<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 June 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 July 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 .. 8
Item 2. Management's Discussion and Analysis of Results of
Operations ............................................ 10
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K ........................ 19
SIGNATURE ........................................................ 20
- ---------
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 June 30, 1994, and the related condensed
consolidated statements of income for the three- and six-month periods ended
June 30, 1994 and 1993, and the condensed consolidated statements of
shareowner's equity and cash flows for the six-month periods ended June 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
San Francisco, California
August 12, 1994
3
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the 3 Months Ended For the 6 Months Ended
June 30, June 30,
---------------------- ----------------------
(Dollars in millions) 1994 1993 1994 1993
- -----------------------------------------------------------------------------
OPERATING REVENUES:
Local service ................. $ 827 $ 858 $1,667 $1,698
Network access
Interstate .................. 387 394 784 784
Intrastate .................. 167 164 340 331
Toll service .................. 501 512 994 1,023
Other ......................... 327 344 671 676
Less: Provision for
uncollectibles ....... 37 35 76 75
-------- -------- -------- --------
Total Operating Revenues ...... 2,172 2,237 4,380 4,437
-------- -------- -------- --------
OPERATING EXPENSES:
Cost of products and services.. 471 479 947 992
Customer operations and
selling expense ............. 461 449 884 868
General, administrative, and
other expense ............... 231 311 535 600
Depreciation and amortization.. 435 429 869 855
-------- -------- -------- --------
Total Operating Expenses ...... 1,598 1,668 3,235 3,315
-------- -------- -------- --------
Net Operating Revenues ........ 574 569 1,145 1,122
-------- -------- -------- --------
OPERATING TAXES:
Income taxes .................. 153 154 302 304
Other taxes ................... 45 47 90 94
-------- -------- -------- --------
Total Operating Taxes ......... 198 201 392 398
-------- -------- -------- --------
OPERATING INCOME .............. 376 368 753 724
-------- -------- -------- --------
Other Income (Expense)......... (3) 6 (1) 4
-------- -------- -------- --------
Income before interest expense
and cumulative effect of change
in accounting principle..... 373 374 752 728
Interest expense.............. 117 111 220 221
-------- -------- -------- --------
Income before cumulative
effect of change in
accounting principles....... 256 263 532 507
Cumulative effect of change
in accounting principle..... - - - (148)
-------- -------- -------- --------
NET INCOME ................... $ 256 $ 263 $ 532 $ 359
======== ======== ======== ========
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
4
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Dollars in millions) 1994 1993
- ---------------------------------------------------------------------------
ASSETS (Unaudited)
Cash and cash equivalents ..................... $ 42 $ 57
Accounts receivable - (net of allowances for
uncollectibles of $143 and $136 in 1994 and
1993, respectively) ......................... 1,496 1,518
Prepaid expenses and other current assets ..... 865 862
------------ ------------
Total current assets .......................... 2,403 2,437
------------ ------------
Property, plant, and equipment - at cost....... 25,816 25,660
Less: accumulated depreciation ............. 10,024 9,708
------------ ------------
Property, plant, and equipment - net .......... 15,792 15,952
------------ ------------
Deferred charges and other noncurrent assets .. 989 989
------------ ------------
TOTAL ASSETS .................................. $19,184 $19,378
============ ============
LIABILITIES AND SHAREOWNER'S EQUITY
Accounts payable .............................. 1,150 1,255
Debt maturing within one year ................. 197 542
Other current liabilities ..................... 1,310 1,136
------------ ------------
Total current liabilities ..................... 2,657 2,933
------------ ------------
Long-term obligations ......................... 4,758 4,753
------------ ------------
Deferred income taxes ......................... 2,253 2,280
------------ ------------
Other noncurrent liabilities and
deferred credits ............................ 3,286 3,258
------------ ------------
Commitments and Contingencies (Note B)
Total shareowner's equity ..................... 6,230 6,154
------------ ------------
TOTAL LIABILITIES AND SHAREOWNER'S EQUITY ..... $19,184 $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 6 Months Ended
June 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
--------- ---------
Balance at end of period ....................... 5,168 5,168
--------- ---------
REINVESTED EARNINGS
Balance at beginning of period ................. 761 1,898
Net income ..................................... 532 359
Common dividends declared ...................... (452) (489)
Minimum pension liability adjustment............ (4) -
--------- ---------
Balance at end of period ....................... 837 1,768
--------- ---------
TOTAL SHAREOWNER'S EQUITY ...................... $6,230 $7,161
========= =========
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
6
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 6 Months Ended
June 30,
----------------------
(Dollars in millions) 1994 1993
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES
Net Income .......................................... $ 532 $ 359
Adjustments to reconcile net income for items
currently not affecting operating cash flows:
Cumulative effect of accounting change........... - 148
Depreciation and amortization ................... 869 855
Deferred income taxes ........................... (49) (36)
Unamortized investment tax credits .............. (35) (25)
Allowance for funds used during construction .... (15) (18)
Changes in operating assets and liabilities:
Accounts receivable ........................... 39 9
Prepaid expenses and other current assets ..... (4) 12
Deferred charges and other noncurrent assets... 2 50
Accounts payable .............................. (105) (200)
Other current liabilities ..................... 173 124
Noncurrent liabilities and deferred credits ... 64 (14)
Other adjustments, net .......................... 2 16
---------- ----------
Cash from operating activities ...................... 1,473 1,280
---------- ----------
CASH FROM (USED FOR) INVESTING ACTIVITIES
Additions to property, plant, and equipment, net .... (700) (842)
Other investing activities, net ..................... 1 (1)
---------- ----------
Cash used for investing activities .................. (699) (843)
---------- ----------
CASH FROM (USED FOR) FINANCING ACTIVITIES
Proceeds from issuance of long-term debt ............ - 1,700
Retirements of long-term debt ....................... - (1,225)
Dividends paid ...................................... (452) (489)
Increase (decrease) in short-term borrowings, net ... (345) (305)
Principal payments under capital lease obligations .. 8 -
Other financing activities, net ..................... - (104)
---------- ----------
Cash used for financing activities .................. (789) (423)
---------- ----------
Increase(decrease) in cash and cash equivalents ..... (15) 14
Cash and cash equivalents at January 1 .............. 57 57
---------- ----------
Cash and cash equivalents at June 30................. $ 42 $ 71
========== ==========
- ---------------------------------------------------------------------------
Cash payments for:
Interest ........................................ $ 190 $ 303
Income taxes .................................... $ 238 $ 275
- ---------------------------------------------------------------------------
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
7
<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") and Pacific Bell Information Services ("PBIS"), 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, independent
accountants. Their report is on page 3.
B. PRIOR YEAR ACCOUNTING CHANGES
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 106, "Employers' Accounting for Postretirement
Benefits Other than Pensions" ("SFAS 106"). Under decisions by the
California Public Utilities Commission (the "CPUC"), the Company was
granted $100 and $108 million for 1994 and 1993, respectively, for partial
recovery of higher costs under SFAS 106. Two ratepayer advocacy groups
have each challenged certain aspects of the original decision adopting
SFAS 106 for ratemaking, which could affect recovery. The Company is
unable to predict the outcome of these pending challenges.
8
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
B. PRIOR YEAR ACCOUNTING CHANGES (Cont'd)
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 requires 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 $103 million.
9
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OR OPERATIONS
- ----------------------------------------------------------------------
RESULTS OF OPERATIONS
The following discussions and data compare the six-month period ended June 30,
1994 to the corresponding period in 1993. Results for the first six months of
1994 may not be indicative of results for the full year. (See discussions in
"Pending Regulatory Issues" beginning on page 15.)
A summary of selected operating data is shown below:
For the 6 Months Ended
June 30, Change
---------------------- -----------------
Selected Operating Data 1994 1993 Amount Percent
- ---------------------------------------------------------------------------
Operating ratio (%) 73.9 74.7 (0.8) -
Return on shareowner's
equity (%) ................... 17.1 10.0** 7.1 -
Total employees ................ 52,207 54,912 (2,705) (4.9)
Revenues per employee
($ thousands) ................ 83.9 80.8 3.1 3.8
Employees per ten thousand
access lines* ................ 33.4 36.3 (2.9) (8.0)
- ---------------------------------------------------------------------------
* Excludes Directory employees
** Restated due to the Cumulative Effect of Change in Accounting Principle
Earnings
- -------- For the 6 Months Ended
June 30, Change
---------------------- -----------------
($ Millions) 1994 1993 Amount Percent
- ---------------------------------------------------------------------------
Net income 532 359 173 48.2
- ---------------------------------------------------------------------------
Earnings reflect an improved 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 $15 million.
10
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Operating Revenues
- ------------------
For the 6 Months Ended
June 30, Change
------------------------ -----------------
Volume Indicators 1994 1993 Amount Percent
- ---------------------------------------------------------------------------
Customer switched access
lines in service at
June 30 (thousands) .......... 14,790 14,443 347 2.4
Interexchange Carrier access
minutes-of-use (millions) ..... 25,931 23,825 2,106 8.8
Interstate .................... 15,247 13,782 1,465 10.6
Intrastate .................... 10,684 10,043 641 6.4
Toll messages (millions)* ....... 2,195 2,097 98 4.7
- ---------------------------------------------------------------------------
* Toll messages for 1993 have been restated to conform to the current
presentation.
For the 6 Months Ended
June 30, Change
------------------------ -----------------
($ millions) 1994 1993 Dollar Percent
- ---------------------------------------------------------------------------
Total operating revenues
4,380 4,437 (57) (1.3)
- ---------------------------------------------------------------------------
Revenues decreased due to rate reductions ordered by the CPUC and the Federal
Communications Commission (the "FCC") under incentive-based regulation. In
addition, revenues were reduced by accruals totaling $32 million for sharing
interstate earnings with customers. The FCC requires sharing earnings above a
threshold rate of return. Revenues were also reduced $27 million due to the
CPUC's refund order related to customer late payment charges. These and other
reductions were partially offset by increases due to customer demand as shown
by the key volume indicators above.
11
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
The primary factors affecting revenue are summarized in the following table.
Total
Late Misc. Change
Price Cap Sharing Payment Rates Customer from
($ millions) Rates Accruals Refund & Other Demand 1993
- ---------------------------------------------------------------------------
Local service ...... (27) - - (36) 32 (31)
Network access
Interstate ....... (8) (32) - (8) 48 0
Intrastate ....... (8) - - (16) 33 9
Toll service ....... (21) - - (13) 5 (29)
Other revenues ..... - - (27) - 22 (5)
Uncollectibles ..... - - - (1) - (1)
-------- -------- -------- -------- -------- --------
Total operating
revenues ......... (64) (32) (27) (74) 140 (57)
- ---------------------------------------------------------------------------
The increases in revenue due to customer demand in the above table are the
result of growth in key volume indicators. Local service revenues reflect a
2.4 percent increase from a year ago in customer access lines. Interstate
network access revenues reflect a 10.6 percent increase in minutes-of-use, as
well as increased access lines. Intrastate network access revenues reflect
6.4 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 37.2 percent. Directory advertising revenues
decreased slightly.
12
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Operating Expenses
- ------------------
For the 6 Months Ended
June 30, Change
------------------------ -----------------
($ millions) 1994 1993 Dollar Percent
- ---------------------------------------------------------------------------
Total operating expenses $3,235 $3,315 $(80) (2.4)
- ---------------------------------------------------------------------------
Total operating expenses for the first half of 1994 decreased when compared
with 1993 reflecting the Company's continuing cost reduction efforts. As
displayed in the table below, salaries, wages and employee benefits decreased.
These decreases were partially offset by increases in contracted services and
software licensing fees relating to the Company's efforts to increase the
capabilities of the telecommunications network.
Total
Software Change
Salaries Employee Miscel- Contract License From
($ millions) & Wages Benefits laneous Services Fees 1993
- ----------------------------------------------------------------------------
Cost of products
& services ........ $(43) $(16) $9 $(11) $16 $(45)
Customer operations
& selling expense.. (7) 9 5 9 0 16
General, admin. &
other expense ..... (5) (40) (25) 5 0 (65)
Depreciation
& amortization..... - - 14 - - 14
-------- -------- -------- -------- -------- --------
Total operating
expenses ......... $(55) $(47) $ 3 $3 $16 $(80)
- -----------------------------------------------------------------------------
Salary and wage expense decreased $38 million due to a reduction in the
workforce which was partially offset by higher nonsalaried wage rates.
Overtime decreased $42 million primarily due to storm repairs in the
comparable period last year, and continued cost reduction efforts. Annual
management salary increases scheduled to take effect in January were deferred
to July 1994. Management estimates this deferral saved about $11 million for
the six month period. 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.
Contracted services expense increased primarily because of research and
development costs supporting the Company's plans to build an integrated
telecommunications, information, and entertainment network. However, this
increase was largely offset by a $15 million reduction for contract systems
programmers which resulted from last year's completion of billing system
enhancements. Licensing fees for digital switching software increased as the
Company implemented plans to create a fully digital telecommunications
network.
13
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Operating Taxes
- ---------------
1994 1993 Change Percent
- ---------------------------------------------------------------------------
Operating Taxes $392 $398 $(6) (1.5)
- ---------------------------------------------------------------------------
Operating taxes decreased slightly in comparison with the first half of 1993.
Reductions in certain deferred tax liabilities lowered tax expense by $16
million. Acceleration of investment tax credits due to shorter plant lives
decreased tax expense by an additional $10 million over the comparable period.
These reductions were largely offset by increases related to the federal tax
increase and higher pre-tax income.
Interest Expense
- ----------------
1994 1993 Change Percent
- ---------------------------------------------------------------------------
Interest expense $220 $221 $(1) (0.0)
- ---------------------------------------------------------------------------
Interest expense remained flat when compared with the first half of 1993.
Interest expense on long term debt decreased $21 million. This decrease is
composed of a $12 million reduction related to higher borrowing levels last
year and a $9 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
offset by increases in miscellaneous interest expense related to the CPUC's
late payment charges decision and other nonrecurring items.
Other Income (Expense)
- ----------------------
1994 1993 Change Percent
- ---------------------------------------------------------------------------
Other Income (Expense) $(1) $4 $(5) (125.0)
- ---------------------------------------------------------------------------
A decrease of $11 million in after-tax charges related to the early redemption
of long term debt in 1993 reduced comparative expense in this category. The
late payment charges penalty increased 1994 other expense by $10 million.
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 also Note B - "Prior Year Accounting Changes" on page 8.)
14
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
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
related costs to restructure its internal business processes through 1997.
The Company expects to reduce force in all of its business units. During the
first six months of 1994, 2,750 employees left the Company. However, this
number does not equal the net force reduction because employees were also
added during the period. A total of $52 million was charged to the reserve in
the first half of 1994, primarily to cover severance benefits for about 1,400
employees. The majority of this year's costs will be incurred during the
second half of 1994. As of June 30, 1994, a balance of $1,045 million
remained in the restructuring reserve.
In order to maximize cost savings from restructuring, the Company is reviewing
the feasibility of moving certain high priority reengineering projects from
later years into 1995. As a result, the timing of force reductions and
charges to the reserve may vary from original estimates. The Company may also
change the distribution among cost components due to refinement of original
estimates. The Company does not believe that these changes would result in a
material adjustment to the total amount of the reserve.
Capital Expenditures
- --------------------
The Company invested about $683 million during the first half of 1994
primarily to modernize and expand the network. The Company expects to invest
about $1.8 billion in 1994, and about $16 billion over the next seven years.
PENDING REGULATORY ISSUES
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.
Effective July 1994, the decision reduces 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 increases the productivity factor from 4.5 percent to 5.0 percent, a
change which each year will reduce annual rates by $32.5 million through 1996.
Including a smaller adjustment, these changes in the price cap formula will
decrease total revenues from current 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.
15
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Toll Services Competition
- -------------------------
In July 1994, the CPUC issued a revised draft decision in Phase III of its
investigation into alternative regulatory frameworks. The draft decision
provides that long-distance and other telecommunications companies would be
allowed to compete with the Company and other local telephone companies in
providing intra-service area toll calls in California. The draft decision
also would rebalance the Company's rates bringing them closer to cost. The
draft decision would lower rates for intra-service area toll calls about 40
percent and increase residential flat rate service from $8.35 to $11.25 per
month. Business basic rates would increase from $8.35 to $9.77 per month.
Other rates would also change. Overall, the CPUC intends the draft decision
to be revenue neutral; that is, the effect of rate decreases would be offset
by the effect of rate increases. The Company believes the draft decision does
not reduce toll rates far enough to assure fair competition. In an August
1994 filing with the CPUC, the Company has proposed a reduction in toll rates
of about 55 percent to be balanced by further rate increases in basic business
access and other services. However, the Company believes there is no need to
raise basic residential rates further to balance an additional reduction in
toll rates.
The CPUC announced it expects to issue a final decision on intra-service area
toll competition in September 1994 with implementation scheduled for January
1, 1995. The Company expects the CPUC in the near future to consider whether
customers should be allowed to "presubscribe" to one carrier to handle all
intra-service area calls.
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 Ratepayer Advocates. If adopted, the
new rates will increase depreciation expense about $30 million effective
January 1, 1995. In July 1994, the FCC authorized new rates which will
increase depreciation expense about $9 million annually retroactive to January
1, 1994. Under incentive-based regulation, increases in depreciation expense
are not recovered in rates.
FCC Annual Access Tariff Filing
- -------------------------------
In June 1994, the FCC adopted 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.
16
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
Personal Communications Services
- --------------------------------
Pacific Telesis Group plans to aggressively pursue licenses for personal
communications services ("PCS") at FCC auctions expected late this year or
early in 1995. 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. Consequently, the FCC amended its
rule to require the recipients to pay approximately 90 percent of the value of
similar licenses.
Interstate Special Access Competition
- -------------------------------------
In June 1993, the FCC ordered large local exchange carriers ("LECs"),
including the Company, to offer expanded network interconnection for
interstate special access services. The Company and other LECs appealed a
provision of the decision which permitted competitive access providers 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
interconnection is located outside the LEC's central office. 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. Interstate special access revenues subject to increased
competition represent less than three percent of the Company's total revenues.
17
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (Cont'd)
- ------------------------------------------------------------------------------
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 1994 Cable Act. The Brooks-Dingell bill would
simplify the procedures under which the telephone regional holding companies
must request authority to provide long-distance service and manufacture
telecommunications equipment. The Markey-Fields bill would open local
telephone service to competition and allow competitors to connect to the local
network. It would also permit LECs to provide video programming to
subscribers in their own service areas, but would prevent them from buying
large existing cable systems within these areas. Similar legislation with
less favorable provisions has been introduced in the U.S. Senate.
In May 1994, the California Assembly passed a bill promoting full competition
for intrastate telecommunications services in California. The legislation
would direct the CPUC to authorize open competition if federal legislation or
court action amends the restriction of the 1982 Consent Decree. If not, the
CPUC would be directed to open all intrastate long-distance markets to full
competition, subject to protective safeguards. The CPUC would also be
directed to issue an order by October 1, 1995 that would require the Company
to offer long-distance services and to seek a waiver of the Consent Decree's
restriction. The legislation is now in the California Senate.
ACCOUNTING UNDER REGULATION
The Company currently 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." 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. If the Company were no
longer to qualify for the provisions of SFAS 71, the financial effects would
be material.
18
<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.
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.
19
<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
August 12, 1994
20
<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.
21
<PAGE>
Exhibit 15
----------
COOPERS & LYBRAND
August 12, 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 August 12, 1994 on our review of the
interim financial information of Pacific Bell and Subsidiaries for the three-
and six-month periods ended June 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
