FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the period ended June 30, 1997
or
|_| Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission File Number 1-8609
PACIFIC TELESIS GROUP
Incorporated under the laws of the State of Nevada
I.R.S. Employer Identification Number 94-2919931
130 Kearny Street, San Francisco, California 94108
Telephone Number: (415) 394-3000
THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF SBC COMMUNICATIONS INC., MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND IS
THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO GENERAL
INSTRUCTION H(2).
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
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
PACIFIC TELESIS GROUP
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CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions except per share amounts
(Unaudited)
<CAPTION>
- ---------------------------------------------------------------------------------------
------------------------------------
Three months Six months
ended ended
June 30, June 30,
------------------------------------
1997 1996 1997 1996
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<S> <C> <C> <C> <C>
Operating Revenues
Local service $ 1,107 $ 1,016 $ 2,144 $ 1,995
Network access:
Interstate 355 461 829 919
Intrastate 217 186 405 366
Long-distance service 298 322 607 639
Directory advertising 264 278 627 585
Other 151 142 315 279
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Total operating revenues 2,392 2,405 4,927 4,783
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Operating Expenses
Cost of services and products 1,000 836 1,876 1,722
Selling, general and administrative 1,903 487 2,370 891
Depreciation and amortization 984 464 1,475 929
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Total operating expenses 3,887 1,787 5,721 3,542
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Operating Income (Loss) (1,495) 618 (794) 1,241
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Other Income (Expense)
Interest expense (117) (94) (209) (187)
Other income (expense)- net (49) (17) (62) (21)
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Total other income (expense) (166) (111) (271) (208)
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Income (Loss) Before Income Taxes and Cumulative
Effect of Accounting Changes (1,661) 507 (1,065) 1,033
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Income Taxes (552) 216 (317) 426
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Income (Loss) Before Cumulative Effect of
Accounting Changes (1,109) 291 (748) 607
Cumulative Effect of Accounting Changes, net of tax - - 322 85
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Net Income (Loss) $ (1,109)$ 291 $ (426) $ 692
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
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PACIFIC TELESIS GROUP
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CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
<CAPTION>
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June 30, December 31,
---------------------------
1997 1996
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<S> <C> <C>
Assets (Unaudited)
Current Assets
Cash and cash equivalents $ 113 $ 72
Accounts receivable - net of allowances for
uncollectibles of $212 and $163 2,287 2,109
Prepaid expenses 62 52
Deferred income taxes 624 144
Deferred charges 21 45
Other current assets 62 52
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Total current assets 3,169 2,474
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Property, Plant and Equipment - at cost 29,796 29,032
Less: Accumulated depreciation and amortization 17,720 16,959
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Property, Plant and Equipment - Net 12,076 12,073
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Intangible Assets - Net of Accumulated
Amortization of $266 and $4 871 1,108
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Other Assets 903 953
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Total Assets $ 17,019 $ 16,608
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Liabilities and Shareowner's Equity
Current Liabilities
Debt maturing within one year $ 1,297 $ 613
Accounts payable and accrued liabilities 3,879 2,914
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Total current liabilities 5,176 3,527
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Long-Term Debt 5,409 5,424
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Deferred Credits and Other Noncurrent Liabilities
Postemployment benefit obligation 2,370 2,250
Unamortized investment tax credits 220 243
Other noncurrent liabilities 734 1,391
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Total deferred credits and other noncurrent liabilities 3,324 3,884
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Commitments and contingencies
Corporation-obligated mandatorily redeemable
preferred securities of subsidiary trusts* 1,000 1,000
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Shareowner's Equity
Common stock (par value of $1 and
$.10 at June 30, 1997 and 1996) - 43
Capital in excess of par value 3,135 3,501
Retained earnings (deficit) (905) (479)
Deferred compensation - LESOP (120) (161)
Treasury shares (at cost) - (131)
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Total shareowner's equity 2,110 2,773
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Total Liabilities and Shareowner's Equity $ 17,019 $ 16,608
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<FN>
* The trusts contain assets of $1,030 in principal amount of the Subordinated
Debentures of Pacific Telesis Group
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
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PACIFIC TELESIS GROUP
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
(Unaudited)
<CAPTION>
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Six months ended
June 30,
-----------------------
1997 1996
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<S> <C> <C>
Operating Activities
Net income (loss) $ (426) $ 692
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization 1,475 929
Undistributed earnings from investments in equity
affiliates 9 19
Provision for uncollectible accounts 149 87
Amortization of investment tax credits (24) (24)
Deferred income taxes (378) 89
Cumulative effect of accounting changes, net of tax (322) (85)
Other - net 596 (661)
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Total adjustments 1,505 354
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Net Cash Provided by Operating Activities 1,079 1,046
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Investing Activities
Construction and capital expenditures (1,273) (1,092)
Investments in affiliates (14) (29)
Dispositions - 18
Acquisitions - (35)
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Net Cash Used in Investing Activities (1,287) (1,138)
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Financing Activities
Net change in short-term borrowings with original
maturities of three months or less 664 (1,019)
Issuance of other short-term borrowings - 75
Issuance of long-term debt - 424
Repayment of long-term debt (2) (18)
Issuance of trust originated preferred securities - 1,000
Issuance of treasury shares - 43
Equity received from parent 137 -
Dividends paid (550) (456)
Other - 21
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Net Cash Provided by Financing Activities 249 70
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Net increase (decrease) in cash and cash equivalents 41 (22)
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Cash and cash equivalents beginning of year 72 76
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Cash and Cash Equivalents End of Period $ 113 $ 54
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Cash paid during the six months ended June 30 for:
Interest $ 195 $ 179
Income taxes $ 33 $ 151
<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
<TABLE>
PACIFIC TELESIS GROUP
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CONSOLIDATED STATEMENT OF SHAREOWNER'S EQUITY
Dollars in millions
(Unaudited)
<CAPTION>
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Deferred
Compensation
Leveraged
Employee
Capital in Retained Stock
Common Excess of Earnings Ownership Treasury
Shares Par Value (Deficit) Trust Shares
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1996 $ 43 $ 3,501 $ (479) $ (161) $ (131)
Net income (loss) - - (426) - -
Dividends to parent - (275) - - -
Dividends to shareowners - (140) - - -
Reduction of debt associated with
Employee Stock Ownership Plans - - - 41 -
Recapitalization of Common and (43) (88) - - 131
Treasury Shares
Net equity received from parent - 137 - -
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Balance, June 30, 1997 $ - $ 3,135 $ (905) $ (120) $ -
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<TABLE>
* * * *
SELECTED FINANCIAL AND OPERATING DATA At June 30, or for the six months then
ended:
<CAPTION>
1997 1996
------------------------
<S> <C> <C>
Return on weighted average shareowners' equity * ........................... -47.54% 48.55%
Debt ratio ................................................................. 68.32% 61.58%
Network access lines in service (000)....................................... 16,709 16,151
Access minutes of use (000,000)............................................. 34,838 31,921
Cellular customers (000).................................................... 123 -
Number of employees......................................................... 53,030 48,660
<FN>
*Calculated using Income Before Cumulative Effect of Accounting Changes.
</FN>
</TABLE>
<PAGE>
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PACIFIC TELESIS GROUP
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions
1. BASIS OF PRESENTATION The consolidated financial statements have been
prepared by Pacific Telesis Group (PAC) pursuant to the rules and regulations
of the Securities and Exchange Commission (SEC) and, in the opinion of
management, include all adjustments (consisting only of normal recurring
accruals) necessary to present fairly the results for the interim periods
shown. Certain information and footnote disclosures, normally included in
financial statements prepared in accordance with generally accepted
accounting principles, have been condensed or omitted pursuant to such SEC
rules and regulations. Certain reclassifications have been made to the 1996
consolidated financial statements to conform with the 1997 presentation. The
results for the interim periods are not necessarily indicative of results for
the full year. The consolidated financial statements contained herein should
be read in conjunction with the consolidated financial statements and notes
thereto included in PAC's 1996 Annual Report on Form 10-K (the Form 10-K)
filed with the SEC.
2. CONSOLIDATION The consolidated financial statements include the accounts of
PAC and its majority-owned subsidiaries. PAC's subsidiaries include, but are
not limited to, Pacific Bell (PacBell, which also includes its subsidiaries)
and Nevada Bell, which are collectively referred to as the Telephone
Companies. PAC is a wholly-owned subsidiary of SBC Communications Inc. (SBC).
All significant intercompany transactions are eliminated in the consolidation
process. Investments in partnerships, joint ventures and less than
majority-owned subsidiaries are principally accounted for under the equity
method.
3. COMPLETION OF MERGER On April 1, 1997, PAC and SBC completed the merger of an
SBC subsidiary with PAC, in a transaction in which each outstanding share of
PAC common stock was exchanged for 0.73145 of a share of SBC common stock
(equivalent to approximately 313 million shares). With the merger, PAC became
a wholly-owned subsidiary of SBC. The transaction was accounted for by SBC as
a pooling of interests and a tax-free reorganization. PAC exchanged the
outstanding common stock at the date of merger with SBC stock, issued 1,000
shares of $1 par stock and retired the treasury stock.
Conforming Accounting Changes
PAC's results include merger transaction costs and the effect of changes to
conform accounting methodologies between PAC and SBC for, among other items,
pensions, postretirement benefits and merger transaction costs. The
accounting changes resulted in a net benefit recorded by PAC in the second
quarter of 1997, retroactive to January 1, 1997 as a cumulative effect of
accounting changes of $322, net of deferred taxes of $221, and increased
income before cumulative effect of accounting changes for the first six
months of 1997 by $20. Had the merger occurred January 1, 1997, incomre
before cumulative effect of accounting changes would have decreased by $165.
Had these changes been adopted January 1, 1996, they would have increased
income before cumulative effect of accounting changes by $31, net of deferred
taxes of $21 for the six months ended June 30, 1996. The changes in
accounting for pension and postretirment benefits were to adopt SBC's
methodology of amortizing gains and losses on assets held within those
benefit plans. The change in accounting for merger transaction costs was to
conform to SBC's policy of recognizing these costs as incurred rather than
deferring until the pooling of interests is effective. Also, PAC recorded in
the second quarter of 1997 the present value of amounts to be returned to
California and Nevada ratepayers as a condition of the merger of $281 ($176
net of tax).
<PAGE>
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PACIFIC TELESIS GROUP
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions
Post-merger initiatives
During the second quarter 1997, PAC recorded after-tax charges of $1.4
billion related to SBC's June 19, 1997 announcement of several strategic
decisions resulting from the merger integration process that began with the
April 1 closing of its merger with PAC, which included $108 ($65 after tax)
of charges related to recent regulatory rulings and $281 ($176 after tax) for
the present value of amounts to be returned to California and Nevada
ratepayers as a condition of the merger. The decisions resulted from an
extensive review of operations throughout the merged company and include
significant integration of operations and consolidation of some
administrative and support functions. Following is a discussion of the most
significant of these charges.
Reorganization SBC will centralize several key functions that will support
the operations of PacBell, Nevada Bell and Southwestern Bell Telephone
Company (SWBell), including network planning, strategic marketing and
procurement. It is also consolidating a number of corporate-wide support
activities, including research and development, information technology,
financial transaction processing and real estate management. PacBell, Nevada
Bell and SWBell will continue as separate legal entities. These initiatives
will result in the creation of some jobs and the elimination and realignment
of others, with many of the affected employees changing job responsibilities
and in some cases assuming positions in other locations.
PAC recognized a charge of approximately $238 ($149 net of tax) during the
second quarter of 1997 in connection with these initiatives. This charge was
comprised mainly of post-employment benefits, primarily related to severance,
and costs associated with closing down duplicate operations, primarily
contract cancellations. Other charges arising out of the merger related to
relocation, retraining and other effects of consolidating certain operations
will be recognized in future periods as those charges are incurred.
Impairments/asset valuation As a result of SBC's merger integration plans,
strategic review of domestic operations and organizational alignments, PAC
reviewed the carrying values of related long-lived assets. This review
included estimating remaining useful lives and cash flows and identifying
assets to be abandoned. Where this review indicated impairment , discounted
cash flows related to those assets were analyzed to determine the amount of
the impairment. As a result of these reviews, PAC wrote off some assets and
recognized impairments to the value of other assets with a combined charge of
$842 ($591 after tax) recorded in the second quarter of 1997. These
impairments and writeoffs related to the wireless digital TV operations in
southern California, certain analog switching equipment in California,
certain rural and other telecommunications equipment in Nevada, selected
wireless equipment, duplicate or obsolete equipment, cable within commercial
buildings in California, certain non-operating plant and other assets.
Video curtailment/purchase commitments SBC also announced it is scaling back
its limited direct investment in video services. As part of this curtailment,
PAC has halted construction on the Advanced Communications Network (ACN) in
California. As part of an agreement with the ACN vendor, PAC will pay the
liabilities of the ACN trust that owns and finances ACN construction, incur
costs to shut down all construction previously conducted under the trust and
receive certain consideration from the vendor. In the second quarter, PAC
recognized its total expense of $553 ($346 after tax) associated with these
activities.
<PAGE>
Additionally, PAC will curtail several other video-related activities
including substantially scaling back its involvement in the Tele-TV joint
venture and evaluating its option to invest in cable television operations in
Chicago. The collective impact of these decisions resulted in a charge of $89
($56 after tax) in the second quarter of 1997.
4. CUMULATIVE EFFECT OF CHANGE IN DIRECTORY ACCOUNTING Prior to January 1, 1996,
Pacific Bell Directory (a subsidiary of PacBell and an indirect subsidiary of
PAC) recognized revenues and expenses related to publishing directories in
California using the "amortization" method, under which revenues and expenses
were recognized over the lives of the directories, generally one year. Under
the new "issue basis" method, revenues and expenses are recognized when the
directories are issued. The change to the issue basis method was made because
it is the method generally followed in the publishing industry and better
reflects the operating activity of the business.
The change was adopted during fourth quarter 1996. The cumulative after-tax
effect of applying the change in method to prior years was recognized as of
January 1, 1996 as a one-time, non-cash gain applicable to continuing
operations of $85. The gain is net of deferred taxes of $58. The first three
quarters of 1996 were restated in the Form 10-K to reflect the new method.
5. COMMITMENTS AND CONTINGENCIES
Purchase Commitments As of June 30, 1997, PacBell had purchase commitments of
about $220 remaining in connection with its previously announced program for
deploying an all digital switching platform with ISDN and SS-7 capabilities.
Property Tax Investigation In 1992, a settlement agreement was reached among
the State Board of Equalization, all California counties, the State Attorney
General, and 28 utilities, including PacBell, on a specific methodology for
valuing utility property for property tax purposes for a period of eight
years. The California Public Utilities Commission (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 of
annual property tax savings should be treated as an exogenous cost reduction
in PacBell's annual price cap filings. These intervenors have also asserted
that past property tax savings totaling as much as approximately $80 as of
June 30, 1997, plus interest, should be returned to customers. Management
believes that, under the CPUC's regulatory framework, any property tax
savings should be treated only as a component of the calculation of shareable
earnings and not as an exogenous cost. In an Interim Opinion issued in June
1995, the CPUC decided to defer a final decision on this matter pending
resolution in a separate proceeding of the criteria for exogenous cost
treatment under its regulatory framework.
<PAGE>
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PACIFIC TELESIS GROUP
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Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
RESULTS OF OPERATIONS
Overview Financial results for Pacific Telesis Group (PAC) for the first six
months of 1997 and 1996 are summarized as follows:
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Six-Month Period
- ------------------------------------------------------------------------
Percent
1997 1996 Change
- ------------------------------------------------------------------------
Operating revenues $ 4,927 $ 4,783 3.0%
Operating expenses 5,721 3,542 61.5
Income (loss) before cumulative
effect of accounting changes (748) 607 -
Cumulative effect of accounting 322 85 -
changes
Net income (loss) $ (426) $ 692 -
========================================================================
Net loss for the six months ended June 30, 1997 includes a cumulative net
benefit of $322 resulting from accounting changes related to conforming
accounting between PAC and SBC Communications Inc. (SBC) for, among other items,
pensions and postretirement benefits. The first six months of 1996 included a
cumulative effect of a change in accounting for directory publishing revenues
and expenses.
PAC's six-month loss before cumulative effect of accounting changes of $748
includes after-tax charges of $1.4 billion reflecting strategic initiatives
resulting from SBC's comprehensive review of operations of the merged company
and the impact of several recent regulatory rulings. Excluding these items, PAC
reported income before cumulative effect of accounting changes of $641 or 5.6%
higher than the first six months of 1996 income before cumulative effect of
accounting changes of $607. PAC currently anticipates incurring additional
after-tax charges for ongoing merger integration costs, primarily related to
movement of employees, and customer number portability of $125 to $200 during
the remainder of 1997.
Excluding these second quarter charges, the primary factors contributing to the
increase in income before cumulative effect of accounting changes during the
first six months of 1997 were growth in demand for services and products at
Pacific Bell (PacBell) and a first quarter 1997 $90 after-tax settlement gain
associated with lump-sum pension payments that exceeded the projected service
and interest costs for 1996 retirements. These increases were partially offset
by increased expenses at PacBell including expenses for the introduction of
Personal Communications Services (PCS) operations in California and Nevada.
<PAGE>
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PACIFIC TELESIS GROUP
================================================================================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
RESULTS OF OPERATIONS - Continued
Revenues PAC's operating revenues for the first six months of 1997 reflect
reductions of $121 related primarily to the impact of several recent regulatory
rulings. Excluding these items, PAC's operating revenues increased $258, or
5.4%. Components of operating revenues for the first six months of 1997 and 1996
are as follows:
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Six-Month Period
- ------------------------------------------------------------------------
Percent
1997 1996 Change
- ------------------------------------------------------------------------
Local service $ 2,144 $ 1,995 7.5%
Network access
Interstate 829 919 -9.8
Intrastate 405 366 10.7
Long-distance service 607 639 -5.0
Directory advertising 627 585 7.2
Other 315 279 12.9
- ---------------------------------------------------------------
Total $ 4,927 $ 4,783 3.0%
========================================================================
Local service revenues increased for the first six months of 1997 due
primarily to increases in demand, including increases in access lines and
vertical services revenues. The number of access lines increased by 3.5%
since June 30, 1996, with approximately 42.5% of access line growth due to
the sales of additional access lines to existing residential customers.
Vertical services revenues, which include custom calling options, Caller
ID and other enhanced services, increased by approximately 16.1%. Local
service revenues also reflect the implementation of the California High
Cost Fund (CHCFB) that went into effect February 1, 1997. The California
Public Utilities Commission (CPUC) has stated the CHCFB is intended to
directly subsidize the provision of service to high cost areas and allow
PacBell to set competitive rates for other services. Amounts received from
the CHCFB resulted in a shift of equivalent revenues from intraLATA
long-distance and intrastate network access revenues to local service
revenues in the first six months of 1997. This shift is subject to final
CPUC approval, expected in third quarter 1997. For further information on
the operations of the CHCFB, see the discussion under the heading
"Regulatory Environment-California" on page 10 of SBC's Current Report on
Form 8-K dated May 8, 1997. Rate reductions due to CPUC price cap orders
and revenue sharing accruals partially offset increases in local service
revenues. Wireless revenues also contributed to the increase in local
service revenues due to product introduction in the first six months of
1997.
Network Access Interstate network access revenues decreased $134 in the
first six months of 1997 due to one-time charges. These one-time charges
include billing claim settlements related to the Percentage Interstate
Usage (PIU) factor in California and several Federal regulatory issues
including end user charges, 800 data base charges, recovery of certain
employee-related expenses and the retroactive effect of the productivity
factor adjustment in the Federal price cap filing. While the change in PIU
factor in California, which is used to allocate network access revenues
between interstate and intrastate jurisdictions, also had the effect of
increasing intrastate network access revenues, it resulted in a slight
decline in total network access revenues. Without these impacts,
interstate access revenues increased in the first six months of 1997 due
to demand for access services by interexchange carriers and growth in
revenues from end user charges attributable to an increasing access line
base. Partially offsetting these increases in interstate network access
revenues were the effects of revenue sharing adjustments made in 1996 at
PacBell.
Intrastate network access revenues increased in the first six months of
1997 due primarily to the PIU settlements described above. Excluding this
impact, intrastate network access revenues were relatively unchanged in
the first six months of 1997 as increases in demand, including usage by
alternative intraLATA toll carriers, were offset by the effects of the
CHCFB discussed above.
Long-Distance Service revenues decreased for the first six months of 1997
primarily due to the effects of the CHCFB discussed above under Local
Service, and were primarily offset by increases in demand resulting from
California's growing economy.
Directory advertising revenues increased for the first six months of 1997
due mainly to the publication of books not published in 1996 and, to a
lesser extent, increased demand.
Other operating revenues increased for the first six months of 1997 due
primarily to increased demand for PacBell's non-regulated services and
products.
Expenses PAC's operating expenses for the first six months of 1997 reflect
$1,941 of charges related to strategic initiatives from a comprehensive review
of operations of the merged company and the impact of several recent regulatory
rulings (see Note 3 to the financial statements). Excluding these charges,
operating expenses increased $238 or 6.7% over the first six months of 1996.
Components of operating expenses for the first six months of 1997 and 1996 are
as follows:
- ------------------------------------------------------------------------
Six-Month Period
------------------------------
Percent
1997 1996 Change
- -----------------------------------------------------------------------
Cost of services and products $ 1,876 $ 1,722 8.9%
Selling, general and administrative 2,370 891 166.0
Depreciation and amortization 1,475 929 58.8
- ----------------------------------------------- -----------------------
Total $ 5,721 $ 3,542 61.5%
=======================================================================
Costs of services and products for the first six months of 1997 reflect
charges of $43 relating to SBC's strategic initiatives and operational
reviews. Excluding these charges, cost of services and products increased
$111, or 6.4%, in the first six months of 1997 due primarily to increases
in employee compensation including increases related to force additions,
increases in contract labor and the introduction of PCS operations. These
increases were somewhat offset by a first quarter 1997 $105 settlement
gain associated with lump-sum pension payments that exceeded the projected
service and interest costs for 1996 retirements.
Selling, general and administrative expenses for the first six months of
1997 reflects $1,382 of charges relating to SBC's strategic initiatives
and operational reviews. As discussed in Note 3 to the financial
statements, the most significant of these charges included shutdown of the
Advanced Communications Network, regulatory costs related to the approval
of the merger with SBC by California and Nevada regulators reorganization
initiatives and write-offs related to wireless digital TV. Excluding these
one-time charges, selling, general and administrative costs increased $97,
or 10.9%, in the first six months of 1997 due to increases related to
expenses associated with the introduction of PCS operations, employee
compensation, contract labor and advertising. These increases were
partially offset by a first quarter 1997 $47 settlement gain associated
with lump-sum pension payments that exceeded the projected service and
interest costs for 1996 retirements.
Depreciation and amortization for the first six months of 1997 reflects
charges totaling $516 to record impairment of plant and intangibles. As
discussed in Note 3 to the financial statements, the most significant of
these impairments related to the wireless digital TV operations in
Southern California, certain analog switching equipment in California,
certain rural and other telecommunications equipment in Nevada and cable
within commercial buildings in California. Excluding these charges,
depreciation and amortization increased $30, or 3.2% in the first six
months of 1997. These increases were primarily due to overall higher plant
levels partially offset by reduced deprecation during the second quarter
on analog switching equipment in California.
Interest Expense increased $22 or 11.8% for the first six months of 1997 due to
interest of $27 associated with one-time charges, increased long term debt
compared to the first six months of 1996 and increased interest on capital
leases. These increases were somewhat offset by increased capitalized interest
related to PCS construction.
Other Income (Expense) - net was net expense of $62 for the first six months of
1997. The increased expenses include $30 in expenses related to SBC's strategic
initiatives, primarily writeoff of nonoperating plant. Other increases from 1996
relate primarily to distributions paid due to the sale of an additional $500 of
Trust Originated Preferred Securities in June 1996.
Income taxes for the first six months of 1997 reflect the tax effect of charges
for strategic initiatives resulting from SBC's comprehensive review of
operations of the merged company and the impact of several recent regulatory
rulings. The effective tax rate on these items was lower as a result of
non-deductible items included in the charges and valuation adjustments to
certain deferred tax assets.
Cumulative Effect of Accounting Changes, as discussed in Note 3 to the financial
statements, include merger transaction costs and the effect of changes applied
retroactively to conform accounting methodologies between PAC and SBC effective
January 1, 1997. The cumulative after-tax effect of these one-time changes is
$322.
<PAGE>
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PACIFIC TELESIS GROUP
================================================================================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
Access Reform/Price Caps On June 3, 1997, SBC filed with the Federal
Communications Commission (FCC) a Petition for Partial Stay (Petition) of
aspects of the orders adopted on May 7, 1997 by the FCC on access reform and
local exchange carrier price caps. The Petition asked the FCC to stay the
application of the 6.5% productivity offset to all price cap Local Exchange
Carriers (LECs), its retroactive application to the 1996 annual tariff filings,
and exogenous reductions associated with the completion of equal access
amortization. The FCC denied the stay on June 18, 1997. The impact of the
retroactive portion of the FCC orders was recorded in the second quarter of
1997.
On June 16, 1997, SBC and several other parties filed court appeals regarding
several aspects of the Access Reform and Price Cap Orders. The appeal related to
access reform was assigned to the U.S. Court of Appeals for the Eighth Circuit
in St. Louis (8th Circuit). The appeal related to price caps and the
productivity offset decision has been assigned to the U.S. Court of Appeals for
the 10th Circuit in Denver but on July 28, 1997 it was transferred to the U.S.
Court of Appeals for the D.C Circuit.
Interconnection Agreements PAC continues to enter into interconnection
agreements with companies desiring to provide local service in its operating
territory. Agreements have been reached and approved by both of the state
commissions where PAC operates. On July 18, 1997, the 8th Circuit set aside key
parts of the FCC interconnection order that attempted to set prices for local
exchange services, holding that the right to set such prices is reserved
exclusively to the states. PAC is in agreement with the 8th Circuit's ruling on
the order and believes the intent of the Telecommunications Act of 1996 (Telecom
Act) retained state regulators' jurisdiction over pricing of intrastate service
and local interconnection. The FCC has indicated it will appeal the 8th
Circuit's decision to the Supreme Court.
Other Billing and Collecting Allocation Methodology Changes On June 13, 1997,
PacBell filed a waiver request with the FCC that if approved, would allow it to
reverse an other billing and collection adjustment resulting from a recently
adopted FCC separations ruling that shifts recovery of substantial other billing
and collecting costs from the intrastate to the interstate jurisdiction. The FCC
has released this waiver request for Public Notice but no comments were filed.
If PacBell's request for a waiver is denied, the separations change could reduce
PacBell's revenues by about $30 in 1997 and about $45 in each subsequent year.
Portions of Telecom Act Challenged On July 2, 1997, SBC sued in U.S. District
Court for the Northern District of Texas to declare a portion of the Telecom Act
unconstitutional on the grounds the Telecom Act improperly discriminates against
SBC by imposing restrictions that prohibit SBC from offering interLATA
long-distance and other services that other local exchange companies are free to
provide. The suit challenges only that portion of the Telecom Act which excludes
SBC from competing in certain lines of business.
<PAGE>
================================================================================
PACIFIC TELESIS GROUP
================================================================================
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
OTHER BUSINESS MATTERS
Restructuring Reserve PAC established a restructuring reserve at the end of 1993
to provide for the incremental cost of force reductions associated with
restructuring business processes through 1997. A total of $43 in cash outlays
was charged to the reserve in the first six months of 1997. As of June 30, 1997,
$53 remained in the restructuring reserve.
Local Number Portability/Interconnection Over the next few years, PAC is
expecting to incur significant capital and software expenditures for customer
number portability and interconnection. PAC expects capital costs and expenses
associated with customer number portability, which allows customers to switch to
local competitors and keep the same phone number to total up to $750 on a
pre-tax basis over the next four years. Full recovery of customer number
portability costs is required under the Telecom Act; however, the FCC has not
yet determined when or how those significant costs will be recovered. PacBell
has filed a tariff with the FCC for recovery of the costs of implementing
customer number portability. The FCC has suspended the tariff until September
1997, pending the issuance of its order on customer number portability recovery.
PacBell is unable to predict the likelihood of the FCC permitting the tariff to
become effective. Capital costs and expenses associated with interconnection
will vary based on the number of competitors seeking interconnection and
customers served and markets entered by those competitors. Accordingly, PAC is
currently unable to reasonably estimate these costs.
<PAGE>
================================================================================
PACIFIC TELESIS GROUP
================================================================================
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 12 Computation of Ratios of Earnings to Fixed Charges.
Exhibit 18 Preferability Letter on Change in Accounting
Exhibit 27 Financial Data Schedule.
(b) Reports on Form 8-K
On April 4, 1997, Pacific Telesis Group (PAC) filed a Current Report on
Form 8-K, reporting on Item 4 Change in Registrant's Certifying
Accountant. In the Report, PAC indicated that Ernst & Young LLP would
replace Coopers & Lybrand L.L.P. as the certifying accountants.
On April 9, 1997, PAC filed a Current Report on Form 8-K, reporting on
Item 1 Change in Control of Registrant. In the Report, PAC indicated that
PAC became a wholly-owned subsidiary of SBC Communications Inc. effective
April 1, 1997.
.
<PAGE>
================================================================================
================================================================================
SIGNATURES
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
August 13, 1997 /s/ Donald E. Kiernan
---------------------
Donald E. Kiernan
Executive Vice President,
Chief Financial Officer and Treasurer
================================================================================
================================================================================
<TABLE>
EXHIBIT 12
PACIFIC TELESIS GROUP
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
Dollars in Millions
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
<CAPTION>
--------------------- -----------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- ------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Income (Loss) From Continuing Operations Before
Income Taxes and Cumulative Effect of
Accounting Changes* $(1,056) $ 1,052 $ 1,798 $ 1,611 $ 1,793 $ 201 $ 1,782
Add: Interest Expense 209 229 455 442 455 509 506
Dividends on Preferred Securities 40 19 60 - - - -
1/3 Rental Expense 36 25 51 31 43 40 44
--------- -------- --------- --------- -------- -------- ----------
Adjusted Earnings $ (771) $1,325 $ 2,364 $ 2,084 $ 2,291 $ 750 $ 2,332
========= ======== ========= ========= ======== ======== ==========
Total Interest Charges $ 272 $ 229 $ 455 $ 442 $ 455 $ 509 $ 510
Dividends on Preferred Securities 40 19 60 - - - -
1/3 Rental Expense 36 25 51 31 43 40 44
--------- -------- --------- --------- -------- -------- ----------
Adjusted Fixed Charges $ 348 $ 273 $ 566 $ 473 $ 498 $ 549 $ 554
========= ======== ========= ========= ======== ======== =========
Ratio of Earnings to Fixed Charges (2.22) 4.85 4.18 4.41 4.60 1.37 4.21
<FN>
*Excluding undistributed earnings on investments accounted for under the equity method.
</FN>
</TABLE>
Exhibit 18
August 8, 1997
Mr. Donald Kiernan
Senior Vice President, Treasurer and
Chief Financial Officer
SBC Communications, Inc.
175 W. Houston Street
San Antonio, Texas 78205
Dear Mr. Kiernan:
Note 3 of Notes to Consolidated Financial Statements of Pacific Telesis Group
(PAC) included in its Form 10-Q for the six months ended June 30, 1997 describes
changes in the methods of accounting for pensions and postretirement benefits.
You have advised us that you believe that the changes are to conform the
accounting of SBC Communications Inc. (SBC) and PAC and that the new methods are
preferable because the new methods for pensions and postretirement benefits are
more widely used. These changes were made by SBC in its consolidated financial
statements reflecting the business combination with PAC accounted for as a
pooling of interests, as reported in SBC's Form 8-K dated May 8, 1997.
We conclude that the changes in the methods for accounting for the items
described above are to acceptable alternative methods which, based on your
business judgment to make these changes for the reasons cited above, are
preferable in your circumstances. We have not conducted an audit in accordance
with generally accepted auditing standards of any financial statements of PAC as
of any date or for any period and therefore we do not express any opinion on any
financial statements of Pacific Telesis Group.
ERNST & YOUNG LLP
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000,000
<S> <C>
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<PERIOD-TYPE> 6-MOS
<CASH> 113,000
<SECURITIES> 0
<RECEIVABLES> 2,499,000
<ALLOWANCES> 212,000
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 3,169,000
<PP&E> 29,796,000
<DEPRECIATION> 17,720,000
<TOTAL-ASSETS> 17,019,000
<CURRENT-LIABILITIES> 5,176,000
<BONDS> 5,409,000
<COMMON> 1
0
0
<OTHER-SE> 2,110,000
<TOTAL-LIABILITY-AND-EQUITY> 17,019,000
<SALES> 0<F2>
<TOTAL-REVENUES> 4,927,000
<CGS> 0<F3>
<TOTAL-COSTS> 1,876,000
<OTHER-EXPENSES> 1,475,000
<LOSS-PROVISION> 149,000
<INTEREST-EXPENSE> 209,000
<INCOME-PRETAX> (1,065,000)
<INCOME-TAX> (317,000)
<INCOME-CONTINUING> (748,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 322,000
<NET-INCOME> (426,000)
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1> THIS AMOUNT IS IMMATERIAL.
<F2> NET SALES OF TANGIBLE PRODUCTS IS NOT MORE THAN 10% OF TOTAL OPERATING
REVENUES AND THEREFORE HAS NOT BEEN STATED SEPARATELY IN THE FINANCIAL
STATEMENTS PURSUANT TO REGULATION S-X, RULE 5-03(B). THIS AMOUNT IS INCLUDED IN
THE "TOTAL REVENUES" TAG.
<F3>COST OF INTANGIBLE GOODS SOLD IS INCLUDED IN COST OF SERVICES AND PRODUCTS
IN THE FINANCIAL STATEMENTS AND THE "TOTAL COST" TAG, PURSUANT TO REGULATION
2-X, RULE 5-03 (B).
</FN>
</TABLE>
