-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, J3jZgj470MvzYcf88ID5d969d45seXew0i4709vfrWVL2WJDGcUjDtXORNBHfkFL EpRewhwz0JrbGiHhTvMSYA== 0000075641-97-000010.txt : 19971114 0000075641-97-000010.hdr.sgml : 19971114 ACCESSION NUMBER: 0000075641-97-000010 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971112 SROS: NYSE SROS: PSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PACIFIC BELL CENTRAL INDEX KEY: 0000075641 STANDARD INDUSTRIAL CLASSIFICATION: TELEPHONE COMMUNICATIONS (NO RADIO TELEPHONE) [4813] IRS NUMBER: 940745535 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-01414 FILM NUMBER: 97712947 BUSINESS ADDRESS: STREET 1: 140 NEW MONTGOMERY ST CITY: SAN FRANCISCO STATE: CA ZIP: 94105 BUSINESS PHONE: 2108214105 MAIL ADDRESS: STREET 1: 175 E HOUSTON STREET 2: RM 9-N-4 CITY: SAN ANTONIO STATE: TX ZIP: 78205 FORMER COMPANY: FORMER CONFORMED NAME: PACIFIC TELEPHONE & TELEGRAPH CO DATE OF NAME CHANGE: 19840115 10-Q 1 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 PART I - FINANCIAL INFORMATION Item 1. Financial Statements PACIFIC BELL - ----------------------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF INCOME Dollars in millions (Unaudited) - -----------------------------------------------------------------------------------------
---------------------------------------- Three months ended Nine months ended September 30, September 30, ------------------------------------------ 1997 1996 1997 1996 - ----------------------------------------------------------------------------------------- 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 - ------------------------------------------------------------------------------------------ Total operating revenues 2,481 2,315 7,324 7,006 - ------------------------------------------------------------------------------------------ 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 - ------------------------------------------------------------------------------------------ Total operating expenses 2,058 1,785 7,047 5,242 - ------------------------------------------------------------------------------------------ Operating Income 423 530 277 1,764 - ------------------------------------------------------------------------------------------ Other Income (Expense) Interest expense (117) (95) (336) (277) Other income (expense) - net 15 2 (15) 4 - ------------------------------------------------------------------------------------------ Total other income (expense) (102) (93) (351) (273) - ------------------------------------------------------------------------------------------ Income (Loss) Before Income Taxes and Cumulative Effect of Accounting Changes 321 437 (74) 1,491 - ------------------------------------------------------------------------------------------ Income Taxes 126 175 5 607 - ------------------------------------------------------------------------------------------ Income (Loss) Before Cumulative Effect of Accounting Changes 195 262 (79) 884 - ------------------------------------------------------------------------------------------ Cumulative Effect of Accounting Changes, net of tax - - 342 85 - ------------------------------------------------------------------------------------------ Net Income $ 195 $ 262 $ 263 $ 969 - ------------------------------------------------------------------------------------------ See Notes to Consolidated Financial Statements.
PACIFIC BELL - -------------------------------------------------------------------------------- CONSOLIDATED BALANCE SHEETS Dollars in millions except per share amounts - -------------------------------------------------------------------------------- September 30, December 31, ----------------------------- 1997 1996 - -------------------------------------------------------------------------------- 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 - -------------------------------------------------------------------------------- Total current assets 3,211 2,429 - -------------------------------------------------------------------------------- Property, Plant and Equipment - at cost 29,304 28,372 Less: Accumulated depreciation and amortization 17,470 16,699 - -------------------------------------------------------------------------------- Property, Plant and Equipment - Net 11,834 11,673 - -------------------------------------------------------------------------------- Other Assets 725 547 - -------------------------------------------------------------------------------- Total Assets $ 15,770 $ 14,649 - -------------------------------------------------------------------------------- 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 - -------------------------------------------------------------------------------- Total current liabilities 4,869 2,833 - -------------------------------------------------------------------------------- Long-Term Debt 5,342 5,364 - -------------------------------------------------------------------------------- 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 - -------------------------------------------------------------------------------- Total deferred credits and other noncurrent liabilities 2,117 2,525 - -------------------------------------------------------------------------------- Commitments and contingencies - -------------------------------------------------------------------------------- Shareowner's Equity Common stock - ($1 par value) 225 225 Paid in surplus 5,352 6,100 Retained earnings (deficit) (2,135) (2,398) - -------------------------------------------------------------------------------- Total shareowner's equity 3,442 3,927 - -------------------------------------------------------------------------------- Total Liabilities and Shareowner's Equity $ 15,770 $ 14,649 - -------------------------------------------------------------------------------- See Notes to Consolidated Financial Statements. PACIFIC BELL - ------------------------------------------------------------------------- CONSOLIDATED STATEMENTS OF CASH FLOWS Dollars in millions, increase (decrease) in cash and cash equivalents (Unaudited) - ------------------------------------------------------------------------- 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) - ------------------------------------------------------------------------- Total adjustments 1,262 785 - ------------------------------------------------------------------------- Net Cash Provided by Operating Activities 1,525 1,754 - ------------------------------------------------------------------------- Investing Activities Construction and capital expenditures (1,687) (1,597) Other - (32) - ------------------------------------------------------------------------- Net Cash Used in Investing Activities (1,687) (1,629) - ------------------------------------------------------------------------- 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 - ------------------------------------------------------------------------- Net Cash Provided by (Used in) Financing Activities 159 (115) - ------------------------------------------------------------------------- Net increase (decrease) in cash and cash (3) 10 equivalents - ------------------------------------------------------------------------- Cash and cash equivalents beginning of year 58 68 - ------------------------------------------------------------------------- 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. PACIFIC BELL - ---------------------------------------------------------------------------- CONSOLIDATED STATEMENT OF SHAREOWNER'S EQUITY Dollars in millions (Unaudited) - ---------------------------------------------------------------------------- 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 - - ------------------------------------------------------------------------------ Balance, September 30, 1997 $ 225 $ 5,352 $ (2,135) - ------------------------------------------------------------------------------ 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 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. 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. 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. 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. 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. 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. 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. 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. 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 EX-3.A 2 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) 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) EX-12 3 EXHIBIT 12 PACIFIC BELL COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES Dollars in Millions
NINE MONTHS ENDED SEPTEMBER 30, YEAR ENDED DECEMBER 31, ------------------ --------------------------------------------------- 1997 1996 1996 1995 1994 1993 1992 --------- --------- --------------------------------------------------- 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
EX-27 4
5 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. DEC-31-1997 JAN-01-1997 SEP-30-1997 9-MOS 55,000 0 2,493,000 241,000 0 3,211,000 29,304,000 17,470,000 15,770,000 4,869,000 5,342,000 225,000 0 0 3,217,000 15,770,000 0 7,324,000 0 2,996,000 1,557,000 201,000 336,000 (74,000) 5,000 (79,000) 0 0 342,000 263,000 0 0 THIS AMOUNT IS IMMATERIAL. 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. 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).
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