<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1995
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-1414
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 April 30, 1995, 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).
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PACIFIC BELL AND SUBSIDIARIES
TABLE OF CONTENTS
Page
Number
------
PART I. FINANCIAL INFORMATION
- ------------------------------
Item 1. Financial Statements
Review Report of Independent Accountants .............. 1
Condensed Consolidated Statements of Income ........... 2
Condensed Consolidated Balance Sheets ................. 3
Condensed Consolidated Statements of
Shareowners' Equity ............................... 4
Condensed Consolidated Statements of Cash Flows ....... 5
Notes to Condensed Consolidated Financial Statements .. 6
Item 2. Management's Discussion and Analysis of Results of
Operations and Financial Condition .................... 11
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits and Reports on Form 8-K ........................ 24
SIGNATURE ........................................................ 26
- ---------
<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 March 31, 1995, and the related condensed
consolidated statements of income, shareowner's equity, and cash flows for the
three-month periods ended March 31, 1995 and 1994. 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 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
referred to above 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, 1994, 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 February 23, 1995, we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 1994, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
/s/ Coopers & Lybrand L.L.P.
San Francisco, California
May 12, 1995
1
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the 3 Months Ended
March 31,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
OPERATING REVENUES:
Local service........................................... $ 931 $ 840
Network access
Interstate............................................ 431 397
Intrastate............................................ 166 174
Toll service............................................ 314 493
Other service revenues.................................. 370 343
------ ------
Total Operating Revenues................................ 2,212 2,247
----- ------
OPERATING EXPENSES:
Cost of products and services........................... 499 477
Customer operations and selling expenses................ 436 422
General, administrative, and other expenses............. 302 343
Property and other taxes................................ 45 45
Depreciation and amortization........................... 460 434
------ ------
Total Operating Expenses................................ 1,742 1,721
------ ------
OPERATING INCOME........................................ 470 526
Interest expense........................................ 108 103
Miscellaneous income.................................... 20 1
------ ------
INCOME BEFORE INCOME TAXES.............................. 382 424
Income taxes............................................ 136 148
------ ------
NET INCOME.............................................. $ 246 $ 276
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
2
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, December 31,
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
ASSETS (Unaudited)
Cash and cash equivalents......................... $ 42 $ 62
Accounts receivable - (net of allowance for
uncollectibles of $137 and $132 in 1995 and
1994, respectively)............................. 1,341 1,531
Prepaid expenses and other current assets......... 959 950
------- -------
Total current assets.............................. 2,342 2,543
------- -------
Property, plant, and equipment - at cost.......... 26,182 26,107
Less: accumulated depreciation................. 10,485 10,243
------- -------
Property, plant, and equipment - net.............. 15,697 15,864
------- -------
Deferred charges and other noncurrent assets...... 951 963
------- -------
TOTAL ASSETS...................................... $18,990 $19,370
======= =======
LIABILITIES AND SHAREOWNER'S EQUITY
Accounts payable.................................. $ 1,057 $ 1,580
Debt maturing within one year..................... 201 255
Other current liabilities......................... 1,573 1,366
------- -------
Total current liabilities......................... 2,831 3,201
------- -------
Long-term obligations............................. 4,754 4,752
------- -------
Deferred income taxes............................. 2,320 2,315
------- -------
Other noncurrent liabilities and deferred credits. 2,857 2,878
------- -------
Commitments and Contingencies (Note B)
Total shareowner's equity......................... 6,228 6,224
------- -------
TOTAL LIABILITIES AND SHAREOWNER'S EQUITY......... $18,990 $19,370
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
3
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREOWNER'S EQUITY
(Unaudited)
For the 3 Months Ended
March 31,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
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........................ 5,169 5,168
------ ------
Balance at end of period.............................. 5,169 5,168
------ ------
REINVESTED EARNINGS
Balance at beginning of period........................ 830 761
Net income............................................ 246 276
Common dividends declared............................. (242) (166)
------ ------
Balance at end of period.............................. 834 871
------ ------
TOTAL SHAREOWNER'S EQUITY............................. $6,228 $6,264
============================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
4
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 3 Months Ended
March 31,
----------------------
(Dollars in millions) 1995 1994
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES
Net Income............................................... $ 246 $ 276
Adjustments to reconcile net income for items
currently not affecting operating cash flows:
Depreciation and amortization........................ 460 434
Deferred income taxes................................ 7 (30)
Unamortized investment tax credits................... (12) (14)
Allowance for funds used during construction......... (9) (8)
Changes in operating assets and liabilities:
Accounts receivable.................................... 186 11
Prepaid expenses and other current assets.............. (7) (5)
Deferred charges and other noncurrent assets........... 3 (27)
Accounts payable....................................... (460) (147)
Other current liabilities.............................. 209 174
Noncurrent liabilities and deferred credits............ (29) 37
Other adjustments, net............................... 4 3
----- -----
Cash from operating activities .......................... 608 704
----- -----
CASH FROM (USED FOR) INVESTING ACTIVITIES
Additions to property, plant, and equipment.............. (331) (341)
Other investing activities, net.......................... - (4)
----- -----
Cash used for investing activities....................... (331) (345)
----- ------
CASH FROM (USED FOR) FINANCING ACTIVITIES:
Dividends paid........................................... (242) (166)
Increase (decrease) in short-term borrowings, net........ (54) (197)
Principal payments under capital lease obligations....... (1) (1)
----- -----
Cash used for financing activities....................... (297) (364)
----- -----
Increase (decrease) in cash and cash equivalents......... (20) (5)
Cash and cash equivalents at January 1................... 62 57
----- -----
Cash and cash equivalents at March 31.................... $ 42 $ 52
===== ======
- ---------------------------------------------------------------------------
Cash payments for:
Interest............................................... $127 $127
Income taxes........................................... $ - $ 22
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
5
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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 Income Statement for 1994
reflects certain reclassifications made to conform with the current
presentation.
The Condensed Consolidated Financial Statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission ("SEC") applicable to interim financial information. Certain
information and footnote disclosures included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted in these interim statements pursuant to such
SEC rules and regulations. Management recommends that these interim
financial statements be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's 1994
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 1.
6
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (CONTINUED)
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 the Company to reflect the rate actions of regulators in its
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:
March 31, December 31,
(Dollars in millions) 1995 1994
---------------------------------------------------------------------
Regulatory assets (liabilities) due to:
Deferred pension costs*.................... $ 424 $ 407
Unamortized debt redemption costs**........ 343 346
Deferred compensated absence costs*........ 210 212
Unamortized purchases of property, plant,
and equipment under $500................. 99 106
Deferred income taxes***................... (175) (185)
Other...................................... 44 48
----- -----
Total ....................................... $ 945 $ 934
======================================================================
* Included primarily in "deferred charges and other noncurrent assets"
in the Company's balance sheet.
** Reflected as a reduction of "long-term obligations."
*** Included in "other current liabilities" and "other noncurrent
liabilities and deferred credits."
7
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (Continued)
Deferred pension costs above reflect an order by the California Public
Utilities Commission ("CPUC") requiring 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 ("IRS") and other limitations, and costs determined under the
provisions of Statement of Financial Accounting Standards No. 87
("SFAS 87"), "Employers' Accounting for Pensions," and No. 88
("SFAS 88"), "Employers' Accounting for Settlements and Curtailments of
Defined Benefit Pension Plans and for Termination Benefits."
When debt is refinanced before maturity, 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
("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, respectively, the FCC and the CPUC increased the
threshold for directly expensing purchases of property, plant, and
equipment from $200 to $500. Purchases of less than $500 which were
previously capitalized are being amortized to expense over periods
prescribed by regulators.
Specific provisions of Statement of Financial Accounting Standards
No. 109 ("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.
8
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (CONTINUED)
In addition to the regulatory assets and liabilities described above, the
carrying amount of property, plant, and equipment is also affected by the
actions of regulators. Property, plant, and equipment is carried at
cost. The cost of self-constructed plant includes employee wages and
benefits, materials, and other costs. Regulators allow the 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. When retired, the original cost of depreciable
telephone plant is charged to accumulated depreciation.
Expenditures in excess of $500 that increase the capacity, operating
efficiency, or useful life of an individual asset are capitalized.
Expenditures for maintenance and repairs are charged to expense. The
costs of computer software purchased or developed for internal use
generally are expensed as incurred. However, initial operating system
software costs are capitalized and amortized over the lives of the
associated hardware. Costs for subsequent additions or modifications to
operating system software are expensed as incurred.
Depreciation of telephone plant is computed essentially by straight-line
depreciation using depreciable lives prescribed periodically by state and
federal regulators. Regulators currently have prescribed the following
depreciable lives for the Company's property, plant, and equipment:
Depreciable Lives
------------------------------------------------------------------------
(in years)
Buildings........................................... 30 to 57
Cable............................................... 10 to 30
Central office equipment............................ 9 to 16.5
Furniture, equipment, and other..................... 5.5 to 20
========================================================================
9
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION (CONTINUED)
An unregulated enterprise 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. Three telephone regional holding companies ("RHCs") have
discontinued the application of SFAS 71 regulatory accounting and have
adopted shorter depreciable lives and reduced their telephone plant
balances. If the Company were to discontinue the application of SFAS 71
and compute the effect on its telephone plant in a manner similar to
these three RHCs, the reduction in the carrying amount of the Company's
property, plant, and equipment would be between $3 and $5 billion.
B. COMMITMENTS AND CONTINGENCIES
Broadband Network
In December 1994, the Company contracted for the purchase of up to
$2 billion of broadband network facilities which will incorporate
emerging technologies. The Company is committed to purchase these
facilities in 1998 if they meet certain quality and performance criteria.
Revenues Subject to Refund
In 1992, the CPUC issued a decision adopting, with modification,
Statement of Financial Accounting Standards No. 106 ("SFAS 106"),
"Employers' Accounting for Postretirement Benefits Other Than Pensions,"
for regulatory accounting purposes. Annual price cap decisions by the
CPUC granted the Company $100 million in each of the years 1995 and 1994
for partial recovery of higher costs under SFAS 106. However, the CPUC
in October 1994 reopened the proceeding to determine if the Company
should continue to recover these costs. The CPUC's order held that
related revenues collected after October 12, 1994 are subject to refund.
Management believes these costs are appropriately included in the
Company's price cap filings, but is unable to predict the outcome of the
CPUC's proceeding.
10
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
RESULTS OF OPERATIONS
The following discussions and data compare the results of operations of
Pacific Bell and Subsidiaries ("the Company") for the three-month period ended
March 31, 1995 to the corresponding period in 1994. Results for the first
three months of 1995 may not be indicative of results for the full year.
A summary of selected operating data is shown below:
For the 3 Months Ended
March 31, Change
------------------------------------------
Selected Operating Data 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Operating ratio (%).................. 78.8 76.6* (1.2) -
Return on shareowner's equity (%).... 15.8 17.6 12.2 -
Total employees...................... 49,884 52,457 (2,573) (4.9)
Revenues per employee ($ thousands).. 44.3 42.8* 2.1 5.3
Employees per ten thousand
access lines**..................... 31.2 34.1 (2.9) (8.5)
===========================================================================
* restated
** excludes Pacific Bell Directory employees
11
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Net Income
- ----------
For the 3 Months Ended
March 31, Change
-----------------------------------------------
($ millions) 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Net Income $246 $276 $(30) (10.9)
- ---------------------------------------------------------------------------
The decline in first quarter 1995 net income was primarily due to revenue
shortfalls resulting from a California Public Utilities Commission ("CPUC")-
ordered price rebalancing that accompanied the introduction of toll services
competition on January 1, 1995. Share loss in the toll market has been about
as expected. Additional pressure on earnings resulted from incremental labor
expense associated with the severe storms in 1995. These earnings decreases
in 1995 were partially offset by the Company's on-going cost-reduction
efforts.
The revenue shortfalls occurred because the average 40 percent reduction in
toll prices did not stimulate demand growth to the extent anticipated by the
CPUC to achieve revenue neutrality as intended by the price rebalancing order.
The CPUC price rebalancing order assumed that volume growth would be a key
source of new revenues to offset the price reductions. Results to date
strongly suggest that neither the CPUC's nor management's forecasted growth in
demand will be realized in 1995. Management believes 1995 earnings could be
about 10 percent less than 1994 due to this revenue rebalancing shortfall.
Volume Indicators
- -----------------
For the 3 Months Ended
March 31, Change
----------------------------------------
Volume Indicators 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Customer switched access lines in
service at March 31 (thousands).... 15,122 14,726 396 2.7
Interexchange carrier access
minutes-of-use (millions).......... 14,096 12,923 1,173 9.1
Interstate....................... 7,872 7,627 245 3.2
Intrastate....................... 6,224 5,296 928 17.5
Toll Messages (millions)............. 1,172 1,084 88 8.1
===========================================================================
12
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The total number of access lines in service grew to 15,122 thousand, an
increase of 2.7 percent for the twelve months ended March 31, 1995. Although
this is an improvement over the 2.3 percent increase for the same period last
year, access line growth slowed in the first quarter 1995. The residential
access line growth rate increased to 1.9 percent for the twelve months ended
March 31, 1995, from 1.4 percent last year. The growth rate in business
access lines climbed to 4.0 percent this year from 3.7 percent last year.
Business Centrex lines grew 10.4 percent during the same period as businesses
continued to link multiple locations and improve disaster preparedness. The
number of ISDN lines in service increased 90 percent in the twelve months
ended March 31, 1995 as customers demanded faster data transmission and
Internet access.
Access minutes-of-use represent the volume of traffic carried by interexchange
carriers over the Company's local network. Access minutes-of-use for the
three months ended March 31, 1995 increased by 9.1 percent over the same
period last year. The increase in access minutes-of-use was attributable to
economic growth and price decreases which increased network usage. The
introduction of competition in the intra-service area toll market that began
in January 1995 also had the effect of increasing intrastate access minutes-
of-use. The Company provides access to other carriers who are now authorized
to complete intra-service area toll calls over the Company's local network.
Toll messages are comprised of Message Telecommunications Service, Optional
Calling Plans, WATS and terminating 800 messages. For the three months ended
March 31, 1995, toll messages increased by 8.1 percent compared to an increase
of 5.1 percent for the corresponding period in 1994. The increase was driven
primarily by lower prices as well as economic growth. On January 1, 1995, the
Company lowered the price of its toll services by an average of 40 percent.
The Company also began offering discount calling plans. Residential customers
receive an additional 15 percent off toll charges above five dollars per month
while businesses receive an additional 20 percent off toll charges over
$15 per month. High volume customers can receive even larger discounts.
Price decreases have stimulated demand slightly but fall short of levels
included in the CPUC's order or forecasted by management. The Company
estimates it lost approximately five percent of the toll services market to
other providers in the first quarter 1995. While it is too early to estimate
when market share loss will stabilize, management expects it to increase.
13
<PAGE>
Operating Revenues
- ------------------
For the 3 Months Ended
March 31, Change
-----------------------------------------------
($ millions) 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Total operating revenues $2,212 $2,247 $(35) (1.6)
- ---------------------------------------------------------------------------
Revenues for first quarter 1995 were reduced from the same period last year
primarily because demand growth was slower than assumed in the CPUC-ordered
price rebalancing, price cap revenue reductions, and the effects of toll
services competition.
Effective January 1, 1995 the CPUC allowed long-distance companies and others
to officially compete with the Company in providing intra-service area toll
call services in California. The decision rebalanced prices for most of the
Company's regulated services so that the Company could remain competitive in
the new environment. The CPUC intended this decision to be initially revenue
neutral so that the effect of price decreases would be offset by the effect of
price increases. Increased demand was expected to result from lower prices
for competitive services, partially offsetting the effect of price decreases
on total revenues. Although the Company observed some increased usage for the
first quarter 1995, calling volumes were below levels envisioned by the CPUC
as necessary to achieve revenue neutrality.
Revenues were also reduced because of price cap revenue reductions ordered by
the CPUC and the Federal Communications Commission ("FCC") under incentive-
based regulation.
Overall, revenue decreases from price rebalancing and price cap orders were
partially offset by $79 million in revenues from increased customer demand.
The increase in customer demand included both general economic growth and the
result of lower prices. Factors affecting revenue changes are summarized in
the following table.
Price
Price Re- Cap Misc. Customer Total
($ millions) balancing Orders Demand Change
- ---------------------------------------------------------------------------
Local service.................... $ 95 $(31) $15 $12 $91
Network access
Interstate..................... 7 (1) 10 18 34
Intrastate..................... (61) (5) (13) 71 (8)
Toll service..................... (123) (12) (3) (41) (179)
Other service revenues........... 4 - 4 19 27
----- ----- ----- ------ ----
Total operating revenues......... $(78) $(49) $13 $79 $(35)
===========================================================================
The $12 million increase in local service revenues due to customer demand in
the above table reflects increased customer access lines due to economic
recovery.
14
<PAGE>
The $18 million increase in interstate network access revenues due to customer
demand reflects increased interexchange carrier access minutes-of-use, as well
as increased access lines. The $71 million demand related increase in
intrastate network access revenues also reflects growth in interexchange
carrier access minutes-of-use. The introduction of competition in the intra-
service area toll market that began in January 1995 had the effect of
increasing access usage revenues.
Decreased customer demand-related revenues from toll services, as displayed in
the table above, primarily results from competition. The Company lost
approximately five percent of the toll services market to competitors in the
first quarter 1995. In addition, the Company has lost and continues to lose
WATS and 800 service business to interexchange carriers who have the
competitive advantage of being able to offer these services both within and
between service areas.
The increase in other service revenues reflects the continuing success of the
Company's voice mail products as well as its directory operations.
Operating Expenses
- ------------------
For the 3 Months Ended
March 31, Change
-----------------------------------------------
($ millions) 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Total operating expenses $1,742 $1,721 $21 1.2
- ---------------------------------------------------------------------------
Total operating expenses increased only slightly when compared with 1994
despite a $63 million increase due to severe storm damage in 1995. As
displayed in the table below, increases in salaries and wages, depreciation,
and expenses associated with the subsidiaries were partially offset by
miscellaneous general and administrative expense decreases.
Pacific Bell Only
---------------------------
Salaries Employee Subsi- Total
($ millions) & Wages Benefits Misc. diaries Change
- ---------------------------------------------------------------------------
Cost of products
& services.................... $25 $ 2 $(8) $3 $22
Customer operations
& selling expenses............ (5) (4) 17 6 14
General, admin.
& other expenses.............. (13) (1) (36) 9 (41)
Property & other taxes.......... - - (1) 1 0
Depreciation
& amortization................ - - 25 1 26
---- ---- ---- --- ---
Total operating expenses........ $7 $(3) $(3) $20 $21
===========================================================================
15
<PAGE>
Salary and wage expense increased primarily as a result of 1995 storm and
flood repairs. This increase was substantially offset by decreases resulting
from the Company's force reduction programs.
Miscellaneous general and administrative expenses decreased primarily because
of costs incurred in 1994 for research and development to support plans to
upgrade the core network infrastructure and to begin building an integrated
telecommunications, information, and entertainment network. A decrease in
licensing fees for digital switching software and miscellaneous benefit
adjustments also lowered general and administrative expense. Miscellaneous
cost of products and services decreased primarily due to lower settlement
payments related to the implementation of toll service competition.
Depreciation expense increased primarily due to higher depreciation rates
ordered by the CPUC effective January 1, 1995 and higher telephone plant
balances.
Interest Expense
- ----------------
For the 3 Months Ended
March 31, Change
------------------------------------------
($ millions) 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Interest Expense $108 $103 $5 4.9
- ---------------------------------------------------------------------------
Interest expense for first quarter 1995 increased mostly due to accruals for
several regulatory liabilities.
Miscellaneous Income
- --------------------
For the 3 Months Ended
March 31, Change
------------------------------------------
($ millions) 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Miscellaneous Income $20 $1 $19 -
- ---------------------------------------------------------------------------
Miscellaneous income increased primarily due to interest income of $18 million
from a tax refund received in 1995 related to prior years.
16
<PAGE>
Income Taxes
- ------------
For the 3 Months Ended
March 31, Change
------------------------------------------
($ millions) 1995 1994 Amount Percent
- ---------------------------------------------------------------------------
Income Taxes $136 $148 $(12) (8.1)
- ---------------------------------------------------------------------------
The decrease in income tax expense for first quarter 1995 is primarily due to
lower pre-tax income and a tax refund received in 1995 related to prior years.
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. A
total of 945 employees left Pacific Bell (excluding subsidiaries) during first
quarter 1995. After new hires, the net force loss was 328 employees. A total
of $48 million in cash outlays was charged to the reserve in first quarter
1995. These costs were primarily for force reduction and information systems
reengineering. During first quarter 1995, the Company continued its efforts
to streamline the service ordering process and consolidated various activation
groups to improve service delivery. The majority of this year's projected
costs are expected to be incurred during the second half of 1995.
Capital Expenditures
- --------------------
The Company invested about $290 million during the first three months of 1995
primarily to modernize and expand the network and to build a wireless network
to offer personal communications services. The Company expects to invest
about $2.0 billion in 1995 excluding broadband costs.
17
<PAGE>
BOND RATING
In May 1995, Duff and Phelps, Inc. lowered the rating of Pacific Bell's bonds
from Double-A ("AA") to Double-A-Minus ("AA-"). At March 31, 1995, the
Company had approximately $5 billion of long- and intermediate-term debt
outstanding. The rating action reflects price cap revenue reductions, toll
services competition, and proposed interim rules on local services competition
(see "Local Services Competition" on page 20). The rating action also reflects
the expected financing requirements of the broadband and Personal
Communications Services networks. Standard & Poor's Corporation has placed
the Company's bond and commercial paper ratings on "CreditWatch," which has
negative implications, following the release by the CPUC of its proposed
interim rules on local services competition. In addition, Moody's Investor
Services, Inc. has changed its outlook on the long-term debt of the Company to
"negative" from "stable," citing concerns about risks associated with
deployment of the broadband network and potential pressure on the financial
profile and performance of the Company.
PENDING REGULATORY ISSUES
Calling Party Identification
- ----------------------------
In May 1995, the FCC established national rules under which telephone
companies, including Pacific Bell, may offer calling party identification
services ("Caller ID"). Caller ID displays the telephone number of the
calling party on a device that attaches to a customer's telephone unless it is
blocked by the calling party. Caller ID is already available in most other
states but has not been offered in California due to CPUC blocking
restrictions that make the service uneconomic to provide. The FCC ruling
preempts the CPUC's restrictions which made providing Caller ID uneconomic.
Management believes that Caller ID could be an important new revenue source
and plans to provide service by early 1996. The CPUC has indicated it will
appeal the FCC's ruling.
FCC Regulatory Framework Review
- --------------------------------
In March 1995, the FCC adopted a new interim set of rules for 1995 that govern
the prices that the larger local exchange carriers ("LECs"), including the
Company, charge interexchange carriers ("IECs") for access to local telephone
networks. The LECs charge for the use of their networks when the IECs connect
to local telephone customers.
18
<PAGE>
Under the FCC price cap system of incentive-based regulation, LECs set access
charges by subtracting from the rate of inflation a specified "productivity
factor" intended to account for increasing productivity in the telephone
industry. If the productivity factor exceeds the rate of inflation, LECs must
cut their access charges by an amount equal to the difference. The annual
price adjustments also reflect the effects on the LECs' costs of exogenous
events beyond their control. The rules also contain a sharing provision that
requires LECs to return a percentage of their earnings to their customers
after they achieve a specified rate of return.
The original FCC price cap rules offered LECs a choice of two productivity
factors: either 3.3 percent or 4.3 percent. In its 1994 price cap filing, the
Company chose a productivity factor of 3.3 percent. The Company must share
with customers 50 percent of its earnings above a 12.25 rate of return, and
return all earnings to customers above 16.25 percent.
The new plan allows LECs to choose among three productivity factors:
4.0 percent, 4.7 percent, or 5.3 percent. LECs electing the 4.0 and
4.7 percent options will share 50 percent of earnings above 12.25 percent in
subsequent year price reductions. In addition, all earnings above 13.25 and
16.25 percent, respectively, will be returned. LECs that choose the
5.3 percent productivity factor can retain all earnings without sharing. In
addition, to modify the FCC's prior methodology, LECs are required to reduce
their 1995 annual access filings by an additional 0.7 percent for each year
they selected a 3.3 percent productivity factor under the old rules, up to
2.8 percent. The Company will have a 2.1 percent reduction due to selecting
the 3.3 percent productivity factor in three prior years.
The FCC has indicated it will adopt permanent rules in 1995 or 1996.
Management continues to believe that the FCC should adopt pure price cap
regulation including elimination of the productivity factor, sharing, and
earnings caps.
In May 1995, the Company submitted its annual access filing under the interim
rules. The Company proposed an annual revenue reduction totaling $123 million
effective August 1, 1995. Of this amount, $69 million was reflected in the
Company's 1994 financials. The Company chose the 5.3 percent productivity
factor which will eliminate the sharing obligation. Management believes that
the negative effect of the higher productivity factor will be more than offset
by not having to share future earnings. If the filing is approved, the
Company's switched access prices will decrease from approximately 2.2 cents
per minute to approximately 1.9 cents per minute.
19
<PAGE>
Local Services Competition
- --------------------------
In December 1994, the CPUC adopted a procedural plan to examine issues related
to opening the local exchange market to competition. The Company participated
in settlement talks with IECs and other interested parties in an effort to
reach agreement on a number of these issues. Since no agreement was reached by
the March 31, 1995 deadline, the CPUC has begun to address these issues in
formal proceedings.
In April 1995, the CPUC proposed interim rules for local telephone competition
that could begin as early as late 1995. The CPUC's proposal includes
provisions allowing competitors to resell the Company's services. It also
sets interconnection rules and allows telephone number portability. The
proposal does not resolve the questions of how to maintain affordable
universal service, pricing flexibility, network unbundling, and the future
regulatory framework. If the proposal is adopted in its current form, the
Company will be at a competitive disadvantage. (See "Competitive Risk" on
page 21.)
In a related action, the CPUC also ordered the Company to offer expanded
interconnection to allow competitive access providers to carry the transport
portion of switched access between the Company's central offices and IECs.
The Company previously proposed to freeze prices of basic services for three
years as part of a comprehensive plan to bring full telecommunications
competition to all Californians. Addressed in its plan are:
1. Universal service, which the Company would assure to all
Californians
2. A three-year freeze of prices for basic services, which are already
among the lowest in the nation
3. Downward pricing flexibility, so that prices can be lowered to meet
competition
4. Number assignment and portability, maintaining existing calling
areas, so that customers who change their telephone company without
changing location can take their numbers with them
5. Competitive access, allowing competitors access to the Company's
network at reasonable rates
6. Unbundling of basic elements of the local network
20
<PAGE>
Management believes its customers should have the opportunity to choose their
local telecommunications providers just as they should be able to choose their
cable TV and long-distance providers. At the same time, management believes
customers should have the opportunity to choose Pacific Bell as a complete
local and long-distance telecommunications service provider. Management
believes that implementation of local exchange competition prior to the
Company being allowed to enter the long-distance market would provide already
strong competitors an unfair advantage. The CPUC plans to issue a decision in
mid-1995.
Property Taxes
- --------------
In 1992, a settlement agreement was reached between the State Board of
Equalization, all California counties, the State Attorney General, and
28 utilities, including the Company, on a specific methodology for valuing
utility property for property tax purposes. The CPUC opened an investigation
to determine if any resulting property tax savings should be returned to
customers. Intervenors have asserted that as much as $20 million of annual
property tax savings should be treated as an exogenous cost reduction in the
Company's annual price cap filings. These intervenors have also asserted that
past property tax savings totaling as much as $60 million plus interest as of
June 30, 1995 should be returned to customers. Management believes that under
the CPUC's New Regulatory Framework, any property tax savings should only be
treated as a component of the calculation of shareable earnings. A CPUC
decision is pending.
DISPOSITION OF BELLCORE
In April 1995, Bellcore announced a decision by its owners to pursue the
disposition of their interests in Bellcore. Bellcore is a leading provider of
communications software and consulting services. It is owned by Pacific Bell
and six other affiliates of the telephone regional holding companies formed at
the divestiture of AT&T Corp. in 1984. A final decision regarding the
disposition of interests and the structure of such a transaction will be
subject to obtaining satisfactory financing and necessary approvals.
COMPETITIVE RISK
Regulatory, legislative and judicial actions, as well as advances in
technology, have expanded the types of available communications products and
services and the number of companies offering such services. Various forms of
competition are growing steadily and are already having an effect on the
Company's earnings. An increasing amount of this competition is from large
companies with substantial capital, technological, and marketing resources.
Currently, competitors primarily consist of interexchange carriers,
competitive access providers and wireless companies. Soon the Company will
also face competition from cable television companies and others.
21
<PAGE>
Effective January 1, 1995, the CPUC authorized toll services competition.
Toll service revenues represent approximately 14 percent of the Company's
total operating revenues. The Company estimates it lost approximately
five percent of the toll services market to other providers in the first
quarter 1995. While it is too early to estimate where market share loss will
stabilize, management expects it to increase. In May 1995, the CPUC issued a
decision that requires the Company to permit Centrex customers who purchase
certain optional routing features to route intra-service area calls to the
toll carrier of their choice. In addition, the CPUC has stated its intention
to open up the local exchange market to competition that could begin as early
as late 1995. Local service revenues represent approximately 42 percent of
the Company's total operating revenues.
The Company recently filed a Form 8-K with the Securities and Exchange
Commission ("SEC") detailing competitive vulnerability. Because of the unique
characteristics of the California market, the Company is vulnerable to
competition should the CPUC adopt local competition rules that are not fair
and even-handed. (See "Local Services Competition" on page 20.)
Pacific Bell's business and residence revenues and profitability are highly
concentrated among a small portion of its customer base and geographic areas.
Competitors need only serve portions of our service area to compete for the
majority of the Company's business and residence usage revenues. Customers
tend to cluster in high density areas such as Los Angeles and Orange County,
the San Francisco Bay Area, San Diego and Sacramento.
Competitors can be expected to target the high-usage, high-profit customers
and can do this by targeting only a small part of our geographic area and a
small part of our customer base. Large and well-capitalized long-distance
carriers, wireless companies, competitive access providers and cable
television companies are preparing to compete in major local exchange markets.
In some cases they are already deploying switches and other facilities. In
California, cable television companies currently pass more than 90 percent of
the Company's residential customers. Cable television companies have already
announced plans for major build-outs to compete in the local exchange market.
All of the Company's customers have already chosen a long-distance company,
and there is more advertising from long-distance companies than from
traditional local exchange companies including Pacific Bell.
22
<PAGE>
Market research has shown that a substantial majority of residence customers
prefer using one company for all telecommunications services. This is a
significant competitive disadvantage to the Company since it is prohibited by
the 1982 consent decree from providing long-distance service between service
areas. Similar market research shows that a substantial majority of business
customers would select one of the major long-distance companies over a
combination of Pacific Bell and a long-distance company because using one
carrier would permit them to apply all of their traffic toward volume discount
plans offered by the long-distance companies.
For these reasons, management believes that implementation of local exchange
competition prior to the Company being allowed to enter the long-distance
market would provide already strong competitors an unfair advantage and that
regulators should ensure that the responsibility for universal service is
shared by all telecommunications providers. Management believes that a truly
open competitive market would allow for the simultaneous entry of all
telecommunications competitors into each others' markets on an equal footing.
Although the Company is facing increasing competition for all of its services,
management believes that a truly open competitive market, in which the Company
can compete without restrictions, offers significant opportunity to grow the
business.
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 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 will no longer apply. The Company
continues to monitor the effects of competition and changes in regulation to
assess the likelihood it will continue to recover its costs. (See "Pending
Regulatory Issues" and "Competitive Risk" beginning on page 18.)
Discontinuing the 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. (See "Accounting under
Regulation" in Note A on page 7.) Three telephone regional holding companies
("RHCs") have discontinued the application of SFAS 71 regulatory accounting
and have reduced their telephone plant balances. If the Company were to
discontinue the application of SFAS 71 and compute the effect on its telephone
plant in a manner similar to these three RHCs, the reduction in carrying
amount of the Company's property, plant, and equipment would be between $3 and
$5 billion.
23
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibits identified in parentheses below as on file with the SEC are
incorporated herein by reference as exhibits hereto.
Exhibit
Number Description
- ------- -----------
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 Article 5 FDS for 1st Quarter 1995 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.
Form 8-K, Date of Report April 19, 1995, was filed with the SEC,
under Item 5 in connection with a Pacific Bell competitive
vulnerability filing with the CPUC.
24
<PAGE>
EXHIBIT INDEX
Exhibits identified in parentheses below as on file with the SEC are
incorporated herein by reference as exhibits hereto. All other exhibits are
provided as part of the electronic transmission.
Exhibit
Number Description
- ------- -----------
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 Article 5 FDS for 1st Quarter 1995 Form 10-Q.
25
<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 /s/ Peter A. Darbee
---------------------------------------
Peter A. Darbee
Vice President, Chief Financial Officer
and Controller
May 12, 1995
26
<PAGE>
Exhibit 15
----------
COOPERS & LYBRAND L.L.P.
May 12, 1995
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
Re: Pacific Bell
Registration Statement on Form S-3
------------------------------------
We are aware that our report dated May 12, 1995 on our review of the interim
financial information of Pacific Bell and Subsidiaries for the three-month
periods ended March 31, 1995 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,
/s/ Coopers & Lybrand L.L.P.
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