<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1994
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-1414
PACIFIC BELL
I.R.S. Employer No. 94-0745535
A California Corporation
140 New Montgomery Street, San Francisco, California 94105
Telephone - Area Code (415) 542-9000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
At October 31, 1994, 224,504,982 common shares were outstanding.
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF PACIFIC TELESIS GROUP, 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).
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION Number
- ------------------------------ ------
Item 1. Financial Statements
Review Report of Independent Accountants .............. 3
Condensed Consolidated Statements of Income ........... 4
Condensed Consolidated Balance Sheets ................. 5
Condensed Consolidated Statements of Shareowner's
Equity.............................................. 6
Condensed Consolidated Statements of Cash Flows ....... 7
Notes to Condensed Consolidated Financial Statements .. 9
Item 2. Management's Discussion and Analysis of Results of
Operations ............................................ 13
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K ........................ 24
SIGNATURE ........................................................ 25
- ---------
2
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowner of Pacific Bell:
We have reviewed the accompanying condensed consolidated balance sheet of
Pacific Bell and Subsidiaries as of September 30, 1994, and the related
condensed consolidated statements of income for the three- and nine-month
periods ended September 30, 1994 and 1993, and the condensed consolidated
statements of shareowner's equity and cash flows for the nine-month periods
ended September 30, 1994 and 1993. These financial statements are the
responsibility of the Company'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 review
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 Bell and Subsidiaries as
of December 31, 1993, and the related consolidated statements of income,
shareowner's equity, and cash flows for the year then ended (not presented
herein); and in our report dated March 3, 1994, 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, 1993, is fairly stated, in all material respects, in
relation to the consolidated balance sheet from which it has been derived.
Coopers & Lybrand L.L.P.
San Francisco, California
November 14, 1994
3
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the 3 Months Ended For the 9 Months Ended
September 30, September 30,
---------------------- ----------------------
(Dollars in millions) 1994 1993 1994 1993
- -----------------------------------------------------------------------------
OPERATING REVENUES:
Local service ................. $ 858 $ 863 $ 2,525 $ 2,561
Network access
Interstate .................. 387 404 1,171 1,188
Intrastate .................. 191 174 532 505
Toll service .................. 491 512 1,485 1,535
Other ......................... 358 343 1,028 1,019
Less: Provision for
uncollectibles ....... 39 45 115 120
-------- -------- -------- --------
Total Operating Revenues ...... 2,246 2,251 6,626 6,688
-------- -------- -------- --------
OPERATING EXPENSES:
Cost of products and services.. 468 476 1,415 1,468
Customer operations and
selling expense ............. 452 456 1,335 1,324
General, administrative, and
other expense ............... 257 313 793 913
Depreciation and amortization.. 444 422 1,312 1,277
-------- -------- -------- --------
Total Operating Expenses ...... 1,621 1,667 4,855 4,982
-------- -------- -------- --------
Net Operating Revenues ........ 625 584 1,771 1,706
-------- -------- -------- --------
OPERATING TAXES:
Income taxes .................. 187 180 489 484
Other taxes ................... 45 43 135 137
-------- -------- -------- --------
Total Operating Taxes ......... 232 223 624 621
-------- -------- -------- --------
OPERATING INCOME .............. 393 361 1,147 1,085
-------- -------- -------- --------
Other Income (Expense)......... 2 3 1 7
-------- -------- -------- --------
Income before interest expense
and cumulative effect of change
in accounting principle..... 395 364 1,148 1,092
Interest expense.............. 103 107 324 328
-------- -------- -------- --------
Income before cumulative
effect of change in
accounting principles....... 292 257 824 764
Cumulative effect of change
in accounting principle..... - - - (148)
-------- -------- -------- --------
NET INCOME ................... $ 292 $ 257 $ 824 $ 616
======== ======== ======== ========
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
4
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(Dollars in millions) 1994 1993
- ---------------------------------------------------------------------------
ASSETS (Unaudited)
Cash and cash equivalents ..................... $ 45 $ 57
Accounts receivable - (net of allowances for
uncollectibles of $143 and $136 in 1994 and
1993, respectively) ......................... 1,539 1,518
Prepaid expenses and other current assets ..... 843 862
------------ ------------
Total current assets .......................... 2,427 2,437
------------ ------------
Property, plant, and equipment - at cost....... 25,905 25,660
Less: accumulated depreciation ............. 10,174 9,708
------------ ------------
Property, plant, and equipment - net .......... 15,731 15,952
------------ ------------
Deferred charges and other noncurrent assets .. 1,014 989
------------ ------------
TOTAL ASSETS .................................. $ 19,172 $ 19,378
============ ============
LIABILITIES AND SHAREOWNER'S EQUITY
Accounts payable .............................. $ 1,253 $ 1,255
Debt maturing within one year ................. 221 542
Other current liabilities ..................... 1,206 1,136
------------ ------------
Total current liabilities ..................... 2,680 2,933
------------ ------------
Long-term obligations ......................... 4,749 4,753
------------ ------------
Deferred income taxes ......................... 2,280 2,280
------------ ------------
Other noncurrent liabilities and
deferred credits ............................ 3,235 3,258
------------ ------------
Commitments and Contingencies (Note B)
Total shareowner's equity ..................... 6,228 6,154
------------ ------------
TOTAL LIABILITIES AND SHAREOWNER'S EQUITY ..... $ 19,172 $ 19,378
============ ============
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
5
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNER'S EQUITY
(Unaudited)
For the 9 Months Ended
September 30,
----------------------
(Dollars in millions) 1994 1993
- -------------------------------------------------------------------------
COMMON STOCK
Balance at beginning of period ................. $ 225 $ 225
--------- ---------
Balance at end of period ....................... 225 225
--------- ---------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of period ................. 5,168 5,168
Other changes 1 -
--------- ---------
Balance at end of period ....................... 5,169 5,168
--------- ---------
REINVESTED EARNINGS
Balance at beginning of period ................. 761 1,898
Net income ..................................... 824 616
Common dividends declared ...................... (747) (747)
Minimum pension liability adjustment............ (4) -
--------- ---------
Balance at end of period ....................... 834 1,767
--------- ---------
TOTAL SHAREOWNER'S EQUITY ...................... $6,228 $7,160
========= =========
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
6
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 9 Months Ended
September 30,
----------------------
(Dollars in millions) 1994 1993
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES
Net Income .......................................... $ 824 $ 616
Adjustments to reconcile net income for items
currently not affecting operating cash flows:
Cumulative effect of accounting change........... - 148
Depreciation and amortization ................... 1,312 1,277
Deferred income taxes ........................... (23) 71
Unamortized investment tax credits .............. (49) (35)
Allowance for funds used during construction .... (22) (26)
Changes in operating assets and liabilities:
Accounts receivable ........................... (4) (80)
Prepaid expenses and other current assets ..... 16 5
Deferred charges and other noncurrent assets... (16) 57
Accounts payable .............................. (18) (79)
Other current liabilities ..................... 68 62
Noncurrent liabilities and deferred credits ... 26 (121)
Other adjustments, net .......................... 6 21
--------- ---------
Cash from operating activities .................. 2,120 1,916
--------- ---------
CASH FROM (USED FOR) INVESTING ACTIVITIES
Additions to property, plant, and equipment, net .... (1,041) (1,248)
Other investing activities, net ..................... (11) 2
--------- ---------
Cash used for investing activities .................. (1,052) (1,246)
--------- ---------
CASH FROM (USED FOR) FINANCING ACTIVITIES
Proceeds from issuance of long-term debt ............ - 2,100
Retirements of long-term debt ....................... - (2,075)
Dividends paid ...................................... (747) (747)
Increase (decrease) in short-term borrowings, net ... (331) 179
Principal payments under capital lease obligations .. (3) (4)
Other financing activities, net ..................... 1 (128)
--------- ---------
Cash used for financing activities .................. (1,080) (675)
--------- ---------
Increase(decrease) in cash and cash equivalents ..... (12) (5)
Cash and cash equivalents at January 1 .............. 57 57
--------- ---------
Cash and cash equivalents at September 30............ $ 45 $ 52
========= =========
7
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 9 Months Ended
September 30,
----------------------
1994 1993
- ---------------------------------------------------------------------------
Cash payments for:
Interest ........................................ $ 315 $ 497
Income taxes .................................... $ 540 $ 499
- ---------------------------------------------------------------------------
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
8
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION
The Condensed Consolidated Financial Statements include the accounts of
Pacific Bell and its wholly owned subsidiaries, Pacific Bell Directory
("Directory"), Pacific Bell Information Services ("PBIS"), and Pacific
Bell Mobile Services ("PBMS"), hereinafter referred to as the "Company."
All significant intercompany balances and transactions have been
eliminated.
The Condensed Consolidated Financial Statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission (the "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 the audited
consolidated financial statements and notes thereto included in the
Company's 1993 annual report on Form 10-K.
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 3.
9
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Accounting Under Regulation
The Company accounts 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 regulated 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." The regulatory assets and liabilities included
in the Company's consolidated balance sheets are listed and discussed
below:
September 30, December 31,
1994 1993
-----------------------------------------------------------------------
(Dollars in millions)
Regulatory assets (liabilities) due to:
Deferred pension costs* .................. $ 387 $ 340
Unamortized debt redemption costs** ...... 348 357
Deferred compensated absence costs* ...... 220 226
Unamortized purchases of property, plant
and equipment under $500 ............... 115 140
Deferred income taxes***.................. (190) (228)
Other .................................... 52 64
-------- --------
Total .................................... $ 932 $ 899
-----------------------------------------------------------------------
* Included primarily in "deferred charges and other noncurrent assets"
on the balance sheet.
** Reflected as a reduction of "long-term obligations."
*** Included in "other current liabilities" and "other noncurrent
liabilities and deferred credits."
Deferred pension costs above reflect an order by the California Public
Utilities Commission (the "CPUC") requiring the Company to use the
"aggregate cost method" for its intrastate operations. These deferred
costs represent differences between the Company's intrastate pension costs
calculated using this actuarial method, subject to Internal Revenue
Service and other limitations, and costs determined under the provisions
of Statement of Financial Accounting Standards No. 87 ("SFAS 87"),
"Employers' Accounting for Pensions," and ("SFAS 88"), "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension
Plans and for Termination Benefits."
10
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
When debt is refinanced before maturity, the Company 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 (the
"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 the Company 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, the FCC and the CPUC, respectively, 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
("SFAS 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.
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 Company 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.
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. When
retired, the original cost of depreciable telephone plant is charged to
accumulated depreciation.
11
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Depreciation of telephone plant is computed primarily using the remaining-
life method, essentially a form of straight-line depreciation, using
depreciation rates prescribed by state and federal regulatory agencies.
Depreciation decisions are made by regulators after deliberation and
consideration of numerous factors. Regulators have prescribed the
following depreciable lives for each category of property, plant and
equipment:
Depreciable Lives
--------------------------------------------------------------------
(in years)
Buildings ......................................... 30 to 57
Cable and conduit .................................. 10 to 30
Central office equipment ........................... 9 to 16.5
Furniture, equipment, and other .................... 5.5 to 20
--------------------------------------------------------------------
Unregulated enterprises, may have selected shorter depreciable lives for
similar assets. At this time, the Company 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. Two telephone regional holding companies ("RHCs") have discontinued
the application of SFAS 71 regulatory accounting and have recorded the
cumulative effect of using shorter depreciable lives for their telephone
plant. If the Company were to discontinue the application of SFAS 71 and
adopt similar depreciable lives and use similar methodologies as these two
RHCs to calculate the cumulative effect, the reduction in the carrying
amount of the Company's property, plant and equipment would be between $3
and $5 billion.
B. PRIOR YEAR ACCOUNTING CHANGES
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 112 ("SFAS 112"), "Employer's Accounting for
Postemployment Benefits." SFAS 112 establishes accounting standards for
benefits that are provided to former or inactive employees after
employment but before retirement. The new Statement required immediate
recognition of the cumulative effect of applying the new rule to prior
years. The Company restated first quarter 1993 results to recognize a
postemployment benefit liability of $251 million. The net income impact
of adopting this accounting standard was $148 million, net of a deferred
income tax benefit of $103 million.
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 106, "Employers' Accounting for Postretirement
Benefits Other than Pensions", ("SFAS 106"). The CPUC granted the Company
$100 million in 1994 for partial recovery of higher costs under SFAS 106.
Two customer advocacy groups challenged the recovery ordered. In October
1994, the CPUC ordered a rehearing to determine if the Company should
continue to recover these costs. The CPUC's order held that related
revenues collected after October 12, 1994 are subject to refund.
12
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OR OPERATIONS
- ----------------------------------------------------------------------
RESULTS OF OPERATIONS
The following discussions and data compare the results of operations of
Pacific Bell (The "Company") for the nine-month period ended September 30,
1994 to the corresponding period in 1993. Results for the first nine months
of 1994 may not be indicative of results for the full year. (See discussions
of "Pending Regulatory Issues" beginning on page 19.)
A summary of selected operating data is shown below:
For the 9 Months Ended
September 30, Change
---------------------- -----------------
Selected Operating Data 1994 1993 Amount Percent
- ---------------------------------------------------------------------------
Operating ratio (%) 73.3 74.5 1.2 -
Return on shareowner's
equity (%) ................... 17.6 11.5
** 6.1 -
Total employees ................ 51,757 54,541 (2,784) (5.1)
Revenues per employee
($ thousands) ................ 128.0 122.6 5.4 4.4
Employees per ten thousand
access lines* ................ 32.8 35.8 (3.0) (8.4)
- ---------------------------------------------------------------------------
* Excludes Pacific Bell Directory employees
** Restated due to the Cumulative Effect of Accounting Change
Earnings
- -------- For the 9 Months Ended
September 30, Change
---------------------- -----------------
($ Millions) 1994 1993 Amount Percent
- ---------------------------------------------------------------------------
Net income $824 $616 208 33.8
- ---------------------------------------------------------------------------
Earnings reflect a modest but consistent improvement in the California economy
and the Company's continuing cost reduction programs. 1993 results included
the adoption of Statement of Financial Accounting Standards 112 "Employers'
Accounting for Postemployment Benefits" effective January 1, 1993. Adoption
of the new standard reduced comparative 1993 net income by $148 million. 1994
net income was reduced about $29 million because of a California Public
Utilities Commission ("CPUC") refund order. In April 1994, the CPUC let stand
its previous order requiring the Company to refund about $35 million in late
payment and reconnection charges which resulted from past problems with its
payment processing system. The order also imposed penalties totaling $15
million.
Management expects the current good performance to continue this year.
However, the effects of regulatory rulings, increased competition and
strategic initiatives will make it difficult to achieve earnings growth next
year. (See discussions of "Pending Regulatory Issues" beginning on page 19.)
13
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Volume Indicators
- -----------------
For the 9 Months Ended
September 30, Change
------------------------ -----------------
Volume Indicators 1994 1993 Amount Percent
- ---------------------------------------------------------------------------
Customer switched access
lines in service at
September 30 (thousands) ...... 14,955 14,557 398 2.7
Interexchange Carrier access
minutes-of-use (millions) ..... 39,155 36,258 2,897 8.0
Interstate .................... 22,934 21,043 1,891 9.0
Intrastate .................... 16,221 15,215 1,006 6.6
Toll messages (millions)* ....... 3,326 3,177 149 4.7
- ---------------------------------------------------------------------------
* Toll messages for 1993 have been restated to conform to the current
presentation.
The Company is seeing continued improvement in volume indicators due to
economic recovery in California. The number of access lines in service grew
to 14,995 thousand, an increase of 2.7 percent for the twelve months ended
September 30, 1994. This represents an improvement over a 1.9 percent
increase for the same period last year. This year's increase was primarily
attributable to the economic recovery and the Company's promotional efforts to
increase the number of households with two lines. The residential access line
growth rate increased to 1.9 percent for the twelve months ended September 30,
1994, from 1.2 percent last year. The growth rate in business access lines
climbed to 3.9 percent this year, from 3.2 percent last year.
Access minutes-of-use represent the volume of traffic carried by interexchange
carriers over the Company's local network. Total access minutes-of-use
increased by 8.0 percent for the nine-month period ended September 30, 1994,
an improvement over the 5.4 percent increase for the same period last year.
The increase in access minutes-of-use was primarily attributable to economic
growth which increased network usage.
Toll messages are comprised of Message Telecommunications Service, Optional
Calling Plans, WATS and terminating 800 messages. For the nine-month period
ended September 30, 1994, toll messages increased by 4.7 percent compared to
an increase of 2.1 percent for the corresponding period in 1993. Unauthorized
competition, particularly in WATS and 800 services, continues to constrain
growth in toll messages.
The CPUC has formally authorized competition in the intra-service area toll
market beginning in January 1995. As a result, the Company will lower average
prices for intra-service area toll services approximately 40 percent. Toll
messages are expected to increase due to lower prices. However, the increase
may be at least partially offset by the loss of some toll business to
competition. Although competition may reduce toll messages, it also has the
effect of increasing access minutes-of-use. (See "Toll Service Competition"
on page 19).
14
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Operating Revenues
- ------------------
For the 9 Months Ended
September 30, Change
------------------------ -----------------
($ millions) 1994 1993 Dollar Percent
- ---------------------------------------------------------------------------
Total operating revenues $6,626 $6,688 (62) (0.9)
- ---------------------------------------------------------------------------
The decrease reflects revenue reductions ordered by the CPUC and the Federal
Communications Commission (the "FCC") under incentive-based regulation. In
addition, revenues were reduced by accruals totaling $56 million for sharing
interstate earnings with customers. The FCC and the CPUC require sharing
earnings above a threshold rate of return. Revenues were also reduced $27
million due to a second quarter CPUC refund order related to customer late
payment charges. These and other reductions were partially offset by
increases due to customer demand as shown in the following table.
Total
Late Change
Price Cap Sharing Payment Customer from
($ millions) Orders Accruals Refund Misc. Demand 1993
- ---------------------------------------------------------------------------
Local service ...... $(46) $ - $ - $(34) $44 $(36)
Network access
Interstate ....... (6) (56) - (8) 53 (17)
Intrastate ....... (14) - - (15) 56 27
Toll service ....... (37) - - (12) (1) (50)
Other revenues ..... - - (27) 1 35 9
Uncollectibles ..... - - - 5 - 5
-------- -------- -------- -------- -------- --------
Total operating
revenues ......... $(103) $(56) $(27) $(63) $187 $(62)
- ---------------------------------------------------------------------------
The increases in revenue due to customer demand in the above table are the
result of growth in key volume indicators. Local service revenues from
increased customer demand reflect a 2.7 percent increase from a year ago in
customer access lines. Interstate network access revenues reflect a
9.0 percent increase in minutes-of-use, as well as increased access lines.
Intrastate network access revenues from increased customer demand reflect 6.6
percent growth in minutes-of-use. Competition continues to constrain demand
for the Company's toll services.
The increase in other revenues due to customer demand reflects the success of
the Company's business and residential voice mail products. Voice processing
units in service increased 37 percent for the twelve months ended September
30, 1994.
15
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Operating Expenses
- ------------------
For the 9 Months Ended
September 30, Change
------------------------ -----------------
($ millions) 1994 1993 Dollar Percent
- ---------------------------------------------------------------------------
Total operating expenses $4,855 $4,982 (127) (2.5)
- ---------------------------------------------------------------------------
Total operating expenses decreased when compared with 1993 reflecting the
Company's continuing cost reduction efforts. As displayed in the table below,
the Company's cost reduction efforts resulted primarily in savings in salaries
and wages, employee benefits, and contract services expenses.
Total
Change
Salaries Employee Contract From
($ millions) & Wages Benefits Services Misc. 1993
- ----------------------------------------------------------------------------
Cost of products
& services ........ $(45) $(24) $(15) $ 31 $ (53)
Customer operations
& selling expense.. (5) 5 15 (4) 11
General, admin. &
other expense ..... (15) (51) (25) (29) (120)
Depreciation
& amortization..... - - - 35 35
-------- -------- ------- -------- --------
Total operating
expenses ......... $(65) $(70) $(25) $ 33 $(127)
- -----------------------------------------------------------------------------
The decrease in salary and wage expense reflects savings of $63 million due to
a reduction in the workforce, and a $44 million reduction in overtime
primarily due to storm repairs last year. These decreases were partially
offset by a $33 million increase due to higher wage rates. The decrease in
employee benefits expense is primarily due to certain nonrecurring adjustments
and a decrease in postretirement benefit costs related to force reduction
plans.
Contract services expense decreased primarily due to a reduction in contract
programmers which resulted from last year's completion of billing system
enhancements. These expenses also decreased because the Company hired fewer
contract laborers this year due to more favorable weather conditions. These
decreases were partially offset by higher contract costs related to
intensified telemarketing efforts.
16
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Depreciation expense increased primarily due to higher average plant balances
and higher interstate depreciation rates authorized by the FCC. (See
"Depreciation Rate Changes" on Page 20).
Operating Taxes
- ---------------
1994 1993 Change Percent
- ---------------------------------------------------------------------------
Operating Taxes $624 $621 3 0.0
- ---------------------------------------------------------------------------
Operating taxes increased slightly over the comparable period in 1993.
Operating taxes increased primarily due to higher pre-tax income. This
increase was partially offset by accelerated recognition of investment tax
credits due to shorter plant lives.
Interest Expense
- ----------------
1994 1993 Change Percent
- ---------------------------------------------------------------------------
Interest expense $324 $328 (4) (1.2)
- ---------------------------------------------------------------------------
Interest expense decreased slightly when compared with the first nine months
of 1993. Interest expense on long-term debt decreased $27 million. This
decrease is comprised of a $16 million decrease related to higher borrowing
levels last year and a $11 million decrease due to lower interest rates.
Long-term debt levels were temporarily higher in 1993 due to time-lags between
new debt issuances and the retirements of refinanced amounts. These decreases
were partially offset by miscellaneous increases in interest expense related
to the CPUC's late payment charges decision, financing charges associated with
the Company's project to build an all digital switching platform and interest
on certain regulatory refunds.
Other Income (Expense)
- ----------------------
1994 1993 Change Percent
- ---------------------------------------------------------------------------
Other Income (Expense) $ 1 $ 7 (6) (85.7)
- ---------------------------------------------------------------------------
A decrease of $14 million in after-tax charges related to the early redemption
of long-term debt in 1993 reduced comparative expense in this category.
17
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Cumulative Effect of Accounting Change
- --------------------------------------
Effective January 1, 1993, the Company adopted a new accounting rule for
postemployment benefits. A first quarter 1993 noncash charge was recorded
representing the cumulative after-tax effect of applying the new rule to prior
years. (See Note B - "Prior Year Accounting Changes" on page 12.)
Status of Restructuring Reserve
- -------------------------------
As previously reported, the Company established a restructuring reserve at the
end of 1993 to provide for the incremental cost of force reductions and other
exit costs related to restructuring its internal business processes through
1997. A total of $106 million was charged to the reserve in the first nine
months of 1994, primarily for severance benefits. As of September 30, 1994, a
balance of $991 million remained in the restructuring reserve.
Pacific Bell is reducing force throughout its traditional telephone business.
Excluding subsidiaries, force reductions totaled 3,783 employees for the first
nine months of 1994. The reduction in force net of new hires was 2,621
employees. During this same period, the Company estimates it has saved $111
million in labor costs and other expenses from what it would have spent
without restructuring. Management expects savings for the year to meet or
exceed its original estimate of approximately $170 million.
The Company continues to refine its reengineering and force reduction plans in
order to maximize cost savings. Management expects fourth quarter 1994
charges to the reserve to exceed the $54 million charged in the third quarter.
However, certain costs originally estimated to be incurred in 1994 may be
delayed to 1995. As a result, management expects total charges to the reserve
in 1994 to be less than the original estimate of $226 million.
Capital Expenditures
- --------------------
The Company invested about $1.1 billion during the first nine months of 1994
primarily to modernize and expand the network. The Company now expects to
invest about $1.6 billion in 1994, and about $16 billion over the next seven
years.
The Company is considering an agreement to defer purchase of broadband network
facilities and operating support systems, now being constructed by AT&T Corp.,
until 1997. Pursuant to the proposed agreement, the cost for these facilities
is expected to total $1.0 to $1.5 billion. Purchase by the Company in 1997
would be conditioned upon the network meeting certain quality and performance
specifications. In the event such agreement is reached, the Company's capital
expenditures for broadband deployment and related long-term financing needs
will be deferred. The Company intends to lease certain operational portions
of the facilities during the initial construction period prior to 1997. If
the agreement is not consummated, the Company has the ability to obtain funds
from external debt or equity financing to fund construction.
18
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
PENDING REGULATORY ISSUES
CPUC Annual Price Cap Filing
- ----------------------------
In October 1994, the Company submitted its annual price cap filing for 1995 in
which it proposed a $196 million revenue reduction. The proposed reduction
includes a decrease of $161 million due to the 5.0 percent productivity factor
of the price cap formula exceeding the growth in the Gross Domestic Product
Price Index by 2.4 percent. The filing also included several additional
factors which, if adopted, will decrease revenue by an additional $35 million.
Of the total proposed reduction, $45 million will have been accrued by the end
of 1994. The CPUC is expected to issue a decision before the end of 1994.
Toll Service Competition
- ------------------------
In September 1994, the CPUC issued its final decision in Phase III of its
investigation into alternative regulatory frameworks. Effective January 1,
1995, the decision provides that long-distance and other telecommunications
companies will be officially allowed to compete with the Company and other
local telephone companies in providing intra-service area toll call services
in California. To allow the Company to be a more effective competitor, the
decision also rebalances prices for services. Rebalancing brings prices for
certain services closer to the costs of providing those services. The
decision lowers intra-service area toll prices an average of about 40 percent
and increases the Company's residential flat rate service from $8.35 to $11.25
per month. The Company's business basic prices will increase from $8.35 to
$10.32 per month. Other prices will also change.
The CPUC intends the decision to be revenue neutral; that is, the effect of
price decreases would be offset by the effect of price increases. However,
the Company believes the decision is based on an estimate of demand growth due
to lower toll prices that may be too optimistic. If actual demand falls short
of estimates, toll service revenues would be adversely affected.
More importantly, as competition intensifies for intra-service area toll
calling, there is a risk that the Company will realize materially reduced toll
revenues. The CPUC has stated that in the near future it will consider
whether customers should be allowed to presubscribe to a specific carrier to
handle their intra-service area toll calls.
CPUC Regulatory Framework Review
- --------------------------------
In June 1994, the CPUC issued a decision in its review of the New Regulatory
Framework ("NRF") ordered in 1989. Among other issues, this review has
examined elements of the price cap formula, including the rate of return on
investment and the productivity factor.
19
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Effective July 1994, the decision reduced the Company's benchmark rate of
return from 13.0 percent to 11.5 percent. Earnings from 11.5 percent to
15.0 percent will be shared equally with customers. Earnings above
15.0 percent will be shared 30.0 percent with customers. Also effective July
1994, the decision increased the productivity factor from 4.5 percent to 5.0
percent, a change which each year will reduce annual revenues by $32.5 million
through 1996. Changes in the price cap formula will decrease total revenues
from previous levels by about $19, $72, and $104 million, respectively for
1994, 1995, and 1996. The CPUC is scheduled to review the NRF again in 1995.
Postretirement Benefits Other Than Pensions
- -------------------------------------------
In December 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 Pensions," for regulatory
accounting purposes. The CPUC decision also granted the Company revenue
increases for recovery of contributions to tax-advantaged funding vehicles for
SFAS 106 costs. The Company was granted $100 million in 1994 for partial
recovery of higher costs under SFAS 106. Two customer advocacy groups
challenged the recovery ordered. In October 1994, the CPUC ordered a
rehearing to determine if the Company should continue to recover these costs.
The CPUC's order held that related revenues collected after October 12, 1994
are subject to refund.
Offering of Telephone Enhanced Services
- ---------------------------------------
In October 1994, the U.S. Court of Appeals for the Ninth Circuit overturned
the FCC's removal of its structural separations requirement for the offering
of enhanced services by the former Bell Operating Companies, including the
Company.
The Company anticipates seeking a waiver from the FCC to continue current
enhanced service offerings pending new FCC proceedings in which the FCC may
reestablish relief from such requirements. The reimposition of structural
separations requirements could result in increased costs and reduced revenues.
Depreciation Rate Changes
- -------------------------
In June 1994, the Company filed an application to change its depreciation
rates with the CPUC. The application reflects a preliminary agreement between
the Company and the CPUC's Division of Ratepayers Advocates. If adopted, the
new depreciation rates will increase depreciation expense about $30 million
effective January 1, 1995. In July 1994, the FCC authorized new depreciation
rates which increase depreciation expense about $9 million annually
retroactive to January 1, 1994. Under incentive-based regulation, increases
in depreciation expense are not recovered in revenues.
20
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
FCC Annual Access Tariff Filing
- -------------------------------
In June 1994, the FCC accepted the Company's annual access tariff filings
under price cap regulation. As a result, the Company's interstate network
access revenues will be reduced about $30 million annually effective July 1,
1994. The decrease reflects the application of the price cap formula and an
$8 million price reduction to help the Company remain competitive with other
access providers.
Video Services
- --------------
In October 1994, the FCC reaffirmed its rule that permits local exchange
carriers ("LECs"), including the Company, to provide a tariffed basic platform
that will deliver video programming developed by others ("video dialtone") and
to provide certain other services to customers of this basic platform. In
December 1993, the Company filed an application with the FCC seeking authority
to offer video dialtone services in specific locations in four of its service
areas: the San Francisco Bay Area, Los Angeles, San Diego, and Orange County.
The advanced integrated broadband telecommunications network which the Company
plans to build will be capable of delivering an array of services including
voice, data and video services. Once FCC approval is obtained, the Company
will deploy the video-exclusive components of the advanced network.
In addition to providing advanced telecommunications services, the new network
will also serve as a platform for other information providers, and will offer
customers an alternative to existing cable television providers. The
integrated network is also expected to spur the development of new interactive
consumer services in education, entertainment, government, and health care.
Personal Communications Services
- --------------------------------
The Company's parent, Pacific Telesis Group (the "Corporation"), plans to
aggressively pursue licenses for personal communications services ("PCS") at
FCC auctions scheduled to begin on December 5, 1994. Winning bids in major
PCS markets are expected to require large capital expenditures. In December
1993, the FCC awarded "pioneer preferences" to three companies without charge.
One company received one of the broad spectrum licenses covering the Los
Angeles, San Diego, and Las Vegas market area. In August 1994, the FCC
reconsidered its previous decision to award pioneer preferences without charge
and amended its rule to require the recipients to pay approximately 90 percent
of the value of similar licenses. In September 1994, legislation was
introduced in Congress which would require recipients of pioneer preferences
to pay 85 percent of the average amount paid for licenses in the 20 largest
cities (exclusive of the pioneer preference cities), but not less than $400
million. The Corporation vigorously opposes this legislation because it would
result in pioneer preference recipients receiving licenses at only a fraction
of their value. This legislation would also prevent the continuation of the
Corporation's pending court appeal of the FCC's order that originally granted
pioneer preferences. In addition, this legislation may prevent the FCC from
reviewing certain licensing issues regarding the pioneer preference awards.
21
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Interstate Access
- -----------------
The FCC ordered large LECs, including the Company, to offer expanded network
interconnection for interstate special access services effective June 1993,
and for the transport portion of interstate switched access services effective
February 1994. The Company and other LECs appealed a provision of the
decision which requires the LECs to permit competitive access providers
("CAPs") and other customers to locate their transmission facilities in the
LECs' central offices. In June 1994, the U.S. Court of Appeals for the D.C.
Circuit overruled the mandatory physical collocation requirement. The Court
also remanded to the FCC the issue of whether the LECs should offer "virtual
collocation" instead of physical collocation. With virtual collocation, the
LECs install and maintain the equipment dedicated for use by the CAPs, and
charge the CAPs for services. In July 1994, the FCC directed the LECs to
provide virtual collocation, but exempted LECs from this requirement at
central offices where they offer physical collocation. The Company plans to
continue to offer physical collocation but has appealed certain requirements
of the FCC's order. Interstate access revenues subject to increased
competition represent less than five percent of the Company's total revenues.
Telecommunications Legislation
- ------------------------------
In June 1994, the U.S. House of Representatives approved two
telecommunications bills which would ease certain restrictions imposed by the
1982 Consent Decree and the 1984 Cable Act. Similar legislation with less
favorable provisions was introduced in the U.S. Senate. However, the Senate
bill was withdrawn before it could be submitted for a vote. The Company
expects that similar legislation will be reintroduced in 1995.
In September 1994, Governor Wilson signed legislation directing the CPUC to
authorize fully open competition for intrastate long-distance services if
federal legislation or court action amends the 1982 Consent Decree. If not
amended, the CPUC by October 1995 must order the Company to offer intrastate
long distance services and to seek a waiver of the 1982 Consent Decree. The
CPUC's order would be subject to specific safeguards which would ensure that
competitors have fair, nondiscriminatory and mutually open access to the
Company's exchanges and to interexchange facilities.
22
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
APPLICABILITY OF REGULATORY ACCOUNTING
- --------------------------------------
The Company currently accounts for the economic effects of regulation under
Statement of Financial Accounting Standards No. 71 ("SFAS 71"), "Accounting
for the Effects for Certain Types of Regulation." If it becomes no longer
reasonable to assume the Company will recover its costs through rates charged
to customers, whether resulting from the effects of increased competition or
specific regulatory actions, SFAS 71 would no longer apply. The Company
monitors the effects of competition and changes in regulation to assess the
likelihood it will continue to recover its costs. The discontinued
application of SFAS 71 would require the Company to eliminate its regulatory
assets and liabilities and may require a reduction of the carrying amount of
its telephone plant. Two telephone regional holding companies ("RHCs") have
discontinued the application of SFAS 71 regulatory accounting and have
recorded the cumulative effect of using shorter depreciable lives for their
telephone plant. If the Company were to discontinue the application of SFAS
71 and adopt similar depreciable lives and use similar methodologies as the
two RHCs to calculate the cumulative effect, the reduction in the carrying
amount of the Company's property, plant and equipment would be between $3 and
$5 billion. (See "Accounting Under Regulation" in Note A on page 10 for a
discussion of regulatory assets and liabilities included in the balance
sheet.)
23
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibits identified in parentheses below, on file with the SEC, are
incorporated herein by reference as exhibits hereto.
Exhibit
Number Description
- ------- -----------
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell is filed herewith pursuant to
Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation,
Pacific Bell hereby agrees to furnish a copy of any such instrument
to the SEC upon request.
15 Letter re: unaudited interim financial information.
27 Financial Data Schedule for Pacific Bell third quarter 1994
Form 10-Q.
The Company will furnish to a security holder upon request a copy of any
exhibit at cost.
(b) Reports on Form 8-K.
--------------------
No reports on Form 8-K have been filed during the quarter for which
this report is filed.
24
<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 Bell
By Peter A. Darbee
---------------------------------------
Peter A. Darbee
Vice President, Chief Financial Officer
and Controller
November 14, 1994
25
<PAGE>
EXHIBIT INDEX
Exhibits identified in parentheses below, 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
- ------- -----------
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell is filed herewith pursuant to
Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this regulation,
Pacific Bell hereby agrees to furnish a copy of any such instrument
to the SEC upon request.
15 Letter re: unaudited interim financial information.
27 Financial Data Schedule for Pacific Bell third quarter 1994
Form 10-Q.
26
<PAGE>
Exhibit 15
----------
COOPERS & LYBRAND L.L.P.
November 14, 1994
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
Re: Pacific Bell
Registration Statement on Form S-3
------------------------------------
We are aware that our report dated November 14, 1994 on our review of the
interim financial information of Pacific Bell and Subsidiaries for the three-
and nine-month periods ended September 30, 1994 included in this Form 10-Q is
incorporated by reference in the Company's registration statement as follows:
Form S-3: Pacific Bell $1.575 Billion Debt Securities
Pursuant to Rule 436(c) under the Securities Act of 1933, this report should
not be considered a part of the registration statement prepared or certified
by us within the meaning of Sections 7 and 11 of that Act.
Very truly yours,
Coopers & Lybrand L.L.P.
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