<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-1414
PACIFIC BELL
I.R.S. Employer No. 94-0745535
A California Corporation
140 New Montgomery Street, San Francisco, California 94105
Telephone - Area Code (415) 542-9000
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
At July 31, 1996, 224,504,982 common shares were outstanding.
THE REGISTRANT, A WHOLLY OWNED SUBSIDIARY OF PACIFIC TELESIS GROUP, MEETS THE
CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(a) AND (b) OF FORM 10-Q AND
IS THEREFORE FILING THIS FORM WITH REDUCED DISCLOSURE FORMAT PURSUANT TO
GENERAL INSTRUCTION H(2).
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PACIFIC BELL AND SUBSIDIARIES
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION Number
- ------------------------------ ------
Item 1. Financial Statements
Review Report of Independent Accountants .............. 1
Condensed Consolidated Statements of Income ........... 2
Condensed Consolidated Balance Sheets ................. 3
Condensed Consolidated Statements of Cash Flows ....... 4
Notes to Condensed Consolidated Financial Statements .. 5
Item 2. Management's Discussion and Analysis of Results of
Operations ............................................ 9
PART II. OTHER INFORMATION
- ---------------------------
Item 6. Exhibits .............................................. 18
SIGNATURE ............................................................ 19
- ---------
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
REVIEW REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareowner of Pacific Bell:
We have reviewed the accompanying condensed consolidated balance sheet of
Pacific Bell and Subsidiaries (the "Company") as of June 30, 1996 and the
related condensed consolidated statements of income for the three- and six-
month periods ended June 30, 1996 and 1995, and the condensed consolidated
statements of cash flows for the six-month periods ended June 30, 1996 and
1995. These financial statements are the responsibility of the Company's
management.
We conducted our review in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical procedures
to financial data and making inquiries of persons responsible for financial
and accounting matters. It is substantially less in scope than an audit
conducted in accordance with generally accepted auditing standards, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that
should be made to the accompanying condensed consolidated financial statements
for them to be in conformity with generally accepted accounting principles.
The Company discontinued application of Statement of Financial Accounting
Standards No. 71 effective third quarter 1995.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated balance sheet of Pacific Bell and Subsidiaries as
of December 31, 1995, and the related consolidated statements of income,
shareowner's equity, and cash flows for the year then ended (not presented
herein); and in our report dated February 22, 1996, we expressed an
unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 1995, is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
/s/Coopers & Lybrand L.L.P.
San Francisco, California
August 12, 1996
1
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
For the 3 Months For the 6 Months
Ended June 30, Ended June 30,
---------------- ----------------
(Dollars in millions) 1996 1995 1996 1995
- ----------------------------------------------------------------------------
OPERATING REVENUES
Local service ................... $ 996 $ 928 $1,956 $1,859
Network access:
Interstate .................... 447 413 890 844
Intrastate .................... 185 177 363 343
Toll service .................... 316 290 628 604
Other service revenues .......... 408 378 798 748
------ ------ ------ -----
TOTAL OPERATING REVENUES......... 2,352 2,186 4,635 4,398
------ ------ ------ -----
OPERATING EXPENSES
Cost of products and services ... 395 425 837 924
Customer operations and
selling expenses .............. 472 439 934 875
General, administrative, and
other expenses ................ 376 317 687 619
Property and other taxes......... 42 51 86 96
Depreciation and amortization ... 456 460 908 920
------ ------ ------ -----
TOTAL OPERATING EXPENSES......... 1,741 1,692 3,452 3,434
------ ------ ------ -----
OPERATING INCOME................. 611 494 1,183 964
Interest expense................. 94 109 182 217
Other income (expense) - net..... (2) 8 1 28
------ ------ ------ -----
INCOME BEFORE INCOME TAXES....... 515 393 1,002 775
Income taxes..................... 211 150 408 286
------ ------ ------ ------
NET INCOME....................... $ 304 $ 243 $ 594 $ 489
============================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
2
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, December 31,
(Dollars in millions) 1996 1995
- ---------------------------------------------------------------------------
ASSETS: (Unaudited)
Cash and cash equivalents......................... $ 45 $ 68
Accounts receivable - (net of allowances for
uncollectibles of $142 and $131 in 1996
and 1995, respectively)......................... 1,519 1,475
Prepaid expenses and other current assets......... 874 802
------- -------
Total current assets.............................. 2,438 2,345
------- -------
Property, plant, and equipment - at cost.......... 27,422 26,688
Less: accumulated depreciation................. (16,213) (15,608)
------- -------
Property, plant, and equipment - net.............. 11,209 11,080
------- -------
Other noncurrent assets........................... 467 474
------- -------
TOTAL ASSETS...................................... $14,114 $13,899
======= =======
LIABILITIES AND SHAREOWNER'S EQUITY:
Accounts payable and accrued liabilities.......... $ 2,052 $2,109
Debt maturing within one year..................... 570 781
Other current liabilities......................... 457 552
------- -------
Total current liabilities......................... 3,079 3,442
------- -------
Long-term obligations............................. 5,020 4,608
------- -------
Deferred income taxes............................. 383 321
------- -------
Other noncurrent liabilities and deferred credits. 2,277 2,417
------- -------
Commitments and contingencies (Note B)
Common stock ($1.00 stated value, 300,000,000
shares authorized, 224,504,982 shares issued
and outstanding)................................ 225 225
Additional paid-in capital........................ 5,549 5,387
Accumulated deficit............................... (2,419) (2,501)
------- -------
Total shareowner's equity......................... 3,355 3,111
------- -------
TOTAL LIABILITIES AND SHAREOWNER'S EQUITY......... $14,114 $13,899
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements.
3
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PACIFIC BELL AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the 6 Months Ended
June 30,
----------------------
(Dollars in millions) 1996 1995
- ---------------------------------------------------------------------------
CASH FROM (USED FOR) OPERATING ACTIVITIES:
Net income........................................... $ 594 $ 489
Adjustments to reconcile net income to cash from
operating activities:
Depreciation and amortization...................... 908 920
Change in deferred income taxes.................... 64 7
Unamortized investment tax credits................. (23) (25)
Changes in operating assets and liabilities:
Accounts receivable.............................. (66) 175
Prepaid expenses and other current assets........ (28) (6)
Other noncurrent assets.......................... (1) 151
Accounts payable and accrued liabilities......... (120) (156)
Other current liabilities........................ (95) (11)
Other noncurrent liabilities and deferred credits (117) (235)
Other adjustments, net............................. 7 (12)
------- -------
Cash from operating activities....................... 1,123 1,297
------- -------
CASH FROM (USED FOR) INVESTING ACTIVITIES:
Additions to property, plant, and equipment.......... (1,057) (817)
Other investing activities, net...................... (20) 2
------- -------
Cash used for investing activities................... (1,077) (815)
------- -------
CASH FROM (USED FOR) FINANCING ACTIVITIES:
Equity infusion from parent.......................... 162 -
Proceeds from issuance of long-term debt............. 248 -
Dividends paid....................................... (417) (477)
Increase (decrease) in short-term borrowings, net.... (223) 1
Proceeds from sale and leaseback transactions........ 178 -
Other financing activities, net...................... (17) (2)
------- -------
Cash used for financing activities................... (69) (478)
------- -------
Increase (decrease) in cash and cash equivalents..... (23) 4
Cash and cash equivalents at January 1............... 68 62
------- -------
Cash and cash equivalents at June 30................. $ 45 $ 66
======= =======
Cash payments for:
Interest........................................... $ 175 $ 218
Income taxes....................................... $ 193 $ 156
===========================================================================
The accompanying Notes are an integral part of the Condensed Consolidated
Financial Statements
4
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
A. BASIS OF PRESENTATION
The Condensed Consolidated Financial Statements include the accounts of
Pacific Bell, and its wholly-owned subsidiaries, Pacific Bell Directory,
Pacific Bell Information Services, Pacific Bell Mobile Services, Pacific
Bell Internet Services, Pacific Bell Network Integration and others,
hereinafter referred to as the "Company". All significant intercompany
balances and transactions have been eliminated. The Condensed
Consolidated Financial Statements reflect reclassifications made to
conform with the current year presentation. These reclassifications did
not affect net income or shareowner's equity.
The Condensed Consolidated Financial Statements have been prepared in
accordance with the rules and regulations of the Securities and Exchange
Commission ("SEC") applicable to interim financial information. Certain
information and footnote disclosures included in financial statements
prepared in accordance with generally accepted accounting principles have
been condensed or omitted in these interim statements pursuant to such
SEC rules and regulations. Management recommends that these interim
financial statements be read in conjunction with the audited consolidated
financial statements and notes thereto included in the Company's 1995
annual report on Form 10-K. Effective third quarter 1995, the Company
discontinued accounting under Statement of Financial Accounting Standards
No. ("SFAS") 71, "Accounting for the Effects of Certain Types of
Regulation."
In management's opinion, the Condensed Consolidated Financial Statements
include all adjustments (consisting of only normal recurring adjustments)
necessary to present fairly the financial position and results of
operations for each interim period shown. The Condensed Consolidated
Financial Statements have been reviewed by Coopers & Lybrand L.L.P.,
independent accountants. Their report is on page 1.
Change In Estimates
In March 1996, management amended the salaried pension plan, which
changed from a final pay plan to a cash balance plan. As a result of
the approval of this plan amendment, in second quarter 1996 the Company
updated its actuarial assumptions to reflect changes in market interest
rates and recent experience, including a change in its assumption
concerning future ad hoc increases in pension benefits. These changes in
estimates increased net income by approximately $37 million for second
quarter 1996 in comparison to the same period in 1995.
5
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
B. COMMITMENTS AND CONTINGENCIES
Merger Agreement
On April 1, 1996, SBC Communications Inc. ("SBC") and Pacific Telesis,
the Company's parent, jointly announced a definitive agreement whereby
Pacific Telesis will become a wholly-owned subsidiary of SBC. Under
terms of the merger agreement, each share of Pacific Telesis common stock
will be exchanged for 0.733 shares of SBC common stock, subject to
adjustment. The transaction is intended to be accounted for as a pooling
of interests and to be a tax-free reorganization. On July 31, 1996, the
shareowners of Pacific Telesis and SBC approved the transaction, which
previously had been approved by the respective Board of Directors of each
company. The merger is subject to certain conditions and regulatory
approvals, including approval by the California Public Utilities
Commission ("CPUC"), which has established a schedule for review of the
transaction with final comments from interested parties due in December
1996. If approvals are granted, the transaction is expected to close in
the first quarter of 1997.
Purchase Commitments
In December 1994, the Company contracted for the purchase of up to
$2 billion of Advanced Communications 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. Management now expects the actual amount of these facilities
purchased in 1998 will be less than $800 million.
As of June 30, 1996, the Company had purchase commitments of about
$232 million remaining in connection with its previously announced
program for deploying an all digital switching platform with ISDN and
SS-7 capabilities.
6
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
B. COMMITMENTS AND CONTINGENCIES (Cont'd)
Revenues Subject to Refund
In 1992, the CPUC issued a decision adopting, with modification,
SFAS 106, "Employers' Accounting for Postretirement Benefits Other than
Pensions," for regulatory accounting purposes. Annual price cap
decisions by the CPUC granted the Company approximately $100 million in
each of the years 1993-1996 for partial recovery of higher costs under
SFAS 106. However, the CPUC in October 1994 reopened the proceeding to
determine the criteria for exogenous cost treatment and whether 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 plus interest. It is possible that the CPUC could decide this
issue in the near term, and that the decision could have a material
adverse effect on the Company. Related revenues subject to refund totaled
about $172 million at June 30, 1996. Management believes postretirement
benefits costs are appropriately recoverable in the Company's price cap
filings.
Property Tax Investigation
In 1992, a settlement agreement was reached between the State Board of
Equalization, all California counties, the State Attorney General, and
28 utilities, including the Company, on a specific methodology for
valuing utility property for property tax purposes. The CPUC opened an
investigation to determine if any resulting property tax savings should
be returned to customers. Intervenors have asserted that as much as
$20 million of annual property tax savings should be treated as an
exogenous cost reduction in the Company's annual price cap filings.
These intervenors have also asserted that past property tax savings
totaling as much as approximately $60 million as of June 30, 1996, plus
interest should be returned to customers. Management believes that,
under the CPUC's regulatory framework, any property tax savings should be
treated only as a component of the calculation of shareable earnings. In
an Interim Opinion issued in June 1995, the CPUC decided to defer a final
decision on this matter pending resolution of the criteria for exogenous
cost treatment under its regulatory framework. The criteria are being
considered in a separate proceeding initiated for rehearing of the CPUC's
postretirement benefits other than pensions decision discussed above. It
is possible that the CPUC could decide this issue in the near term, and
that the decision could have a material adverse effect on the Company.
7
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PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
C. SUBSEQUENT EVENT
In August 1996, the Company issued $250 million of 6.875 percent
debentures due August 15, 2006. The debentures may not be redeemed prior
to maturity. The proceeds from the sale of the debentures will be used
to reduce short-term debt incurred to retire the Company's debentures
totalling approximately $500 million in December 1995.
8
<PAGE>
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
Except for historical information contained herein, this quarterly report on
Form 10-Q contains certain forward-looking statements that involve potential
risks and uncertainties. Pacific Bell's (the "Company") future results could
differ materially from those discussed herein. Factors that could cause or
contribute to such differences include, but are not limited to, those
discussed herein and those discussed in "Management's Discussion and Analysis
of Results of Operations" included in the Company's December 31, 1995 Form
10-K. Readers are cautioned not to place undue reliance on these forward-
looking statements which speak only as of the date hereof. The Company
undertakes no obligation to revise or update these forward-looking statements
to reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.
RESULTS OF OPERATIONS
The following discussions and data compare the results of operations of the
Company for the six-month period ended June 30, 1996 to the corresponding
period in 1995. Results for the first six months of 1996 may not be
indicative of results for the full year.
A summary of selected operating data is shown below:
For the 6 Months Ended
June 30,
----------------------
%
Operating Statistics 1996 1995 Change
- --------------------------------------------------------------------------
Return on shareowner's equity (%)............... 36.8 15.7 -
Capital expenditures ($mil)..................... 1,026 766 33.9
Total employees at June 30...................... 46,604 49,419 -5.7
Telephone network employees at June 30*......... 43,876 46,802 -6.3
Telephone network employees per ten thousand
access lines*................................. 27.6 30.8 -10.4
==========================================================================
* Excludes Pacific Bell Directory and Pacific Bell Mobile Services employees.
9
<PAGE>
Earnings
- --------
Fueled by increases in customer access line growth, marketing efforts, a
rebound in the California economy and continued cost containment, offset by
costs for this year's new business initiatives, the Company reported net
income of $594 million for the first six months of 1996, a 21.5 percent
increase over the $489 million reported for the same period last year. (See
"Change In Estimates" under Note A on page 5.)
For the first six months in 1995, pressure on earnings resulted from
incremental labor expense associated with the severe storms in early 1995.
These earnings decreases in 1995 were partially offset by the Company's
ongoing cost-reduction efforts.
The California Public Utilities Commission ("CPUC") authorized facilities-
based local services competition effective January 1996, and resale
competition effective March 1996. As of June 30, 1996, such competition had
not yet had a significant effect on the Company's earnings. Management is
concerned, however, that depending on the outcome of certain open issues in
the local competition rules proceedings, such competition could deprive the
Company of the opportunity to earn a fair rate-of-return.
For a discussion on a recent FCC order that may affect future earnings, see
"FCC Interconnection Order" and "FCC Proposal on Wireless Interconnection" on
page 16.
For the 6 Months Ended
June 30,
----------------------
%
Volume Indicators 1996 1995 Change
- --------------------------------------------------------------------------
Switched access lines in service
at June 30 (thousands).......................... 15,917 15,209 4.7
Residence.................................... 9,950 9,547 4.2
Business..................................... 5,758 5,453 5.6
Other........................................ 209 209 -
ISDN access lines (Included in above
access lines).............................. 77 34 126.5
Interexchange carrier access
minutes-of-use (millions)...................... *31,345 28,476 *10.1
Interstate................................... *16,883 15,736 *7.3
Intrastate................................... *14,462 12,740 *13.5
Toll messages (millions)......................... 2,542 2,363 7.6
Toll minutes-of-use (millions)................. 7,627 7,139 6.8
Voice mailbox equivalents at June 30 (thousands). 1,585 1,278 24.0
Custom calling services at June 30 (thousands)... 7,512 6,857 9.6
==========================================================================
* Preliminary
10
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The total number of access lines in service grew to 15.917 million, an
increase of 4.7 percent for the twelve months ended June 30, 1996. This is an
improvement over the 2.8 percent increase for the same period last year. The
residential access line growth rate increased to 4.2 percent for the twelve
months ended June 30, 1996, from 2.1 percent last year. Changes in
technology, telecommuting, Internet access and the Company's marketing efforts
continue to fuel increased demand for additional telephone lines in the home.
Second access lines in residences grew 13.9 percent from 1.685 million lines
to 1.919 million lines for the twelve months ended June 30, 1996. The growth
rate in business access lines was 5.6 percent for the twelve months ended
June 30, 1996, up from 4.0 percent for the same period last year. The number
of ISDN lines in service for the Company grew to 77 thousand, an increase of
126.5 percent for the twelve months ended June 30, 1996, as customers
increased telecommuting and demanded faster data transmission and Internet
access. Accelerated demand for the Company's high-speed data transmission
continued through the second quarter due to the Company's intensified
marketing efforts.
Access minutes-of-use represent the volume of traffic carried by interexchange
carriers over the Company's local network. Total access minutes-of-use for
the six months ended June 30, 1996 increased by 10.1 percent (preliminary)
over the same period last year. The increase in access minutes-of-use was
primarily attributable to economic growth.
Toll messages and minutes-of-use are comprised of Message Telecommunications
Service and Optional Calling Plans ("local toll") as well as WATS and
terminating 800 services. For the six months ended June 30, 1996, toll
minutes-of-use increased by 6.8 percent driven by economic growth.
High demand for the Company's voice mail products continued in 1996. Voice
mailbox equivalents in service increased 24.0 percent for the twelve months
ended June 30, 1996 to 1.585 million. Similarly, demand for custom calling
services, such as call waiting, grew 9.6 percent for the twelve months ended
June 30, 1996 due to a rebound in the California economy and the Company's
focused customer retention efforts.
11
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Operating Revenues
- ------------------
For the 6 Months Ended
June 30,
----------------------
($ millions) 1996 1995 Change
- ---------------------------------------------------------------------------
Total operating revenues ....................... $4,635 $4,398 $237
5.4%
- ---------------------------------------------------------------------------
Revenues for the first six months of 1996 increased from the same period last
year primarily due to increased customer demand for the Company's telephone
services driven by marketing efforts and a rebound in the California economy.
Revenues for the six months ended June 30, 1996 were offset by $60 million due
to the Federal Communications Commission ("FCC") price cap order for the
fiscal year ending June 30, 1996. For the 1996 annual access tariff filing
effective July 1, 1996, see "FCC Annual Access Tariff Filing and Regulatory
Framework Review" on page 17. The CPUC price cap order effective January 1,
1996, had a minimal effect on the Company's revenues due to an order in
December 1995 suspending use of the "inflation minus productivity" component
of the price cap formula for 1996 through 1998. This action freezes the price
caps on most of the Company's regulated services through 1998 except for
adjustments due to exogenous costs or price changes approved through the
CPUC's application process.
Factors affecting revenue changes are summarized in the following table.
Total
Price Change
Cap Customer From
Orders Misc. Demand 1995
- --------------------------------------------------------------------------
Local service........................ $ - $17 $ 80 $ 97
Network access
Interstate......................... -60 59 47 46
Intrastate......................... - -12 32 20
Toll service......................... - -27 51 24
Other service revenues............... - 10 40 50
----- ----- ----- ----
Total operating revenues............. $-60 $47 $250 $237
==========================================================================
The $80 million increase in customer demand for local service revenues is the
result of the 4.7 percent growth in access lines and the 9.6 percent growth in
custom calling services. These increases were generated by a rebound in the
California economy and the Company's focused customer retention efforts. In
addition for the second quarter 1996, the Company introduced a new feature,
"Call Return," on a "pay-per-use" basis in April 1996 that generated revenues
of approximately $15 million for the quarter.
12
<PAGE>
The $47 million increase in interstate network access revenues due to customer
demand reflects increased interexchange carrier access minutes-of-use, as well
as increased access lines. The $32 million customer demand-related increase
in intrastate network access revenues also resulted from growth in access
minutes-of-use.
The $51 million increase in toll service revenues due to customer demand was
driven primarily by increased local toll usage resulting from general economic
growth. The customer demand-related increase in local toll service revenues
was partially offset by competitive losses in WATS and 800 services.
Interexchange carriers currently have the competitive advantage of being able
to offer WATS and 800 service both within and between service areas.
The $40 million increase in other service revenues due to customer demand
reflects the continuing success of the Company's voice mail products and
directory operations. In addition, primarily in the second quarter 1996,
customer demand-related revenues increased in the Company's network
integration services.
Operating Expenses
- ------------------
For the 6 Months Ended
June 30,
----------------------
($ millions) 1996 1995 Change
- --------------------------------------------------------------------------
Total operating expenses....................... $3,452 $3,434 $18
0.5%
- --------------------------------------------------------------------------
The increase in total operating expenses for the six months ended June 30,
1996 compared to the same period in 1995 reflects costs for the Company's new
business initiatives. Increased expenses were partially offset by cost
reductions from the Company's ongoing efficiency efforts and savings due to
changes in employee benefit plans and benefit plan assumptions. Primary
factors affecting expense changes are summarized below.
Salaries Employee Subsi- Total
($ millions) & Wages* Benefits* Misc. diaries Change
- ---------------------------------------------------------------------------
Cost of products and services.. -$18 -$66 $ 2 -$ 5 -$87
Customer operations
and selling expenses......... 3 -36 26 66 59
General, administrative
and other expenses........... - 6 57 5 68
Property and other taxes....... - - -10 - -10
Depreciation and amortization.. - - -14 2 -12
---- ---- ---- ---- ----
Total operating expenses....... -$15 -$96 $61 $68 $18
===========================================================================
* Excludes Pacific Bell subsidiaries.
13
<PAGE>
Salary and wage expense at the Company, excluding its subsidiaries, decreased
$15 million for the six-month period ended June 30, 1996 compared to the same
period in 1995, primarily due to the continued force reduction programs and
decreased overtime in first quarter 1996 due to milder weather when compared
to 1995. The effect of these decreases was partially offset by wage increases
associated with new labor agreements effective August 1995 and overtime due to
increased business volumes.
Employee benefits expense at the Company, excluding its subsidiaries,
decreased $96 million for the six-month period ended June 30, 1996 compared to
the same period in 1995 primarily due to changes in employee benefit plans and
a related remeasurement of benefit plan expense. The changes in employee
benefit plans and benefit plan assumptions will continue to produce savings
throughout the year and in future periods. (See "Change In Estimates" under
Note A on page 5.)
Excluding its subsidiaries, the Company's miscellaneous customer operations
and selling expenses, and general, administrative and other expenses increased
for the six-month period ended June 30, 1996 compared to 1995 primarily due to
increased contract services and advertising associated with Caller ID.
Excluding its subsidiaries, the Company's miscellaneous property and other
taxes decreased for the six-month period ended June 30, 1996 compared to 1995
primarily due to nonrecurring audit adjustments accrued in 1995.
Depreciation expense at the Company, excluding its subsidiaries, decreased
$14 million for the six-month period ended June 30, 1996 compared to 1995
primarily due to the elimination of the amortization of certain regulatory
assets associated with the discontinued application of Statement of Financial
Accounting Standards No. ("SFAS") 71, "Accounting for the Effects of Certain
Types of Regulation." The effect of this decrease was partially offset by
higher telecommunications plant balances.
The Company's subsidiaries total operating expenses increased for the six-
month period ended June 30, 1996 compared to 1995 due to new business
initiatives, such as Personal Communications Services ("PCS") and Internet
access.
Interest Expense
- ----------------
For the 6 Months Ended
June 30,
----------------------
($ millions) 1996 1995 Change
- --------------------------------------------------------------------------
Interest expense................................ $182 $217 -$ 35
-16.1%
- --------------------------------------------------------------------------
Interest expense decreased for the six-month period ended June 30, 1996
compared to 1995 primarily due to lower interest rates and a change in
classification of interest capitalized during construction from an item of
other income to a reduction in interest expense due to the discontinued
application of SFAS 71.
14
<PAGE>
Other Income (Expense) - Net
- ----------------------------
For the 6 Months Ended
June 30,
----------------------
($ millions) 1996 1995 Change
- --------------------------------------------------------------------------
Other income (expense) - net .................. $ 1 $ 28 -$ 27
-96.4%
- --------------------------------------------------------------------------
Other income (expense) - net decreased for the six-month period ended June 30,
1996 compared to 1995 primarily due to interest income received on a tax
refund in first quarter 1995 and a change in classification of interest
capitalized during construction from an item of miscellaneous income to a
reduction of interest expense.
Income Taxes
- ------------
For the 6 Months Ended
June 30,
----------------------
($ millions) 1996 1995 Change
- --------------------------------------------------------------------------
Income taxes...................................... $408 $286 $122
42.7%
- --------------------------------------------------------------------------
The increase in income tax expense for the six-month period ended June 30,
1996 compared to 1995 is primarily due to higher pre-tax income and tax
adjustments.
Status of Reserves
- ------------------
As previously reported, the Company established a restructuring reserve at the
end of 1993 to provide for the incremental cost of force reductions and other
related costs to restructure its internal business processes through 1997.
After new hires, net force reduction for the Company, excluding its
subsidiaries, was approximately 810 employees for the first six months of
1996. A total of $89 million in cash outlays was charged to the reserve in
the first half of 1996. These costs were for business infrastructure,
information system standards, service delivery and facilities consolidation.
In 1995, the Company charged $219 million to the restructuring reserve for the
cost through 1997 of enhanced retirement benefits negotiated in the 1995 union
contracts. Upon further study, the Company has revised its estimate of these
retirement costs. Consequently, $64 million of these 1995 noncash charges
were reversed in second quarter 1996. There was no effect on net income from
either the 1995 charge or the 1996 change in estimate. As of June 30, 1996 a
balance of $194 million remained in the restructuring reserve.
15
<PAGE>
Capital Expenditures
- --------------------
The Company invested $1,026 million during the first half of 1996, primarily
due to investments in the Pacific Bell Mobile Services PCS network and to
modernize and expand the Company's core telecommunications network.
CREDIT RATINGS
In March 1996, Moody's Investors Services, Inc. placed the senior long-term
debt ratings of the Company under review for possible downgrade. The ratings
are still under review.
In April 1996, reflecting the announcement of the merger agreement with SBC,
Standard & Poor's Corporation's credit rating outlook remains negative. (See
"Merger Agreement" under Note B on page 7.) Also reflecting the merger
agreement announcement, Duff and Phelps, Inc. reaffirmed its ratings of Duff
1+ and Double-A-Minus ("AA-") on the Company's commercial paper and
debentures, respectively.
MERGER AGREEMENT
On April 1, 1996, SBC and Pacific Telesis, the Company's parent, jointly
announced a definitive agreement whereby Pacific Telesis will become a wholly-
owned subsidiary of SBC. Under terms of the merger agreement, each share of
Pacific Telesis common stock will be exchanged for 0.733 shares of SBC common
stock, subject to adjustment. The transaction is intended to be accounted for
as a pooling of interests and to be a tax-free reorganization. On July 31,
1996, the shareowners of Pacific Telesis and SBC approved the transaction,
which previously had been approved by the respective Board of Directors of
each company. The merger is subject to certain conditions and regulatory
approvals, including approval by the CPUC, which has established a schedule
for review of the transaction with final comments from interested parties due
in December 1996. If approvals are granted, the transaction is expected to
close in the first quarter of 1997.
PENDING REGULATORY ISSUES
FCC Interconnection Order
- -------------------------
In August 1996, the FCC released a decision (the "Interconnection Order")
which, among other things, will affect revenues collected for carrier access
used by interexchange carriers ("IECs") and for unbundled network elements
used by competitive local carriers ("CLCs"). Management is currently
reviewing this decision to assess the impact it will have on the Company.
16
<PAGE>
FCC Proposal on Wireless Interconnection
- ----------------------------------------
In January 1996, the FCC released a Notice of Proposed Rulemaking in which the
FCC proposed to change the arrangement under which the Company and other local
exchange carriers ("LECs") are compensated for interconnecting with and
terminating traffic for Commercial Mobile Radio Service ("CMRS") providers
(including cellular and PCS providers). The Interconnection Order superseded
this Notice of Proposed Rulemaking and will result in the Company providing
interconnection at lower prices than those now in effect. Management is
currently reviewing this decision to assess the impact it will have on the
Company.
FCC Annual Access Tariff Filing and Regulatory Framework Review
- ---------------------------------------------------------------
The Company filed its 1996 annual access tariff with the FCC for the fiscal
year effective July 1, 1996. The proposed revenue increase of about
$24 million is still under review by the FCC.
The FCC adopted new interim price cap rules in 1995 that govern the prices
that the larger LECs, including the Company, charge IECs for access to local
telephone networks. The interim rules require the LECs to adjust their
maximum prices for changes in inflation, productivity and certain costs beyond
the control of the LEC. Under the interim plan, LECs may choose from three
productivity factors: 4.0, 4.7 or 5.3 percent. Election of the 5.3 percent
productivity factor permits the LEC to retain all of its earnings whereas the
other lower productivity factors require earnings to be shared with customers.
As in 1995, the Company again chose the 5.3 percent productivity factor that
will enable it to retain all of its earnings effective July 1, 1996. The
higher productivity factor was chosen because management believes that it will
be more than offset by elimination of the sharing mechanism. Permanent price
cap rules are scheduled for September 1996 but may be delayed due to
implementation of the Telecommunications Act of 1996.
Management continues to believe that the FCC should adopt pure price cap
regulation and eliminate the productivity factor, sharing and earnings cap.
CPUC Proposal on Universal Service
- ----------------------------------
In August 1996, a CPUC Administrative Law Judge issued a proposed decision on
universal phone service rules in California. Management is currently
reviewing this proposal to assess the impact it will have on the Company.
However, management is concerned that the proposal underestimates the cost of
providing universal service. A final decision is scheduled for September
1996.
17
<PAGE>
PART II. OTHER INFORMATION
Item 6. Exhibits
(a) Exhibits.
Exhibits identified as on file with the SEC are incorporated herein
by reference as exhibits hereto.
Exhibit
Number Description
- ------- -----------
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell is filed herewith pursuant to
Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this
regulation, Pacific Bell hereby agrees to furnish a copy of any such
instrument to the SEC upon request.
15 Letter re unaudited interim financial information.
27 Article 5 FDS for 2nd Quarter 1996 Form 10-Q.
The Company will furnish to a security holder upon request a copy of any
exhibit at cost.
18
<PAGE>
FORM 10-Q
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Pacific Bell
By: /s/Peter A. Darbee
---------------------------------------
Peter A. Darbee
Vice President, Chief Financial Officer
and Controller
Date: August 12, 1996
19
<PAGE>
EXHIBIT INDEX
Exhibits identified as on file with the SEC are incorporated herein by
reference as exhibits hereto. All other exhibits are provided as part of the
electronic transmission.
Exhibit
Number Description
- ------- -----------
4 No instrument which defines the rights of holders of long- and
intermediate-term debt of Pacific Bell is filed herewith pursuant to
Regulation S-K, Item 601(b)(4)(iii)(A). Pursuant to this
regulation, Pacific Bell hereby agrees to furnish a copy of any such
instrument to the SEC upon request.
15 Letter re unaudited interim financial information.
27 Article 5 FDS for 2nd Quarter 1996 Form 10-Q.
20
<PAGE>
EXHIBIT 15
----------
COOPERS & LYBRAND L.L.P.
August 12, 1996
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Ladies and Gentlemen:
Re: Pacific Bell Registration Statement on Form S-3
----------------------------------------------------
We are aware that our report dated August 12, 1996 on our review of the
interim financial information of Pacific Bell and Subsidiaries for the six-
month period ended June 30, 1996 included in this Form 10-Q is incorporated by
reference in the Company's registration statement as follows:
Form S-3: Pacific Bell $1.575 Billion Debt Securities
------------------------------------------------------
Pursuant to Rule 436(c) under the Securities Act of 1933, this report should
not be considered a part of the registration statement prepared or certified
by us within the meaning of Sections 7 and 11 of that Act.
Very truly yours,
/s/ Coopers & Lybrand L.L.P.
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