<PAGE>
FORM 10-Q
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended September 30, 1997
or
|_| Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the transition period from to
Commission File Number 1-1414
PACIFIC BELL
A California Corporation
I.R.S. Employer Identification Number 94-0745535
140 New Montgomery Street, San Francisco, California 94105
Telephone Number: (415) 542-9000
THE REGISTRANT, AN INDIRECTLY HELD WHOLLY-OWNED SUBSIDIARY OF SBC COMMUNICATIONS
INC., 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).
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
<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
PACIFIC BELL
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CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
(Unaudited)
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<CAPTION>
----------------------------------------
Three months ended Nine months ended
September 30, September 30,
------------------------------------------
1997 1996 1997 1996
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<S> <C> <C> <C> <C>
Operating Revenues
Local service $ 1,153 $ 1,006 $ 3,261 $ 2,962
Network access:
Interstate 455 448 1,254 1,338
Intrastate 194 176 596 539
Long-distance service 302 324 900 953
Directory advertising 218 204 834 780
Other 159 157 479 434
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Total operating revenues 2,481 2,315 7,324 7,006
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Operating Expenses
Cost of services and products 1,049 893 2,996 2,618
Selling, general and administrative 538 433 2,494 1,257
Depreciation and amortization 471 459 1,557 1,367
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Total operating expenses 2,058 1,785 7,047 5,242
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Operating Income 423 530 277 1,764
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Other Income (Expense)
Interest expense (117) (95) (336) (277)
Other income (expense) - net 15 2 (15) 4
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Total other income (expense) (102) (93) (351) (273)
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Income (Loss) Before Income Taxes and
Cumulative Effect of Accounting Changes 321 437 (74) 1,491
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Income Taxes 126 175 5 607
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Income (Loss) Before Cumulative Effect of
Accounting Changes 195 262 (79) 884
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Cumulative Effect of Accounting Changes, net of tax - - 342 85
- ------------------------------------------------------------------------------------------
Net Income $ 195 $ 262 $ 263 $ 969
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<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<PAGE>
PACIFIC BELL
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CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
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September 30, December 31,
-----------------------------
1997 1996
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Assets (Unaudited)
Current Assets
Cash and cash equivalents $ 55 $ 58
Accounts receivable - net of allowances for
uncollectibles of $241 and $161 2,493 2,133
Prepaid expenses 49 37
Deferred income taxes 539 119
Deferred charges 26 45
Other current assets 49 37
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Total current assets 3,211 2,429
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Property, Plant and Equipment - at cost 29,304 28,372
Less: Accumulated depreciation and amortization 17,470 16,699
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Property, Plant and Equipment - Net 11,834 11,673
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Other Assets 725 547
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Total Assets $ 15,770 $ 14,649
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Liabilities and Shareowner's Equity
Current Liabilities
Debt maturing within one year $ 1,217 $ 287
Accrued taxes 1,023 95
Accounts payable and accrued liabilities 2,629 2,451
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Total current liabilities 4,869 2,833
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Long-Term Debt 5,342 5,364
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Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 596 476
Postemployment benefit obligation 906 671
Unamortized investment tax credits 204 236
Other noncurrent liabilities 411 1,142
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Total deferred credits and other noncurrent liabilities 2,117 2,525
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Commitments and contingencies
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Shareowner's Equity
Common stock - ($1 par value) 225 225
Paid in surplus 5,352 6,100
Retained earnings (deficit) (2,135) (2,398)
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Total shareowner's equity 3,442 3,927
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Total Liabilities and Shareowner's Equity $ 15,770 $ 14,649
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See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
(Unaudited)
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Nine months ended
September 30,
------------------------
1997 1996
- -------------------------------------------------------------------------
Operating Activities
Net income $ 263 $ 969
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,557 1,367
Provision for uncollectible accounts 201 128
Amortization of investment tax credits (32) (36)
Deferred income taxes (248) 149
Cumulative effect of accounting change, net of tax (342) (85)
Other - net 126 (738)
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Total adjustments 1,262 785
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Net Cash Provided by Operating Activities 1,525 1,754
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Investing Activities
Construction and capital expenditures (1,687) (1,597)
Other - (32)
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Net Cash Used in Investing Activities (1,687) (1,629)
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Financing Activities
Net change in short-term borrowings with
original maturities of three months or less 301 (186)
Issuance of other short-term borrowings 610 -
Issuance of long-term debt - 700
Repayment of long-term debt (4) (3)
Equity received from parent 156 198
Dividends paid (904) (830)
Other - 6
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Net Cash Provided by (Used in) Financing Activities 159 (115)
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Net increase (decrease) in cash and cash (3) 10
equivalents
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Cash and cash equivalents beginning of year 58 68
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Cash and Cash Equivalents End of Period $ 55 $ 78
- -------------------------------------------------------------------------
Cash paid during the nine months ended September 30 for:
Interest $ 357 $ 305
Income taxes, net of refunds $ (416) $ 253
See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL
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CONSOLIDATED STATEMENT OF SHAREOWNER'S EQUITY
Dollars in millions
(Unaudited)
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Retained
Common Paid-in Earnings
Stock Surplus (Deficit)
- -----------------------------------------------------------------------------
Balance, December 31, 1996 $ 225 $ 6,100 $ (2,398)
Net income - - 263
Dividend to shareowner - (904) -
Net equity from parent - 156 -
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Balance, September 30, 1997 $ 225 $ 5,352 $ (2,135)
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See Notes to Consolidated Financial Statements.
* * * *
SELECTED FINANCIAL AND OPERATING DATA
At September 30, or for the nine months then 1997 1996
ended:
--------- ---------
Return on weighted average total capital* ..... 3.09% 17.16%
Debt ratio .................................... 65.58% 63.13%
Network access lines in service (000).......... 16,594 16,018
Access minutes of use (000,000) ............... 51,674 47,307
Cellular Customers (000)....................... 266 0
Number of employees ........................... 49,920 46,190
*Calculated using Income Before Cumulative Effect of Accounting Changes
<PAGE>
PACIFIC BELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Dollars in millions
1. BASIS OF PRESENTATION The consolidated financial statements have been
prepared by Pacific Bell (PacBell, which includes its subsidiaries) pursuant
to the rules and regulations of the Securities and Exchange Commission (SEC)
and, in the opinion of management, include all adjustments (consisting only
of normal recurring accruals) necessary to present fairly the results for the
interim periods shown. Certain information and footnote disclosures, normally
included in financial statements prepared in accordance with generally
accepted accounting principles, have been condensed or omitted pursuant to
such SEC rules and regulations. Certain reclassifications have been made to
the 1996 consolidated financial statements to conform with the 1997
presentation. The results for the interim periods are not necessarily
indicative of results for the full year. The consolidated financial
statements contained herein should be read in conjunction with the
consolidated financial statements and notes thereto included in PacBell's
1996 Annual Report on Form 10-K (the Form 10-K) filed with the SEC.
2. CONSOLIDATION The consolidated financial statements include the accounts of
PacBell and its subsidiaries. PacBell is a wholly-owned subsidiary of Pacific
Telesis Group (PAC), a wholly-owned subsidiary of SBC Communications Inc.
(SBC). All significant intercompany transactions between PacBell subsidiaries
are eliminated in the consolidation process. During the third quarter of
1997, PacBell's commercial paper was replaced by intercompany loans from SBC.
Intercompany loans as of September 30, 1997 totaled $573.
3. COMPLETION OF MERGER On April 1, 1997, SBC and PAC completed the merger of an
SBC subsidiary with PAC, in a transaction in which each outstanding share of
PAC common stock was exchanged for 0.73145 of a share of SBC common stock
(equivalent to approximately 313 million shares). With the merger, PAC became
a wholly-owned subsidiary of SBC. The transaction was accounted for by SBC as
a pooling of interests and a tax-free reorganization.
Conforming Accounting Changes
PacBell's results include merger transaction costs and the effects of changes
to conform accounting methodologies between PacBell and SBC for, among other
items, pensions and postretirement benefits. These changes were recorded by
PacBell in the second quarter of 1997, retroactive to January 1, 1997, as a
cumulative effect of accounting changes of $342 net of deferred taxes of
$238, and increased income before cumulative effect of accounting changes for
the first nine months of 1997 by $34. Had these changes been adopted January
1, 1996 they would have increased income before cumulative effect of
accounting changes by $64, net of taxes of $47 for the nine months ended
September 30, 1996. The changes in accounting for pension and postretirement
benefits were to adopt SBC's methodology of amortizing gains and losses on
assets held within those benefit plans. Among other costs relating to the
close of the merger, PacBell recorded the present value of amounts to be
returned to California ratepayers as a condition of the merger of $276 ($173
net of tax).
Post-merger initiatives
During the second quarter 1997, PacBell recorded after-tax charges of $943
related to SBC's June 19, 1997 announcement of several strategic decisions
resulting from the merger integration process that began with the April 1
closing of its merger with PAC which included $107 ($65 after tax) of charges
related to recent regulatory rulings and $276 ($173 after tax) for the
present value of amounts to be returned to California ratepayers as a
condition of the merger. The decisions resulted from an extensive review of
operations throughout the merged company and include significant integration
of operations and consolidation of some administrative and support functions.
Following is a discussion of the most significant of these charges.
<PAGE>
PACIFIC BELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions
Reorganization SBC will centralize several key functions that will support
the operations of PacBell and two other SBC subsidiaries, Nevada Bell and
Southwestern Bell Telephone Company (SWBell), including network planning,
strategic marketing and procurement. It is also consolidating a number of
corporate-wide support activities, including research and development,
information technology, financial transaction processing and real estate
management. PacBell, Nevada Bell and SWBell will continue as separate legal
entities. These initiatives will result in the creation of some jobs and the
elimination and realignment of others, with many of the affected employees
changing job responsibilities and in some cases assuming positions in other
locations.
PacBell recognized a charge of approximately $154 ($97 net of tax) during the
second quarter of 1997 in connection with these initiatives. This charge was
comprised mainly of postemployment benefits, primarily related to severance,
and costs associated with closing down duplicate operations, primarily
contract cancellations. Other charges arising out of the merger related to
relocation, retraining and other effects of consolidating certain operations
are being recognized in the periods those charges are incurred.
Impairments/asset valuation As a result of SBC's merger integration plans,
strategic review of domestic operations and organizational alignments,
PacBell reviewed the carrying values of related long-lived assets. This
review included estimating remaining useful lives and cash flows and
identifying assets to be abandoned. Where this review indicated impairment,
discounted cash flows related to those assets were analyzed to determine the
amount of the impairment. As a result of these reviews, PacBell wrote off
some assets and recognized impairments to the value of other assets with a
combined charge of $416 ($262 after tax) recorded in the second quarter of
1997. These impairments and writeoffs related to certain analog switching
equipment, selected wireless equipment, duplicate or obsolete equipment,
cable within commercial buildings, certain nonoperating plant and other
assets.
Video curtailment/purchase commitments SBC also announced it is scaling back
its limited direct investment in video services. As part of this curtailment,
PacBell has halted construction on the Advanced Communications Network (ACN)
in California. As part of an agreement with the ACN vendor, PacBell will pay
the liabilities of the ACN trust that owns and finances ACN construction,
incur costs to shut down all construction previously conducted under the
trust and receive certain consideration from the vendor. In the second
quarter of 1997, PacBell recognized its net expense of $553 ($346 after tax)
associated with these activities. During the third quarter of 1997, PacBell
recorded the corresponding short-term debt of $610 previously incurred by the
ACN trust on its balance sheet.
4. CUMULATIVE EFFECT OF CHANGE IN DIRECTORY ACCOUNTING Prior to January 1, 1996,
Pacific Bell Directory (a subsidiary of PacBell) recognized revenues and
expenses related to publishing directories in California using the
"amortization" method, under which revenues and expenses were recognized over
the lives of the directories, generally one year. Under the new "issue basis"
method, revenues and expenses are recognized when the directories are issued.
The change to the issue basis method was made because it is the method
generally followed in the publishing industry and better reflects the
operating activity of the business.
The change was adopted during fourth quarter 1996. The cumulative after-tax
effect of applying the change in method to prior years was recognized as of
January 1, 1996 as a one-time, non-cash gain applicable to continuing
operations of $85. The gain is net of deferred taxes of $58. The first three
quarters of 1996 were restated in the Form 10-K to reflect the new method.
<PAGE>
5. COMMITMENTS AND CONTINGENCIES
Purchase Commitments As of September 30, 1997, PacBell had purchase
commitments of about $220 remaining in connection with its previously
announced program for deploying an all digital switching platform with ISDN
and SS-7 capabilities.
Property Tax Investigation In 1992, a settlement agreement was reached among
the State Board of Equalization, all California counties, the State Attorney
General, and 28 utilities, including PacBell, on a specific methodology for
valuing utility property for property tax purposes for a period of eight
years. The California Public Utilities Commission (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 of
annual property tax savings should be treated as an exogenous cost reduction
in PacBell's annual price cap filings. These intervenors have also asserted
that past property tax savings totaling as much as approximately $85 as of
September 30, 1997, 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 and not as an exogenous cost. In an Interim Opinion issued
in June 1995, the CPUC decided to defer a final decision on this matter
pending resolution in a separate proceeding of the criteria for exogenous
cost treatment under its regulatory framework. To date the CPUC has taken no
further action on this issue.
<PAGE>
PACIFIC BELL
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
RESULTS OF OPERATIONS
Overview Financial results for Pacific Bell (PacBell, which also includes its
subsidiaries) for the first nine months of 1997 and 1996 are summarized as
follows:
- -------------------------------------------------------------------------------
Nine-Month Period
---------------------------
Percent
1997 1996 Change
- -------------------------------------------------------------------------------
Operating revenues $ 7,324 $ 7,006 4.5%
Operating expenses $ 7,047 $ 5,242 34.4
Income (loss) before cumulative effect of
accounting changes $ (79) $ 884 -
Cumulative effect of accounting changes $ 342 $ 85 -
Net income $ 263 $ 969 -
===============================================================================
Net income for the nine months ended September 30, 1997 includes a cumulative
net benefit of $342 resulting from accounting changes related to conforming
accounting between PacBell and SBC Communications Inc. (SBC) for, among other
items, pensions and postretirement benefits. The first nine months of 1996
included a cumulative effect of a change in accounting for directory publishing
revenues and expenses.
PacBell's nine-month loss before cumulative effect of accounting changes of $79
includes after-tax charges of $968 reflecting strategic initiatives resulting
from SBC's comprehensive review of operations of the merged company, the impact
of several regulatory rulings during the second quarter of 1997, costs incurred
for customer number portability since the merger and charges for ongoing merger
integration costs, primarily related to movement of employees. Excluding these
items, PacBell reported income before cumulative effect of accounting changes of
$889 approximately equal to the first nine months of 1996 income before
cumulative effect of accounting changes of $884. PacBell currently anticipates
incurring additional after-tax charges for ongoing merger integration costs,
primarily related to movement of employees, and customer number portability of
$120 to $170 during the remainder of 1997.
Excluding these charges, the primary factors contributing to the increase in
income before cumulative effect of accounting changes during the first nine
months of 1997 were growth in demand for services and products at PacBell and a
first quarter 1997 $87 after-tax settlement gain associated with lump-sum
pension payments that exceeded the projected service and interest costs for 1996
retirements. These increases were offset by rate reductions from price cap
filings and increased expenses including expenses for the introduction of
Personal Communications Services (PCS) operations in California and Nevada.
<PAGE>
PACIFIC BELL
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
RESULTS OF OPERATIONS - Continued
Revenues PacBell's operating revenues for the first nine months of 1997 reflect
reductions of $114 related primarily to the impact of several regulatory rulings
during the second quarter of 1997. Excluding these items, PacBell's operating
revenues increased $432, or 6.2%. Components of operating revenues for the first
nine months of 1997 and 1996 are as follows:
- ------------------------------------------------------------------------
Nine-Month Period
--------------------------
Percent
1997 1996 Change
- ------------------------------------------------------------------------
Local service $ 3,261 $ 2,962 10.1%
Network access
Interstate 1,254 1,338 -6.3
Intrastate 596 539 10.6
Long-distance service 900 953 -5.6
Directory advertising 834 780 6.9
Other 479 434 10.4
- ------------------------------------------------------------
Total $ 7,324 $ 7,006 4.5%
========================================================================
Local service revenues increased for the first nine months of 1997 due
primarily to increases in demand, including increases in access lines and
vertical services revenues. The number of access lines increased by 3.6%
since September 30, 1996, with approximately 46% of access line growth due
to the sales of additional access lines to existing residential customers.
Vertical services revenues, which include custom calling options, Caller
ID and other enhanced services, increased by approximately 14%. Local
service revenues also reflect the implementation of the California High
Cost Fund (CHCFB) that went into effect February 1, 1997. The California
Public Utilities Commission (CPUC) has stated that the CHCFB is intended
to directly subsidize the provision of service to high cost areas and
allow PacBell to set competitive rates for other services. The rebalancing
provisions of the CHCFB resulted in a shift of equivalent revenues from
intraLATA long-distance and intrastate network access revenues to local
service revenues in the first nine months of 1997. This shift is subject
to final CPUC approval, expected in the second quarter of 1998. For
further information on the operations of the CHCFB, see the discussion
under the heading "State Regulation" on page 8 of PacBell's Annual Report
on Form 10-K dated December 31, 1996 and the discussion under the heading
"Regulatory Environment-California" on page 10 of SBC's Current Report on
Form 8-K dated May 8, 1997. Additionally, Federal payphone deregulation
increased local service and decreased other operating revenues and, to a
lesser extent, long-distance service and interstate network access; the
overall impact was a slight increase in total operating revenues. Rate
reductions due to CPUC price cap orders partially offset increases in
local service revenues. Wireless revenues also contributed to the increase
in local service revenues due to product introduction of PCS in the first
nine months of 1997.
Network Access Interstate network access revenues decreased $134 in the
first nine months of 1997 due to one-time charges. These one-time charges
include billing claim settlements related to the Percentage Interstate
Usage (PIU) factor and several Federal regulatory issues including
end-user charges, 800 data base charges, recovery of certain
employee-related expenses and the retroactive effect of the productivity
factor adjustment mandated in the July 1, 1997 Federal price cap filing.
While the change in PIU factor, which is used to allocate network access
revenues between interstate and intrastate jurisdictions, also had the
effect of increasing intrastate network access revenues, it resulted in a
slight decline in total network access revenues. Without these impacts,
interstate access revenues increased in the first nine months of 1997 due
to demand for access services by interexchange carriers and growth in
revenues from end-user charges attributable to an increasing access line
base. Partially offsetting these increases were the effects of the rate
reduction related to the productivity factor adjustment and of revenue
sharing adjustments made in 1996.
Intrastate network access revenues increased in the first nine months of
1997 due primarily to the PIU settlements described above. Excluding this
impact, intrastate network access revenues increased slightly in the first
nine months of 1997 as increases in demand, including usage by alternative
intraLATA toll carriers were partially offset by the effects of the CHCFB
discussed above in Local Service.
Long-Distance Service revenues decreased for the first nine months of 1997
primarily due to the effects of the CHCFB discussed above and rate
reductions due to CPUC price cap orders partially offset by increases in
demand resulting from California's growing economy.
Directory advertising revenues increased for the first nine months of 1997
due mainly to the publication of books not published in 1996 and, to a
lesser extent, increased demand.
Other operating revenues increased for the first nine months of 1997 due
primarily to increased equipment sales at Pacific Bell Mobile Services and
increased demand for nonregulated products and services. Revenues from new
business initiatives primarily voice messaging services and Internet
services, also contributed to the increase. Results also reflect the
impact of payphone deregulation as described in Local Service.
Expenses PacBell's operating expenses for the first nine months of 1997 reflect
$1,377 of charges related to strategic initiatives from a comprehensive review
of operations of the merged company, the impact of several regulatory rulings
during the second quarter of 1997 (see Note 3 to the financial statements),
costs incurred for customer number portability since the merger and charges for
ongoing merger integration costs. Excluding these charges, operating expenses
increased $428, or 8.2%, over the first nine months of 1996. Components of
operating expenses for the first nine months of 1997 and 1996 are as follows:
- -------------------------------------------------------------------------------
Nine-Month Period
-------------------------------------
Percent
1997 1996 Change
- -------------------------------------------------------------------------------
Cost of services and products $ 2,996 $ 2,618 14.4%
Selling, general and administrative 2,494 1,257 98.4
Depreciation and amortization 1,557 1,367 13.9
- ------------------------------------------------------------------
Total $ 7,047 $ 5,242 34.4%
===============================================================================
Cost of services and products for the first nine months of 1997 reflects
charges of $53 relating to SBC's strategic initiatives, operational
reviews, costs incurred for customer number portability since the merger
and ongoing merger integration costs. Excluding these charges, cost of
services and products increased $325, or 12.4%, in the first nine months
of 1997. These increases were significantly impacted by the introduction
of PCS operations during 1997. Additional increases were due primarily to
employee compensation including increases related to force additions and
increases in contract labor. These cost increases were partially offset by
the conforming of accounting methodologies and assumptions for pensions
and postretirement benefits. During the third quarter of 1997, pension
settlement gains previously reported as cost of services and products were
reclassified to selling, general and administrative expense; prior
quarters of 1997 were restated to reflect this reclassification.
Selling, general and administrative expense for the first nine months of
1997 reflects $1,166 of charges relating to SBC's strategic initiatives,
operational reviews and ongoing merger integration costs. As discussed in
Note 3 to the financial statements, the most significant of these charges
included shutdown of the Advanced Communications Network, regulatory costs
related to the approval of the merger with SBC by California regulators
and reorganization initiatives. Excluding these one-time charges, selling,
general and administrative expense increased $71, or 5.6%, in the first
nine months of 1997. These increases were significantly impacted by the
introduction of PCS operations during 1997. Additional increases were due
primarily to employee compensation and contract labor which were partially
offset by a first quarter 1997 $146 settlement gain associated with
lump-sum pension payments that exceeded the projected service and interest
costs for 1996 retirements and reduced expenses resulting from conforming
of accounting methodologies and assumptions for pensions and
postretirement benefits.
Depreciation and amortization for the first nine months of 1997 reflects
charges totaling $158 to record impairment of plant and intangibles. As
discussed in Note 3 to the financial statements, the most significant of
these impairments related to certain analog switching equipment and cable
within commercial buildings. Excluding these charges, depreciation and
amortization increased $32, or 2.3% in the first nine months of 1997.
These increases were primarily due to overall higher plant levels
partially offset by reduced depreciation beginning with the second quarter
on analog switching equipment in California.
Interest Expense increased $59 or 21.3% for the first nine months of 1997 due to
interest of $27 associated with certain second quarter one-time charges and
increased debt levels compared to the first nine months of 1996. These increases
were somewhat offset by capitalized interest related to PCS construction.
Other Income (Expense) - net was a net expense of $15 for the first nine months
of 1997. The increased expenses include $30 in expenses related to SBC's
strategic initiatives, primarily writeoffs of nonoperating plant. Other
increases relate primarily to the recognition of investment returns on funds
held in trust for deferred compensation.
Income taxes for the first nine months of 1997 reflect the tax effect of charges
for strategic initiatives resulting from SBC's comprehensive review of
operations of the merged company and the impact of several regulatory rulings
during the second quarter of 1997.
Income taxes paid, net of refunds reflect the impact of reduced tax payments due
to merger-related and integration costs incurred and the application of the SBC
tax sharing agreement.
Cumulative Effect of Accounting Changes, as discussed in Note 3 to the financial
statements, include the effect of changes applied retroactively to conform
accounting methodologies between PAC and SBC effective January 1, 1997. The
cumulative after-tax effect of these one-time changes is $342.
<PAGE>
PACIFIC BELL
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
State Interconnection Agreements/ Reselling Developments PacBell continues to
enter into interconnection agreements with companies desiring to provide local
service in its operating territory. Approximately 40 interconnection agreements
have been reached, and most have been approved by the CPUC. AT&T Corp. and other
competitors are reselling PacBell local exchange services, and as of September
30, 1997 there were more than 180,000 access lines supporting services resold by
competitors.
Federal Interconnection In September 1997, 28 state commissions, the National
Association of Regulatory Utilities Commissioners and the D.C. Public Service
Commission along with many companies who have Local Exchange Carriers (LECs),
including SBC filed petitions to enforce the July 18, 1997 ruling of the U.S.
Court of Appeals for the Eighth Circuit in St. Louis (8th Circuit) that the
right to set local exchange prices, including the pricing methodology used, is
reserved exclusively to the states. The petitions respond to the Federal
Communications Commission's (FCC) rejection of Ameritech Corporation's interLATA
long-distance application in Michigan in which the FCC stated it is applying its
own pricing standards to interLATA applications. The petitioners assert the FCC
is violating state authority. On October 14, 1997, the 8th Circuit granted the
LECs' petitions for rehearing and ruled that they do not have to deliver network
elements to competitors in anything other than completely unbundled form.
Payphone Deregulation/Market Price Adjustments Final price deregulation of the
payphone industry took effect October 7, 1997. PacBell raised payphone prices
throughout its operating territories, beginning in October 1997. The new prices
are the result of federal telecommunications deregulation, which prohibits
subsidy of payphone service directly or indirectly from its telephone service
operations and allows payphone providers to determine their own pricing.
Portions of the Telecommunications Act of 1996 Challenged In July 1997, SBC
brought suit against the FCC in the U.S. District Court for the Northern
District of Texas, seeking a declaration that a portion of the Telecom Act is
unconstitutional on the grounds that it improperly discriminates against SBC by
imposing restrictions that prohibit SBC from offering interLATA long-distance
and other services that other LECs are free to provide. The suit challenges only
that portion of the Telecom Act that excludes SBC from competing in certain
lines of business. SBC is currently awaiting a decision by the court on its
motion for summary judgement.
California Universal Service Rebalancing Hearings related to the PacBell March
1997 filing to permanently reduce certain toll and access rates and eliminate
universal service surcredits to ratepayers for rebalancing of the CHCFB were
held in October 1997 with a decision expected in the second quarter of 1998.
<PAGE>
PACIFIC BELL
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Dollars in millions
OTHER BUSINESS MATTERS
Restructuring Reserve PacBell established a restructuring reserve at the end of
1993 to provide for the incremental cost of force reductions associated with
restructuring business processes through 1997. A total of $62 in cash outlays
was charged to the reserve in the first nine months of 1997. As of September 30,
1997, $32 remained in the restructuring reserve.
Local Number Portability/Interconnection Over the next few years, PacBell is
expecting to incur significant capital and software expenditures for customer
number portability and interconnection. PacBell expects capital costs and
expenses associated with customer number portability, which allows customers to
switch to local competitors and keep the same phone number, to total up to $600
on a pre-tax basis over the next four years. Full recovery of customer number
portability costs is required under the Telecom Act; however, the FCC has not
yet determined when or how those significant costs will be recovered. PacBell
has filed a tariff with the FCC for recovery of these costs. No action has been
taken by the FCC on this tariff, pending the issuance of its order on customer
number portability. PacBell is unable to predict the likelihood of the FCC
permitting the tariff to become effective. Capital costs and expenses associated
with interconnection will vary based on the number of competitors seeking
interconnection and customers served and markets entered by those competitors.
Accordingly, PacBell is currently unable to reasonably estimate these costs.
CPUC Ruling A complaint filed with the CPUC challenged PacBell's practice of
charging to reconnect wires between the utility terminal board and the customer
utility board in apartment buildings, claiming that the wiring between these two
points were part of PacBell's facilities. On November 5, 1997, the CPUC ordered
PacBell to retroactively refund these charges dating from 1993. PacBell believes
it has several meritorious defenses and plans to file for rehearing and
reconsideration with the CPUC, and if appropriate, file for judicial review.
Management is evaluating the order and while it is currently unable to estimate
the specific amount of any refund that may be required, it does not believe the
amount would be material.
<PAGE>
PACIFIC BELL
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 3-a By-Laws of Pacific Bell, as amended to November 10, 1997
Exhibit 12 Computation of Ratios of Earnings to Fixed Charges.
Exhibit 27 Financial Data Schedule.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the third quarter ended
September 30, 1997.
<PAGE>
SIGNATURES
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
November 12, 1997 /s/ Daniel J. Fete
Daniel J. Fete
Controller
Exhibit 3-a
BY-LAWS
OF
PACIFIC BELL
(As amended November 10, 1997)
Article I
Shareholders' Meetings
......Section 1. The annual meeting of shareholders may be called at any time
between March 1 and July 31 of each year on such day (other than a legal
holiday), at such time and at such place as may be designated by the Board of
Directors, and in the absence of such designation at the principal office of the
corporation, at 10 a.m. on the fourth Friday in April, or, if said day is a
legal holiday, then on the first business day of the following week, to elect
directors and to transact such other business as may properly come before the
meeting. (As amended February 26, 1982)
......Written notice of the time and place of said meeting and the business to
be transacted thereat shall be given by the Secretary to the shareholders
personally or by mail, to the extent and in the manner specified by law, at
least ten days but no more than sixty days before the meeting. (As amended
December 22, 1976)
......Section 2. Special meetings of the shareholders may be called at any time
by the Chairman of the Board of Directors, if one has been elected, by the
President, by the Board of Directors or by three or more of the directors, or by
any number of shareholders representing not less than ten percent of the votes
entitled to be cast at the meeting, and may be held at any time, whether on a
holiday or not, and at any place. (As amended December 22, 1976)
......Written notice of the time and place of said meeting and the business to
be transacted thereat shall be given by the Secretary to the shareholders
personally or by mail, to the extent and in the manner specified by law, at
least ten days but no more than sixty days before the meeting. (As amended
December 22, 1976)
......Section 3. At any meeting of shareholders, whether regular or special, the
presence in person or by proxy of shareholders entitled to exercise a majority
of the voting power of the outstanding shares entitled to vote at such meeting
shall constitute a quorum for the transaction of business. (As amended January
22, 1960)
......Section 4. The Board of Directors may fix a time as a record date for the
determination of the shareholders entitled to notice of and to vote at any
meeting of shareholders or entitled to receive any dividend or distribution, or
any allotment of rights, or to exercise rights in respect to any change,
conversion or exchange of shares. The record date so fixed shall not be more
than sixty nor less than ten days prior to the date of the meeting nor more than
sixty days prior to any other event for the purposes of which it is fixed and
only shareholders of record on that date are entitled to notice of and vote at
the meeting or to receive the dividend, distribution or allotment of rights or
to exercise the rights, as the case may be. (As amended December 22, 1976)
Article II
The Board of Directors, Directors' Meetings
......Section 1. The number of Directors shall be fixed at 8 until changed, from
time to time, by resolution of the Board of Directors or of the Shareholders but
at no time shall be less than 7 nor more than 13 until changed by amendment of
these By-Laws. The Board of Directors shall be elected by the shareholders at
the annual meeting or at any other meeting held for that purpose, and directors
shall hold office until the next annual election and until their successors are
elected. Any vacancy or vacancies in the Board of Directors may be filled by a
majority of the remaining directors or by the shareholders. (As amended November
10, 1997)
......Section 2. Regular meetings of the Board of Directors may be held without
notice at such time and place as shall from time to time be determined by the
Board and no notice of such meeting shall be necessary to the newly elected
directors in order legally to constitute the meeting, provided a quorum shall be
present. (As amended July 28, 1989)
......Section 3. Special meetings of the Board of Directors may be called by the
Chairman of the Board or the President, or a Vice Chairman, and shall be called
by the Chairman of the Board, the President or Secretary on the written request
of a majority of the directors. Notice of special meetings shall be given by the
Secretary or Assistant Secretary of the corporation to each director personally
or by telephone, facsimile transmission or telegram at least 48 hours before the
meeting, or by mailing written notice at least four days before the meeting. (As
amended November 20, 1992)
......Section 4. A majority of the Board of Directors shall constitute a quorum
at any meeting. (As amended November 10, 1997)
......Section 5. The Board of Directors may, by resolution adopted by a majority
of the authorized number of directors, designate one or more committees, each
consisting of two or more directors, to serve at the pleasure of the Board. The
Board may designate one or more directors as alternate members of any committee,
who may replace any absent member at any meeting of the committee. Any such
committee, to the extent provided in the resolution of the Board or in the
By-Laws, shall have all the authority of the Board, except with respect to those
powers enumerated in Article III, Section 2 of these By-Laws.
......Unless other procedures are established by resolution adopted by the
Board, the provisions of Sections 2 and 3 of this Article II shall be applicable
to committees of the Board of Directors, if any are established. For such
purpose, references to "the Board" or "the Board of Directors" shall be deemed
to refer to each such committee. The committees shall keep regular minutes of
their proceedings and report the same to the Board when required.
......A majority of the committee members at a meeting duly assembled shall be
necessary to constitute a quorum for the transaction of business and the act of
a majority of the committee members present at any meeting at which a quorum is
present shall be the act of the committee. Any action required or permitted to
be taken at a meeting of the committee may be taken without a meeting if a
consent in writing, setting forth the action so taken, shall be signed by all of
the committee members entitled to vote with respect to the subject matter
thereof. (As amended July 28, 1989)
Article III
Executive Committee
......Section 1. The Executive Committee, if one is appointed, shall consist of
two or more directors. The remaining directors shall be alternate members of the
Executive Committee, and, in the absence or disability of any regular member of
the Executive Committee, any such alternate member may be called by the Chairman
or by the President to serve in the place of such absent or disabled regular
members. (As amended February 26, 1996)
......Section 2. The Executive Committee may exercise all the powers of the
Board of Directors during the intervals between meetings of the Board, except
the powers to:
(a) Approve any action which under the General Corporation Law also
requires shareholders' approval or approval of the outstanding
shares.
(b) Fill vacancies on the Board or on any committee.
(c) Fix the compensation of the directors for serving on the Board or
on any committee.
(d) Adopt, amend, or repeal By-Laws.
(e) Amend or repeal any resolution of the Board which by its express
terms is not so amendable or repealable.
(f) Cause a distribution to the shareholders, except at a rate or in a
periodic amount or within a price range determined by the Board.
(g) Appoint other committees of the Board or the members thereof. (As
amended December 22, 1976)
Section 3. Meetings of the Executive Committee may be called for any time
and place by the Chairman of the Board of Directors, if one has been elected, or
by the President.
Section 4. Notice of a meeting of the Executive Committee shall be given
by the Secretary or an Assistant Secretary of the corporation to each members
personally or by telephone, facsimile transmission or telegram at least 48 hours
before the meeting or by mailing written notice at least four days before the
meeting. (As amended November 20, 1992)
Section 5. A Majority of the Executive Committee shall constitute a quorum
at any meeting. All actions taken at meetings of the Committee shall be
recorded, and shall be reported to the Board of Directors from time to time.
ARTICLE IV
Officers
The officers of the corporation shall be elected by the Board of Directors
and shall hold office at the pleasure of the Board. The Chairman of the Board
shall not be an officer of the corporation. The officers of the corporation
shall consist of such Vice Chairmen of the Board as the Board of Directors may
elect, a President, such Executive Vice Presidents, such Senior Vice Presidents
and such Vice Presidents as the Board may elect, a Secretary, a Treasurer, a
Controller, such Assistant Secretaries and Assistant Treasurers as the Board may
elect, and such other officers as the Board may elect. The Board of Directors
shall designate one officer of the corporation as the Chief Financial Officer.
(As amended February 8, 1996)
Section 1. The Chairman of the Board of Directors shall preside at all
meetings of the Board of Directors, of the Executive Committee and of the
shareholders and have such authority and shall perform such other duties as the
By-Laws establish or as the Board of Directors may from time to time assign. (As
amended January 27, 1984)
Section 2. Each Vice Chairman of the Board shall have such powers and
shall perform such duties as may from time to time be assigned by the Board of
Directors or as the Chairman of the Board of Directors may from time to time
delegate or direct. (As amended July 28, 1989)
ARTICLE VI
President
The President shall be the Chief Executive Officer of the corporation and
shall have such powers and shall perform such duties as may from time to time be
assigned by the Board of Directors or as the Chairman of the Board may from time
to time delegate or direct. (As amended January 27, 1984)
ARTICLE VII
Powers and Duties
Each officer of the corporation shall have such powers and perform such
duties as the Board of Directors or the Chairman of the Board may from time to
time delegate or direct. The Board of Directors or the Chairman of the Board may
delegate to certain officers the power to define the authority and powers of
other officers. (As amended July 14, 1987)
ARTICLE VIII
Shares and Share Certificates
Section 1. The certificates for the shares of the corporation shall be in
form and content as required by law and as approved by the Board of Directors.
Section 2. The corporation shall not issue any certificate evidencing,
either singly or with other shares, any fractional part of or interest in a
share.
Section 3. The person, firm, or corporation in whose name shares stand on
the books of the corporation, whether individually or as trustee, pledgee or
otherwise, may be recognized and treated by the corporation as the absolute
owner of the shares, and the corporation shall in no event be obliged to deal
with or to recognize the rights or interests of other persons in such shares or
in any part thereof.
ARTICLE IX
Annual Reports
An annual report shall be sent to the shareholders not later than one
hundred twenty days after the close of the fiscal year, but at least fifteen
days prior to the next annual meeting of shareholders to be held during the next
fiscal year. (As amended December 22, 1976)
ARTICLE X
Seal
The corporate seal shall have inscribed thereon the name of the
corporation, the year of its organization and the State within which it is
incorporated. The seal may be used by causing it or a facsimile thereof to be
impressed or affixed or reproduced or otherwise. (As amended November 20, 1992)
<PAGE>
ARTICLE XI
Adoption, Amendment, and Repeal of By-Laws
These By-Laws may be amended or repealed or new by-laws may be adopted by
the vote of shareholders entitled to exercise a majority of the voting power of
the corporation or by the written assent of such shareholders filed with the
Secretary. Subject to the right of the shareholders to amend or repeal these
By-Laws, or to adopt new by-laws, the Board of Directors may adopt, amend or
repeal any by-law other than Article II, Section 1 hereof. (As amended November
25, 1953)
ARTICLE XI
Indemnification of Officers and Directors
This corporation shall, to the maximum extent permissible under applicable
common or statutory law, state or federal, indemnify each of its agents against
expenses, judgments, fines, settlements and other amounts actually and
reasonably incurred in connection with any proceeding arising by reason of the
fact that any such person is or was an agent of this corporation. For purposes
of this Article XII, an `agent' of this corporation includes any person who is
or was a director or officer of this corporation, or who is or was serving at
the request of this corporation as a director, officer, employee or agent of
another corporation, partnership, joint venture, trust or other enterprise.
Prior to the disposition of any such proceeding, this corporation, upon
the request of any such agent, shall promptly advance to such agent, or
otherwise as directed by such agent, such amounts as shall be equal to the
expenses which shall have been incurred by such agent in defending such
proceeding, provided that such agent requesting such amounts shall first have
delivered to this corporation an undertaking to repay any and all such advances
unless it shall be determined ultimately that such agent is entitled to be
indemnified with respect thereto in accordance with this Article XII. (As
amended February 28, 1986)
<TABLE>
EXHIBIT 12
PACIFIC BELL
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
Dollars in Millions
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ ---------------------------------------------------
1997 1996 1996 1995 1994 1993 1992
--------- --------- ---------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Income (Loss) From Continuing Operations Before
Income Taxes, Extraordinary Loss and
Cumulative Effect of Accounting Changes $ (74) $ 1,491 $ 1,945 $ 1,538 $ 1,692 $ (39) $ 1,738
Add: Interest Expense 336 277 363 410 439 429 460
1/3 Rental Expense 52 37 46 28 40 37 35
--------- --------- -------- --------- -------- -------- ---------
Adjusted Earnings $ 314 $ 1,805 $ 2,354 $ 1,976 $ 2,171 $ 427 $ 2,233
========= ========= ======== ========= ======== ======== =========
Total Interest Charges $ 373 $ 306 $ 411 $ 410 $ 439 $ 429 $ 460
1/3 Rental Expense 52 37 46 28 40 37 35
--------- --------- -------- --------- -------- -------- ---------
Adjusted Fixed Charges $ 425 $ 343 $ 457 $ 438 $ 479 $ 466 $ 495
========= ========= ========= ========= ======== ======== =========
Ratio of Earnings to Fixed Charges 0.74 5.26 5.15 4.51 4.53 0.92 4.51
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFIC
BELL'S QUARTERLY REPORT ON FORM 10-Q AND IS QUALIFIED IN ITS ENTIRETY BY
REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
<PERIOD-TYPE> 9-MOS
<CASH> 55,000
<SECURITIES> 0
<RECEIVABLES> 2,493,000
<ALLOWANCES> 241,000
<INVENTORY> 0 <F1>
<CURRENT-ASSETS> 3,211,000
<PP&E> 29,304,000
<DEPRECIATION> 17,470,000
<TOTAL-ASSETS> 15,770,000
<CURRENT-LIABILITIES> 4,869,000
<BONDS> 5,342,000
<COMMON> 225,000
0
0
<OTHER-SE> 3,217,000
<TOTAL-LIABILITY-AND-EQUITY> 15,770,000
<SALES> 0 <F2>
<TOTAL-REVENUES> 7,324,000
<CGS> 0
<TOTAL-COSTS> 2,996,000
<OTHER-EXPENSES> 1,557,000
<LOSS-PROVISION> 201,000
<INTEREST-EXPENSE> 336,000
<INCOME-PRETAX> (74,000)
<INCOME-TAX> 5,000
<INCOME-CONTINUING> (79,000)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 342,000
<NET-INCOME> 263,000
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
<FN>
<F1> THIS AMOUNT IS IMMATERIAL.
<F2> NET SALES OF TANGIBLE PRODUCTS IS NOT MORE THAN 10% OF TOTAL OPERATING REVENENUES AND THEREFORE HAS NOT BEEN
STATED SEPARATELY IN THE FINANCIAL STATEMENTS PURSUANT TO REGULATION S-X, RULE 5-03(B). THIS AMOUNT IS INCLUDED
IN THE "TOTAL REVENUES' TAG.
<F3> COST OF TANGIBLE GOODS SOLD IS INCLUDED IN COST OF SERVICES AND PRODUCTS IN
THE FINANCIAL STATEMENTS AND THE "TOTAL COST" TAG, PURSUANT TO REGULATION 2-X,
RULE 5-03(B).
</FN>
</TABLE>
