FORM 10-Q
United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
|X| Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended March 31, 1999
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
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
PACIFIC BELL
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CONSOLIDATED STATEMENTS OF INCOME
Dollars in millions
(Unaudited)
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Three months ended
March 31,
--------------------------
1999 1998
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Operating Revenues
Local service $ 1,219 $ 1,166
Network access:
Interstate 513 479
Intrastate 186 180
Long distance service 269 306
Other 176 141
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Total operating revenues 2,363 2,272
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Operating Expenses
Operations and support 1,307 1,300
Depreciation and amortization 468 451
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Total operating expenses 1,775 1,751
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Operating Income 588 521
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Other Income (Expense)
Interest expense (103) (106)
Other income (expense) - net 28 (2)
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Total other income (expense) (75) (108)
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Income Before Income Taxes 513 413
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Income Taxes 203 161
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Net Income $ 310 $ 252
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See Notes to Consolidated Financial Statements.
PACIFIC BELL
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CONSOLIDATED BALANCE SHEETS
Dollars in millions except per share amounts
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March 31, December 31,
------------------------------
1999 1998
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Assets (Unaudited)
Current Assets
Cash and cash equivalents $ 35 $ 15
Accounts receivable - net of allowances for
uncollectibles of $160 and $161 1,895 2,015
Prepaid expenses 215 90
Deferred income taxes 428 280
Other current assets 29 31
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Total current assets 2,602 2,431
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Property, Plant and Equipment - at cost 30,169 29,871
Less: Accumulated depreciation and amortization 18,544 18,272
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Property, Plant and Equipment - Net 11,625 11,599
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Other Assets 1,180 1,063
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Total Assets $ 15,407 $ 15,093
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Liabilities and Shareowner's Equity
Current Liabilities
Intercompany loans $ 1,496 $ 1,551
Current portion of long-term obligations 103 103
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Total debt maturing within one year 1,599 1,654
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Accrued taxes 386 122
Accounts payable and accrued liabilities 2,435 2,669
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Total current liabilities 4,420 4,445
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Long-Term Debt 4,614 4,614
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Deferred Credits and Other Noncurrent Liabilities
Deferred income taxes 1,210 1,082
Postemployment benefit obligation 850 894
Unamortized investment tax credits 141 149
Other noncurrent liabilities 606 649
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Total deferred credits and other noncurrent liabilities 2,807 2,774
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Shareowner's Equity
Common shares ($1 par value) 225 225
Capital in excess of par value 4,206 4,210
Retained earnings (deficit) (865) (1,175)
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Total shareowner's equity 3,566 3,260
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Total Liabilities and Shareowner's Equity $ 15,407 $ 15,093
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See Notes to Consolidated Financial Statements.
PACIFIC BELL
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CONSOLIDATED STATEMENTS OF CASH FLOWS
Dollars in millions, increase (decrease) in cash and cash equivalents
(Unaudited)
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Three months ended
March 31,
---------------------------
1999 1998
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Operating Activities
Net income $ 310 $ 252
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 468 451
Provision for uncollectible accounts 33 40
Amortization of investment tax credits (8) (10)
Deferred income tax expense (4) 7
Other - net (221) (491)
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Total adjustments 268 (3)
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Net Cash Provided by Operating Activities 578 249
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Investing Activities
Construction and capital expenditures (498) (415)
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Net Cash Used in Investing Activities (498) (415)
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Financing Activities
Net change in short-term borrowings with original
maturities of three months or less (56) 53
Issuance of long-term debt - 197
Repayment of long-term debt - (175)
Net equity from parent 8 215
Dividends paid (12) (114)
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Net Cash Provided by (Used in) Financing Activities (60) 176
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Net increase in cash and cash equivalents 20 10
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Cash and cash equivalents beginning of year 15 43
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Cash and Cash Equivalents End of Period $ 35 $ 53
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<FN>
Cash paid during the three months ended March 31 for:
Interest $ 115 $ 141
Income taxes, net of refunds $ (31) $ 222
See Notes to Consolidated Financial Statements.
</FN>
PACIFIC BELL
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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, 1998 $ 225 $ 4,210 $ (1,175)
Net income - - 310
Dividends to shareowner - (12) -
Net equity from parent - 8 -
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Balance, March 31, 1999 $ 225 $ 4,206 $ (865)
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See Notes to Consolidated Financial Statements.
* * * *
SELECTED FINANCIAL AND OPERATING DATA
At March 31, or for the three months then ended: 1999 1998
----------- ----------
Debt ratio................................. 63.53% 65.55%
Network access lines in service (000)...... 18,233 17,578
Access minutes of use (000,000)*........... 18,750 17,656
Resold lines (000)......................... 266 260
Number of employees........................ 47,850 45,880
*1998 amounts have been restated.
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 also includes its subsidiary Pacific
Bell Information Services) 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).
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. Certain reclassifications have been made to the 1998
consolidated financial statements to conform with the 1999 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 1998 Annual Report on Form 10-K filed with the
SEC. Comprehensive income for PacBell is the same as net income for all
periods presented. As PacBell operates in only one of SBC's segments,
wireline telecommunications services, separate segment reporting is not
applicable to PacBell.
2. CONSOLIDATION The consolidated financial statements include the accounts of
PacBell. All significant intercompany transactions within PacBell are
eliminated in the consolidation process.
3. COMPLETION OF MERGERS 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). With the merger, PAC became
a wholly-owned subsidiary of SBC. The transaction has been accounted for as a
pooling of interests and a tax-free reorganization.
On October 26, 1998, SBC and Southern New England Telecommunications
Corporation (SNET) completed the merger of an SBC subsidiary with SNET, in a
transaction in which each share of SNET common stock was exchanged for 1.7568
shares of SBC common stock (equivalent to approximately 120 million shares).
SNET became a wholly-owned subsidiary of SBC effective with the merger and
the transaction has been accounted for by SBC as a pooling of interests and a
tax-free reorganization.
Post-merger initiatives
During the second quarter of 1997, SBC announced PacBell had incurred
after-tax charges of $883 related to several strategic decisions resulting
from the merger integration process that began with the April 1, 1997 closing
of its merger with PAC, which included $107 ($65 after tax) of charges
related to several regulatory rulings during the second quarter of 1997 and
$276 ($173 after tax) for 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.
One-time charges related to the strategic decisions reached by the review
teams totaled $1 billion ($645 after tax) in the second quarter of 1997.
During the fourth quarter of 1998, SBC again performed a complete review of
all operations affected by the merger with SNET to determine the impact on
ongoing merger integration processes. This review resulted in no significant
additional financial effect
PACIFIC BELL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) - Continued
Dollars in millions
on PacBell. At March 31, 1999 and December 31, 1998, remaining accruals for
anticipated cash expenditures related to these decisions were approximately
$55 and $61.
4. SOFTWARE COSTS The American Institute of Certified Public Accountants has
issued a Statement of Position (SOP) that requires capitalization of certain
computer software expenditures beginning in 1999. The SOP, which has been
adopted prospectively as of January 1, 1999, requires the capitalization of
certain costs incurred in connection with developing or obtaining internal
use software. Prior to the adoption of the SOP, the costs of computer
software purchased or developed for internal use were expensed as incurred.
However, initial operating system software costs were, and continue to be,
capitalized.
With comparable levels of software expenditures, the SOP would tend to
increase net income in comparison with PacBell's former method of accounting
for software costs. However, the increases would be largest in the year of
adoption with diminishing levels of increases compared with current
accounting throughout the amortization period. Consequently, given otherwise
comparable income levels excluding software, and otherwise comparable
software expenditures, the effect of the SOP would be to increase income in
the first year and decrease income in each subsequent year until the number
of years affected by the SOP equals the amortization period. The effect of
adopting the SOP was to increase net income for the quarter ended March 31,
1999 by approximately $7.
PACIFIC BELL
Item 2. Management's Discussion and Analysis
Dollars in millions
RESULTS OF OPERATIONS
Overview Financial results for Pacific Bell (PacBell, which includes its
subsidiary) for the first quarter of 1999 and 1998 are summarized as follows:
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Three-Month Period
-----------------------------
Percent
1999 1998 Change
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Operating revenues $ 2,363 $ 2,272 4.0%
Operating expenses $ 1,775 $ 1,751 1.4%
Net income $ 310 $ 252 23.0%
===========================================================================
PacBell reported net income of $310 for the first quarter of 1999 and $252 for
the first quarter of 1998. The primary factor contributing to this increase was
growth in demand for services and products and a slowing of growth in operating
expenses due to merger related initiatives and benefits.
Operating Revenues PacBell's operating revenues increased $91, or 4.0%, in the
first quarter of 1999. Components of operating revenues for the first quarter of
1999 and 1998 are as follows:
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Three-Month Period
------------------------------
Percent
1999 1998 Change
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Local service $ 1,219 $ 1,166 4.5%
Network access:
Interstate 513 479 7.1
Intrastate 186 180 3.3
Long distance service 269 306 (12.1)
Other 176 141 24.8
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Total $ 2,363 $ 2,272 4.0%
============================================================================
Local service Local service revenues increased $53, or 4.5%, in the first
quarter of 1999 due primarily to increased demand, which totaled
approximately $59, including increases in access lines, data and vertical
services revenues. The number of access lines increased by approximately
3.7% in the first quarter of 1999, with approximately 48% 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, voice mail and other enhanced
services, increased by approximately 26% and totaled approximately $199
for the first quarter of 1999.
Additionally, local service revenues increased as a result of the
California High Cost Fund (CHCFB) which also had the effect of decreasing
two other types of operating revenues. In the first quarter of 1999, the
CHCFB increased local service revenues by approximately $25 and decreased
long distance revenues by approximately $23 and intrastate network access
revenues by approximately $12. The net effect on total operating revenues
for the CHCFB was a decrease of $10. 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
PACIFIC BELL
Item 2. Management's Discussion and Analysis
Dollars in millions
RESULTS OF OPERATIONS - Continued
competitive rates for other services. The increase in local service
revenues was partially offset by decreases of approximately $24 resulting
from rate reductions under CPUC price cap orders.
Network access Interstate network access revenues increased $34, or 7.1%,
in the first quarter of 1999 due primarily to increased demand for access
services by interexchange carriers, primarily special access, and growth
in end-user charges attributable to an increasing access line base, which
collectively resulted in an increase of approximately $44. In addition,
customer number portability cost recovery contributed approximately $17 to
the increase. Partially offsetting these increases were the effects of
PacBell's rate reduction of approximately $29 related to the Federal
Communications Commission's (FCC) productivity factor adjustment.
Intrastate network access revenues increased $6, or 3.3%, in the first
quarter of 1999 attributable to increased demand of $23, offset in part by
the effect of the CHCFB described above in local service of approximately
$12 and by CPUC rate reductions of approximately $3.
Long distance service decreased $37, or 12.1%, in the first quarter of
1999 due to the effect of the CHCFB noted in local service of
approximately $23 and by CPUC rate reductions of approximately $9.
Other operating revenues increased $35, or 24.8%, in the first quarter of
1999 due primarily to increased sales from nonregulated products and
services totaling approximately $12 and increased equipment sales of
approximately $25.
Operating Expenses PacBell's operating expenses increased $24, or 1.4%, in the
first quarter of 1999. Components of total operating expenses for the first
quarter of 1999 and 1998 are as follows:
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Three-Month Period
-----------------------------
Percent
1999 1998 Change
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Operations and support $ 1,307 $ 1,300 0.5%
Depreciation and amortization 468 451 3.8
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Total operating expenses $ 1,775 $ 1,751 1.4%
===========================================================================
Operations support increased $7, or 0.5%, in the first quarter of 1999.
The increase includes costs of approximately $74 related to
progression in the merger implementation process including charges from
centralized support functions throughout SBC and other merger
initiatives. Operations and support also increased due to increased
costs for materials, wages and salaries and right-to-use fees of
approximately $53. In addition, costs associated with reciprocal
compensation for the termination of Internet traffic increased
approximately $8. These increases were offset by reductions in contract
labor, benefits and employee training and development of approximately $22
and a reduction in other non-labor costs of approximately $61 due in part
to merger initiative benefits and first quarter 1998 storm related costs.
In addition, expenditures for interconnection, customer number portability
and local competition initiatives decreased approximately $33. Another
contribution offsetting the increase in operations and
PACIFIC BELL
Item 2. Management's Discussion and Analysis
Dollars in millions
RESULTS OF OPERATIONS - Continued
support expense was the change in accounting for software costs
(see Note 4 of Notes to the Consolidated Financial Statements),
which resulted in approximately $12 of such costs being capitalized
rather than expensed at March 31, 1999.
Depreciation and amortization expense increased $17, or 3.8%, in the first
quarter of 1999. The increase was due primarily to overall higher plant
levels of approximately $15.
Other income (expense) - net was net income of $28 in the first quarter of 1999
due primarily to a gain recognized from the sale of PacBell's interest in
Advanced Communications Network (ACN) of $24. In 1997, ACN was written off as an
impairment in conjunction with the merger with PAC.
Income Taxes increased $42, or 26.1%, in the first quarter of 1999 primarily due
to higher income before income taxes.
COMPETITIVE AND REGULATORY ENVIRONMENT
IntraLATA Toll Dialing Parity In a January 1999 decision, the United States
Supreme Court (Supreme Court) ruled that the FCC had the authority to issue
rules to guide the state commissions in implementing intrastate and intraLATA
dialing parity. In March 1999, the FCC released an order establishing new
deadlines by which local exchange carriers (LECs) must implement dialing parity
for intraLATA long distance calls. Specifically, the FCC ordered carriers whose
dialing parity plans had been approved by a state commission to implement
dialing parity no later than May 7, 1999. Carriers that had not filed dialing
parity plans with their state commissions were required to do so by April 22,
1999. If state commissions have not approved the plans by June 22, 1999, the
carriers must file them with the FCC for approval. Carriers will be required to
implement dialing parity within 30 days of state or FCC approval. PacBell
began providing dialing parity in California in early May 1999. PacBell
anticipates that implementation of dialing parity will contribute to a loss of
intraLATA long distance revenue in 1999.
In March 1999, U S WEST, Inc. (U S West) filed pleadings in the Eighth Circuit
Court of Appeals (Eighth Circuit) challenging both the validity of the FCC's
March 1999 order and the authority of the FCC to determine the date by which a
state must provide intraLATA dialing parity. While SBC believes that the
pleadings of U S West are meritorious, at present, it is uncertain how the
Eighth Circuit will rule on these pleadings.
Pay Phone Per Call Compensation In February 1999, the FCC issued a ruling that
reduced the pay phone dial-around access or toll free call rate from 28.4 cents
to 24 cents per call, effective April 1999. In addition, the FCC order
determined that a reduced rate of 23.8 cents per call be applied retroactively
from October 1997 to April 1999. The retroactive rate change did not
significantly affect PacBell's first quarter 1999 results of operations.
Customer Local Number Portability Long-term customer local number portability
(LNP) allows customers to change local exchange carriers while maintaining their
existing telephone numbers. In December 1998, the FCC issued an order on
recovery of costs incurred for LNP by LECs. This order provides for the levying
of federally tariffed LNP monthly end-user charges for a five-year period,
PACIFIC BELL
Item 2. Management's Discussion and Analysis
Dollars in millions
COMPETITIVE AND REGULATORY ENVIRONMENT - Continued
beginning in February 1999. PacBell began recovering LNP costs at the rate of 50
cents per access line per month. This rate is the subject of an FCC inquiry,
which is expected to be completed by mid-1999. Although PacBell cannot currently
predict the results of this rate inquiry, it is not expected to have a material
impact on PacBell's results of operations or financial position.
FCC Equipment Audit In March 1999, the FCC released the results of its 1997
audit of regional holding companies' (RHCs) and GTE Corporation's (GTE)
telecommunications and other equipment. The FCC's audit alleged that each of the
RHCs and GTE were missing millions of dollars in equipment. Specifically, the
audit alleged that PacBell was missing $527 in equipment. PacBell believes that
the audit methodology was flawed and amounts of "missing" equipment dramatically
overstated. For example, the FCC's auditors sometimes labeled equipment as
missing because it was not in the precise location indicated in the property
records, even if it had been relocated. In April 1999, the FCC opened an inquiry
on the audit's ramifications. Among other things, the FCC is interested in
feedback on the audit methodology and statistical validity, the impact of the
audit findings on telephone customers and what action the FCC should take
against the RHCs and GTE. As PacBell uses composite group depreciation
accounting for its telephone plant, most reductions in plant levels (e.g.,
sales, retirements) are not reflected in earnings, but are reflected as changes
in accumulated depreciation. Accordingly, if the write down of equipment is
required, it is not expected to have a material impact on PacBell's results of
operations or financial position.
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), which will require all derivatives to be recorded on the
balance sheet at fair value and changes in the fair value 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. Management
is currently evaluating the impact of the change in accounting required by FAS
133, but is not able to quantify the effect at this time.
See Note 4 of Notes to Consolidated Financial Statements for a discussion of the
new accounting standard on software costs.
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. Companywide teams are in place to address and resolve Year 2000
issues and processes are under way to evaluate and manage the risks and costs
associated with preparing SBC's date-impacted systems and networks for the new
millennium.
SBC is using a four-step methodology to address the issue. The methodology
consists of inventory and assessment, hardware and software fixes, testing and
deployment. SBC measures its progress by tracking the number of completed
hardware and software applications, network components, personal computers and
building facilities that can correctly process Year 2000 dates.
PACIFIC BELL
Item 2. Management's Discussion and Analysis
Dollars in millions
OTHER BUSINESS MATTERS - Continued
The inventory and assessment phase is estimated to require 20% of the overall
effort and includes the identification of items (i.e., line-by-line review of
software code, switch generics, vendor products, etc.) that could be impacted by
the Year 2000 and the determination of the work effort required to ensure
compliance. The inventory and assessment phase has been completed. This process
involved reviewing over 340 million lines of software code, 1,200 central office
switches, 7,000 company buildings, conducting an inventory and assessment of
117,000 personal computers and coordinating with 1,500 suppliers of 15,000
products to obtain adequate assurance they will be Year 2000 compliant or
determine and address any appropriate contingency plans or backup systems.
Making the hardware and software fixes is the second phase of the process and is
estimated to require 25% of the overall effort. This activity involves modifying
program code, upgrading computer software and upgrading or replacing hardware.
As of March 31, 1999, SBC had completed 96% of the hardware and software fixes.
Testing involves ensuring that hardware and software fixes will work properly in
1999 and beyond and occurs both before and after deployment. Testing is
estimated to comprise 45% of the overall effort. Testing began early in 1998 and
is 89% complete. Contingency plans and backup systems are currently being
written.
Deployment involves placing the "fixed" systems into a live environment to
ensure they are working properly. Additional testing is done after deployment as
well. Deployment is estimated to require 10% of the overall effort. Ninety-three
percent of the deployment phase was completed as of March 31, 1999.
SBC has budgeted $265 on the entire project, with approximately $171 spent
through March 31, 1999. As testing and hardware and software fixes are estimated
to require most of the expenditures, there is not a strict correlation between
expenditures and project completion.
The activities involved in SBC's Year 2000 project necessarily require 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.
PACIFIC BELL
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Dollars in millions
There has been no material change in PacBell's market risks since December 31,
1998.
CAUTIONARY LANGUAGE CONCERNING FORWARD-LOOKING STATEMENTS
Information set forth in this form contains forward-looking statements that are
subject to risks and uncertainties. PacBell claims the protection of the safe
harbor for forward-looking statements provided by the Private Securities
Litigation Reform Act of 1995.
The following factors could cause PacBell's future results to differ materially
from those expressed in the forward-looking statements: (1) adverse economic
changes in the markets served by PacBell or changes in available technology; (2)
the final outcome of various FCC rulemakings and judicial review, if any, of
such rulemakings; (3) the final outcome of various CPUC proceedings, and
judicial review, if any, of such proceedings; and (4) the timing of entry and
the extent of competition in the local and intraLATA toll markets in California.
Readers are cautioned that other factors discussed in this form, although not
enumerated here, also could materially impact PacBell's future earnings.
PACIFIC BELL
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
There were no reports on Form 8-K filed during the quarter ended March 31,
1999.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PACIFIC BELL
May 11, 1999 /s/ Robert B. Pickering
Robert B. Pickering
Vice President and Chief Financial
Officer