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FORM 10-K
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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(X) ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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For The Fiscal Year Ended December 31, 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
A California Corporation I.R.S. Employer Number 94-0745535
140 New Montgomery Street, San Francisco, California 94105
Telephone - Area Code (415) 542-9000
-------------------
Securities registered pursuant to Section 12(b) of the Act:
See attached Schedule A.
Securities registered pursuant to Section 12(g) of the Act: None.
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 .
--- ---
THE REGISTRANT, A WHOLLY-OWNED SUBSIDIARY OF PACIFIC TELESIS GROUP, MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION J (1) (a) AND (b) OF FORM 10-K AND
IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO
GENERAL INSTRUCTION J(2).
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SCHEDULE A
Securities registered pursuant to Section 12(b) of the Act*:
Name of each exchange
Title of each class on which registered
------------------- -----------------------
7.800% Debenture due 03/01/07 New York Stock Exchange
7.250% Debenture due 02/01/08 New York Stock Exchange
7.625% Debenture due 06/01/09 New York Stock Exchange
7.250% Note due 07/01/02 New York Stock Exchange
6.250% Note due 03/01/05 New York Stock Exchange
7.125% Debenture due 03/15/26 New York Stock Exchange
7.500% Debenture due 02/01/33 New York Stock Exchange
6.875% Debenture due 08/15/23 New York Stock Exchange
6.625% Debenture due 10/15/34 New York Stock Exchange
* Pacific Bell has other securities outstanding not registered pursuant
to Section 12(b) of the Act.
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TABLE OF CONTENTS
PART I
Description
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Item Page
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1. Business (Abbreviated pursuant to General Instruction J(2))... 4
2. Properties.................................................... 11
3. Legal Proceedings............................................. 11
4. Submission of Matters to a Vote of Security Holders (Omitted
pursuant to General Instruction J(2))
PART II
Description
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5. Market for Registrant's Common Equity and Related Stockholder
Matters....................................................... 12
6. Selected Financial Data (Omitted pursuant to General
Instruction J(2))
7. Management's Discussion and Analysis of Results of Operations. 13
8. Financial Statements and Supplementary Data................... 33
9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure...................................... 59
PART III
Description
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10. Directors and Executive Officers of Registrant (Omitted
pursuant to General Instruction J(2))
11. Executive Compensation (Omitted pursuant to General
Instruction J(2))
12. Security Ownership of Certain Beneficial Owners and Management
(Omitted pursuant to General Instruction J(2))
13. Certain Relationships and Related Transactions (Omitted
pursuant to General Instruction J(2))
PART IV
Description
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14. Exhibits, Financial Statement Schedules and Reports on
Form 8-K...................................................... 60
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PART I
Item 1. Business.
GENERAL
Pacific Bell (the "Company") was incorporated in 1906 under the laws of the
State of California and has its principal executive offices at
140 New Montgomery Street, San Francisco, California 94105 (telephone number
(415) 542-9000).
Through December 31, 1983, the Company was a subsidiary of AT&T Corp.
("AT&T"). Effective January 1, 1984, the Company became a subsidiary of
Pacific Telesis Group ("Telesis" or the "Corporation"), one of the seven
regional holding companies ("RHCs") formed in connection with the 1984
divestiture by AT&T of its 22 wholly-owned operating telephone companies
("Bell Operating Companies" or "BOCs") pursuant to a consent decree settling
antitrust litigation ("Consent Decree") approved by the United States District
Court for the District of Columbia (the "Court") which has retained
jurisdiction over the interpretation and enforcement of the Consent Decree.
The Company and its wholly-owned subsidiaries, Pacific Bell Directory,
Pacific Bell Information Services and Pacific Bell Mobile Services, provide a
variety of communications and information services in California. These
services include: (1) dialtone and usage services, including local service
(both exchange and private line), message toll services within a service area,
Wide Area Toll Service (WATS)/800 services within a service area, Centrex
service (a central office-based switching service) and various special and
custom calling services; (2) exchange access to interexchange carriers and
information service providers for the origination and termination of switched
and non-switched (private line) voice and data traffic; (3) billing services
for interexchange carriers and information service providers; (4) various
operator services; (5) installation and maintenance of customer premises
wiring; (6) public communications services; (7) directory publishing; and
(8) selected information services, such as voice mail and electronic mail.
Pacific Bell Mobile Services was formed in 1994 to offer personal
communications and other mobile telecommunications services.
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Pacific Bell Directory
Pacific Bell Directory ("Directory") is the publisher of the Pacific Bell
SMART Yellow Pages(R). It is the oldest and largest publisher of Yellow Pages
in California, and is among the largest Yellow Pages publishers in the
United States. Directory has recently introduced four-color, knock-out and
menu ads; and has added two new features - California Tourist Guide and CD
Sampler - to its "Local Talk(SM)" section which contains interactive guides on
a range of topics accessible via telephone. As part of its ongoing small
business advocacy efforts, Directory produces an award-winning publication in
partnership with the U.S. Small Business Administration. "Small Business
Success", now in its eighth year, addresses topics of importance to
entrepreneurs.
Pacific Bell Information Services
Pacific Bell Information Services ("PBIS") provides business and residential
voice mail and other selected information services. Current products include
The Message Center for home use, Pacific Bell Voice Mail for businesses and
Pacific Bell Call Management, a service that routes incoming business calls
and connects computer databases to answer routine customer questions.
Pacific Bell Mobile Services
Pacific Bell Mobile Services ("PBMS") was formed in July 1994 to pursue
opportunities in personal communications services ("PCS"), a new generation of
wireless services geared to the business and consumer markets. In March 1995,
Pacific Telesis Mobile Services ("PTMS"), a wholly-owned subsidiary of the
Corporation, was the high bidder for two licenses to offer PCS services in
California and Nevada at the close of Federal Communications Commission
("FCC") auctions. It is intended that PBMS and PTMS will work together to
construct, manage and market services for the licensed wireless network.
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PRINCIPAL SERVICES:
Significant components of the Company's operating revenues are depicted in the
chart below:
% of Total Operating Revenues
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Revenues by Major Category 1994 1993
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Local Service
Recurring.............................. 22% 22%
Other Local............................ 16% 17%
Network Access
Carrier Access Charges................. 18% 18%
End User & Other....................... 7% 7%
Toll Service
Message Toll Service.................... 22% 21%
Other................................... 1% 2%
Other Service Revenues
Directory Advertising.................. 11% 11%
Other.................................. 5% 4%
Uncollectibles (2%) (2%)
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TOTAL...................................... 100% 100%
===========================================================================
The percentages of total operating revenues attributable to interstate and
intrastate telephone operations are displayed below:
% of Total Operating Revenues
-----------------------------
1994 1993
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Interstate telephone operations............ 18% 18%
Intrastate telephone operations............ 82% 82%
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TOTAL...................................... 100% 100%
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CONSENT DECREE
Under the terms of the Consent Decree, all territory served by the BOCs was
divided into geographical areas called "Local Access and Transport Areas"
("LATAs", also referred to as "service areas"). The Consent Decree generally
prohibits BOCs and their affiliates* from providing communications services
that cross service area boundaries; however, the networks of the BOCs
interconnect with carriers that provide such services (commonly referred to as
"interexchange carriers").
--------------------------
* The terms of the Consent Decree, with certain exceptions, apply generally
to all the BOCs and their affiliates.
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The Consent Decree provides that the RHCs shall not engage in certain lines of
business. The Consent Decree provides that the Court may waive the line of
business restrictions (i.e., grant a "Waiver") upon a showing that there is no
substantial possibility that the RHCs could use their monopoly power to impede
competition in the market they seek to enter. The Court has placed certain
conditions on the Waivers it has granted and may do so again on future
Waivers.
Under the Consent Decree the principal restrictions initially prohibited the
provision of interexchange telecommunications, information services and
telecommunications equipment. As described below, the information services
prohibition was lifted in 1991. The telecommunications businesses permitted
by the Consent Decree include the provision of exchange telecommunications*
and exchange access services, customer premises equipment ("CPE") and printed
directory advertising. The RHCs are prohibited from manufacturing
telecommunications equipment and CPE. On December 3, 1987, the Court
interpreted the manufacturing restriction to mean that the RHCs are prohibited
from designing and developing telecommunications equipment and CPE as well as
from fabricating them. In March 1995, the Court granted a Waiver that allows
the RHCs to provide telecommunications equipment to unaffiliated parties. In
March 1995, the Court also granted a Waiver to allow the Corporation to own
and operate certain facilities to receive video programming and to provide
limited interexchange video services.
In May 1993, the U.S. Court of Appeals for the District of Columbia affirmed
the Court's removal of the ban on the provision of information services by the
Corporation. The removal of this ban in July 1991 allowed the Company to
offer a variety of new information services, subject to regulatory approvals,
such as enhanced gateway services and electronic publishing services. In
November 1993, the U.S. Supreme Court declined to review the Appeals Court
decision.
In January 1995, the Corporation asked the U.S. Department of Justice to
support a Waiver of the provisions of the Consent Decree which prohibit the
Company from providing long-distance services. Long-distance calls are calls
between service areas. The Waiver requests permission for the Company to
provide long-distance service for calls originating in California that
terminate either in or outside of California and 800 services for calls
originating in or outside of California that terminate in California. This
filing is consistent with the California Public Utilities Commission ("CPUC")
and California Legislature's goal of having full competition for
telecommunications services in California. The final decision to grant a
Waiver must be made by the Court. The waiver process could take two or more
years. See Item 7 below, Management's Discussion and Analysis of Results
Operations ("MD&A") under the heading "Telecommunications Legislation" on
pages 20 through 21 for additional information on the regulation of the
provision on long-distance services which is incorporated herein by reference.
-------------------------
* "Exchange telecommunications" includes toll services within a service area
as well as local service.
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STATE REGULATION
As a provider of telecommunications services in California, the Company is
subject to regulation by the CPUC with respect to intrastate prices and
services, intrastate depreciation rates, the issuance of securities and other
matters.
The CPUC adopted a new regulatory framework ("NRF"), which is a form of "price
cap" regulation, for the Company in October 1989. In June 1994, the CPUC
issued a decision in its scheduled review of the NRF. The decision increased
the productivity factor and reduced the Company's benchmark rate of return
from 13.0 percent to 11.5 percent. Earnings between 11.5 percent and 15.0
percent will be shared equally between the Company and its customers.
Earnings above 15.0 percent will be shared 70.0 percent and 30.0 percent
between the Company and its customers, respectively.
Under "price cap" regulation, the CPUC requires the Company to submit an
annual price cap filing to determine prices for categories of services for
each new year. Price adjustments reflect the effects of any change in the
Gross Domestic Product Price Index ("GDP-PI") less the productivity factor.
The CPUC increased the productivity factor from 4.5 percent to 5.0 percent
effective July 1994. The annual price adjustments also reflect the effects on
the Company's costs of exogenous events beyond its control. In December 1994,
the CPUC ordered a $232 million revenue reduction* for 1995 as a result of the
Company's annual price cap filing. The ordered reduction includes a decrease
of $161 million because the 5.0 percent productivity factor of the price cap
formula exceeded the growth in the GDP-PI by 2.4 percent. The order also
included several other items that will decrease revenues by an additional $71
million.
See MD&A under the headings "Toll Services Competition," "Local Services
Competition" and "Intrastate Access Services Competition" on pages 17 through
19 and "CPUC Regulatory Framework Review" on page 21 for additional
information on regulation of the Company by the CPUC which is incorporated
herein by reference.
See MD&A under the headings "Postretirement Benefits Other Than Pensions" on
page 31, "Information Services Subsidiary" on page 32,"Change in Accounting
for Postretirement and Postemployment Costs" in Note A to the 1994
Consolidated Financial Statements on page 45 and "Revenues Subject to Refund"
in Note I to the 1994 Consolidated Financial Statements on page 56 for a
discussion of other CPUC proceedings, including regulatory and ratemaking
treatment for postretirement benefits in connection with the adoption of
Statement of Financial Accounting Standards No. 106 and the reduction of the
Company's revenue due to its transfer of assets to PBIS which is incorporated
herein by reference.
----------------
* Unless otherwise indicated, revenue changes from the CPUC price cap orders
are estimated on an annual basis and may be more or less than the amount
ordered, due to later changes in volumes of business.
8
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FEDERAL REGULATION
The Company is subject to the jurisdiction of the FCC with respect to
interstate access charges and other matters. The FCC prescribes a Uniform
System of Accounts and interstate depreciation rates for operating telephone
companies. The FCC also prescribes "separations procedures", which are the
principles and standard procedures used to separate plant investment,
expenses, taxes and reserves between those applicable to interstate services
under the jurisdiction of the FCC and intrastate services under the
jurisdiction of state regulatory authorities. The Company is also required to
file tariffs with the FCC for the services it provides. In addition, the FCC
establishes procedures for allocating costs and revenues between regulated and
unregulated activities.
Beginning in 1991, the FCC adopted a price cap system of incentive-based
regulation for local exchange carriers. The Company's access rates were
retargeted to a new 11.25 percent rate of return on rate base assets. The
FCC's price cap system provides a formula for adjusting rates annually for
changes in the Gross National Product Price Index, less a productivity factor
and changes in certain costs that are triggered by administrative, legislative
or judicial action beyond the control of the local exchange carriers.
The FCC's price cap plan allows the Company to choose between two productivity
offset factors of 3.3 percent or 4.3 percent on an annual basis. This choice
affects both the sharing threshold and the threshold above which all earnings
must be returned to customers. In its fourth annual access filing, the
Company again chose the productivity factor of 3.3 percent, which the FCC
approved in June 1994. For the Company, the 3.3 percent factor sets the
benchmark rate of return for sharing of earnings at 12.25 percent. If
earnings for 1994 are determined to exceed its sharing threshold, the Company
must share the excess earnings equally with customers. The Company's earnings
above 16.25 percent must be returned entirely to customers. New interstate
access prices became effective July 1, 1994. As a result, the Company's
interstate network access revenues will be reduced about $30 million annually
beginning July 1, 1994. This decrease reflects the application of the price
cap formula, increased support payments to the National Exchange Carrier
Association and an $8 million price reduction to help the Company remain
competitive with other access providers.
In 1994, the FCC began a comprehensive review of the Local Exchange Carrier
price cap framework. See MD&A under the headings "Interstate Access Service
Competition" on page 19 and "FCC Regulatory Framework Review" on page 21 for
additional information on the regulation of the Company by the FCC which is
incorporated herein by reference.
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COMPETITION
Regulatory, legislative and judicial actions since the Consent Decree, as well
as advances in technology, have expanded the types of available communications
services and products 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.
Management supports the simultaneous entry of all telecommunications
competitors into each others' markets.
Telephone Services Competition
See MD&A under the heading "Competition" on pages 17 through 19 for
information on current developments in toll services, local services,
interstate access services and intrastate access services competition which is
incorporated herein by reference.
Directory Publishing
Other producers of printed directories offer products that compete with
certain Pacific Bell Directory SMART Yellow Pages products. Competitors
include large companies that have significant resources. Competition is not
limited to other printed directories, but includes newspapers, radio,
television and, increasingly, direct mail. In addition, new advertising and
information products may compete directly or indirectly with the SMART Yellow
Pages. The Company is unable to predict the extent to which these competitors
may affect future revenues.
PCS
The Company will face competition in the provision of PCS services from the
holders of the other licenses in such areas. In addition, the Company must
compete with established providers of cellular service. Although the Company
anticipates significant competition in PCS, management believes that its
reputation for superior services will be a competitive advantage.
10
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Item 2. Properties.
The properties of the Company do not lend themselves to description by
character and location of principal units. At December 31, 1994, the
percentage distribution of total telephone plant by major category for the
Company was as follows:
Telephone Property, Plant and Equipment 1994
------------------------------------------------------------------------------
Land and buildings (occupied principally by central offices)........... 10%
Cable and conduit...................................................... 40%
Central office equipment............................................... 36%
Other.................................................................. 14%
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Total.................................................................. 100%
==============================================================================
At December 31, 1994, the Company's central office equipment was utilized to
approximately 92 percent of capacity.
Substantially all of the installations of central office equipment and
administrative offices are in buildings and on land owned by the Company.
Many garages, business offices and telephone service centers are in rented
quarters.
As of December 31, 1994, about 26 percent of the network access lines of the
Company were in Los Angeles and vicinity and about 25 percent were in
San Francisco and vicinity. The Company provided approximately 77 percent of
the total access lines in California on December 31, 1994. The Company does
not furnish local service in certain sizeable areas of California which are
served by non-affiliated telephone companies.
Item 3. Legal Proceedings.
Not Applicable.
11
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PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters.
The Company has 224,504,982 shares of common stock outstanding without par
value. There is no public trading market for the Company's common stock.
Pacific Telesis Group, incorporated in 1983 under the laws of the State of
Nevada, holds all the Company's outstanding shares.
Additional information about the Company's common shares and dividends paid
monthly thereon is in the Consolidated Financial Statements under "Item 8.
Financial Statements and Supplementary Data", which is incorporated herein by
reference.
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Item 7. Management's Discussion and Analysis of Results of Operations.
OVERVIEW
Pacific Bell (the "Company"), a wholly-owned subsidiary of Pacific Telesis
Group (the "Corporation"), provides telecommunications services including
local exchange, network access and toll services; directory advertising
through its wholly-owned subsidiary, Pacific Bell Directory ("Directory"); and
selected information services through its wholly-owned subsidiary,
Pacific Bell Information Services ("PBIS"). Pacific Bell Mobile Services
("PBMS") was established as a new subsidiary in 1994 to offer personal
communications and other mobile telecommunications services.
With increasing competition for existing services and the formal introduction
of toll services competition effective January 1995, the Company faces an
increasingly competitive marketplace. In response to the competitive
challenge, management is implementing strategic initiatives designed to
strengthen the Company's core business, develop new markets, accelerate
product development, and increase operational efficiencies. These strategic
initiatives and the competitive environment for each of the Company's major
service categories are discussed below. Also presented are critical public
policy issues affecting the telecommunications industry and the Company's
ability to compete with the same freedom as other service providers.
STRATEGIC INITIATIVES
To strengthen the Company's core business, management has formulated a
strategy known as "California First." This investment and marketing strategy
is predicated on the belief that the Company's unparalleled commitment and
presence in California provides a strong competitive advantage. The Company's
goal is to be the vendor of choice for telecommunications and advanced data
and video services in California and to retain and increase its customer base.
Investing in the Core Network
-----------------------------
In order to offer the products and services customers want, now and in the
future, the Company continues to invest heavily in improvements to the core
telephone network. The Company spent a total of $1.6 billion on the network
during 1994. The focus of these investments has been in the advanced digital
technologies discussed below:
December 31
----------------------
Technology Deployment 1994 1993
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Access lines served by digital switches 65% 51%
Access lines with SS-7 capability 95% 79%
Access lines with ISDN capability 79% 60%
Miles of installed optical fiber (thousands) 413 364
===========================================================================
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Digital switches and optical fiber, a technology using thin filaments of glass
or other transparent materials to transmit coded light pulses, increase the
capacity and reliability of transmitted data while reducing maintenance costs.
Signaling System 7 ("SS-7") permits faster call setup and new custom calling
features. Integrated Services Digital Network ("ISDN") allows simultaneous
transmission of voice, data, and video over a single telephone line. Fueled
by telecommuting, the need for branch offices to access centralized computer
networks, and increased access to the Internet, the Company's ISDN sales
increased substantially in 1994. The growth has come primarily in single line
applications.
In 1994, the Company launched a major program to upgrade its core network
infrastructure and began building California's "communications superhighway."
This broadband network will integrate telecommunications, information and
entertainment technologies and provide advanced voice, data, and video
services. Using a combination of fiber optics and coaxial cable, the Company
expects to provide broadband services to several hundred thousand homes by the
end of 1995 and about 5.0 million homes by the end of the decade. Because the
network employs emerging technologies and is subject to regulatory approvals,
there can be no assurances that these services will be offered on schedule.
In addition to providing advanced telecommunications services, the new network
will serve as a platform for other information providers and will offer
customers alternatives to existing cable television providers. The broadband
network also is expected to spur the development of new interactive consumer
services in education, entertainment, financial services, government, and
healthcare, such as the Company's Education First and Healthcare Information
Network programs. It will promote capital and operational cost savings,
service quality improvements, and opportunities to earn additional revenues
from an array of new service possibilities. Construction of the non-video
components of the network began in May 1994.
In October 1994, the Federal Communications Commission (the "FCC") reaffirmed
its rule that permits local exchange carriers ("LECs"), including the Company,
to provide a tariffed platform ("video dialtone") that will deliver video
programming developed by others and provide certain other services to
customers. The FCC concluded that video dialtone should be subject to
existing price cap rules and treated as switched access services. In December
1993, the Company filed an application with the FCC seeking authority to offer
video dialtone services in specific locations in four of its service areas:
the San Francisco Bay Area, Los Angeles, San Diego, and Orange County. The
Company has urged the FCC to quickly encourage video competition in California
by expediting its applications review. Subject to regulatory approval,
management expects to offer video services by mid-1996. In July 1994, the
Company signed a contract with the first of many programmers expected to
supply video content. Once FCC approval is obtained, the Company will deploy
the video components of the advanced network.
Capital expenditures in 1995 are forecast to be $2.0 billion excluding
broadband costs. This amount includes $1.5 billion for projects designed to
generate revenues and the remainder for projects designed to reduce costs or
meet other requirements.
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Capital expenditures may increase as much as $2.0 billion in 1998 if the
broadband network is purchased. In December 1994, the Company contracted for
the purchase of up to $2 billion of broadband network facilities which
incorporate emerging technologies. The Company has committed to purchase the
facilities in 1998 if they meet certain quality and performance criteria.
Under this arrangement, the Company's capital expenditures for broadband
deployment and related long-term financing requirements are expected to be
deferred until 1998. The Company intends to lease certain operational
portions of the facilities prior to 1998 during the construction period.
As part of its current plan, the Company has made purchase commitments of
about $380 million in accordance with its previously announced $1 billion
program for deploying an all-digital switching platform with ISDN and
SS-7 capabilities.
Developing New Markets
----------------------
To develop new markets for mobile communications services, management plans to
offer personal communications services ("PCS"). In March 1995, the
Corporation announced it was the high bidder for two licenses to offer PCS
services in California and Nevada at the close of FCC auctions. PCS will be a
digital wireless service offering mobility for both voice and data
communications. PCS technology should allow customers to be reachable,
wherever they are, with a single telephone number. The Corporation must still
apply to the FCC for authority to offer PCS and will be required to meet
certain network completion schedules.
In December 1994, PBMS contracted with a wireless system design company to
perform all the radio frequency design work for the Company's PCS network.
The PCS network will be designed to connect seamlessly to the wired network to
provide an integrated system. Although the Company anticipates significant
competition for PCS, management believes that Pacific Bell's reputation for
superior service is a competitive advantage and anticipates introducing PCS
services in early 1997.
Developing New Products
-----------------------
The Company also is responding to competition by streamlining new product
development to shorten the time between product conception and market roll-
out. In 1994, the Company introduced prepaid calling cards, moving from
inception to market in just six months. The Company also introduced a credit
card that accumulates credits towards the purchase of Pacific Bell products
and services. Other products in various stages of development include custom
calling features, which provide a distinctive ring to alert customers to
incoming toll calls, and do-not-disturb features. Also under development are
network management products that will allow customers to set up their own
internal telephone networks to streamline internal communications. The
Company also plans an array of new products to take advantage of the increased
capabilities of the broadband network.
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Reengineering Core Processes
----------------------------
To improve operational efficiencies, management continues to employ core
process reengineering ("CPR"). CPR is a method for achieving significant
increases in performance by fundamentally rethinking basic business processes
and systems. The Company's CPR projects will result in better, faster
customer service and will reduce costs as the Company responds to competition.
Some of the more significant projects are summarized below.
To increase responsiveness and lower costs, the Company is establishing new,
integrated customer service centers. The Company consolidated 128 service
centers into 15 centers in 1994. By 1997, these will be further consolidated
into five centers. These new centers will reduce customer hand-offs by
employees due to the centralization of responsibilities previously handled by
several different organizations in different locations. Customer-requested
changes will be less expensive and easier to accomplish with fewer facilities.
To create a more efficient and reliable network, the Company is reducing the
number of network operations centers from 25 to four state-of-the-art
facilities and streamlining network management processes. Each of the four
centers will be responsible for network surveillance and control, network
provisioning and maintenance, and network reliability and quality assurance.
The new centers will reduce cycle times because of fewer hand-offs, and allow
greater concentration of technical expertise at each center. The Company
anticipates the consolidation of customer services centers will be completed
by the end of 1995.
To reduce overhead costs, the Company has initiated changes in the use of its
real estate. Expense savings will result from consolidating operations,
terminating leases and selling surplus property. Telecommuting, virtual
offices, and shared offices will be encouraged.
To establish service more quickly, plant facilities will be dedicated to a
customer's telephone line. This new process is called "quick dialtone". It
will require less human intervention to initiate telephone service and will
allow the Company to activate service within about two hours. It will allow
the customer to access certain repair, 911 and business office numbers, even
after service is disconnected. Quick dialtone will make it easy for customers
to choose Pacific Bell now, and after local competition is authorized.
As a result of reengineering its processes and other restructuring, the
Company reduced its net force by about 3,800 employees during 1994. Employees
per ten thousand access lines decreased 10.5 percent, a further improvement
from the 4.6 percent decrease in 1993. Revenues per employee increased
7.9 percent in 1994.
Management is confident that its strategic initiatives described above will
allow it to offer premier telecommunications services at competitive prices
and to remain the customer's first choice for telecommunications products and
services in California.
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COMPETITION
The Company is facing increasing competition for existing and new services.
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. Management
supports the simultaneous entry of all telecommunications competitors into
each others' markets. The competitive environments for the Company's major
services categories are summarized below.
Toll Services Competition
-------------------------
In September 1994, the California Public Utilities Commission (the "CPUC")
issued a decision in the third phase of its investigation into alternative
regulatory frameworks. Effective January 1, 1995, the decision allowed long-
distance and other telecommunications companies to officially compete with the
Company and other local telephone companies in providing intra-service area
toll call services in California. Toll calls are calls within a customer's
service area but beyond the local calling area. The decision also rebalanced
prices for services in order to allow the Company to be a more effective
competitor. Rebalancing brings prices for certain services closer to the
costs of providing those services. The decision lowered intra-service area
toll prices an average of about 40 percent and increased the Company's
residential flat rate service from $8.35 to $11.25 per month. The Company's
business basic prices increased from $8.35 to $10.32 per month. In addition,
charges for intrastate access were reduced and other prices were changed.
The CPUC intends the decision to be revenue neutral; the effect of price
decreases would be offset by the effect of price increases. In January 1995,
the CPUC ordered that the new rates are subject to adjustment, including
refunds and backcharges, pending its resolution of various applications for
rehearing. The CPUC has stated its intention to order such adjustments if
necessary to maintain revenue neutrality or remedy any harm.
The Company believes the decision is based on an estimate of growth in demand
for services due to lower toll prices that may be too optimistic. If actual
demand falls short of estimates, toll service revenues would be adversely
affected. More importantly, as competition intensifies for intra-service area
toll calling, there is a risk that the Company's toll revenues could be
materially reduced. Several competitors have advertised promotional prices
that are lower than the Company's prices for certain toll-calling patterns.
However, a customer must currently dial a five-digit access code to use a
competitor's toll services. The Company is aggressively marketing volume
discount plans to its residential and business customers.
The CPUC has stated that in May 1995 it will begin to consider whether
customers should be allowed to presubscribe to a specific carrier to handle
their intra-service area toll calls. Presubscription would allow a customer
to select a carrier without dialing the carrier's access code. As part of the
local services competition procedural plan (See "Local Services Competition"
below), the CPUC is encouraging interested parties to pursue the development
of a settlement agreement on presubscription by March 1995.
17
<PAGE>
Local Services Competition
--------------------------
In December 1994, the CPUC adopted a procedural plan to achieve the CPUC's and
California Legislature's goal of opening local exchange markets to competition
by January 1, 1997. Opening local markets to competition would increase
demand for, and stimulate private development of, new types of
telecommunications and video services, bringing innovative new products into
businesses, homes, and communities. The CPUC plans to issue interim rules for
local competition in June 1995. The CPUC is encouraging interested parties to
negotiate a settlement of issues related to opening local telephone markets to
competition as well as presubscription and regulatory framework reform. The
parties must issue a progress report by March 31, 1995. For issues remaining
unresolved, the CPUC proposes to address local competition in three related
proceedings which are intended to remove barriers to competition, resolve
technical issues, and implement consumer protection and regulatory
streamlining.
In January 1995, the CPUC instituted a proceeding to reexamine the definition,
objectives, and subsidy support for universal service. The CPUC will report
its recommendations to the California Legislature by January 1, 1996.
The CPUC proposes to adopt specific requirements for the unbundling and
nondiscriminatory provision of monopoly functions that allow the provision of
telecommunications services. These functions would be subject to open access
for all telecommunications providers. In response to the CPUC's unbundling
plan, the Company has proposed separation of the loop (the telephone line
between a customer's location and the telephone company's central office) from
the switch (the central office equipment that selects the paths to be used for
transmission of information). The CPUC is scheduled to issue a decision in
first quarter 1995 concerning expanded interconnection and local transport
restructuring. A later decision will adopt a methodology to be used for cost
studies and may also define the network building blocks necessary for network
unbundling.
The Company has been conducting tests and trials with a variety of industry
participants to test the feasibility of unbundling the loop from the switch
and of various points of interconnection. Successful trials will allow
competitors to connect to the Company's network to carry calls and facilitate
the CPUC's local competition goals.
The CPUC plans to establish minimum consumer protection requirements
applicable to all local service providers by January 1997. At the same time,
the CPUC will develop plans to streamline regulatory processes for initiating
service offerings or changing prices.
18
<PAGE>
Interstate Access Services Competition
--------------------------------------
The FCC ordered large LECs, including the Company, to offer expanded network
interconnection for interstate special access services effective June 1993,
and for the transport portion of interstate switched access services effective
February 1994. Upon appeal, the U.S. Court of Appeals for the D.C. Circuit
decided that the FCC lacks the authority to require physical collocation and
remanded to the FCC the issue of whether the LECs should offer "virtual
collocation" instead of physical collocation. With virtual collocation, the
LECs install and maintain the equipment dedicated for use by the competitive
access providers ("CAPs"), and charge the CAPs for services. In July 1994,
the FCC directed the LECs to provide virtual collocation, but exempted LECs
from this requirement at central offices where they offer physical
collocation. The Company plans to continue to offer physical collocation but
has appealed certain requirements of the FCC's order. The portion of
interstate access revenues subject to increased competition represents less
than five percent of the Company's total revenues.
Intrastate Access Services Competition
--------------------------------------
In August 1993, the CPUC issued a proposal that would require the Company to
offer expanded network interconnection for intrastate special access services
and for the transport portion of intrastate switched access services. The
CPUC proposes to allow CAPs to locate transmission facilities in the Company's
central offices; adopt a new transport rate structure that includes pricing
flexibility for dedicated traffic; and authorize competition for switched
transport services within the state. Intrastate access revenues subject to
increased competition represent less than four percent of the Company's total
revenues. A decision from the CPUC is expected in first quarter 1995.
On January 1, 1995, the Company lowered the prices it charges interexchange
carriers for intrastate switched access in order to remain competitive with
CAPs. The new prices average 1.4 cents per minute of use compared to the
previous rate of about 2.8 cents per minute. The price decrease was
authorized by the CPUC in its September 1994 rate rebalancing decision.
Resulting decreases in access revenues are being offset by increases in local
service revenues. (See "Toll Services Competition" on page 17.)
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 undue restrictions, offers significant
opportunities to grow the business.
19
<PAGE>
PUBLIC POLICY
Telecommunications policy reform has been, and will continue to be, the
subject of much debate in Congress, the California Legislature, the courts,
the FCC, and the CPUC. The Company supports public policy reforms that
promote fair competition and ensure the responsibility for universal service
is shared by all who seek to provide telecommunications services in
California. The Company continues to believe it should be allowed the
opportunity to compete in other markets, such as long-distance, cable
television programming, and manufacturing. Competition could bring great
benefits to customers by giving them the opportunity to choose among service
providers, for everything from dialtone to long-distance.
Long Distance Services Waiver
-----------------------------
In January 1995, the Company asked the U.S. Department of Justice to support a
waiver of the provisions of the 1982 Consent Decree which prohibit the Company
from providing long-distance services. Long-distance calls are calls between
service areas. This filing is consistent with the CPUC's and California
Legislature's goal of having full competition for telecommunications services
in California. The final decision to grant a waiver must be made by the U.S.
District Court for the District of Columbia which has retained jurisdiction
over the interpretation and enforcement of the 1982 Consent Decree. The
waiver process could take two or more years.
Court Decision on Video Programming
-----------------------------------
Under the 1984 Cable Act, the Corporation is currently prohibited from
providing video programming in its service areas. In November 1993, the
Corporation filed suit in the U.S. District Court in San Jose challenging the
constitutionality of the 1984 Cable Act's provisions. In December 1994, the
U.S. Court of Appeals for the Ninth Circuit overturned these provisions. The
Appellate Court's decision, when issued, will return the case to the lower
court for further proceedings consistent with its decision. The ruling is
subject to appeal to the U.S. Supreme Court. The Company still needs approval
from the FCC before it can provide video services. (See "Investing in the Core
Network" on page 13.)
Telecommunications Legislation
------------------------------
In 1994, the U.S. House of Representatives approved two telecommunications
bills which would have eased certain restrictions imposed by the 1982 Consent
Decree and the 1984 Cable Act. Similar legislation with less favorable
provisions was introduced in the U.S. Senate but was withdrawn. Similar
legislation has been reintroduced in the House of Representatives in January
1995. The Company expects telecommunications legislation will also be
introduced in the Senate in 1995.
20
<PAGE>
In September 1994, Governor Wilson signed legislation directing the CPUC to
authorize fully open competition for intrastate long-distance services if
federal legislation or court action amends the 1982 Consent Decree. If not
amended by October 1995, the CPUC must order the Company to offer intrastate
long-distance services and to seek a waiver of the 1982 Consent Decree. (See
"Long-Distance Services Waiver" above.) The CPUC's order would be subject to
specific safeguards which would ensure that competitors have fair,
nondiscriminatory, and mutually open access to the Company's exchanges and to
interexchange facilities.
In September 1994, Governor Wilson signed legislation that will allow cable
television companies to offer local telephone services in areas of California
where local telephone companies are allowed to offer video services.
CPUC Regulatory Framework Review
--------------------------------
Effective July 1994, the CPUC issued a decision in its scheduled review of its
incentive-based New Regulatory Framework ("NRF"). The decision reduced the
Company's benchmark rate of return from 13.0 percent to 11.5 percent.
Earnings of 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. The decision also increased the productivity factor from
4.5 percent to 5.0 percent. A high productivity factor reduces revenues.
The Company has recommended that the CPUC move toward pure price regulation,
without ceilings, floors, sharing, exogenous costs, or productivity and
inflation factors. The CPUC is scheduled to begin a review of the NRF again
in mid-1995 if parties do not settle these and other issues involving local
competition. (See "Local Services Competition" on page 18.)
FCC Regulatory Framework Review
-------------------------------
In 1994, the FCC began a comprehensive review of the Local Exchange Carrier
price cap framework. The Company proposed several specific changes to the
current plan including the elimination of the productivity factor, sharing,
and earnings caps. The Company also proposed increased pricing flexibility
for certain competitive services. Other parties have advocated increasing the
productivity factor, retaining the sharing and earnings caps, and reducing the
benchmark rate of return. The FCC is expected to issue an order in March
1995. Any changes to the plan will most likely be incorporated into the 1995
annual access tariff filing which is scheduled to take effect on July 1, 1995.
Management believes that the public policies discussed above should ensure
that service providers get simultaneous and equal access to each others'
markets; anything less would not be fair. A competitive advantage accrues to
any company that can offer customers one-stop shopping for local, toll, and
long-distance services as a package. It is crucial for the Company to be
allowed to offer long-distance and video services when the local market is
opened to competition.
21
<PAGE>
RESULTS OF OPERATIONS
The following discussions and data compare the 1994 results of operations of
Pacific Bell and subsidiaries to 1993.
Change
----------------
Operating Statistics 1994 1993 Amount Percent
---------------------------------------------------------------------------
Return on shareowner's equity....... 17.2% (2.1%) 19.3 -
Operating ratio .................... 74.1% 93.4% (19.3) -
Revenues per employee (thousands) .. $178 $165 $13 7.9
Employees per ten thousand
access lines* .................... 31.6 35.3 (3.7) (10.5)
===========================================================================
* Excludes Pacific Bell Directory employees
Change
----------------
($ millions) 1994 1993 Amount Percent
--------------------------------------------------------------------------
Net income (loss) ................. $1,071 $(130) $1,201 --
--------------------------------------------------------------------------
The Company's 1994 earnings increased $1.201 billion. This year's results
include an after-tax charge of about $29 million due to a CPUC order related
to customer late payment charges. In 1993, results were reduced by after-tax
charges of about $1.16 billion for adopting a new accounting standard,
restructuring and curtailment charges, and other one-time items. Without
these 1993 charges and excluding one-time items in each year, earnings would
have increased about 7.0 percent.
Looking ahead, management expects that the effects of toll-service competition
and a CPUC-ordered revenue reduction, coupled with dilution from initial costs
for wireless services, will create some pressure on the Company's current
earnings level. In the long-term, the core telephone business performance is
expected to improve due to cost reduction efforts, growth prospects, strategic
initiatives, and continued recovery of the California economy. These
prospects should provide opportunity for stronger earnings.
22
<PAGE>
Volume Indicators
-----------------
Change
--------------------
Volume Indicators 1994 1993 Amount Percent
-----------------------------------------------------------------------------
Customer switched access lines
in service at December 31
(thousands)................. 15,026 14,617 409 2.8
Interexchange carrier access
minutes-of-use (millions)... 52,383 48,657 3,726 7.7
Interstate................ 30,581 28,318 2,263 8.0
Intrastate................ 21,802 20,339 1,463 7.2
Toll messages (millions)...... 4,442 4,230 212 5.0
=============================================================================
The Company is seeing continued improvement in volume indicators due to
economic recovery in California. The number of access lines in service
increased 2.8 percent in 1994, an improvement over a 2.2 percent increase in
1993. The 1994 increase was primarily attributable to the economic recovery
and the Company's promotional efforts to increase the number of households
with two lines. The residential access line growth rate increased to 2.0
percent in 1994, up from 1.4 percent last year. The growth rate in business
access lines climbed to 4.1 percent in 1994 from 3.3 percent last year.
Business Centrex lines grew 10.3 percent in 1994, fueled by businesses
focusing on networking multiple locations and disaster preparedness.
Access minutes-of-use represent the volume of traffic carried by interexchange
carriers over the Company's local networks. Total access minutes-of-use
increased by 7.7 percent in 1994, an improvement over the 6.1 percent increase
in 1993. The increase in access minutes-of-use was attributable primarily to
economic growth which increased network usage.
Toll messages include Message Telecommunications Services, Optional Calling
Plans, WATS and terminating 800 messages. Toll messages increased by
5.0 percent compared to an increase of 2.4 percent in 1993. Unauthorized
competition, particularly in WATS and 800 services, has constrained the growth
rate in toll messages compared to the growth rate in intrastate carrier access
minutes-of-use.
The CPUC formally authorized competition in the intra-service area toll market
effective January 1995. As a result, the Company lowered average prices for
intra-service area toll services approximately 40 percent. Toll messages are
expected to increase due to lower prices. However, the increase is expected
to be at least partially offset by the loss of some toll business to
competition. Although competition may reduce the number of toll messages
carried by the Company, it also has the effect of increasing access minutes-
of-use. (See "Toll Services Competition" on page 17.)
23
<PAGE>
Operating Revenues
------------------
Change
-----------------
($ millions) 1994 1993 Amount Percent
---------------------------------------------------------------------------
Total operating revenues........ $8,917 $8,894 $23 0.3
---------------------------------------------------------------------------
In 1994, total operating revenues increased slightly because increases due to
customer demand were partially offset by revenue reductions ordered by the
CPUC and the FCC under price cap regulation. In addition, revenues were
reduced by accruals for sharing interstate earnings with customers. The FCC
and the CPUC require the sharing of earnings above a threshold rate of return.
Revenues were also reduced due to a CPUC refund order related to customer late
payment charges. Revenues were further reduced by a July 1994 CPUC decision
which increased the productivity factor of the price cap formula from 4.5
percent to 5.0 percent. (See "CPUC Regulatory Framework Review" on page 21.)
Factors affecting revenue changes are summarized in the table below.
Price Late Product-
Cap Sharing Payment ivity Total
Operating Revenues Orders Accrual Refund Factor Misc. Demand Change
----------------------------------------------------------------------------
($ millions)
Local service..... $ (51) $ (9) $(50) $ 83 $ (27)
Network access
Interstate...... (6) (58) (5) 58 (11)
Intrastate...... (16) (3) (3) 74 52
Toll service...... (40) (7) 7 (11) (51)
Other revenue..... (27) 23 53 49
Uncollectibles.... 11 11
------ ------ ------ ------ ------ ------ ------
Total Operating
Revenues........ $(113) $(58) $(27) $(19) $(17) $257 $ 23
============================================================================
Local service revenues include basic monthly service fees and usage charges.
Fees and charges for custom calling features, coin phones, installation, and
service connections are also included in this category. The increase in local
service revenues due to customer demand in the above table reflects increased
customer access lines.
Network access revenues reflect charges to interexchange carriers and to
business and residential customers for access to the Company's local network.
The increase in interstate network access revenues due to customer demand
reported above reflects increased carrier access minutes-of-use, as well as
increased access lines. The increase in intrastate network access revenues
due to customer demand also reflects growth in carrier access minutes-of-use.
24
<PAGE>
Toll service revenues include charges for long-distance services within
service area boundaries. Unauthorized competition reduced toll service
revenues in 1994. However, this reduction was partially offset by increased
access charges paid by competitors to complete toll calls over the Company's
local network.
Other service revenues are generated from a variety of services including
directory advertising, information services, and billing and collection
services. Other service revenues for 1994 include an increase in information
service revenues of $28 million, chiefly due to the success of the Company's
business and residential voice mail products. Customer voice processing units
in service increased 37 percent in 1994.
Looking ahead, the CPUC ordered a $232 million revenue reduction for 1995 as a
result of the Company's annual price cap filing. The ordered reduction
includes a decrease of $161 million because the 5.0 percent productivity
factor of the price cap formula exceeded the growth in the Gross Domestic
Product Price Index by 2.4 percent. The order also included several other
items that will decrease revenues by an additional $71 million. In addition,
the CPUC ordered a rebalancing of prices effective January 1995. As a result,
1995 revenues will shift between service categories. (See "Toll Services
Competition" on page 17.)
In June 1994, the FCC accepted the Company's annual access tariff filing under
price cap regulation. As a result, the Company's interstate network access
revenues will be reduced about $30 million annually beginning July 1, 1994.
The decrease reflects the application of the price cap formula, increased
support payments to the National Exchange Carrier Association, and an $8
million price reduction to help the Company remain competitive with other
access providers.
Operating Expenses
------------------
Change
----------------
($ millions) 1994 1993 Amount Percent
--------------------------------------------------------------------------
Total operating expenses......... $6,606 $8,309 $(1,703) (20.5)
--------------------------------------------------------------------------
The decrease in total operating expenses for 1994 reflects the Company's
continuing cost reduction efforts and resulting expense savings. Without
restructuring and curtailment charges of $1,567 million in 1993, expenses for
1994 would have decreased $136 million or 2.0 percent.
25
<PAGE>
Factors affecting expense changes are summarized in the table below.
Pacific Bell Only Total
------------------------------- Change
Salaries Employee Subsid- from
Operating Expenses & Wages Benefits Other iaries 1993
----------------------------------------------------------------------------
($ Millions)
Cost of products
& services.......... $ (56) $ (24) $ 28 $ 5 $ (47)
Customer operations
& selling expense... (11) (1) 51 11 50
General, admin. &
other expense....... (10) (36) (154) 6 (194)
Depreciation
& amortization...... - - 48 7 55
Restructuring and
Curtailment......... - (590) (977) - (1,567)
------ ------ ------- ------ -------
Total Operating
Expenses............ $(77) $(651) $(1,004) $ 29 $(1,703)
============================================================================
The 1994 decreases in salary and wage expense and employee benefits are
primarily due to force reductions. Without the 1993 restructuring charge,
other expenses would have decreased $27 million. This restructuring charge
was recorded to recognize the incremental cost of force reductions associated
with restructuring internal business processes through 1997. (See "Status of
Restructuring Reserve" on page 30.)
The decrease in general and administrative expense in other expenses was
primarily due to $73 million in regulatory and other adjustments in 1993, a
$44 million decrease in 1994 costs for contracted programmers and plant
laborers, and a reclass of certain vendor expenses. The Company hired fewer
programmers in 1994 due to the completion of a billing system enhancement
project in 1993 and fewer contract plant laborers were utilized in 1994 due to
more favorable weather conditions. A reclass of certain vendor expenses
shifted costs from general and administrative expense to the cost of products
and services category. These decreases in other expenses were partially
offset by higher depreciation expense.
26
<PAGE>
Change
------------------
Salary and Wage Expense* 1994 1993 Amount Percent
----------------------------------------------------------------------------
($ millions)
Pacific Bell................... $2,042 $2,119 $(77) (3.6)
Subsidiaries................... 169 180 (11) (6.1)
---------------------------------------
Total Salary and Wage Expense..... $2,211 $2,299 $(88) (3.8)
----------------------------------------------------------------------------
Employees - End of Year
Pacific Bell................... 47,176 51,304 (4,128) (8.0)
Subsidiaries................... 3,031 2,722 309 11.4
---------------------------------------
Total Employees - End of Year..... 50,207 54,026 (3,819) (7.1)
============================================================================
*1993 amount restated to conform to current presentation
Salary and wage expense is the largest component of total operating expenses.
The decrease in salary and wage expense reflects force reduction savings and
lower overtime costs which were slightly offset by higher compensation rates.
Salaries and wage expense decreased primarily as a result of a net workforce
reduction of about 3,800 employees. In addition, overtime decreased
$35 million primarily because of extensive storm repairs necessary in 1993.
The effect of the declining workforce was partially offset by a $12 million
increase related to higher compensation rates. The Company expects salary and
wage expense to decline further in 1995 due to continued force reduction
programs. (See "Status of Restructuring Reserve" on page 30.) Future salary
and wage expense will be affected by the renegotiation of the Company's union
contracts which expire in August 1995.
Change
----------------
Depreciation and Amortization 1994 1993 Amount Percent
--------------------------------------------------------------------------
($ millions)
Pacific Bell.................... $1,727 $1,679 $48 2.9
Subsidiaries.................... 31 24 7 29.2
--------------------------------------
Total Depreciation and
Amortization..................... $1,758 $1,703 $55 3.2
--------------------------------------------------------------------------
Total depreciation as a percent of
average plant (%)................ 7.0 6.9 .1 -
==========================================================================
Depreciation expense in 1994 increased due to higher telephone plant balances,
a change in the composition of the Company's plant and increased depreciation
rates prescribed by regulators. Network modernization programs have caused
higher telephone plant balances resulting in higher depreciation expense.
27
<PAGE>
Higher interstate depreciation rates prescribed by the FCC increased
depreciation expense by approximately $9 million annually. Under incentive-
based regulation, the Company is not granted revenue recovery for increased
depreciation expense.
Looking ahead, new intrastate depreciation rates authorized by the CPUC in
December 1994 will increase depreciation expense by approximately $30 million
annually effective January 1, 1995. As a result of the Company's strategic
initiatives, projected capital investment is expected to continue to increase
telephone plant levels resulting in higher depreciation expense in future
years.
Change
----------------
Other Employee-Related Expenses 1994 1993* Amount Percent
--------------------------------------------------------------------------
($ millions)
Pacific Bell
Postretirement Benefits......... $299 $331 $(32) (9.7)
Healthcare and life insurance
benefits of active employees.. 210 211 (1) (0.5)
Other benefits.................. 76 113 (37) (32.7)
Payroll taxes................... 159 165 (6) (3.6)
Pensions........................ 9 (6) 15 250.0
-------------------------------------
Total Pacific Bell................. $753 $814 $(61) (7.5)
Subsidiaries....................... 39 46 (7) (15.2)
-------------------------------------
Total Employee-Related Expenses.... $792 $860 $(68) (7.9)
===========================================================================
* 1993 amounts exclude SFAS 106 curtailment and postemployment benefits
accounting change (See "Cumulative Effect of Prior Year Accounting Change"
on page 30 and Note B - "Restructuring and Curtailment Charges" on
page 45.)
Other employee-related expenses decreased $68 million, excluding the 1993
effects of the postretirement benefits curtailment and change in accounting
principle. (See "Change in Accounting for Postretirement and Postemployment
Costs" in Note A on page 45.) The decrease in this category is primarily
attributable to the Company's continued force reduction programs.
Postretirement benefits expense decreased primarily due to reduced expense
associated with the amortization of the transition obligation resulting from
the 1993 curtailment. Miscellaneous adjustments to true-up certain benefit
liabilities, including a $36 million reduction in other benefits, also lowered
other employee-related expenses.
28
<PAGE>
Income Taxes
------------
Change
----------------
($ millions) 1994 1993 Amount Percent
--------------------------------------------------------------------------
Income taxes...................... $621 $(57) $678 -
Effective tax rate (%)............ 36.7 132.4 (95.7) -
--------------------------------------------------------------------------
The increase in income taxes for 1994 reflects the Company's higher pre-tax
income. This increase was slightly offset by the Company's ability to claim
more tax credits this year and several tax true-ups which together lowered tax
expense by a net $30 million.
Interest Expense
----------------
Change
----------------
($ millions) 1994 1993 Amount Percent
--------------------------------------------------------------------------
Interest expense................. $439 $429 $10 2.3
--------------------------------------------------------------------------
Interest expense increased slightly when compared with 1993. Interest on
long-term debt decreased $29 million, including an $18 million reduction
related to higher borrowing levels in 1993 and $11 million in savings due to
lower interest rates resulting from refinancings. Long-term debt levels were
temporarily higher in 1993 due to time-lags between new debt issuances and the
retirements of refinanced amounts. These decreases were more than offset by
miscellaneous increases in interest expense related to the CPUC's late payment
charges decision, interest on certain regulatory refunds and other financing
charges.
Other Income (Expense)
----------------------
Change
----------------
($ millions) 1994 1993 Amount Percent
--------------------------------------------------------------------------
Other income (expense)............. $3 $(14) $17 121.4
--------------------------------------------------------------------------
Other income (expense) in 1994 increased in comparison to the 1993 amount
which had included increased debt refinancing costs.
29
<PAGE>
Cumulative Effect of Prior Year Accounting Change
-------------------------------------------------
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 112, "Employer's Accounting for
Postemployment Benefits." SFAS 112 requires a change from cash to accrual
accounting by recording a cumulative catch-up-charge at implementation. A
one-time, noncash charge was recorded against earnings of $148 million, which
is net of a deferred income tax benefit of $103 million. The Company was
unable to defer these charges under the criteria for recognizing a regulatory
asset under SFAS 71, "Accounting for the Effects of Certain Types of
Regulation." The annual periodic expense does not differ materially from
expense under the prior method.
Status of Restructuring Reserve
-------------------------------
In recent years, the Company has established reserves to record the effects of
restructuring certain parts of its business.
In 1991, a $201 million reserve was established for the cost of management
force reduction programs through 1994. A balance of $77 million remained at
the end of 1993. An additional $1,020 million reserve was established in
December 1993 to record the incremental cost of force reductions associated
with restructuring Pacific Bell's business processes through 1997. This
restructuring will allow Pacific Bell to eliminate more than 14,000 employee
positions by the end of 1997. After considering new positions expected to be
created, a net reduction of approximately 10,000 positions is anticipated.
Pacific Bell also expects to relocate approximately 10,000 employees as it
consolidates business offices, network facilities, installation and collection
centers, and other operations.
Under the restructuring plan, Pacific Bell had anticipated gross force
reductions of approximately 2,700 employees in 1994. However, Pacific Bell's
actual 1994 gross force reduction was 5,852. The excess primarily represents
pension-eligible employees who took advantage of favorable discount rates
coupled with early retirement incentives to leave the business in 1994. After
new hires, the net reduction was 4,128. Pacific Bell now expects gross force
reductions in 1995 will be about 3,000 employees, rather than the 5,500
previously forecast. Gross force reductions for the restructuring period are
not expected to differ materially from the original forecast, although the
timing of the reductions may vary depending on the outcome of labor contract
negotiations and other variables.
30
<PAGE>
Due to the higher force reductions, estimated 1994 expense savings from the
restructuring of $187 million exceeded the original estimate by about
$20 million. Charges to the reserve totaled $278 million, $52 million more
than the original estimate of $226 million. Of this amount, severance costs
of $170 million exceeded the original $120 million estimate by $50 million;
systems costs of $92 million were $2 million less than the original
$94 million estimate; and facilities consolidation costs of $16 million
exceeded the original $12 million estimate by $4 million. The overrun in
severance costs reflects the larger than expected force reductions. Severance
costs include $62 million of costs for enhanced retirement benefits paid from
pension fund assets which do not require current outlays of the Company's
funds. Pension plan gains offsetting the 1994 loss are expected in 1995
through 1997 as more force reductions occur under nonpension-related
offerings.
Because of the acceleration of force reductions into 1994, charges to the
restructuring reserve in 1995 are expected to be approximately $50 million
less than the $436 million previously forecast. Also included in the reserve
were estimated costs of $280 million in 1996 and $155 million in 1997. Actual
costs are not expected to differ materially from these estimates. Savings in
1995, primarily in labor costs from force reductions, are expected to slightly
exceed 1995 restructuring costs. Annual savings, primarily in labor costs,
are expected to reach approximately $1 billion when the restructuring is
completed.
See Schedule II on page 63 for a table detailing the status and activity of
the reserve.
PENDING REGULATORY ISSUES
Postretirement Benefits Other Than Pensions
-------------------------------------------
In 1992, the CPUC issued a decision adopting, with modification, SFAS 106,
"Employers' Accounting for Postretirement Benefits Other than Pensions," for
regulatory accounting purposes. The CPUC decision also granted the Company
revenue increases for recovery of contributions to tax-advantaged funding
vehicles for SFAS 106 costs. 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.
31
<PAGE>
Structural Separations Requirements
-----------------------------------
In October 1994, the U.S. Court of Appeals for the Ninth Circuit overturned
the FCC's removal of its structural separations requirements for the offering
of enhanced services by the former Bell Operating Companies ("BOCs"),
including the Company.
In January 1995, the FCC granted a waiver allowing the Company and other BOCs
to continue current enhanced service offerings, conduct research and
development, and seek FCC approval for new service offerings. The
reimposition of structural separations requirements would result in increased
costs and reduced revenues and would delay the introduction of new products
and services.
Information Services Subsidiary
-------------------------------
Effective January 1, 1993, the Company transferred its Information Services
Group to a wholly-owned subsidiary, Pacific Bell Information Services
("PBIS"). PBIS provides business and residential voice mail and other
selected information services. In 1992, the CPUC issued a decision which
required the Company to reduce revenues by the difference between the "going
concern" value of PBIS and its adjusted net book value. In 1993, the Company
filed a Petition for Modification of the decision based on its belief that the
decision resulted in a double refund to customers. The CPUC has taken no
action on the petition. In May 1994, the Company began refunding about
$12.5 million over 12 months.
APPLICABILITY OF REGULATORY ACCOUNTING
The Company currently accounts for the economic effects of regulation under
SFAS 71. 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 monitors the effects of competition and
changes in regulation to assess the likelihood it will continue to recover its
costs. 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. 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. (See "Accounting Under Regulation" in Note A on
page 42 for a discussion of regulatory assets and liabilities included in the
balance sheet.)
32
<PAGE>
Item 8. Financial Statements and Supplementary Data.
REPORT OF MANAGEMENT
The management of Pacific Bell is responsible for preparing the accompanying
financial statements and for their integrity and objectivity. The statements
have been prepared in accordance with generally accepted accounting principles
applied on a consistent basis and are not misstated due to material fraud or
error. In instances where exact measurement is not possible, the financial
statements include amounts based on management's best estimates and judgments.
Management also prepared the other information contained in this annual
financial review and is responsible for its accuracy and consistency with the
financial statements.
The Company's financial statements have been audited by Coopers & Lybrand
L.L.P., independent accountants. Management has made available to Coopers
& Lybrand L.L.P. the Company's financial records and related data, as well as
the minutes of directors' meetings. Furthermore, management believes that all
of its representations made to Coopers & Lybrand L.L.P. during their audit are
valid and appropriate.
Management has established and maintains a system of internal control that
provides reasonable assurance as to the integrity and reliability of the
financial statements, the protection of assets from unauthorized use or
disposition, and the prevention and detection of fraudulent financial
reporting. The system of internal control provides for appropriate division
of responsibility and is documented by written policies and procedures that
are communicated to employees with significant roles in the financial
reporting process and are updated as necessary. Management continually
monitors the system of internal control for compliance, and maintains a strong
internal auditing program that independently assesses the effectiveness of the
internal controls and recommends improvements when necessary. In addition,
as part of their audit of the Company's financial statements, Coopers
& Lybrand L.L.P. have obtained a sufficient understanding of the internal
control structure to determine the nature, timing and extent of audit tests to
be performed. Management has considered the internal auditors' and Coopers
& Lybrand L.L.P.'s recommendations concerning the Company's system of internal
control and has taken actions that it believes are cost-effective under the
circumstances to respond appropriately to these recommendations. Management
believes that the Company's system of internal control is adequate to
accomplish the objectives discussed.
Management also recognizes its responsibility to foster a strong ethical
climate that enables the Company to conduct its affairs according to the
highest standards of personal and corporate conduct. This responsibility is
characterized and reflected in the Company's code of corporate conduct, which
is publicized throughout the Company. The code of conduct addresses, among
other things: potential conflicts of interests; compliance with domestic
laws, including those relating to foreign transactions and financial
disclosure; and the confidentiality of proprietary information. The Company
maintains a systematic program to assess compliance with these policies.
33
<PAGE>
Financial Statements and Supplementary Data (continued)
The Audit Committee of the Board of Directors is responsible for overseeing
the Company's financial reporting process on behalf of the Board. In
fulfilling its responsibility, the Committee recommends to the Board, subject
to shareowner ratification, the selection of the Company's independent
accountants. The Committee consists of five members of the Board who are
neither officers nor employees of the Company. It meets regularly with
representatives of management, internal audit and the independent accountants
to review internal accounting controls and accounting, auditing and financial
reporting matters. During 1994, the Committee held five meetings. The
Company's internal auditors and independent accountants periodically meet
alone with the Committee to discuss the matters previously noted and have
direct access to it for private communication at any time.
34
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowner of Pacific Bell:
We have audited the consolidated financial statements and the financial
statement schedule of Pacific Bell (a wholly-owned subsidiary of Pacific
Telesis Group) and Subsidiaries (the "Company") as listed in Item 14(a) of
this Form 10-K. These financial statements and the financial statement
schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and the
financial statement schedule based on our audits.
As discussed in Note A to the Consolidated Financial Statements, the Company
adopted new accounting rules for postretirement and postemployment benefits
during 1993.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform an audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Pacific Bell and
Subsidiaries as of December 31, 1994 and 1993 and the consolidated results of
their operations and their cash flows for each of the three years in the
period ended December 31, 1994 in conformity with generally accepted
accounting principles. In addition, in our opinion, the financial statement
schedule referred to above, when considered in relation to the basic financial
statements taken as a whole, presents fairly, in all material respects, the
information required to be included therein.
/s/ Coopers & Lybrand L.L.P.
San Francisco, California
February 23, 1995
35
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
For the year ended
December 31,
----------------------------
(Dollars in millions) 1994 1993 1992
---------------------------------------------------------------------------
OPERATING REVENUES:
Local service............................ $3,385 $3,411 $3,316
Network access
Interstate............................. 1,561 1,572 1,534
Intrastate............................. 731 679 663
Toll service............................. 1,984 2,035 2,082
Other revenues........................... 1,406 1,358 1,330
Less: provision for uncollectibles....... 150 161 176
------- ------- -------
Total Operating Revenues................... 8,917 8,894 8,749
------- ------- -------
OPERATING EXPENSES:
Cost of products and services............ 1,898 1,945 1,870
Depreciation and amortization............ 1,758 1,703 1,674
Customer operations and selling expense.. 1,846 1,796 1,512
General, administrative and
other expense.......................... 1,104 1,298 1,391
Restructuring and curtailment............ - 1,567 -
------- ------- -------
Total Operating Expenses................... 6,606 8,309 6,447
------- ------- -------
Net Operating Revenues..................... 2,311 585 2,302
------- ------- -------
Operating Taxes:
Income taxes............................. 621 (57) 607
Other taxes.............................. 183 181 187
------- ------- -------
Total Operating Taxes...................... 804 124 794
------- ------- -------
OPERATING INCOME........................... 1,507 461 1,508
------- ------- -------
Other Income (Expense) 3 (14) 83
------- ------- -------
Income before interest expense and
cumulative effect of change in accounting
principle................................ 1,510 447 1,591
Interest expense........................... 439 429 460
------- ------- -------
Income before cumulative effect of change
in accounting principle.................. 1,071 18 1,131
Cumulative effect of change in accounting
principle................................ - (148) -
------- ------- -------
NET INCOME (LOSS).......................... $1,071 $ (130) $1,131
===========================================================================
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
36
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
(Dollars in millions) 1994 1993
---------------------------------------------------------------------------
ASSETS
Cash and cash equivalents......................... $ 62 $ 57
Accounts receivable-net of allowances for
uncollectibles of $132 and $136................. 1,531 1,518
Prepaid expenses and other current assets......... 950 862
-------- --------
Total current assets.............................. 2,543 2,437
-------- --------
Property, plant, and equipment.................... 26,107 25,660
Less: accumulated depreciation................. 10,243 9,708
-------- --------
Property, plant, and equipment - net.............. 15,864 15,952
-------- --------
Deferred charges and other noncurrent assets...... 963 989
-------- --------
TOTAL ASSETS...................................... $19,370 $19,378
===========================================================================
LIABILITIES AND SHAREOWNER'S EQUITY
Accounts payable:
Trade........................................... 474 $ 377
Other........................................... 1,106 878
-------- --------
Total accounts payable............................ 1,580 1,255
Debt maturing within one year..................... 255 542
Other current liabilities......................... 1,366 1,136
-------- --------
Total current liabilities......................... 3,201 2,933
-------- --------
Long-term obligations............................. 4,752 4,753
-------- --------
Deferred Credits:
Accumulated deferred income taxes............... 2,315 2,280
Other noncurrent liabilities and deferred
credits...................................... 2,878 3,258
-------- --------
Total deferred credits............................ 5,193 5,538
-------- --------
Commitments and contingencies (Note I)
Common shares ($1.00 stated value, 300,000,000
shares authorized, 224,504,982 shares issued
and outstanding)................................ 225 225
Additional paid-in capital........................ 5,169 5,168
Reinvested earnings............................... 830 761
-------- --------
Total shareowner's equity......................... 6,224 6,154
-------- --------
TOTAL LIABILITIES AND SHAREOWNER'S EQUITY......... $19,370 $19,378
===========================================================================
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
37
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREOWNER'S EQUITY
For the year ended
December 31,
-----------------------------
(Dollars in millions) 1994 1993 1992
---------------------------------------------------------------------------
COMMON STOCK
Balance at beginning of year............. $ 225 $ 225 $ 225
------- ------- -------
Balance at end of year................... 225 225 225
------- ------- -------
ADDITIONAL PAID-IN CAPITAL
Balance at beginning of year............. 5,168 5,168 5,168
Equity investment by parent.............. 1 - -
------- ------- -------
Balance at end of year................... 5,169 5,168 5,168
------- ------- -------
REINVESTED EARNINGS
Balance at beginning of year............. 761 1,898 1,824
Net Income (Loss)........................ 1,071 (130) 1,131
Common dividends declared................ (998) (1,007) (1,057)
Other.................................... (4) - -
------- ------- -------
Balance at end of year................... 830 761 1,898
------- ------- -------
TOTAL SHAREOWNER'S EQUITY.................. $6,224 $6,154 $7,291
===========================================================================
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
38
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the year ended
December 31,
----------------------------
(Dollars in millions) 1994 1993 1992
---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES
Net Income (loss)......................... $ 1,071 $(130) $1,131
Adjustments to reconcile net income for
items currently not affecting operating
cash flows:
Depreciation and amortization......... 1,758 1,703 1,674
Restructuring and curtailment......... - 1,567 -
Deferred income taxes................. 1 (525) (686)
Unamortized investment tax credits.... (63) (48) (61)
Allowance for funds used during
construction........................ (28) (34) (31)
Changes in operating assets and
liabilities:
Accounts receivable............... (24) (78) 74
Prepaid expenses and other current
assets.......................... (1) 23 108
Deferred charges and other
noncurrent assets............... (25) 76 (6)
Accounts payable.................. 164 128 18
Other current liabilities......... 46 (71) 66
Other noncurrent liabilities and
deferred credits................ (7) 129 452
Other adjustments, net................ 10 31 12
-------- -------- --------
Cash from operating activities.............. 2,902 2,771 2,751
-------- -------- --------
CASH FROM (USED FOR) INVESTING ACTIVITIES
Additions to property, plant, and
equipment .............................. (1,612) (1,802) (1,669)
Other investing activities, net........... 2 (11) (3)
-------- --------- --------
Cash used for investing activities.......... (1,610) (1,813) (1,672)
===========================================================================
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
(Continued next page)
39
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
For the year ended
December 31,
----------------------------
(Dollars in millions) 1994 1993 1992
---------------------------------------------------------------------------
CASH FROM (USED FOR) FINANCING ACTIVITIES
Proceeds from issuance of long-term debt.... $ - $ 2,578 $ 925
Retirements of long-term debt............... (11) (2,669) (972)
Equity infusion from parent................. 1 - -
Dividends paid.............................. (998) (1,007) (1,057)
Increase (decrease)in short-term
borrowings, net........................... (287) 133 116
Principal payments under capital lease
obligations............................... 8 (5) (5)
Other financing activities, net............. - 12 (74)
-------- -------- --------
Cash used for financing activities.......... (1,287) (958) (1,067)
-------- -------- --------
Increase (decrease) in cash and cash
equivalents............................... 5 0 12
Cash and cash equivalents at January 1...... 57 57 45
-------- -------- --------
Cash and cash equivalents at December 31.... $ 62 $ 57 $ 57
===========================================================================
The accompanying Notes are an integral part of the Consolidated Financial
Statements.
40
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Pacific Bell ("the Company"), a wholly-owned subsidiary of Pacific Telesis
Group ("the Corporation"), provides telecommunications services including
local exchange, network access and toll services; directory advertising
through its wholly-owned subsidiary, Pacific Bell Directory ("Directory);
and selected information services through its wholly-owned subsidiary,
Pacific Bell Information Services ("PBIS"). In 1994, the Company
established a new subsidiary, Pacific Bell Mobile Services ("PBMS"), to
offer personal communications and other mobile telecommunications
services.
The Consolidated Financial Statements include the accounts of Pacific
Bell, Directory, PBIS, and PBMS. All significant intercompany balances
and transactions have been eliminated. The Consolidated Balance Sheet for
1993 reflects certain reclassifications made to conform with the current
presentation.
41
<PAGE>
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
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:
December 31,
1994 1993
-----------------------------------------------------------------------
(Dollars in millions)
Regulatory assets (liabilities) due to:
Deferred pension costs*.................. $ 407 $ 340
Unamortized debt redemption costs**...... 346 357
Deferred compensated absence costs*...... 212 226
Unamortized purchases of property, plant,
and equipment under $500............... 106 140
Deferred income taxes***................. (185) (228)
Other.................................... 48 64
-------- --------
Total .................................... $ 934 $ 899
-----------------------------------------------------------------------
* 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."
Deferred pension costs above reflect an order by the California Public
Utilities Commission (the "CPUC") requiring the Company to use the
"aggregate cost method" for its intrastate operations. These deferred
costs represent differences between the Company's intrastate pension
costs calculated using this actuarial method, subject to Internal Revenue
Service (the "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 Statement of
Financial Accounting Standards No. 88 ("SFAS 88"), "Employers' Accounting
for Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits."
42
<PAGE>
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
When debt is refinanced before maturity, the Company amortizes to expense
any difference between net book value and redemption price evenly over
the term of the replacing issue for its intrastate operations, in
accordance with the ratemaking treatment of such costs by the CPUC.
These costs are expensed as incurred for interstate operations.
In prior years, the CPUC and the Federal Communications Commission (the
"FCC") changed the required accounting for the costs of compensated
absences, such as vacation days, from a cash basis to an accrual basis.
A transition liability for earned, but unused, compensated absence days
is being amortized to expense over periods prescribed by each regulator.
However, the CPUC continues to require the Company to recognize certain
compensated absence costs on a cash basis for ratemaking. The above
regulatory asset for compensated absences reflects those costs which have
been deferred in accordance with ratemaking treatment.
In 1989 and 1990, 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.
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.
43
<PAGE>
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
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 and conduit............................. 10 to 30
Central office equipment...................... 9 to 16.5
Furniture, equipment, and other............... 5.5 to 20
=======================================================================
An unregulated enterprise may have selected shorter depreciable lives for
similar assets. At this time, the 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.
Cash and Cash Equivalents
Cash equivalents include all highly liquid monetary instruments with
maturities of ninety days or less from the date of purchase. In its cash
management practices, the Company maintains zero-balance disbursement
accounts for which funds are made available as checks are presented for
clearance. Checks outstanding are included in accounts payable.
Income Taxes
Pacific Telesis Group allocates consolidated taxes as if the Company were
a separate taxpayer. The Company records its share of the consolidated
taxes as tax liabilities and pays amounts due to tax authorities through
Pacific Telesis Group.
Deferred income taxes are provided to reflect the tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for tax purposes.
Investment tax credits earned prior to their repeal by the Tax Reform Act
of 1986 are amortized as reductions in tax expense over the lives of the
assets which gave rise to the credits.
44
<PAGE>
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont'd)
Advertising Costs
Costs for advertising products and services or corporate image are
expensed as incurred.
Change in Accounting for Postretirement and Postemployment Costs
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 112 ("SFAS 112"), "Employers' Accounting for
Postemployment Benefits." SFAS 112 establishes accounting standards for
benefits that are provided to former or inactive employees after
employment but before retirement. SFAS 112 required immediate recognition
of the cumulative effect of applying the new rule to prior years. The
Company restated first quarter 1993 results to recognize a postemployment
benefit liability of $251 million. The net income impact of adopting this
accounting standard was $148 million, net of a deferred income tax benefit
of $103 million. The annual periodic expense under SFAS 112 does not
differ materially from expense under the prior method.
Effective January 1, 1993, the Company adopted Statement of Financial
Accounting Standards No. 106 ("SFAS 106"), "Employers' Accounting for
Postretirement Benefits Other than Pensions." Annual price cap decisions
by the CPUC granted the Company $100 million and $108 million in 1994 and
1993, respectively, for partial recovery of its higher costs. However,
the CPUC in October 1994 reopened a proceeding to determine if the Company
should continue to recover these costs. (See "Revenues Subject to Refund"
in Note I on page 56.)
The Company was unable to defer these charges under the criteria for
recognizing a regulatory asset under SFAS 71. The FCC did not provide
additional recovery for either new accounting standard. The CPUC did not
provide the Company additional recovery for SFAS 112 and only provided
partial recovery of its higher costs under SFAS 106. In addition, the
Company is required to reapply for this recovery each year. Therefore,
the recovery period is uncertain but exceeds the 20-year period required
by accounting rules for deferral of these costs.
B. RESTRUCTURING AND CURTAILMENT CHARGES
In 1993, the Company recorded a pre-tax restructuring charge of
$977 million to recognize the incremental cost of force reductions
associated with restructuring its internal business processes through
1997. This charge is to cover the incremental severance costs associated
with terminating approximately 14,400 employees from 1994 through 1997.
It will also cover the incremental costs of consolidating and streamlining
operations and facilities to support this downsizing initiative.
45
<PAGE>
B. RESTRUCTURING AND CURTAILMENT CHARGES (Cont'd)
In addition, the Company recorded a $590 million pre-tax expense to
accelerate recognition of a portion of its embedded post-retirement
benefits costs that would otherwise have been recorded over the next
19 years. Accelerated recognition of these costs is required under the
curtailment provisions of SFAS 106 because the Company expects to
significantly reduce its workforce. Because Pacific Telesis Group already
recognized all of its post-retirement benefit transition costs in the
first quarter 1993, this additional charge did not affect its consolidated
financial statements.
C. INCOME TAXES
The components of income tax expense for each year are as follows:
Income Tax Expense 1994 1993 1992
----------------------------------------------------------------------
(Dollars in millions)
Current:
Federal.................................. $552 $519 $649
State and local income taxes............. 166 156 170
--------------------------
Total current.............................. 718 675 819
Deferred:
Federal.................................. (29) (548) (107)
State and local income taxes............. (7) (148) (12)
--------------------------
Total deferred............................. (36) (696) (119)
--------------------------
Amortization of investment
tax credits - net........................ (63) (51) (61)
--------------------------
Total income taxes......................... 619 (72) 639
Less: Non-operating income tax
expense (benefit)........................ (2) (15) 32
---------------------------
Operating income taxes..................... $621 $(57) $607
======================================================================
46
<PAGE>
C. INCOME TAXES (Cont'd)
Significant components of the Company's deferred tax assets and
liabilities are as follows:
December 31
-----------------
Deferred Tax Assets and Liabilities 1994 1993
----------------------------------------------------------------------
(Dollars in millions)
Deferred tax (assets)/liabilities due to:
Depreciation and amortization.................... $2,885 $2,971
Restructuring.................................... (359) (401)
Employee Benefits................................ (371) (321)
Customer rate reductions......................... (146) (126)
Other, net....................................... (74) (189)
------ ------
Net deferred tax liabilities....................... $1,935 $1,934
====== ======
Amounts recorded in consolidated
balance sheet:
Deferred tax assets*......................... $1,418 $1,449
======= =======
Deferred tax liabilities*.................... $3,353 $3,383
======= =======
=======================================================================
* Reflects reclassification of certain current and noncurrent amounts
by federal and state tax jurisdictions to a net presentation.
Amounts include both current and noncurrent portions. (See Note J -
"Additional Financial Information" on page 57 for current deferred
tax benefits.)
During August 1993, new tax provisions were enacted under the Omnibus
Budget Reconciliation Act of 1993 which included an increase in the
corporate tax rate from 34 to 35 percent retroactive to January 1, 1993.
The cumulative effect of the new tax provisions was recognized during
third quarter 1993 increasing tax expense by $15 million. However, this
increase was offset by the tax benefit recognized in fourth quarter 1993
due to restructuring and curtailment. Overall, the new tax provisions did
not affect the Company's 1993 tax expense for the year.
47
<PAGE>
C. INCOME TAXES (Cont'd)
The reasons for differences each year between the effective income tax
rate and applying the statutory federal income tax rate to pre-tax income
are provided in the following reconciliation:
Effective Tax Rate 1994 1993 1992
-----------------------------------------------------------------------
Federal statutory rate...................... 35.0% 35.0% 34.0%
Increase (decrease) in taxes resulting from:
Plant basis differences - net of
applicable depreciation................. 2.0 (63.6) 2.0
Amortization of investment tax credits.... (3.6) 92.9 (3.5)
State income taxes - net of federal
income tax benefit...................... 6.1 (9.2) 5.9
Excess deferred taxes..................... (2.8) 70.1 (3.6)
Other differences......................... 0.0 7.2 1.3
--------------------------
Effective income tax rate................... 36.7% 132.4% 36.1%
=======================================================================
The 1993 effective tax rate increased due to lower pre-tax income caused
by the restructuring charge and the postretirement benefits curtailment.
During 1992, the Company was refunded $113 million from the IRS under a
Summary Assessment relating to contested issues for pre-divestiture tax
years 1979 and 1980. As a result of the refund and $68 million of related
interest, 1992 net income increased $44 million.
D. EMPLOYEE RETIREMENT PLANS
Defined Benefit Plans
The Company provides pension, death and survivor benefits to substantially
all of its employees through participation in certain Pacific Telesis
Group defined benefit pension plans. Nonsalaried plan benefits are based
on a flat dollar amount and vary according to job classification, age, and
years of service. Salaried plan benefits are based on a percentage of
final five-year average pay and vary according to age and years of
service.
The Company is responsible for contributing enough to the pension plans,
while the employee is still working, to ensure that adequate funds are
available to provide the benefit payments upon the employee's retirement.
These contributions are made to an irrevocable trust fund in amounts
determined using the aggregate cost actuarial method, one of the actuarial
methods specified by the Employee Retirement Income Security Act of 1974
("ERISA"), subject to ERISA and Internal Revenue Code limitations.
48
<PAGE>
D. EMPLOYEE RETIREMENT PLANS (Cont'd)
The Company reports pension costs and related obligations under the
provisions of SFAS 87 and SFAS 88. Regulatory accounting under SFAS 71
requires the Company to recognize pension cost consistent with its
ratemaking treatment. Pension cost recognized reflects a CPUC order
requiring the continued use of the aggregate cost method for intrastate
operations and an FCC requirement to use SFAS 87 and SFAS 88 for
interstate operations.
During 1994, special pension benefits and cash incentives were offered in
connection with the Company's restructuring and related force reduction
program. On March 28, 1994, the Company offered a special pension benefit
which removed any age discount from pensions for management employees who
were eligible to retire with a service pension on that date. Also during
1994, pension benefit increases were offered to various groups of
nonsalaried employees under 1992 plan amendments which increase benefits
for specified groups who elect early retirement under incentive programs.
Approximately 3,400 employees left Pacific Bell during 1994 under early
retirement or voluntary and involuntary severance programs. During 1992,
approximately 1,000 of the Company's nonsalaried employees elected to
retire early under an incentive program.
Components of pension costs and the funded status of the plans are not
presented because the structure of the Pacific Telesis Group-sponsored
plans does not currently permit this data to be disaggregated by
subsidiary. Annual pension cost in the following table excludes
$62 million of additional pension costs charged to Pacific Bell's
restructuring reserve in 1994 and excludes $5 million of additional
pension expense for incentive programs in 1992. As required by regulatory
accounting, pension cost in the table below also excludes the intrastate
portion of the Company's SFAS 87 costs of $79, $53, and $54 million for
1994, 1993 and 1992, respectively. (See "Accounting under Regulation" in
Note A on page 42 for amounts of regulatory assets associated with
deferred pension costs.)
Annual pension cost recognized in the financial statements during each
year presented are:
Pension Cost 1994 1993 1992
-----------------------------------------------------------------------
(Dollars in millions)
Current year pension cost................ $ 28 $ 10 $ 0
Settlements & curtailments............... (10) (10) 5
----------------------------
Pension cost recognized.................. $ 18 $ 0 $ 5
=======================================================================
The amounts shown above for annual pension cost reflect the effects of
strong fund asset performance in prior years and IRS funding limitations.
49
<PAGE>
D. EMPLOYEE RETIREMENT PLANS (Cont'd)
Pension Obligation 1994 1993
-----------------------------------------------------------------------
(Dollars in millions)
Accumulated Benefit Obligation............... $8,008 $8,537
Vested Benefit Obligation.................... $7,174 $7,668
-----------------------------------------------------------------------
Accrued pension cost liability
recognized in the consolidated
balance sheets............................. $ 753 $620
-----------------------------------------------------------------------
Present value discount rate (%).............. 8.0 7.5
Long-term rate of return on plan
assets (%) ................................ 8.0 -
=======================================================================
The assets of the plans are primarily composed of common stocks,
U.S. Government and corporate obligations, index funds, and real estate
investments. The plans' projected benefit obligations for employee
service to date reflect the Corporation's expectations of the effects of
future salary progression and benefit increases.
Effective December 31, 1993, the salaried pension plan was amended to
permanently remove the age discount from pension benefits for employees
with 30 or more years of net credited service. Effective January 1, 1995,
the salaried pension plan was also amended to cap net credited service for
pension benefits at 30 years or, if greater, the amount of the employee's
service on January 1, 1995. Upon adoption, these amendments affected
approximately 400 and 800 employees, respectively.
The Company has entered into labor negotiations with union-represented
employees in the past and expects to do so in the future. Pension
benefits have been included in these negotiations, and improvements in
benefits have been made periodically. Additionally, the Company has
increased benefits to pensioners on an ad hoc basis. While no assurance
can be offered with respect to future increases, the Company's
expectations for future benefit increases have been reflected in
determining pension costs.
Defined Contribution Plans
The Company also participates in certain Pacific Telesis Group-sponsored
defined contribution retirement plans covering substantially all
employees. These plans include the Pacific Telesis Group Supplemental
Retirement and Savings Plan for Salaried Employees and, and the Pacific
Telesis Group Supplemental Retirement and Savings Plan for Nonsalaried
Employees (collectively, the "Savings Plans").
50
<PAGE>
D. EMPLOYEE RETIREMENT PLANS (Cont'd)
The Company's contributions to the Savings Plans are based on matching a
portion of employee contributions. All matching employer contributions to
the Savings Plans are made through a leveraged employee stock ownership
("LESOP") trust. Total Company contributions to these plans, including
contributions allocated to participant accounts through the LESOP trust,
were $64, $64 million and $61 million in 1994, 1993 and 1992,
respectively.
E. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS
Substantially all retirees and their dependents are covered under the
Company's plans for medical, dental and life insurance benefits.
Approximately 41,000 retirees were eligible to receive these benefits as
of January 1, 1994. Currently, the Company pays the full cost of retiree
health benefits. However, by 1999, all employees retiring after 1990 will
pay a share of the costs of medical coverage that exceeds a defined dollar
medical cap. Such future cost sharing provisions have been reflected in
determining the Company's postretirement benefit costs. The Company
retains the right, subject to applicable legal requirements, to amend or
terminate these benefits.
Effective January 1, 1993, the Company adopted SFAS 106. The standard
requires that the cost of retiree benefits be recognized in the financial
statements from an employee's date of hire until the employee becomes
eligible for these benefits. Previously, the Company expensed these
retiree benefits as they were paid. The Company is amortizing the
transition obligation over 20 years. The transition obligation represents
the unrecognized cost of benefits that had already been earned by retirees
and active employees when the new standard was adopted.
The Company's periodic expense under SFAS 106 in 1994 and 1993, as
displayed in the table below, increased from a level of $103 million in
costs in 1992 under the prior method. The Company's higher postretirement
benefits costs are being partially recovered in revenues pursuant to CPUC
rules. (See "Change in Accounting for Postretirement and Postemployment
Costs" in Note A on page 45.)
51
<PAGE>
E. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (Cont'd)
The components of net periodic postretirement benefit cost for 1994 and
1993 are as follows:
Postretirement Benefit Cost 1994 1993
---------------------------------------------------------------------
(Dollars in millions)
Service cost.................................. $57 $40
Interest cost on accumulated postretirement
benefit obligation.......................... 251 242
Actual return on plan assets.................. (17) (79)
Net amortization and deferral................. 45 160
Curtailment due to force reduction............ - 632
------ -----
Postretirement periodic benefit cost.......... $336 $995
=====================================================================
Pacific Bell partially funds the obligation by contributing to Voluntary
Employee Benefit Association trusts. Plan assets are invested primarily
in domestic and international stocks and domestic investment-grade bonds.
An 8.5 percent long-term rate of return on assets is assumed in
calculating postretirement benefit costs.
The funded status of the plans follows:
December 31,
Postretirement Benefit Obligation 1994 1993
---------------------------------------------------------------------
(Dollars in millions)
Accumulated postretirement benefit obligation*:
Retirees.................................. $2,250 $2,314
Eligible active employees................. 264 207
Other active employees.................... 784 919
------ -------
Total accumulated postretirement benefit
obligation................................. $3,298 $3,440
Less:
Fair value of plan assets*................ (860) (786)
Transition obligation..................... (1,704) (1,799)
Unrecognized net loss**................... (157) (328)
------ -------
Accrued net postretirement benefit obligation
recognized in the consolidated
balance sheets............................. $ 577 $ 527
=====================================================================
52
<PAGE>
E. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS (Cont'd)
* The measurement date for determining the accumulated postretirement
benefit obligation and fair value of plan assets was changed to
December 31, 1994, from September 30 in 1993. The fair value of plan
assets as of December 31, 1993 includes contributions made during
fourth quarter 1993 after the measurement date that year. Fair value
of plan assets reflect an estimated allocation of the Company's
portion of Pacific Telesis Group plans' assets.
** The unrecognized net loss is amortized over time and reflects
differences between actuarial assumptions and actual experience. It
also includes the impact of changes in actuarial assumptions.
The assumed discount rate used to measure the accumulated postretirement
benefit obligation was 8.0 percent for 1994 and 7.5 percent for 1993. An
annual increase in health care costs of 13 percent was assumed for 1995,
declining ultimately to an assumed rate of 6 percent by the year 2002.
Increasing the assumed health care cost trend rates by one percent each
year, would increase the December 31, 1994 accumulated postretirement
benefit obligation by $424 million and increase the combined service and
interest cost components of net periodic postretirement benefit cost for
1994 by $39 million.
Effective January 1, 1993, the Company adopted SFAS 112 for accounting for
postemployment benefits which required a change from cash to accrual
accounting. Postemployment benefits offered by the Company include
workers compensation, disability benefits, medical benefit continuation,
and severance pay. These benefits are paid to former or inactive
employees who terminate without retiring. A one-time, noncash charge
representing prior benefits earned was recorded in 1993 which reduced
earnings by $148 million. The charge was net of a deferred income tax
benefit of $103 million. The annual periodic expense under SFAS 112 does
not differ materially from expense under the prior method.
53
<PAGE>
F. DEBT AND LEASE OBLIGATIONS
Long-term obligations as of December 31, 1994 and 1993 consist of
debentures of $4,047 million each year, and corporate notes of $1,150 and
$1,161 million, respectively. Maturities and interest rates of long-term
obligations follow:
December 31
-------------------------
Long-Term Obligations 1994 1993
--------------------------------------------------------------------
(Dollars in millions)
1999 4.625%................ $ 100 $ 100
2000-2043 4.625% to 8.700%...... 5,097 5,108
-------------------------
Long-term debt 5,197 5,208
Unamortized discount-net of premium...... (461) (475)
Long-term capital lease obligations...... 16 20
--------------------------
Total long-term obligations.............. $4,752 $4,753
====================================================================
The Company has remaining authority from the CPUC to issue up to
$1.25 billion of long- and intermediate-term debt. The proceeds may be
used only to redeem maturing debt and to refinance other debt issues. The
Company has remaining authority from the Securities and Exchange
Commission to issue up to $650 million of long- and intermediate-term debt
through a shelf registration filed in April 1993.
As of December 31, 1994 and 1993, the weighted average interest rate on
short-term borrowings was 6.05 percent and 3.25 percent, respectively.
Debt maturing within one year in the balance sheets consists of short-term
borrowings and the portion of long-term obligations that matures within
one year as follows:
54
<PAGE>
F. DEBT AND LEASE OBLIGATIONS (Cont'd)
December 31
-------------------------
Debt maturing within one year 1994 1993
--------------------------------------------------------------------
(Dollars in millions)
Advances from Pacific Telesis Group....... 249 -
Notes payable to banks.................... $ 2 $ 4
Commercial paper.......................... - 534
-------------------------
Total short-term borrowings............... 251 538
-------------------------
Current maturities of
long-term obligations................... 4 4
-------------------------
Total debt maturing within one year....... $ 255 $ 542
======================================================================
Lines of Credit
The Company has various lines of credit with certain banks. These
arrangements do not require compensating balances or commitment fees and,
accordingly, are subject to continued review by the lending institutions.
As of December 31, 1994 and 1993, the total unused lines of credit
available were approximately $2.2 and $1.6 billion, respectively.
G. FINANCIAL INSTRUMENTS
The following table presents the estimated fair values of the Company's
financial instruments:
December 31, 1994 December 31, 1993
----------------- -----------------
Estimated Estimated
Carrying Fair Carrying Fair
(Dollars in millions) Amount Value Amount Value
------------------------------------------------------------------------
Cash and cash equivalents........ $ 62 $ 62 $ 57 $ 57
Debt maturing within one year.... 255 255 542 542
Deposit liabilities.............. 305 305 290 290
Long-term debt................... $5,197 $4,578 $5,208 $5,302
========================================================================
The following methods and assumptions were used to estimate the fair values
of each category of financial instrument. The fair values of cash and cash
equivalents, debt maturing within one year, and deposit liabilities
approximate their carrying amounts because of the short-term maturities of
these instruments.
55
<PAGE>
G. FINANCIAL INSTRUMENTS (CONT'D)
The fair value of long-term debt issues as of December 31, 1994 was
estimated based on the net present value of future expected cash flows,
which were discounted using current interest rates. The fair value as of
December 31, 1993 was estimated using quotes on an exchange or interest
rates available to the Company under similar terms and maturities. The
carrying amounts reflect unamortized net discount.
H. RELATED PARTY TRANSACTIONS
The Company receives certain services associated with corporate functions,
e.g., legal, financial, external affairs and governmental relations, human
resources and corporate strategy, performed on the Company's behalf by its
parent, Pacific Telesis Group. Costs incurred by Pacific Telesis Group
which are attributable to the Company are charged directly to the Company.
The Company is also charged for its proportionate share of other indirect
costs incurred by Pacific Telesis Group. Total costs charged by
Pacific Telesis Group and included in general, administrative, and other
expenses were $81 million, $76 million and $65 million in 1994, 1993 and
1992, respectively.
The Company provides nontelecommunications and telecommunications services
including local, toll and access services to certain Pacific Telesis Group
affiliated companies. Revenues recorded for these services totaled
$21 million, $30 million and $30 million in 1994, 1993 and 1992,
respectively.
I. 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, SFAS 106
for regulatory accounting purposes. The CPUC decision also granted the
Company revenue increases for recovery of contributions to tax-advantaged
funding vehicles for SFAS 106 costs. 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.
56
<PAGE>
J. ADDITIONAL FINANCIAL INFORMATION
December 31
---------------------
(Dollars in millions) 1994 1993
---------------------------------------------------------------------------
Prepaid expenses and other current assets:
Prepaid directory expenses................... $323 $336
Miscellaneous prepaid expenses............... 23 23
Notes and other receivables.................. 63 45
Materials and supplies....................... 60 68
Current deferred income tax benefits......... 380 346
Pacific Telesis Group and subsidiaries....... 29 17
Deferred compensation trusts................. 52 -
Other........................................ 20 27
------ ------
Total............................................ $950 $862
===========================================================================
Property, plant, and equipment - net:
Land and buildings........................... $ 2,636 $ 2,538
Cable and conduit............................ 10,566 10,251
Central office equipment..................... 9,444 9,396
Furniture, equipment, and other.............. 2,892 2,906
Construction in progress..................... 569 569
-------- --------
26,107 25,660
Less: accumulated depreciation............... 10,243 9,708
-------- --------
Total............................................ $15,864 $15,952
==========================================================================
Deferred charges and other noncurrent assets:
Deferred charges............................. $ 67 $ 107
Deferred compensated absence................. 212 226
SFAS 87 pension deferral..................... 430 367
Investments.................................. 77 79
Postretirement benefits prefunding........... 176 176
Other........................................ 1 34
-------- --------
Total............................................ $ 963 $ 989
===========================================================================
Other accounts payable:
Pacific Telesis Group and subsidiaries....... $ 52 $ 23
AT&T and subsidiaries........................ 218 214
Payroll...................................... 43 52
Checks outstanding........................... 319 177
Incentive awards payable..................... 224 188
Bellcore..................................... 16 19
Other........................................ 234 205
------ ------
Total............................................ $1,106 $ 878
==========================================================================
57
<PAGE>
J. ADDITIONAL FINANCIAL INFORMATION (Cont'd)
December 31
---------------------
(Dollars in millions) 1994 1993
---------------------------------------------------------------------------
Other current liabilities:
Taxes accrued................................. $ - $ 25
Interest accrued.............................. 127 114
Advance billing and customers' deposits....... 286 269
Accrued compensated absence................... 281 284
Deferred regulatory liabilities (SFAS 109).... 145 120
Restructuring................................. 441 274
Other......................................... 86 50
------ ------
Total............................................. $1,366 $1,136
===========================================================================
Other noncurrent liabilities and deferred credits:
Unamortized investment tax credits............ $ 464 $ 526
Accrued pension cost liability................ 755 620
Deferred regulatory liabilities (SFAS 109).... 40 108
Workers' compensation......................... 175 175
Restructuring................................. 378 823
SFAS 106 Liability............................ 753 703
Other......................................... 313 303
------ ------
Total............................................. $2,878 $3,258
==========================================================================
For the Year Ended
December 31
----------------------------------
(Dollars in millions) 1994 1993 1992
---------------------------------------------------------------------------
Other revenues:
Directory advertising............... $ 984 $ 989 $1,003
Billing and collections............. 77 79 86
Non-regulated revenue............... 232 169 112
Other............................... 113 121 129
------- ------- -------
Total................................... $1,406 $1,358 $1,330
===========================================================================
Other income (expense):
Allowance for funds used during
construction...................... $ 28 $ 35 $ 31
Interest income..................... 5 5 103
Other............................... (30) (54) (52)
------- ------- -------
Total................................... $ 3 $ (14) $ 83
===========================================================================
Advertising expense..................... $ 66 $ 61 $ 56
===========================================================================
Cash payments for:
Interest............................ $ 377 $ 614 $ 529
Income taxes........................ $ 762 $ 744 $ 829
===========================================================================
58
<PAGE>
Major Customer
Nearly all of the Company's revenues were from telecommunications and related
services. Approximately 11 percent, 11 percent and 12 percent of operating
revenues were earned in 1994, 1993 and 1992, respectively, for services
provided to AT&T Corp. No other customer accounted for more than 10 percent
of operating revenues.
K. QUARTERLY FINANCIAL INFORMATION
(Unaudited)
(Dollars in millions)
-----------------------------------------
1994 First Second Third Fourth
--------------------------------------------------------------------------
Total Operating Revenues.... $2,208 $2,172 $2,246 $2,291
Operating Income............ 377 376 393 360
Net Income..................
$ 276 $ 256 $ 292 $ 247
--------------------------------------------------------------------------
1993 First Second Third Fourth
--------------------------------------------------------------------------
Total Operating Revenues.... $2,200 $2,237 $2,251 $2,206
Operating Income............ 356 368 361 (624)
Cumulative effect of
accounting changes........ (148) - - -
Net Income.................. $ 96 $ 263 $ 257 $ (746)
==========================================================================
Second quarter 1994 results reflect an after-tax charge of $29 million
resulting from a CPUC order related to customer late payment charges.
First quarter 1993 results were restated to reflect the adoption of SFAS 112,
"Employers' Accounting for Postemployment Benefits" effective January 1, 1993.
Adoption of the new standard reduced first quarter net income by $148 million.
Fourth quarter 1993 net income was reduced by a restructuring charge of
$576 million to recognize the cost of force reductions associated with
reengineering internal business processes through 1997. Also as a result of
force reductions, fourth quarter 1993 net income was further reduced by
$348 million to accelerate recognition of a portion of postretirement benefits
costs in accordance with the curtailment provisions of SFAS 106.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
No disagreements with the Company's independent accountants on any accounting
or financial disclosure matters occurred during the period covered by this
report.
59
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Documents filed as part of the report:
(1) Financial Statements:
Report of Management............................... 33
Report of Independent Accountants.................. 35
Financial Statements:
Consolidated Statements of Income............. 36
Consolidated Balance Sheets................... 37
Consolidated Statements of Shareowner's
Equity........................................ 38
Consolidated Statements of Cash Flows......... 39
Notes to Consolidated Financial Statements.... 41
(2) Financial Statement Schedule:
II - Valuation and Qualifying Accounts........ 63
Financial statement schedules other than listed above
have been omitted because the required information is
contained in the Consolidated Financial Statements and
Notes thereto, or because such schedules are not required
or applicable.
60
<PAGE>
EXHIBIT INDEX
(3) Exhibits:
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
------- -----------
3a Articles of Incorporation of Pacific Bell, as amended and restated to
January 11, 1993 (Exhibit (3)a to Form SE filed March 26, 1993 in
connection with the Company's Form 10-K for 1992).
3b By-Laws of Pacific Bell, as amended to March 10, 1994 (Exhibit 3b to
Form 10-K for 1993, File No. 1-1414).
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell and its subsidiaries 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.
12 Computation of Ratio of Earnings to Fixed Charges.
23 Consent of Coopers & Lybrand L.L.P.
24 Powers of Attorney executed by Directors and Officers who signed this
Form 10-K.
27 Financial Data Schedule for Pacific Bell Form 10-K.
The Corporation 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 last quarter of the
period covered by this report.
61
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) 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
DATE: March 24, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the date indicated.
Philip J. Quigley,* Chairman of the Board
David W. Dorman,* President and Chief Executive Officer
Peter A. Darbee,* Vice President, Chief Financial Officer and Controller
William P. Clark,* Director Mary S. Metz,* Director
Herman E. Gallegos,* Director Lewis E. Platt,* Director
Donald E. Guinn, Director Toni Rembe,* Director
Frank C. Herringer,* Director S. Donley Ritchey,* Director
Ivan J. Houston,* Director Richard M. Rosenberg,* Director
*BY
/s/ Peter A. Darbee
-----------------------
Peter A. Darbee, attorney-in-fact
DATE March 24, 1995
62
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Dollars in millions)
---------------------------------------------------------------------------
Col. A Col. B Col. C Col. D Col. E
---------------------------------------------------------------------------
Allowance for Doubtful Accounts
-------------------------------
Additions
----------------------
(1) (2)
Booked as Charged
Balance at Reductions to Other Balance at
End of Prior to Revenues Accounts Deductions End of
Period (a) (b) (c) Period
---------------------------------------------------------------------------
Year 1994 $136 $135 $143 $282 $132
Year 1993 $127 $147 $140 $278 $136
Year 1992 $ 95 $159 $164 $291 $127
===========================================================================
(a) Provision for uncollectibles as stated in the Consolidated Statements of
Income includes certain direct write-offs which are not reflected in this
account.
(b) Amounts in this column reflect items of uncollectible interstate and
intrastate accounts receivable purchased from and billed for AT&T and
other interexchange carriers under contract arrangements.
(c) Amounts in this column include items written off, net of amounts that had
previously been written off but subsequently recovered.
Reserve for Restructuring
-------------------------
Additions
----------------------
(1) (2)
Charged Charged
Balance at to Costs to Other Balance at
End of Prior and Expenses Accounts Deductions End of
Period (d) (e) (f) Period
---------------------------------------------------------------------------
Year 1994 $1,097 $ 0 $0 $278 $ 819
Year 1993 $ 101 $977 $43 $ 24 $1,097
Year 1992 $ 165 $ 0 $0 $ 64 $ 101
===========================================================================
(d) In 1993 recorded a pre-tax restructuring charge to recognize the
incremental cost of force reductions.
(e) Amounts in this column reflect items capitalized to construction.
(f) The 1994 amount reflects a $62 million of costs for enhanced retirement
benefits paid from pension fund assets which do not require current
outlays of the Company's funds. Pension plan gains offsetting the 1994
loss are expected in 1995 through 1997 as more force reductions occur
under nonpension-related offerings.
63
<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
------- -----------
3a Articles of Incorporation of Pacific Bell, as amended and restated to
January 11, 1993 (Exhibit (3)a to Form SE filed March 26, 1993 in
connection with the Company's Form 10-K for 1992).
3b By-Laws of Pacific Bell, as amended to March 10, 1994 (Exhibit 3b to
Form 10-K for 1993, File No. 1-1414).
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell and its subsidiaries 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.
12 Computation of Ratio of Earnings to Fixed Charges.
23 Consent of Coopers & Lybrand L.L.P.
24 Powers of Attorney executed by Directors and Officers who signed this
Form 10-K.
27 Financial Data Schedule for Pacific Bell Form 10-K.
The Corporation will furnish to a security holder upon request a copy of any
exhibit at cost.
64
<PAGE>
Exhibit 12
----------
PACIFIC BELL AND SUBSIDIARIES
RATIO OF EARNINGS TO FIXED CHARGES
(Dollars in millions)
-----------------------------------------------
1994 1993 1992 1991 1990
------- ------- ------- ------- -------
1. Earnings
--------
(a) Income before
Interest Expense $1,510 $ 447 $1,591 $1,427 $1,541
(b) Federal Income
Taxes 462 (68) 458 416 446
(c) State and local
Income Taxes 159 11 149 157 178
(d) 1/3 Operating
Rental Expense 40 37 35 33 33
------- ------- ------- ------- ------
Total $2,171 $ 427 $2,233 $2,033 $2,198
2. Fixed Charges
-------------
(a) Total Interest
Deductions $ 439 $ 429 $ 460 $ 485 $ 501
(b) 1/3 Operating
Rental Expense 40 37 35 33 33
------- ------- ------- ------- -------
Total $ 479 $ 466 $ 495 $ 518 $ 534
3. Ratio (1 divided by 2) 4.53 .92* 4.51 3.92** 4.12
* This figure reflects the restructuring and curtailment charges totaling
$924 million after taxes taken in the fourth quarter 1993.
** This figure reflects the restructuring charges of $121 million after taxes
taken in fourth quarter 1991.
<PAGE>
SIGNATURE
Exhibit 23
----------
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference of our report dated
February 23, 1995, on our audits of the consolidated financial statements and
the financial statement schedule of Pacific Bell and Subsidiaries as of
December 31, 1994 and 1993, and for each of the three years in the period
ended December 31, 1994, which report is included in this Annual Report on
Form 10-K, and in Pacific Bell's registration statement as follows:
Form S-3: Pacific Bell $1.575 Billion Debt Securities
/s/ COOPERS & LYBRAND L.L.P.
San Francisco, California
March 24, 1995
<PAGE>
SIGNATURE
Exhibit 24
----------
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
WHEREAS, PACIFIC BELL, a California corporation (the "Company"), proposes to
file with the Securities and Exchange Commission (the "SEC"), under the
provisions of the Securities Act of 1934, as amended, an Annual Report on
Form 10-K; and
WHEREAS, each of the undersigned is a director of the Company;
NOW, THEREFORE, each of the undersigned, hereby constitutes and appoints
P. J. Quigley, D. W. Dorman, W. E. Downing, P. A. Darbee and R. W. Odgers, and
each of them, his/her attorney for him/her in his/her stead, in his capacity
as a director of the Company, to execute and to file such Annual Report on
Form 10-K, and any and all amendments, modifications or supplements thereto,
and any exhibits thereto, and granting to each of said attorneys full power
and authority to sign and file any and all other documents and to perform and
do all and every act and thing whatsoever requisite and necessary to be done
as fully, to all intents and purposes, as he/she might or could do if
personally present at the doing thereof, and hereby ratifying and confirming
all that said attorneys may or shall lawfully do, or cause to be done, by
virtue hereof in connection with effecting the filing of the Annual Report on
Form 10-K.
IN WITNESS WHEREOF, each of the undersigned has hereunto set his/her hand this
24th day of March, 1995.
/s/ William P. Clark /s/ Mary S. Metz
Director Director
/s/ Herman E. Gallegos /s/ Lewis E. Platt
Director Director
/s/ Toni Rembe
Director
/s/ Frank C. Herringer /s/ S. Donley Ritchey
Director Director
/s/ Ivan J. Houston /s/ Richard R. Rosenberg
Director Director
1
<PAGE>
SIGNATURE
Exhibit 24
----------
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS:
WHEREAS, PACIFIC BELL, a California corporation (the "Company"), proposes to
file with the Securities and Exchange Commission (the "SEC"), under the
provisions of the Securities Act of 1934, as amended, an Annual Report on
Form 10-K; and
WHEREAS, each of the undersigned is an officer or director, or both, of the
Company, as indicated below his name;
NOW, THEREFORE, each of the undersigned, hereby constitutes and appoints
P. J. Quigley, D. W. Dorman, W. E. Downing, P. A. Darbee and R. W. Odgers, and
each of them, his attorney for him in his stead, in his capacity as an officer
or director, or both, of the Company, to execute and file such Annual Report
on Form 10-K, and any and all amendments, modifications or supplements thereto
and any exhibits thereto, and granting to each of said attorneys full power
and authority to sign and file any and all other documents and to perform and
do all and every act and thing whatsoever requisite and necessary to be done
as fully, to all intents and purposes, as he might or could do if personally
present at the doing thereof, and hereby ratifying and confirming all that
said attorneys may or shall lawfully do, or cause to be done, by virtue hereof
in connection with effecting the filing of the Annual Report on Form 10-K.
IN WITNESS WHEREOF, each of the undersigned has hereunto set his hand this
24th day of March 1995.
/s/ Philip J. Quigley
Chairman of the Board
/s/ David W. Dorman
President and Chief Executive Officer
/s/ Peter A. Darbee
Vice President, Chief Financial Officer and Controller
2
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