $ 0.66 $ 0.72
Fully diluted earnings per share...................... $ 0.66 $ 0.72
============================================================================
Earnings per share amounts for the three-months ended March 31, 1995 and
March 31, 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 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.
May 12, 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 May 12, 1995 on our review of the interim
financial information of Pacific Telesis Group and Subsidiaries for the three-
month period ended March 31, 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-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: PacTel Corporation Retirement 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.
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<PAGE>
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<PERIOD-START> JAN-01-1995
<PERIOD-END> MAR-31-1995
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0
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