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 June 30, 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
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CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
(Unaudited)
Three months ended Six months ended
June 30, June 30,
----------------------------------
1998 1997 1998 1997
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Operating Revenues
Local service $1,167 $1,066 $2,285 $2,093
Network access:
Interstate 506 340 1,006 799
Intrastate 189 216 369 402
Long-distance service 306 293 612 598
Other 177 178 366 340
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Total operating revenues 2,345 2,093 4,638 4,232
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Operating Expenses
Cost of services and products 850 815 1,697 1,636
Selling, general and administrative 396 1,500 870 1,785
Depreciation and amortization 463 567 914 1,036
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Total operating expenses 1,709 2,882 3,481 4,457
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Operating Income (Loss) 636 (789) 1,157 (225)
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Other Income (Expense)
Interest expense (110) (124) (216) (226)
Other income (expense) - net 2 (32) - (28)
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Total other income (expense) (108) (156) (216) (254)
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Income (Loss) Before Income Taxes and
Cumulative Effect of Accounting Changes 528 (945) 941 (479)
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Income Taxes 207 (340) 368 (155)
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Income (Loss) Before Cumulative
Effect of Accounting Changes 321 (605) 573 (324)
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Cumulative Effect of Accounting
Changes, net of tax - - - 345
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Net Income (Loss) $ 321 $ (605) $ 573 $ 21
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See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
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CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
(Unaudited)
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June 30, December 31,
--------------------------------
1998 1997
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Assets
Current Assets
Cash and cash equivalents $ 59 $ 43
Accounts receivable - net of allowances for
uncollectibles of $154 and $152 1,821 1,782
Prepaid expenses 111 53
Deferred income taxes 395 415
Other current assets 49 44
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Total current assets 2,435 2,337
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Property, Plant and Equipment - at cost 29,352 28,695
Less: Accumulated depreciation and amortization 18,014 17,442
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Property, Plant and Equipment - Net 11,338 11,253
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Other Assets 968 749
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Total Assets $14,741 $14,339
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Liabilities and Shareowner's Equity
Current Liabilities
Intercompany loans $ 559 $ 542
Current portion of long-term obligations 104 4
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Total debt maturing within one year 663 546
Accrued taxes 536 334
Accounts payable and accrued liabilities 2,406 2,719
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Total current liabilities 3,605 3,599
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Long-Term Debt 5,281 5,358
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Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 1,017 957
Postemployment benefit obligation 918 881
Unamortized investment tax credits 168 188
Other noncurrent liabilities 613 569
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Total deferred credits and other noncurrent liabilities 2,716 2,595
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Shareowner's Equity
Common shares ($1 par value) 225 225
Capital in excess of par value 4,593 4,814
Retained earnings (deficit) (1,679) (2,252)
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Total shareowner's equity 3,139 2,787
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Total Liabilities and Shareowner's Equity $14,741 $14,339
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See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
(Unaudited)
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Six months ended
June 30,
--------------------------
1998 1997
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Operating Activities
Net income $ 573 $ 21
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 914 1,036
Provision for uncollectible accounts 79 111
Amortization of investment tax credits (20) (21)
Deferred income tax expense 90 (299)
Cumulative effect of accounting changes, net of tax - (345)
Other - net (476) 742
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Total adjustments 587 1,224
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Net Cash Provided by Operating Activities 1,160 1,245
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Investing Activities
Construction and capital expenditures (957) (1,015)
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Net Cash Used in Investing Activities (957) (1,015)
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Financing Activities
Net change in short-term borrowings with
original maturities of three months or less 17 128
Issuance of long-term debt 198 -
Repayment of long-term debt (178) (2)
Equity received from parent 164 14
Dividends paid (388) (344)
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Net Cash Used in Financing Activities (187) (204)
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Net increase in cash and cash equivalents 16 26
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Cash and cash equivalents beginning of year 43 57
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Cash and Cash Equivalents End of Period $ 59 $ 83
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Cash paid during the six months ended June 30 for:
Interest $ 213 $ 213
Income taxes, net of refunds $ 94 $ 85
See Notes to Consolidated Financial Statements.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
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STATEMENTS OF SHAREOWNER'S EQUITY
Dollars in millions
(Unaudited)
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Capital in Retained
Common Excess of Earnings
Shares Par Value (Deficit)
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Balance, December 31, 1997 $225 $4,814 $(2,252)
Net income - - 573
Dividend to shareowner - (388) -
Net equity from parent - 167 -
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Balance, June 30, 1998 $225 $4,593 $(1,679)
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See Notes to Consolidated Financial Statements.
* * * *
SELECTED FINANCIAL AND OPERATING DATA*
At June 30, or for the six months then ended: 1998 1997
------------ ------------
Debt ratio............................. 65.44% 68.00%
Network access lines in service (000).. 17,730 16,940
Resold lines (000)..................... 251 115
Number of employees.................... 45,800 46,630
* SBC is in the process of revalidating the access minutes of use for Pacific
Bell. While this process may result in a change in the growth trends of the
quarterly minutes of use, SBC does not expect that the previously disclosed year
to date growth trends will be materially affected.
<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.
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. 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 1.4629 shares of SBC common stock
(equivalent to approximately 626 million shares; both the exchange ratio and
shares issued have been restated to reflect SBC's first quarter 1998
two-for-one stock split, effected in the form of a stock dividend). 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 $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 six months of 1997 by $42 and
$25. 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).
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions
Post-merger initiatives
During the second quarter of 1997, PacBell recorded after-tax charges of $883
related to SBC's June 19, 1997 announcement of several strategic decisions
resulting from the merger integration process that began with the April 1,
1997 closing of its merger with PAC. These charges included $107 ($65 after
tax) of charges related to several regulatory rulings during the second
quarter of 1997 and $276 ($173 after tax) for the merger approval costs. 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.
Reorganization SBC is centralizing 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 are resulting 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 $127 ($80 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 $341 ($219 after tax) recorded in the second quarter of
1997. These impairments and writeoffs related to certain analog switching
equipment, duplicate or obsolete equipment, cable within commercial
buildings, certain nonoperating plant and other assets.
Video curtailment/purchase commitments SBC also announced it was scaling back
its limited direct investment in video services. As part of this curtailment,
PacBell halted construction on the Advanced Communications Network (ACN) in
California. As part of an agreement with the ACN vendor, PacBell paid the
liabilities of the ACN trust that owned and financed ACN construction,
incurred costs to shut down all construction previously conducted under the
trust and received certain consideration from the vendor. In the second
quarter of 1997, PacBell recognized a net expense of $553 ($346 after tax)
associated with these activities.
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.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions
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 six months of 1998 and 1997 are summarized as
follows:
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Six-Month Period
------------------------------
Percent
1998 1997 Change
- -------------------------------------------------------------------------------
Operating revenues $ 4,638 $ 4,232 9.6%
Operating expenses $ 3,481 $ 4,457 (21.9)%
Income (loss) before cumulative effect of
accounting changes $ 573 $ (324) -
Cumulative effect of accounting changes - $ 345 -
Net income $ 573 $ 21 -
===============================================================================
Net income for the six months ended June 30, 1997 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 loss before cumulative effect of accounting changes for the first six
months of 1997 includes after-tax charges of $883 reflecting strategic
initiatives resulting from SBC's comprehensive review of operations of the
merged company and the impact of several recent regulatory rulings. In addition,
the first six months of 1997 includes an $87 after-tax settlement gain
associated with lump-sum pension payments that exceeded the projected service
and interest costs for 1996 retirements. Excluding these 1997 one-time charges
and the gain, PacBell's income before cumulative effect of accounting changes
for the first six months of 1998 increased by $101, or 21.4%, compared to $472
for the first six months of 1997. The primary factors for this increase in
income before cumulative effect of accounting changes during the first six
months of 1998 were growth in demand for services and products.
Operating Revenues PacBell's operating revenues for the second quarter and first
six months of 1997 reflect reductions of $114 related primarily to the impact of
several regulatory rulings. Excluding these items, PacBell's operating revenues
increased $292, or 6.7% for the first six months of 1998. Components of
operating revenues for the first six months of 1998 and 1997 are as follows:
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Six-Month Period
------------------------------
Percent
1998 1997 Change
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Local service $ 2,285 $ 2,093 9.2%
Network access:
Interstate 1,006 799 25.9
Intrastate 369 402 (8.2)
Long-distance service 612 598 2.3
Other 366 340 7.6
- ---------------------------------------------------------------
Total $ 4,638 $ 4,232 9.6%
============================================================================
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
RESULTS OF OPERATIONS - Continued
Local service revenues increased $192 in the first six months of 1998 due
to increases in demand, which account for more than 73% of the increase,
including increases in access lines and vertical services revenues. The
number of access lines increased by 4.6% since June 30, 1997, with
approximately 41% 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 27% totaling more
than $245 for the first six months of 1998. Additionally, Federal payphone
deregulation implemented in April 1997 increased local service by
approximately $48 and decreased interstate network access by approximately
$8, long-distance service by approximately $9 and other operating revenues
by approximately $16; the overall impact was a slight increase in total
operating revenues.
Network access Interstate network access revenues increased $207 in the
first six months of 1998 primarily due to the second quarter 1997 one-time
charges of $134. These one-time charges included 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 in the Federal price cap
filing. While the change in the PIU factor, which is used to allocate
network access usage 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 due to rate
differences between the two jurisdictions. Without these impacts,
interstate access revenues increased $73 or 7.8%. The increase was due
primarily to approximately $86 in demand for access services by
interexchange carriers, primarily special access, and growth in end-user
charges attributable to an increasing access line base. Also contributing
to the increase was the absence of the 1997 revenue offset of
approximately $23 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 of
approximately $37 related to the Federal productivity factor adjustment,
as discussed in PacBell's 1997 Annual Report on Form 10-K, and payphone
deregulation of approximately $8 referred to above in local service.
Intrastate network access revenues decreased $33 in the first six months
of 1998 due to the 1997 PIU settlements of $32 described above. Excluding
this impact, intrastate network access revenues remained relatively
unchanged.
Long-distance service revenues increased slightly in the first six months
of 1998. A higher volume of toll messages due to the growing California
economy and alternative calling plans resulted in a $22 increase in
revenues. The increase was partially offset by the Federal payphone
deregulation of approximately $9 referred to in local service and
implementation of the February 1997 California high cost fund of
approximately $6.
Other operating revenues increased $26 in the first six months of 1998.
Approximately 80% of this increase was due to increased demand for
nonregulated products and services, voice messaging services and equipment
sales, partially offset by payphone deregulation referred to above in
local service.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
RESULTS OF OPERATIONS - Continued
Operating Expenses PacBell's operating expenses in the first six months of 1997
reflect $1.1 billion of charges related to SBC's strategic initiatives and a
comprehensive review of operations of the merged company, the impact of several
regulatory rulings and a settlement gain associated with lump-sum pension
payments that exceeded the projected service and interest costs for 1996
retirements. Excluding these items, PacBell's operating expenses increased $111,
or 3.3%, for the first six months of 1998. Components of operating expenses for
the first six months of 1998 and 1997 are as follows:
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Six-Month Period
-----------------------------
Percent
1998 1997 Change
- ---------------------------------------------------------------------------
Cost of services and products $ 1,697 $ 1,636 3.7%
Selling, general and administrative 870 1,785 (51.3)
Depreciation and amortization 914 1,036 (11.8)
- ---------------------------------------------------------------
Total $ 3,481 $ 4,457 (21.9)%
===========================================================================
Cost of services and products for the first six months of 1997 reflect the
second quarter 1997 one-time charges of $19 relating to SBC's strategic
initiatives and operational reviews of the merged company. Excluding these
charges, costs of services and products increased $80, or 4.9%, in the
first six months of 1998 due primarily to increased employee compensation
of more than $39 (resulting from additional weather related expenditures),
additional costs associated with reciprocal compensation for the
termination of Internet traffic of approximately $33, increases in merger
implementation costs of approximately $28, and increases in universal
service fund (USF) charges of approximately $42 that were previously
reported as an offset against network access revenues. The current USF
system assesses charges, recorded as expense, and any amounts to be
received separately. Previously, a net payment or receipt for long-term
support would be recorded as an offset to (or increase in) revenue. These
increases were partially offset by net reductions of more than $89 in
costs related to benefits, contract labor, right-to-use fees and research
and development costs. Expenses relating to implementing customer number
portability were comparable between 1998 and 1997.
Selling, general and administrative expense decreased in the first six
months of 1998 due to second quarter 1997 one-time charges of $1,087
relating to SBC's strategic initiatives and operational reviews. These
items were partially offset by a first quarter of 1997 settlement gain of
$146 associated with lump-sum pension payments that exceeded the projected
service and interest costs for 1996 retirements.
Excluding these charges, selling, general and administrative expense
increased $26, or 3.1%, in the first six months of 1998 primarily due to
increased costs associated with merger implementation and other costs
associated with the consolidation of operations since the merger of more
than $97 and second quarter pension settlement gains of $63. These
increases were partially offset by decreased contract labor costs and
employee compensation and benefits and insurance refunds totaling
approximately $134. A lower level of expenses has resulted during 1998
from merger initiatives that have already been implemented.
Depreciation and amortization for the first six months of 1997 reflects
charges totaling $127 to record impairment of plant and intangibles
including analog switching equipment. Excluding these charges,
depreciation and amortization increased $5 for the first six months of
1998. The
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
RESULTS OF OPERATIONS - Continued
increase was primarily due to increased depreciation expense of
$47 resulting from overall higher plant levels. This increase was
substantially offset by reduced depreciation of $42 on analog switching
equipment.
Interest expense decreased $10, or 4.4%, for the first six months of 1998 due to
interest of $27 associated with the second quarter 1997 one-time charges.
Excluding these one-time charges interest expense increased $17, or 8.5%, due to
increased interest expense of approximately $6 resulting from an increase in
long-term debt and interest related to the merger approval order amount to be
returned to the California ratepayers of approximately $10.
Other income (expense) - net was a net expense of $28 for the first six months
of 1997 due to a second quarter one-time charge of $30 for SBC's strategic
initiatives, primarily writeoffs of nonoperating plant. Excluding this charge,
other income (expense) - net was income of $2 for the first six months of
1997.
Income Tax expense for the first six 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 as
well as taxes on the pension settlement gain discussed in selling, general and
administrative expense. Excluding these items, income taxes for the first six
months of 1997 would have been $307. Income taxes for the first six months of
1998 were higher due primarily to higher income before income taxes.
Cumulative Effect of Accounting Changes, as discussed in Note 3 to the
Consolidated 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 of Results of Operations
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS
COMPETITIVE AND REGULATORY ENVIRONMENT
Interconnection Reciprocal compensation is billed to PacBell by Competitive
Local Exchange Carriers (CLECs) for the termination of certain local exchange
traffic to CLEC customers. SBC believes that under the Telecommunications Act of
1996 the state commissions only have authority to order reciprocal compensation
for local traffic, while only the Federal Communications Commission (FCC) has
authority over interstate and interexchange traffic, which is where SBC believes
most Internet traffic terminates. The question of whether Internet
communications should be classified as local or interstate traffic for
reciprocal compensation purposes is the subject of a pending FCC proceeding and
the FCC is expected to rule on this issue in the near future.
The issue of payment by PacBell to CLECs of reciprocal compensation for the
termination of Internet traffic to Information Service Providers (i.e. Internet
Access Providers) is pending before the California Public Utilities Commission
(CPUC).
State commissions in Texas, Missouri, and Oklahoma have issued orders finding
that SBC is required to pay CLECs reciprocal compensation for the termination of
Internet traffic to Information Service Providers. In June 1998, a U.S. District
Court in Texas affirmed the Texas Public Utility Commission's (TPUC)
determination, and upheld payment of reciprocal compensation, holding that the
TPUC had jurisdiction over the local portion of the traffic and the FCC over the
Internet component.
Similar treatment of Internet traffic has been applied in Missouri and Oklahoma
with respect to reciprocal compensation arrangements. In Missouri, the Missouri
Public Service Commission has ordered that reciprocal compensation for Internet
traffic should be paid at least until the FCC decides whether such traffic
should be considered local or interstate for purpose of reciprocal compensation.
SBC has sought review or reconsideration of all of these cases.
SBC's subsidiaries have been recording amounts sought by the CLECs for the
termination of Internet traffic to Internet Service Providers as they have been
billed.
Long-distance Application SBC continues to seek entry into interLATA
long-distance by requesting favorable recommendation from state commissions and
approval from the FCC, and as necessary through the courts. In response to a
July 1998 CPUC initial report, PacBell has begun collaborative efforts with the
CPUC and competitors to provide additional evidence regarding PacBell's
checklist compliance efforts. A final vote by the CPUC on whether to recommend
PacBell's application to the FCC is expected by the end of 1998.
Universal Service In July 1998, the CPUC issued a rate rebalancing decision
related to its 1996 order on universal service. The CPUC's decision will be
implemented prospectively beginning September 1, 1998 and will reduce PacBell's
non-basic local service, network access and long distance service revenues by
$305 annually to offset the approximately $305 annually that PacBell expects to
receive from the California high cost fund based on CPUC estimates of the cost
of providing universal service.
Beginning in February 1997, PacBell began collecting funds via customer
surcharges and classifying revenues in anticipation of the CPUC's decision,
utilizing a method similar to the July 1998 order. The CPUC has yet to decide on
the refund mechanism for funds collected by PacBell from February 1997 through
August 1998.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS - Continued
OTHER BUSINESS MATTERS
New Accounting Standards In June 1998, the Financial Accounting Standards Board
issued Statement No. 133, "Accounting for Derivative Instruments and Hedging
Activities" (FAS 133) that will require all derivatives to be recorded on the
balance sheet at fair value, and will require changes in the fair values of the
derivatives to be recorded in net income or comprehensive income. FAS 133 must
be adopted for years beginning after June 15, 1999 with earlier adoption
permitted. PacBell currently has no derivative financial instruments.
See Note 4 to the Consolidated Financial Statements for a discussion of the new
accounting standard on software costs.
Employees On May 27, 1998, members of the Communications Workers of America
(CWA) ratified the tentative labor agreement that was reached on April 7, 1998
between PacBell and the CWA. The new agreement covers approximately 34,000
employees of PacBell through April 1, 2001. Among other items, the agreement
specifies an 11% increase in wages over the life of the contract.
SBC's Year 2000 Project SBC operates numerous date-sensitive computer
applications and systems throughout its businesses. Since 1996, SBC has been
working to upgrade its networks and computer systems to properly recognize the
Year 2000 and continue to process critical operational and financial
information. SBC has formed companywide teams to address and resolve Year 2000
issues, and processes have been developed to evaluate and manage the risks
and costs associated with preparing all of its systems and applications for
the new millennium.
SBC is using a four-step methodology for addressing the issue. The methodology
includes inventory and assessment, hardware and software fixes, testing and
deployment. SBC measures its progress by the number of systems addressed.
Inventory and assessment includes the identification of items (i.e.,
line-by-line review of software code, switch generics, etc.) that could be
impacted by the Year 2000 and the determination of the work effort required to
get them ready. These activities are nearly complete. For all of SBC, this
process involves reviewing over 300 million lines of software code, 1,100
central office switches, 6,800 company buildings, conducting an inventory and
assessment of 100,000 personal computers, and coordinating with its 900
suppliers of 12,000 products to obtain adequate assurance they will be compliant
with the Year 2000 or determine and address any appropriate contingency plans or
back up systems.
Hardware and software fixes are the activities that will be required to modify
program code, upgrade computer software and upgrade or replace hardware. As of
June 30, 1998, nearly half of the systems to be addressed by these activities
were complete.
Testing involves ensuring that hardware and software fixes will work properly in
1999 and beyond and occurs both before and after deployment. Testing began early
in 1998 and will continue through 1999 to allow for thorough testing before the
Year 2000. Any need for contingency plans or back-up systems would be determined
and addressed during the testing phase.
Deployment is the installation of hardware and software components in a live
environment. Nearly half of the systems deployment were completed as of June 30,
1998.
<PAGE>
PACIFIC BELL AND SUBSIDIARIES
Item 2. Management's Discussion and Analysis of Results of Operations
Dollars in millions
OPERATING ENVIRONMENT AND TRENDS OF THE BUSINESS - Continued
Total expenses for all of SBC's Year 2000 project have been estimated to
be less than $250, and SBC has incurred approximately $60 through June 30, 1998.
The activities involved in SBC's Year 2000 project necessarily involve estimates
and projections, as described above, of activities and resources that will be
required in the future. These estimates and projections could change as work
progresses on the project.
<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 April 15, 1998, PacBell filed a Current Report on Form 8-K,
reporting on Item 5. Other Events. The Report contained selected
restated financial statement information related to PacBell's
distribution of Pacific Bell Directory, Pacific Bell Mobile Services,
Pacific Bell Internet Services and PB Comm Switches, Inc. to Pacific
Telesis Group.
<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
August 13, 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>
SIX MONTHS ENDED
JUNE 30, YEAR ENDED DECEMBER 31,
---------------- -----------------------------------------
1998 1997 1997 1996 1995 1994 1993
---------------- -----------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Income (Loss) Before Income Taxes,
Extraordinary Loss and Cumulative
Effect of Accounting Changes $ 941 $ (479) $ 34 $1,567 $1,161 $1,276 $ (54)
Add: Interest Expense 216 226 460 379 420 437 429
1/3 Rental Expense 19 29 41 47 29 22 23
------- ------- ------ ------ ------- ------- -------
Adjusted Earnings $1,176 $ (224) 535 $1,993 $1,610 $1,735 $ 398
======= ======= ====== ====== ======= ======= =======
Total Interest Charges $ 233 $ 246 497 412 $ 420 $ 437 $ 429
1/3 Rental Expense 19 29 41 47 29 22 23
------- ------- ------ ------ ------- ------- -------
Adjusted Fixed Charges $ 252 $ 275 $ 538 $ 459 $ 449 $ 459 $ 452
======= ======= ====== ====== ======= ======= =======
Ratio of Earnings to Fixed Charges 4.67 (0.81)* 0.99** 4.34 3.59 3.78 0.88***
<FN>
* As defined within the computation of earnings to fixed charges, earnings
are $499 less than fixed charges for the first six months of 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 $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 of Results of Operations - 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' JUNE 30, 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> 6-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1998
<CASH> 59
<SECURITIES> 0
<RECEIVABLES> 1,975
<ALLOWANCES> 154
<INVENTORY> 0<F1>
<CURRENT-ASSETS> 2,435
<PP&E> 29,352
<DEPRECIATION> 18,014
<TOTAL-ASSETS> 14,741
<CURRENT-LIABILITIES> 3,605
<BONDS> 5,281
0
0
<COMMON> 225
<OTHER-SE> 2,914
<TOTAL-LIABILITY-AND-EQUITY> 14,741
<SALES> 0<F2>
<TOTAL-REVENUES> 4,638
<CGS> 0<F3>
<TOTAL-COSTS> 1,697
<OTHER-EXPENSES> 914
<LOSS-PROVISION> 79
<INTEREST-EXPENSE> 216
<INCOME-PRETAX> 941
<INCOME-TAX> 368
<INCOME-CONTINUING> 573
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 573
<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>
