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 March 31, 1998
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
Incorporated under the laws of the State of California
I.R.S. Employer Identification Number 94-0745535
140 New Montgomery Street, San Francisco, California 94105-3705
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
PACIFIC BELL AND SUBSIDIARIES
- --------------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
(Unaudited)
- --------------------------------------------------------------------------------
Three months ended
March 31,
-----------------------------
1998 1997
- --------------------------------------------------------------------------------
Operating Revenues
Local service $ 1,118 $ 1,027
Network access:
Interstate 500 459
Intrastate 180 186
Long-distance service 306 305
Other 189 162
- --------------------------------------------------------------------------------
Total operating revenues 2,293 2,139
- --------------------------------------------------------------------------------
Operating Expenses
Cost of services and products 847 821
Selling, general and administrative 474 285
Depreciation and amortization 451 469
- --------------------------------------------------------------------------------
Total operating expenses 1,772 1,575
- --------------------------------------------------------------------------------
Operating Income 521 564
- --------------------------------------------------------------------------------
Other Income (Expense)
Interest expense (106) (102)
Other income (expense) - net (2) 4
- --------------------------------------------------------------------------------
Total other income (expense) (108) (98)
- --------------------------------------------------------------------------------
Income Before Income Taxes and Cumulative
Effect of Accounting Changes 413 466
- --------------------------------------------------------------------------------
Income Taxes 161 185
- --------------------------------------------------------------------------------
Income Before Cumulative Effect of
Accounting Changes 252 281
- --------------------------------------------------------------------------------
Cumulative Effect of Accounting Changes, net of - 345
tax
- --------------------------------------------------------------------------------
Net Income $ 252 $ 626
- --------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
- -------------------------------------------------------------------------------
CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
(Unaudited)
- -------------------------------------------------------------------------------
March 31, December
31,
--------------------------------
1998 1997
- -------------------------------------------------------------------------------
Assets
Current Assets
Cash and cash equivalents $ 53 $ 43
Accounts receivable - net of allowances for
uncollectibles of $164 and $152 1,689 1,782
Prepaid expenses 116 53
Deferred income taxes 408 415
Other current assets 53 44
- -------------------------------------------------------------------------------
Total current assets 2,319 2,337
- -------------------------------------------------------------------------------
Property, Plant and Equipment - at cost 28,993 28,695
Less: Accumulated depreciation and amortization 17,761 17,442
- -------------------------------------------------------------------------------
Property, Plant and Equipment - Net 11,232 11,253
- -------------------------------------------------------------------------------
Other Assets 813 749
- -------------------------------------------------------------------------------
Total Assets $14,364 $14,339
- -------------------------------------------------------------------------------
Liabilities and Shareowner's Equity
Current Liabilities
Intercompany loans $ 596 $ 542
Current portion of long-term obligations 4 4
- -------------------------------------------------------------------------------
Total debt maturing within one year 600 546
- -------------------------------------------------------------------------------
Accrued taxes 315 334
Accounts payable and accrued liabilities 2,335 2,719
- -------------------------------------------------------------------------------
Total current liabilities 3,250 3,599
- -------------------------------------------------------------------------------
Long-Term Debt 5,381 5,358
- -------------------------------------------------------------------------------
Deferred Credits and Other Noncurrent
Liabilities
Deferred income taxes 966 957
Postemployment benefit obligation 871 881
Unamortized investment tax credits 178 188
Other noncurrent liabilities 575 569
- -------------------------------------------------------------------------------
Total deferred credits and other noncurrent liabilities 2,590 2,595
- -------------------------------------------------------------------------------
Shareowner's Equity
Common shares ($1 par value) 225 225
Capital in excess of par value 4,918 4,814
Retained earnings (deficit) (2,000) (2,252)
- -------------------------------------------------------------------------------
Total shareowner's equity 3,143 2,787
- -------------------------------------------------------------------------------
Total Liabilities and Shareowner's Equity $14,364 $14,339
- -------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
- ----------------------------------------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
(Unaudited)
- ----------------------------------------------------------------------------
Three months ended
March 31,
--------------------------
1998 1997
- ----------------------------------------------------------------------------
Operating Activities
Net income $ 252 $ 626
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 451 469
Provision for uncollectible accounts 40 42
Amortization of investment tax credits (10) (11)
Deferred income tax expense 7 77
Cumulative effect of accounting changes, net of tax - (345)
Other - net (491) (479)
- ----------------------------------------------------------------------------
Total adjustments (3) (247)
- ----------------------------------------------------------------------------
Net Cash Provided by Operating Activities 249 379
- ----------------------------------------------------------------------------
Investing Activities
Construction and capital expenditures (415) (498)
- ----------------------------------------------------------------------------
Net Cash Used in Investing Activities (415) (498)
- ----------------------------------------------------------------------------
Financing Activities
Net change in short-term borrowings with original
maturities of three months or less 53 302
Issuance of long-term debt 197 -
Repayment of long-term debt (175) (1)
Equity received from parent 215 16
Dividends paid (114) (165)
- ----------------------------------------------------------------------------
Net Cash Provided by Financing Activities 176 152
- ----------------------------------------------------------------------------
Net increase in cash and cash equivalents 10 33
- ----------------------------------------------------------------------------
Cash and cash equivalents beginning of year 43 57
- ----------------------------------------------------------------------------
Cash and Cash Equivalents End of Period $ 53 $ 90
- ----------------------------------------------------------------------------
Cash paid during the three months ended March 31 for:
Interest $ 141 $ 143
Income taxes $ 222 $ 85
See Notes to Consolidated Financial
Statements.
<PAGE>
<TABLE>
PACIFIC BELL AND SUBSIDIARIES
- -----------------------------------------------------------------------------------
STATEMENTS OF SHAREOWNER'S EQUITY
Dollars in millions
(Unaudited)
<CAPTION>
- -----------------------------------------------------------------------------------
Capital in Retained
Common Excess of Earnings
Shares Par Value (Deficit)
- -----------------------------------------------------------------------------------
<S> <C> <C> <C>
Balance, December 31, 1997 $225 $4,814 $(2,252)
Net income - - 252
Dividend to shareowner - (114) -
Net equity from parent - 218 -
- -----------------------------------------------------------------------------------
Balance, March 31, 1998 $225 $4,918 $(2,000)
- -----------------------------------------------------------------------------------
<FN>
See Notes to Consolidated Financial Statements.
</FN>
</TABLE>
* * * *
<TABLE>
SELECTED FINANCIAL AND OPERATING DATA*
<CAPTION>
At March 31, or for the three months then ended: 1998 1997
-------------- -------------
<S> <C> <C>
Return on weighted average total capital..................... 15.80% 16.94%
Debt ratio................................................... 65.55% 63.02%
Network access lines in service (000)........................ 17,578 16,770
Access minutes of use (000,000).............................. 18,542 17,619
Number of employees.......................................... 45,880 44,780
<FN>
*Operating data may be periodically revised to reflect the most current information.
</FN>
</TABLE>
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
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 also includes its subsidiaries
Pacific Bell Information Services and Pacific Bell Network Integration)
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. PacBell is a wholly-owned
subsidiary of Pacific Telesis Group (PAC), a wholly-owned subsidiary of SBC
Communications Inc. (SBC). On March 31, 1998, PacBell distributed the shares
of Pacific Bell Directory, Pacific Bell Mobile Services, Pacific Bell
Internet Services and PB COMM Switches, Inc. to PAC. PacBell has accounted
for this distribution as a change in reporting entity; the financial
statements of all periods presented have been restated to show financial
information for the new reporting entity. This restatement reflects a
reduction of net income of $69 and $89 for the three months ended March 31,
1998 and 1997 and a reduction of income before cumulative effect of
accounting changes of $91 for the three months ended March 31, 1997.
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 SEC rules and
regulations. 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
1997 Annual Report on Form 10-K filed with the SEC. Comprehensive income for
PacBell is the same as Net Income for all periods presented.
2. CONSOLIDATION The consolidated financial statements include the accounts of
PacBell and its subsidiaries. All significant intercompany transactions
within PacBell are eliminated in the consolidation process.
3. CONFORMING ACCOUNTING CHANGES PacBell's results include the effects of
changes to conform accounting methodologies between SBC and PacBell for
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 $345, net of deferred taxes of
$239, and increased income before income taxes and cumulative effect of
accounting changes and net income for the first quarter of 1997 by $21 and
$13. 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.
4. SOFTWARE COSTS PacBell currently expenses costs as incurred for software
purchased or developed for internal use, except for initial operating
software costs, which are capitalized and amortized over the lives of the
associated hardware. The American Institute of Certified Public Accountants
has issued a Statement of Position (SOP) that will require capitalization of
certain computer software expenditures beginning in 1999, with earlier
adoption permitted.
PacBell did not elect to early adopt the provisions of the SOP. Management is
currently evaluating the impact of the change in accounting required by the
SOP, but is not able to quantify the effect at this time. The SOP would tend
to cause an increase in net income in the first year of adoption.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
RESULTS OF OPERATIONS
Overview Financial results for Pacific Bell (PacBell, which includes its
subsidiaries) for the first three months of 1998 and 1997 are summarized as
follows:
- ---------------------------------------------------------------------------
Three-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Operating revenues $ 2,293 $ 2,139 7.2%
Operating expenses $ 1,772 $ 1,575 12.5%
Income before cumulative effect of $ 252 $ 281 (10.3)%
accounting changes
Cumulative effect of accounting changes - $ 345 -
Net income $ 252 $ 626 -
===========================================================================
PacBell reported net income of $252 for the first quarter of 1998 and net income
of $626 for the first quarter of 1997. First quarter 1997 net income includes a
cumulative net benefit of $345 resulting from accounting changes related to
conforming accounting methodologies between PacBell and SBC Communications Inc.
(SBC) for, among other items, pensions and postretirement benefits.
PacBell's income before cumulative effect of accounting changes for the first
quarter of 1997 of $281 includes 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. Excluding the 1997 settlement
gain, PacBell's reported income before cumulative effect of accounting changes
increased $58, or 29.9% for the first quarter of 1998.
Excluding the settlement gain, the primary factor contributing to this increase
was growth in demand for services and products. This increase was partially
offset by increased costs associated with merger integration costs and other
costs associated with the merger and increases in employee compensation,
including those resulting from higher force levels.
Revenues Components of operating revenues for the first quarter of 1998 and 1997
are as follows:
- ----------------------------------------------------------------------------
Three Month Period
------------------------------
Percent
1998 1997 Change
- ----------------------------------------------------------------------------
Local service $ 1,118 $ 1,027 8.9%
Network access:
Interstate 500 459 8.9
Intrastate 180 186 (3.2)
Long-distance service 306 305 0.3
Other 189 162 16.7
- -------------------------------------------------------------------
Total $ 2,293 $ 2,139 7.2%
============================================================================
Local Service Local service revenues increased in the first quarter of
1998 due primarily to increases in demand, including increases in access
lines and vertical services revenues. The number of access lines increased
by 4.8% since March 31, 1997, with approximately 38% of access line growth
due to the sales of additional access lines to existing residential
customers. Vertical services revenues, which include custom calling
services, call control options, Caller ID and other services, increased by
approximately 18%. Additionally, Federal payphone deregulation implemented
in April 1997 increased local service and decreased interstate network
access, long-distance service and other operating revenues; the overall
impact was a slight increase in total operating revenues.
Network Access Interstate network access revenues increased $41 in the
first quarter of 1998 due to demand for access services by interexchange
carriers and growth in revenues from end-user charges attributable to an
increasing access line base. Also contributing to the increase was the
absence of the 1997 revenue offset required for net payments for long-term
support which were designed to subsidize universal service. This change is
discussed further in Cost of Services and Products below. Partially
offsetting these increases were the effects of PacBell's 1997 rate
reduction related to the Federal productivity factor adjustment, as
discussed in the 1997 Annual Report on Form 10-K, and payphone
deregulation referred to above in Local Service.
Intrastate network access revenues decreased slightly in the first quarter
of 1998 due to California Public Utility Commission (CPUC) rate order
reductions and implementation of the February 1997 California high cost
fund.
Long-Distance Service revenues were unchanged in the first quarter of 1998
as increased toll messages due to the growing California economy were
offset by the Federal payphone deregulation referred to in Local Service
and rate reductions in CPUC price cap orders.
Other operating revenues increased $27 for the first quarter of 1998 due
primarily to increased demand for PacBell's nonregulated products and
services.
Expenses Components of operating expenses for the first quarter of 1998 and 1997
are as follows:
- ---------------------------------------------------------------------------
Three-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Cost of services and products $ 847 $ 821 3.2%
Selling, general and administrative 474 285 66.3
Depreciation and amortization 451 469 (3.8)
- ------------------------------------------------------------------
Total $ 1,772 $ 1,575 12.5%
===========================================================================
Cost of services and products for the first quarter of 1998 increased $26,
or 3.2%, over the first quarter of 1997. This increase was due primarily
to the January 1, 1998 implementation of the Federal Universal Service
Fund which replaced the 1997 net payments for long-term support which were
accounted for as an offset against Interstate Network Access Revenues.
Also increasing expenses were employee compensation, including increases
related to force additions, interconnection costs, additional costs
associated with El Nino storms and continuing costs for local number
portability implementation of $14. These increases were partially offset
by a reduction in right-to-use fees and contract labor. Selling, general
and administrative expense for the first quarter of 1997 reflects a
settlement gain of $146 associated with lump-sum pension payments that
exceeded the projected service and interest costs for 1996 retirements.
Excluding the 1997 settlement gain, selling, general and administrative
costs would have increased $43, or 10.0%. This was due to increased costs
associated with merger implementation and other costs associated with the
consolidation of operations since the merger. These costs were partially
offset by a decrease in contract labor.
Depreciation and amortization for the first quarter of 1998 decreased $18,
or 3.8%. This decrease was due primarily to reduced depreciation on analog
switching equipment and reduced effective composite depreciation rates.
These decreases were partially offset by increased depreciation resulting
from higher plant levels.
Income Tax expense for 1997 included taxes of $59 on the pension settlement gain
discussed in Selling, General and Administrative expense. Excluding this item,
income taxes were higher in 1998 primarily due to higher income before income
tax.
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 PacBell and SBC effective January 1, 1997. The
cumulative after-tax effect of these one-time changes is $345.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
Long-distance Application SBC continues to seek entry into interLATA
long-distance through the courts and by approval from the Federal Communications
Commission (FCC). PacBell has a section 271 application pending with the CPUC to
provide interLATA long-distance service in California.
OTHER BUSINESS MATTERS
Employees A tentative labor agreement was reached on April 7, 1998 between
PacBell and the Communications Workers of America (CWA) to replace a contract
that would expire on August 8, 1998. The new agreement is subject to
ratification by the CWA membership and covers approximately 34,000 employees of
PacBell through April 1, 2001. Among other items, the contract specifies an 11%
increase in wages over the life of the contract.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
Exhibit 12 Computation of Ratios of Earnings to Fixed Charges.
Exhibit 27 Financial Data Schedule.
(b) Reports on Form 8-K
On February 13, 1998, PacBell filed a Current Report on Form 8-K,
reporting on Item 7. Financial Statements and Exhibits. The Report
contained exhibits related to PacBell's issuance of $200 million of the 6
1/8% Notes due February 15, 2008.
On February 10, 1998, PacBell filed a Current Report on Form 8-K,
reporting on Item 5. Other Events. The Report contained selected PacBell
financial statement information for the three-month and twelve-month
periods ended December 31, 1997 and 1996.
On January 9, 1998, PacBell filed a Current Report on Form 8-K/A amending
a Current Report dated April 4, 1997 reporting on Item 4. Change in
Registrant's Certifying Accountant.
<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
May 11, 1998 /s/ Robert B.Pickering
Robert B. Pickering
Vice President and Chief Financial
Officer (Principal Accounting/
Financial Officer)
<TABLE>
EXHIBIT 12
PACIFIC BELL AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
Dollars in Millions
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEAR ENDED DECEMBER 31,
----------------------- ----------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------------------- ----------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Income Before Income Taxes,
Extraordinary Loss and
Cumulative Effect of Accounting Changes $ 413 $ 466 $ 34 $ 1,567 $ 1,161 $ 1,276 $ (54)
Add:Interest Expense 106 102 460 379 420 437 429
1/3 Rental Expense 9 10 41 47 29 22 23
--------- --------- -------- --------- ---------- ---------- -----------
Adjusted Earnings $ 528 $ 578 $ 535 $ 1,993 $ 1,610 $ 1,735 $ 398
========= ========= ======== ========= ========== ========== ===========
Total Interest Charges $ 115 $ 112 $ 497 $ 412 $ 420 $ 437 $ 429
1/3 Rental Expense 9 10 41 47 29 22 23
--------- --------- -------- --------- ---------- ---------- -----------
Adjusted Fixed Charges $ 124 $ 122 $ 538 $ 459 $ 449 $ 459 $ 452
========= ========= ======== ========= ========== ========== ===========
Ratio of Earnings to Fixed Charges 4.26 4.74 0.99* 4.34 3.59 3.78 0.88**
<FN>
* As defined within the computation of earnings to fixed charges, earnings are
$3 less than fixed charges for 1997. See Management's Discussion and Analysis
of Results of Operations in Pacific Bell's 1997 Annual Report on Form 10-K
for a discussion of merger-related and other unusual items that reduced
earnings for 1997.
** As defined within the computation of earnings to fixed charges, earnings are
$54 less than fixed charges for 1993. See Management's Discussion and
Analysis-Other Business Matters in Pacific Bell's 1997 Annual Report on Form
10-K for a discussion of the restructuring charge which reduced earnings for
1993.
</FN>
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM PACIFIC BELL
AND SUBSIDIARIES' MARCH 31, 1998 CONSOLIDATED FINANCIAL STATEMENTS, AS RESTATED,
AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> MAR-31-1998
<CASH> 53
<SECURITIES> 0
<RECEIVABLES> 1,853
<ALLOWANCES> 164
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 2,319
<PP&E> 28,993
<DEPRECIATION> 17,761
<TOTAL-ASSETS> 14,364
<CURRENT-LIABILITIES> 3,250
<BONDS> 5,381
0
0
<COMMON> 225
<OTHER-SE> 2,918
<TOTAL-LIABILITY-AND-EQUITY> 14,364
<SALES> 0<F2>
<TOTAL-REVENUES> 1,118
<CGS> 0<F3>
<TOTAL-COSTS> 847
<OTHER-EXPENSES> 451
<LOSS-PROVISION> 40
<INTEREST-EXPENSE> 106
<INCOME-PRETAX> 413
<INCOME-TAX> 161
<INCOME-CONTINUING> 252
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 252
<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
REVENUES 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 S-X, RULE 5-03(B).
</FN>
</TABLE>
