PACIFIC TELESIS GROUP 10-K 1993-12-31:
Item 1. Business.
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GENERAL
Pacific Telesis Group (the "Corporation") was incorporated in 1983 under the
laws of the State of Nevada and has its principal executive offices at 130
Kearny Street, San Francisco, California 94108 (telephone number (415)
394-3000).
The Corporation is one of seven regional holding companies ("RHCs") formed in
connection with the 1984 divestiture by American Telephone and Telegraph
Company ("AT&T") of its 22 wholly owned operating telephone companies ("BOCs")
pursuant to a consent decree settling antitrust litigation (the "Consent
Decree") approved by the United States District Court for the District of
Columbia (the "Court"), which has retained jurisdiction over the interpreta-
tion and enforcement of the Consent Decree.
Under the terms of the Consent Decree, all territory served by the BOCs was
divided into geographical areas called "Local Access and Transport Areas"
("LATAs", also referred to as "service areas"). The Consent Decree generally
prohibits BOCs and their affiliates* from providing communications services
that cross service area boundaries; however, the networks of the BOCs
interconnect with carriers that provide such services (commonly referred to as
"interexchange carriers").
The Corporation includes a holding company, Pacific Telesis; two BOCs, Pacific
Bell and Nevada Bell (the "Telephone Companies"); and certain diversified
subsidiaries, all described more fully below. The holding company provides
financial, strategic planning, legal and general administrative functions on
its own behalf and on behalf of its subsidiaries.
THE TELEPHONE COMPANIES AND LINE OF BUSINESS RESTRICTIONS
Pacific Bell and its wholly-owned subsidiaries, Pacific Bell Directory and
Pacific Bell Information Services, and Nevada Bell provide a variety of
communications services in California and Nevada. These services include:
(1) dial tone and usage services, including local service (both exchange and
private line), message toll services within a service area, Wide Area Toll
Service (WATS)/800 services, Centrex service (a central office-based switching
service) and various special and custom calling services; (2) exchange access
to interexchange carriers and information service providers for the
origination and termination of switched and non-switched (private line) voice
and data traffic; (3) billing services for interexchange carriers and
information service providers; (4) various operator services; (5) installation
and maintenance of customer premises wiring; (6) public communications
services (including service for coin telephones); (7) directory publishing;
and (8) selected information services, such as voice mail and electronic mail
(See also "Pacific Bell Information Services," below). Efforts to develop
additional advanced services are described below.
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* The terms of the Consent Decree, with certain exceptions, apply generally
to all the BOCs and their affiliates.
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The Consent Decree provides that the RHCs shall not engage in certain lines of
business. The principal restrictions initially prohibited the provision of
interexchange telecommunications, information services and telecommunications
equipment. As described below, the information services prohibition was
lifted in 1991. The telecommunications businesses permitted by the Consent
Decree include the provision of exchange telecommunications* and exchange
access services, customer premises equipment ("CPE") and printed directory
advertising. The RHCs are prohibited from manufacturing telecommunications
equipment and CPE. On December 3, 1987, the Court interpreted the
manufacturing restriction to mean that the RHCs are prohibited from designing
and developing telecommunications equipment and CPE as well as from
fabricating them. The Consent Decree provides that the Court may waive the
line of business restrictions (i.e., grant a "Waiver") upon a showing that
there is no substantial possibility that the RHCs could use their monopoly
power to impede competition in the market they seek to enter. The Court has
placed certain conditions on the Waivers it has granted and may do so again on
future Waivers.
In May 1993, the U.S. Court of Appeals for the District of Columbia affirmed
the Court's removal of the ban on the provision of information services by the
Corporation. The removal of this ban in July 1991 allowed the Telephone
Companies to offer a variety of new information services, subject to
regulatory approvals, such as enhanced voice mail and electronic yellow pages.
In November 1993, the U.S. Supreme Court declined to review the Appeals Court
decision.
In November 1993, legislation was introduced in Congress that would simplify
the procedures under which BOCs seek relief from provisions of the Consent
Decree that prohibit the Telephone Companies from manufacturing telephone
equipment or providing long-distance service. The legislation would set
conditions and establish waiting periods of up to five years before the RHCs
could seek authority to enter all aspects of these businesses. One of the
bills would also impose stringent separate subsidiary requirements on RHC
electronic publishing ventures.
SPIN-OFF OF THE CORPORATION'S WIRELESS OPERATIONS
In December 1992, Pacific Telesis' Board of Directors approved a plan to spin
off the Corporation's wireless operations. In connection with the separation,
AirTouch Communications ("AirTouch"), formerly PacTel Corporation, completed
an initial public offering of common stock in December 1993.
The Corporation will spin off AirTouch and its domestic and international
wireless operations as a separate entity. These wireless operations
principally include cellular, paging, radiolocation and other wireless
telecommunications services in the United States, Europe and Asia. (See
"AirTouch Communications," below.) The Corporation will continue to own the
Telephone Companies, Pacific Bell's directory publishing and information
services subsidiaries, and several smaller diversified entities, including
real estate assets.
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* "Exchange telecommunications" includes toll or long-distance services
within a service area as well as local service.
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In February 1993, the California Public Utilities Commission ("CPUC")
instituted an investigation of the proposed spin-off of the Corporation's
wireless businesses for the purpose of assessing any effects it might have on
telephone customers of Pacific Bell and regulated cellular and paging firms in
California. On November 2, 1993, the CPUC adopted a decision permitting the
spin-off to proceed. The CPUC further ordered a refund by the Corporation of
approximately $50 million (including interest) of cellular pre-operational and
development expenses. Further proceedings will determine how the refund will
be disbursed. The CPUC decision was effective immediately. The Public
Services Commission of Nevada (the "PSCN") approved the spin-off in August
1993.
Two parties to the CPUC investigation filed Applications for Rehearing by the
CPUC of its treatment of the claims for compensation owed to Pacific Bell
customers. The CPUC's Division of Ratepayer Advocates filed a Petition for
Modification of the CPUC's decision. In March 1994 the CPUC denied these
requests. One of these parties further stated that if it were unsuccessful
with the CPUC it would seek review by the California Supreme Court. In the
event the California Supreme Court were to review and reverse the CPUC's
decision, no assurance can be given that the CPUC might not reach a new
decision materially less favorable to the Corporation or AirTouch with respect
to the compensation issues. In addition, a substantial period of time could
elapse before final resolution of these issues should a review be granted.
The Corporation believes that the California Supreme Court will deny a review.
On March 10, 1994, the Board gave final approval to the spinoff of AirTouch.
The spin-off will be effected April 1, 1994. The remaining 86 percent of
AirTouch's common shares currently owned by the Corporation will be
distributed to the Corporation's shareowners of record on March 21, 1994 in
proportion to their shares in the Corporation. The distribution has been
ruled as qualifying as a tax-free transaction to shareowners by the Internal
Revenue Service. The distribution will be accounted for as a stock dividend
by the Corporation when made.
Upon the spin-off of AirTouch, the Corporation and AirTouch will have no
common directors, officers or employees. Philip J. Quigley will become
Chairman and Chief Executive Officer of the Corporation and will remain as
President and Chief Executive Officer of Pacific Bell. Sam Ginn, currently
Chairman and Chief Executive Officer of the Corporation, will leave Pacific
Telesis Group but will continue as Chairman and Chief Executive Officer of
AirTouch. C. Lee Cox, currently Group President of the PacTel Companies, will
also leave Pacific Telesis Group and will continue as President and Chief
Operating Officer of AirTouch.
The Corporation and AirTouch have entered into a separation agreement that
provides for the disengagement of the two corporations' affairs in an orderly
manner and their complete separation after the spin-off. For example, the
agreement provides for the allocation of procedural and financial
responsibility with respect to contingent liabilities that become certain
after the spin-off and for the exchange of information necessary for
governmental reporting requirements.
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Pacific Bell Directory
Pacific Bell Directory ("Directory") is a publisher of the Pacific Bell SMART
Yellow Pages(R). Directory is the oldest and largest publisher of directory
information products in California and is among the largest Yellow Pages
publishers in the United States. Directory has enhanced the content,
organization and visual appeal of the local information in its directories and
improved other features to make the SMART Yellow Pages even more helpful and
easier to use. Most recently, a "Government Officials" section was added that
contains the names, address, telephone numbers and photographs of elected
officials, along with a map identifying congressional and state representative
boundaries. An audiotext feature called "Local Talk" is planned for
60 markets statewide by the end of 1994. In addition, government, business
and residential listings have been divided into separate sections in the White
Pages for faster accessibility, with colored tabs on the outer edges of the
pages identifying each section. As part of its ongoing small business
advocacy efforts, Directory also produces Small Business Success in
partnership with the U.S. Small Business Administration. Small Business
Success is an annual publication now in its seventh year that addresses
subjects of critical importance to entrepreneurs.
Pacific Bell Information Services
Effective January 1, 1993, Pacific Bell transferred its Information Services
Group to Pacific Bell Information Services ("PBIS"). PBIS provides business
and residential voice mail and other selected information services. Current
products include The Message Center for home use, Pacific Bell Voice Mail for
businesses, and Pacific Bell Call Management, a service that routes incoming
business calls and connects computer data bases to answer routine customer
questions. (See page F-23 of 1994 Proxy Statement* for discussion of CPUC
proceeding concerning PBIS.)
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* All references herein to the 1994 Proxy Statement shall be deemed to
incorporate the specific pages or notes into the section of this
Form 10-K where the reference appears.
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OTHER SUBSIDIARIES AND TELESIS FOUNDATION
PacTel Finance, formerly a subsidiary of AirTouch, is now directly owned by
the Corporation. Among subsidiaries held by PacTel Finance are PacTel Cable
and CalFront Associates (formerly PacTel Properties).
PacTel Cable has sold all of its wholly-owned subsidiaries which owned cable
franchises in the United Kingdom. The final sales were made to a subsidiary
of Jones InterCable, Inc. in January 1994. PacTel Cable retains options to
purchase from TC Cable, Inc. up to a 75 percent interest in Prime Cable of
Chicago, Inc., which acquired certain Chicago cable television properties in
June 1990 for $213 million. Under the terms of the current agreements, PacTel
Cable would be required to exercise its minority option (for 18.8 percent
ownership) if it receives the necessary regulatory approvals, including a
Waiver to provide interLATA services. If PacTel Cable does not obtain the
necessary regulatory approvals, it will be prohibited from exercising this
option but it has guaranteed TC Cable a minimum price for a sale to another
party. (See discussion of related loan guarantees on page F-57 in Note L to
the Consolidated Financial Statements contained in the 1994 Proxy Statement.)
PacTel Cable's majority option (for 56.2 percent ownership) is exercisable at
its sole discretion.
CalFront Associates holds a portfolio of real estate assets which the
Corporation plans to sell over the next three to five years. As of
December 31, 1993, the balance of the reserves taken for real estate losses
totaled $338 million. (See discussion of restructuring reserve on page F-13
of the 1994 Proxy Statement.)
PacTel Capital Resources ("PTCR") was formed to provide funding for the former
PacTel Corporation and its subsidiaries, primarily through the sale of debt
securities in the United States and other markets. PTCR has issued
commercial paper and medium-term notes guaranteed by the Corporation from time
to time since 1987. In the future, PTCR may also provide funding or issue
guarantees and other forms of financial support for its other affiliates.
PacTel Capital Funding ("PTCF") was formed to provide funding for the former
PacTel Corporation and its subsidiaries and third parties engaged in business
with those companies, primarily through the nonpublic sale of debt securities.
In the future, PTCF may provide funding or issue guarantees and other forms of
financial support for its other affiliates and third parties.
PacTel Re Insurance Company, Inc. reinsures policies of outside insurance
companies covering workers' compensation, general liability and auto liability
exposures of the Corporation and its subsidiaries and affiliates. The
subsidiary also issues policies of property insurance directly to the
Corporation's subsidiaries and engages in property reinsurance transactions in
insurance markets worldwide.
Pacific Telesis Group - Washington represents the Corporation's interests in
Washington, D.C. before the three branches of the federal government. It also
acts as a liaison with other telecommunications companies, trade associations
and a wide variety of interest groups.
Telesis Foundation, a private foundation organized under section 501(c)(3) of
the Internal Revenue Code, makes grants in the areas of education, health and
welfare, cultural, community and civic activities. Telesis Foundation is a
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newly formed foundation, replacing Pacific Telesis Foundation. Pacific
Telesis Foundation is being terminated and its assets distributed to two new
foundations, Telesis Foundation and PacTel Foundation. As of December 31,
1993, Pacific Telesis Foundation had total assets with an estimated market
value of $68 million.
RESEARCH AND DEVELOPMENT
Bell Communications Research, Inc. ("Bellcore") furnishes the BOCs, including
the Telephone Companies, with technical and consulting assistance to support
their provision of exchange telecommunications and exchange access services.
Each of the other six RHCs or their BOCs, including Pacific Bell, holds
one-seventh of the voting stock of Bellcore, which serves as a central point
of contact for coordinating the efforts of the RHCs in meeting the national
security and emergency preparedness requirements of the federal government.
In addition, the Corporation conducts research and development through Pacific
Bell and through Telesis Technologies Laboratory, Inc., a wholly-owned
subsidiary of the Corporation. The Corporation, excluding spin-off
operations, spent approximately $30 million, $30 million and $31 million in
1993, 1992 and 1991, respectively, on research and development activities.
FINANCING ACTIVITIES OF THE CORPORATION
In 1993, the Corporation redeemed $2.62 billion and issued $2.65 billion of
long-term debt. As of December 31, 1993, Pacific Bell had remaining authority
to issue up to $1.25 billion in long- and intermediate-term debt pursuant to a
CPUC order issued in September 1993. As of December 31, 1993, Pacific Bell
had authority to issue up to $650 million in long- and intermediate-term debt
through a shelf registration statement on file with the Securities and
Exchange Commission (the "SEC"). Proceeds from debt issuances in 1993 and
future issuances will be used to refund maturing debt and to refinance other
debt issues. Effective April 23, 1993, AT&T redeemed $300 million in long-
term debt for which Pacific Bell was a secondary obligor. This debt was
assumed by AT&T at divestiture.
Pursuant to a shelf registration on file with the SEC, PTCR has authority to
issue up to $192 million of medium-term notes, guaranteed by the Corporation
as to payment of principal and interest.
The following are bond and commercial paper ratings for the Corporation and
its subsidiaries:
| Long- and
|Intermediate-Term
Commercial Paper | Debt
----------------------------------------------------------|-----------------
Pacific |
Telesis Pacific | Pacific
Group PTCR Bell | PTCR Bell
----------------------------------------------------------|-----------------
Moody's Investors Service, Inc. Prime-1 Prime-1 Prime-1 | A1 Aa3
Standard & Poor's Corporation A-1 A-1 A-1+ | A+ AA-
Duff and Phelps, Inc. - - Duff 1+ | - AA
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Pacific Bell and PTCR are the only subsidiaries of the Corporation with any
long- or intermediate-term publicly held debt issues outstanding as of
December 31, 1993. The holding company itself has no publicly held debt
issues outstanding.
No recapitalization of Pacific Bell is planned as a result of the
Corporation's spin-off of AirTouch. After the announcement of the Board's
decision in December 1992 to spin off AirTouch and its wireless operations,
Duff and Phelps, Inc. ("D&P") reaffirmed its rating of Pacific Bell's debt.
Standard & Poor's ("S&P") affirmed its rating on the outstanding long-term
debt of PTCR and Pacific Bell, and on the commercial paper programs of Pacific
Bell, PTCR and the Corporation. S&P also revised its ratings outlook for the
long-term debt of PTCR and Pacific Bell from "stable" to "positive."
Additionally, Moody's stated that the debt ratings of all three entities are
unlikely to be affected by the spin-off.
The Corporation expects that each of the separate businesses will continue
upon separation to have access to the public and private markets for debt,
although the terms are likely to be less favorable for AirTouch. S&P has
assigned an implied senior debt rating of BBB+ to the post-spin AirTouch.
AirTouch has been capitalized through an initial public offering of stock in
December 1993.
The ratings noted above reflect the views of the rating agencies; they should
be evaluated independently of one another and are not recommendations to buy,
sell or hold the securities of the Corporation. There is no assurance that
such ratings will continue for any period of time or that they will not be
changed or withdrawn.
Additional discussion of the Corporation's financing activities is on pages
F-19 through F-21 and in Notes H and I to the 1993 Consolidated Financial
Statements contained in the 1994 Proxy Statement.
PRINCIPAL SERVICES
Due to the impending spin-off, the operations of AirTouch have been classified
separately within the Corporation's financial statements as "spin-off
operations" and are excluded from the amounts of revenues and expenses of the
Corporation's "continuing operations." Under this presentation, the Telephone
Companies accounted for almost all of the Corporation's operating revenues in
1993. For these reasons, the following discussion focuses on selected
operating information for the Telephone Companies. Additional information
regarding revenues, operating profit or loss and assets of the Corporation,
relating primarily to the Telephone Companies, is incorporated from the 1994
Proxy Statement by reference in "Item 8. Financial Statements and
Supplementary Data" below.
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Significant components of Pacific Telesis Group's operating revenues are
depicted in the chart below:
% of Total Operating Revenues*
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Revenues by Major Category 1993 1992 1991
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Local Service
Recurring .............................. 22% 21% 20%
Other Local ............................ 16% 16% 16%
Network Access
Carrier Access Charges ................. 18% 18% 18%
End User & Other ....................... 7% 7% 7%
Toll Service**
Message Toll Service ................... 20% 19% 19%
Other .................................. 2% 4% 5%
Other Service Revenues
Directory Advertising .................. 11% 11% 11%
Other .................................. 4% 4% 4%
------ ------ ------
TOTAL ...................................... 100% 100% 100%
===========================================================================
* Excludes revenues of spin-off operations.
** Percentages for 1993 are not comparable to prior years' percentages due to
reclassifications in the current presentation.
The percentages of Pacific Telesis Group's operating revenues attributable to
interstate and intrastate telephone operations are displayed below:
% of Total Operating Revenues*
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1993 1992 1991
---------------------------------------------------------------------------
Interstate telephone operations ............ 18% 18% 17%
Intrastate telephone operations ............ 82% 82% 83%
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TOTAL ...................................... 100% 100% 100%
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* Excludes revenues of spin-off operations.
As of December 31, 1993 about 33 percent of the network access lines of
Pacific Bell were in Los Angeles and vicinity and about 25 percent were in San
Francisco and vicinity. On that date, about 64 percent of Nevada Bell's
network access lines were in Reno and vicinity. The Telephone Companies
provided approximately 77 percent and 30 percent of the total access lines in
California and Nevada, respectively, on December 31, 1993. The Telephone
Companies do not furnish local service in certain sizeable areas of California
and Nevada which are served by nonaffiliated telephone companies.
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MAJOR CUSTOMER
Payments from AT&T for access charges and other services accounted for
11 percent of the Corporation's operating revenues during 1993. No other
customer accounted for more than 10 percent of the Corporation's operating
revenues in 1993.
STATE REGULATION
As a provider of telecommunications services in California, Pacific Bell is
subject to regulation by the CPUC with respect to intrastate rates and
services, the issuance of securities and other matters. The Public Service
Commission of Nevada ("PSCN") regulates Nevada Bell on similar issues.
The CPUC adopted a new regulatory framework, which is a form of "price cap" or
"incentive" regulation, for Pacific Bell and one other large local exchange
carrier in California in October 1989. The authorized market-based rate of
return under the CPUC's new regulatory framework is 11.5 percent. If Pacific
Bell's rate of return exceeds 13 percent, earnings above the 13 percent
benchmark must be shared 50-50 with customers. Earnings above 16.5 percent
must be returned 100 percent to customers. The third phase of the CPUC's
ongoing investigation into alternative regulatory frameworks has addressed
competition for intra-service area toll and related services. The CPUC's
formal authorization of competition into Pacific Bell's intra-service area
toll market is expected in 1994. (See "Toll Services Competition" below.)
Under incentive-based regulation, the CPUC requires Pacific Bell to submit an
annual price cap filing to determine prices for categories of services for
each new year. Price adjustments reflect the effects of any change in the
Gross National Product Price Index ("GNPPI") less 4.5 percent, the
productivity factor established by the CPUC under the new incentive
regulation. The annual price adjustments also reflect the effects on Pacific
Bell's costs of exogenous events beyond its control. In December 1993, the
CPUC approved Pacific Bell's annual price cap filing for 1994 in which Pacific
Bell had proposed a $105 million rate reduction. This reduction includes a
decrease of $85 million because the 4.5 percent productivity factor of the
price cap formula exceeded the increase in the GNPPI by 1.3 percent. The
filing also included several additional factors which will decrease revenues*
by an additional $20 million.
In 1992, the CPUC began its scheduled review of the current incentive-based
regulatory framework. Among other issues, this review has examined elements
of the price cap formula, including the productivity factor and the benchmark
rate of return on investment adopted in the 1989 New Regulatory Framework
("NRF") order. Pacific Bell proposed no significant changes to the new
framework because the Corporation's experience to date suggests that it is
working as intended.
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* Unless otherwise indicated, revenue changes from CPUC price cap orders are
estimated on an annual basis and may be more or less than the amount
ordered, due to later changes in volumes of business.
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In March 1994, a CPUC Administrative Law Judge issued a proposed decision in
the NRF review. The proposed decision would eliminate an element of the
regulatory framework which requires equal sharing with customers of earnings
exceeding a benchmark rate of return. Earnings above a rate of return of
16.5 percent would continue to be returned to customers. The proposed
decision also recommends increasing the productivity factor of the price cap
formula from 4.5 percent to 6.0 percent for the period 1994 through 1996. If
adopted by the CPUC, the change in the productivity factor would reduce
annualized revenues by approximately $100 million each year through 1996.
Pacific Bell plans to file comments objecting to the proposed increase in
productivity factor. The Corporation is unable to predict the final outcome
of these proceedings or the effective date of any rate reductions.
In August 1993, the CPUC issued a proposal to allow competition in the
provision of intrastate switched transport services. The CPUC proposes to
allow competitors to locate transmission facilities in Pacific Bell's central
offices; adopt a new transport rate structure that includes pricing
flexibility for dedicated traffic; and authorize competition for switched
transport services within the state. Revenues from intrastate switched
transport services represent approximately four percent of Pacific Bell's
total revenues. The Corporation is unable to predict the outcome of this
proceeding.
In April 1993, the CPUC initiated an investigation to establish a framework to
govern open network access i.e., access to so-called "bottleneck" services.
The CPUC proposes to adopt specific requirements for the unbundling and
nondiscriminatory provision of functions underlying services provided by
dominant telecommunications providers. Functions considered bottleneck and
subject to open access for competitive telecommunications providers include
all transport switching, call processing and call management. In comments
filed in February 1994, Pacific Bell urged the CPUC to recognize that
widespread competition exists throughout the telecommunications industry and
asked the CPUC to consider rules for local competition immediately.
Pacific Bell's proposal calls for the separation of the loop (the telephone
line between a customer's location and the telephone company's central office)
from the switch (the central office equipment that selects the paths to be
used for transmission of information.) Pacific Bell has filed an application
for authority to conduct tests and trials with a variety of industry
participants to test the feasibility of unbundling the loop from the switch
and of various points of interconnection. The trials would allow competitors
to connect to Pacific Bell's network to carry calls. Eventually, customers
would be able to decide whether they want Pacific Bell to provide all of their
telecommunications services, including local service, or if they want to
subscribe to another provider for dialtone and other services. Pacific Bell
also believes it should be given the opportunity to compete in other markets,
such as long-distance, cable television programming and manufacturing. The
Corporation's entry into these markets would benefit consumers by providing
them alternatives to existing sources of products and services. The
Corporation is unable to predict the outcome of this proceeding.
In December 1993, the CPUC released a report to the Governor of California
proposing streamlined regulation of telecommunications companies. The report
states that the benefits of deregulation and fostering advanced
telecommunications in California would be substantial. It predicts that
expanded use of telecommunications will create new products, services and job
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opportunities and could increase the productivity of the state's businesses.
The CPUC proposes that within the next year California should: streamline
regulation where markets are workably competitive; continue the CPUC's focus
on consumer protection in all markets; develop policies and partnerships that
encourage consumer demand and the increased use of advanced telecommunications
networks; and establish a grant program to enhance development and use of
advanced telecommunications in schools and libraries. The report recommends
that disincentives to investments (such as the current cap on earnings and
sharing mechanisms) be removed, that restrictions on Pacific Bell's ability to
provide certain services be removed and that interconnection and
interoperability among competing networks be required to expand customer
choice.
Additionally, the CPUC proposed that within three years California open all
markets to all competitors, thereby making the state an "open competition
zone." It would also restructure universal service funding, and gradually
redefine the concept of basic service to ensure that all residents benefit
from advanced telecommunications technologies. In addition, it would make
digital access to networks available as a prelude to making switched video and
mobile services available throughout the state by the end of the decade.
By opening markets to competition, the policies proposed by the CPUC would
increase demand for and stimulate the private development of new types of
telecommunications and video services, bringing innovative new products into
businesses, homes, and communities. Various elements of these proposals
require consideration by the California Legislature as well as formal review
by the CPUC.
Discussion of other CPUC proceedings, including regulatory and ratemaking
treatment for postretirement benefits in connection with the adoption of
Financial Accounting Standard No. 106, and the limited rehearing of a decision
involving certain erroneous late payment charges, is on pages F-22 through F-
24 of the 1994 Proxy Statement.
In Nevada, the PSCN authorized an Alternative Plan of Regulation for telephone
companies, including Nevada Bell, beginning in 1991. Nevada Bell was awarded
an equity-based rate of return ("ROE") of 13 percent and a sharing formula
allows Nevada Bell to share in any earnings above the benchmark ROE of
13 percent. The new incentive-based framework places a five-year cap on basic
rates. The earnings and sharing review conducted in 1993 based upon 12 months
of results of operations resulted in no sharing due to an ROE under 13
percent.
The PSCN has also recently opened a proceeding to consider revising existing
regulations for telecommunications providers; we hope this proceeding will
streamline regulation in Nevada.
The Corporation continues to support changes in public policy and regulation
that will allow it to offer the products and services that customers want.
FEDERAL REGULATION
The Telephone Companies are subject to the jurisdiction of the Federal
Communications Commission (the "FCC") with respect to interstate access
charges and other matters. The FCC prescribes a Uniform System of Accounts and
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interstate depreciation rates for operating telephone companies. The FCC also
prescribes "separations procedures," which are the principles and standard
procedures used to separate plant investment, expenses, taxes and reserves
between those applicable to interstate services under the jurisdiction of the
FCC, and intrastate services under the jurisdiction of state regulatory
authorities. The Telephone Companies are also required to file tariffs with
the FCC for the services they provide. In addition, the FCC establishes
procedures for allocating costs and revenues between regulated and unregulated
activities.
Beginning in 1991, the FCC adopted a price cap system of incentive-based
regulation for local exchange carriers. Pacific Bell's access rates were
retargeted to a new 11.25 percent rate of return on rate base assets. The
FCC's price cap system provides a formula for adjusting rates annually for
changes in the GNPPI, less a productivity factor and changes in certain costs
that are triggered by administrative, legislative or judicial action beyond
the control of the local exchange carriers.
The FCC's price cap plan allows the Telephone Companies to choose between two
productivity offset factors of 3.3 or 4.3 percent on an annual basis. This
choice affects both the sharing threshold and the threshold above which all
earnings must be returned to customers. In its third annual access filing,
Pacific Bell again chose the productivity factor of 3.3 percent, which the FCC
approved in June 1993. Nevada Bell elected the productivity factor of 4.3
percent. For Pacific Bell, the 3.3 percent factor sets the benchmark rate of
return for sharing of earnings at 12.25 percent. For Nevada Bell, the 4.3
percent factor changes the sharing threshold to 13.25 percent. If earnings
for 1993 are determined to exceed their respective sharing thresholds, Pacific
Bell and Nevada Bell must share the excess earnings equally with customers.
Pacific Bell's earnings above 16.25 percent must be returned entirely to
customers. For Nevada Bell, all earnings above 17.25 percent must be returned
to customers. New interstate access rates became effective July 1, 1993.
Pacific Bell and Nevada Bell's annual interstate access rates were decreased
by $17 and $3.7 million, respectively, for the 12 months July 1993 through
June 1994. The reductions reflect the net effects of inflation, productivity
gains and other required cost adjustments.
In February 1994, the FCC issued a notice of proposed rulemaking to review its
price cap alternative regulatory framework. Parties, including the Telephone
Companies, will file comments with the FCC in April 1994. The FCC is looking
for comments on three main sets of issues: (1) refining the goals of price
caps to better meet the public interest and the purposes of the Communications
Act; (2) whether to revise the current plan (which became effective January 1,
1991) to help it better meet the FCC's goals, or to adjust the plan to changes
in circumstances; and (3) possible transition from the baseline price cap plan
toward reduced or streamlined regulation of services provided by local
exchange carriers ("LECs") as competition grows.
The FCC released a Notice of Inquiry in December 1991 "to open public debate
on the interrelationship of Open Network Architecture with emerging network
design" and to gather information on future network capabilities. The FCC
stated that its goal is to encourage development of future local exchange
networks that are as open, responsive and procompetitive as possible,
consistent with the FCC's other public interest goals. The Telephone
Companies filed comments on March 3, 1993, stating that market forces must
drive network evolution. In August 1993, the FCC issued a notice of proposed
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rulemaking to require Tier I local telephone companies implementing
intelligent networks to offer third party mediated access to their networks.
In comments filed with the FCC, the Telephone Companies asserted that access
to intelligent networks should not be mandated because market forces are
sufficient to bring about open access.
Effective in June 1993, the FCC ordered expanded network interconnection for
interstate special access services. Special access services are used
primarily by large businesses to connect to their branch offices or to
interexchange carriers. The decision requires large LECs, including the
Telephone Companies, to offer expanded interconnection to customers, including
other access providers. The decision permits these customers to locate their
transmission facilities in the LECs central offices. The FCC granted
additional, but limited, pricing flexibility to the LECs to respond to the
increased competition that will result. Along with other LECs, the Telephone
Companies have filed a petition for review of this FCC decision with the U.S.
Court of Appeals for the D.C. Circuit. We are unable to predict the outcome
of this appeal. Pacific Bell currently has orders from Competitive Access
Providers to locate facilities in more than 20 of its central offices, with
more requests expected to follow. Interstate special access revenues subject
to increased competition represent less than three percent of the Telephone
Companies' total revenues.
Effective in February 1994, the FCC ordered LECs, including the Telephone
Companies, to provide all interested customers, including competitors, with
expanded interconnection for interstate switched transport services. The LECs
must allow interconnectors to physically locate their transmission facilities
in the LECs' central offices and certain other LEC locations, in order to
terminate their own switched transport facilities. Switched transport
services help connect a business or residential customer with an interexchange
carrier. One of the FCC's goals is to promote increased competition for these
services. The FCC granted additional, but limited, pricing flexibility for
these services so that the LECs can better respond to the competition that
will result. Along with other LECs, the Telephone Companies have filed a
petition for review of this FCC decision with the U.S. Court of Appeals for
the D.C. Circuit. The Court has held this case in abeyance pending the
Court's decision in the appeal of the FCC's special access collocation order.
Revenues from interstate switched transport services represent approximately
three percent of the Telephone Companies' total revenues. Rates reflecting
the new rules became effective in early 1994.
To facilitate expanded interconnection for switched transport services, the
FCC ordered a new interim rate structure effective December 1993. Under the
new structure, interexchange carriers pay different rates based on volume,
distance and other factors. The FCC intends these interim rates to be revenue
neutral. Pacific Bell and others have petitioned the FCC for reconsideration
of this decision, contending that the interim rate structure will cause
revenue losses. The Corporation is unable to predict the outcome of this
proceeding.
In August 1992, the FCC modified its rules to permit LECs, including the
Telephone Companies, to provide a tariffed basic platform ("video dialtone")
that will deliver video programming developed by others on a nondiscriminatory
basis. (See "Video Services," below, for a discussion of Pacific Bell's four
applications to provide video dialtone services.) The FCC's order has been
appealed but the appeals are stayed pending the FCC's reconsideration
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decision. The FCC also recommended that Congress repeal the statutory cross-
ownership restriction imposed on cable and telephone companies. Until
Congress acts, additional services authorized by the FCC rules include video
gateways, interactive enhanced services, video transport, video customer
premises equipment, and billing and collection.
In July 1993, five of the RHCs, including the Corporation, filed a petition
with the FCC asking for new rules governing the provision of long-distance
services. The RHCs are currently prohibited from providing long-distance
services by the terms of the Consent Decree. Even with a favorable ruling
from the FCC, the RHCs must still obtain relief from the Consent Decree from
Congress, or the courts, before providing long-distance services. During
1993, Pacific Bell joined other members of the United States Telephone
Association ("USTA") in a petition to the FCC to establish a rulemaking for
the purpose of reforming regulation of interstate access services. USTA urges
the FCC to address several major matters needing reform including existing
subsidy funding and recovery mechanisms, the need for greater pricing
flexibility as competition increases and the need to revise current price cap
rules.
NEW TECHNOLOGY AND ADVANCED SERVICES
The Telephone Companies continue to modernize and expand their telephone
networks to meet customer demands for faster and more reliable services as
well as demands for new products and services. New technologies being
deployed include optical fiber, digital switches and Signaling System 7 ("SS-
7"). Digital switches and optical fiber, a technology using thin filaments of
glass or other transparent materials to transmit coded light pulses, greatly
increase the capacity and reliability of transmitted data while reducing
maintenance costs. SS-7 permits faster call setup and new custom calling
features. Investments in key technologies are summarized on pages F-8 and F-9
of the 1994 Proxy Statement.
SS-7 has made it possible for Pacific Bell to offer many new custom calling
features, subject to regulatory approvals. New custom calling features
include call return, priority ringing, call trace and other Custom Local Area
Signaling Services ("CLASS"). Pacific Bell began offering priority ringing,
repeat dialing and select call forwarding services in selected areas in 1992.
Pacific Bell introduced call trace, call screen and call return services in
1993. Over half a million customers subscribed to these new services in 1993.
Pacific Bell will introduce additional features and expand the availability of
the "CLASS" Services in 1994. However, as a result of a CPUC decision in
November 1992, Pacific Bell has decided not to offer caller identification
("Caller ID"). The stringent number blocking requirements placed on the
service by the CPUC prevent Pacific Bell from offering customers a viable
service at a reasonable price. Pacific Bell continues to work with the CPUC
in this area, with the goal of providing California customers the benefits of
Caller ID service. In March 1994, the FCC adopted free per call blocking as
the national standard for the offering of Caller ID on interstate calls,
effective April, 1995.
Pacific Bell, either directly or through its subsidiary, Pacific Bell
Information Services, also offers voice mail, electronic messaging and
interactive voice response services. (See "Pacific Bell Information
Services," above.) Other enhanced services may be offered in the future. The
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Corporation does not expect revenues from enhanced services to have a material
effect on reported earnings in 1994 but the new services are expected to
increase the use of the networks of the Telephone Companies.
In November 1993, Pacific Bell announced a capital investment plan totaling
$16 billion over the next seven years to upgrade its core network
infrastructure and to begin building California's "communications
superhighway." This will be an integrated telecommunications, information and
entertainment network providing advanced voice, data and video services.
Using a combination of fiber optics and coaxial cable, Pacific Bell expects to
provide broadband services to more than 1.5 million homes by the end of 1996
and more than 5.0 million homes by the end of the decade. As part of its
current plan, Pacific Bell has made purchase commitments totaling nearly $600
million in accordance with its previously announced $1 billion program for
deploying an all digital switching platform with ISDN (Integrated Services
Digital Network) and SS-7 capabilities. The advanced network will make
possible capital and operational cost savings, service quality improvements
and new revenues from the array of new service possibilities. The offering of
any new advanced services will depend upon their economic and technological
feasibility. Construction of the portions of the network that are not video-
specific will begin early in the second quarter of 1994. (See "Video
Services," below.) The network should be capable of offering fully
interactive digital telephone services by the end of 1996.
In order to offer the new products and services customers want, the Telephone
Companies have been making substantial investments to improve the telephone
networks. During 1993, the Telephone Companies invested $1.9 billion in their
networks.
Capital expenditures in 1994 for the Telephone Companies are forecast to be
$1.9 billion including $1,136 million for projects designed to generate
revenues and $589 million for projects designed to reduce costs. Capital
expenditures under Pacific Bell's seven year investment plan are not expected
to increase until 1996 due to the timing of capital expenditures associated
with the construction of the broadband network.
The PSCN has approved CLASS services for Nevada Bell. Effective August 1,
1992, Nevada Bell began offering Caller ID, call return, priority ringing,
call tracing, repeat dialing, call screening and select call forwarding.
Nevada Bell offers two free blocking options to Caller ID -- per call and per
line blocking. Nevada Bell is also working with the Nevada Telephone
Association on a major contract to provide a digital telecommunications system
for the State of Nevada. This digital microwave network will provide an
advanced infrastracture for all communications in the public sector,
permitting both video conferencing and high-speed data applications.
CHANGING INDUSTRY ENVIRONMENT
One of the challenges facing the Telephone Companies is the accelerating
convergence of the telecommunications, computer and video industries. The new
information services industry is being shaped by advances in digital and
fiber-optic technologies that will make possible the provision of interactive
broadband services by the Telephone Companies as well as others. Although
this convergence will bring further competition, it also should mean
unprecedented reasons to enter new businesses from which we have been barred
historically. The Clinton administration has indicated it will support
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legislation to remove many of the legal restrictions that have prevented
telephone companies from offering video services. The administration has also
indicated it will support the removal of restrictions which prevent the RHCs
from providing long-distance services. Similar proposals have been made by
the CPUC to the Governor of California. The public policy initiatives
discussed below will determine the terms and conditions under which the
Telephone Companies may offer new services in this dynamic marketplace.
Video Services
As described above, the FCC currently permits LECs, including the Telephone
Companies, to provide a tariffed basic platform that will deliver video
programming developed by others ("video dialtone") and to provide certain
other services to customers of this basic platform. In December 1993, Pacific
Bell filed an application with the FCC seeking authority to offer video
dialtone services in specific locations in four of its service areas: the San
Francisco Bay Area; Los Angeles; San Diego; and Orange County. The advanced
integrated broadband telecommunications network which Pacific Bell plans to
build over the next seven years will be capable of delivering an array of
services including traditional voice, data and video services. Once FCC
approval is obtained, Pacific will deploy the video exclusive components of
the advanced network.
In addition to providing advanced telecommunications services, the new network
will also serve as a platform for other information providers, and will offer
customers an alternative to existing cable television providers. The
integrated network is also expected to spur the development of new interactive
consumer services in education, entertainment, government and health care.
In November 1993, the Corporation sued to overturn the 1984 Cable Act
provision barring telephone companies from providing video programming in
their service areas. The Cable Act bars telephone companies from having more
than a de minimis ownership stake in video programming services, although it
permits them to carry other companies' programs. The Corporation believes
that video programming is a form of speech protected by the First Amendment of
the United States Constitution. If the suit is successful, the Corporation
plans to begin providing programming in California as soon as its video
dialtone network is deployed.
In November 1993, legislation was introduced in Congress that would permit
LECs, including the Telephone Companies, to provide video programming to
subscribers in their own service areas, subject to separate subsidiary
requirements and other safeguards. The legislation would also permit
competition in the provision of local telephone service and allow access to
LEC facilities by competitors.
In January 1994, Pacific Telesis Video Services, a newly created Pacific
Telesis subsidiary, announced an advanced interactive television services
trial with AT&T that will test consumer acceptance of sophisticated services
such as multi-player games, interactive home shopping and educational
programs, movies-on-demand and time-shifted television programs. PTVS will
purchase transport from Pacific Bell when video dialtone tariffs are approved.
Pacific Telesis Video Services is also working with Hewlett-Packard Company to
build an interactive video system that will offer consumers movies and other
programs "on demand" by late 1994 or early 1995. Hewlett-Packard will provide
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large video servers to distribute digital video "streams" to individual
subscribers' homes. The servers will be built around a new technology, or
"video transfer engine," that is flexible, reliable and upgradeable.
Electronic Publishing Services
In November 1993, legislation was introduced in Congress that would simplify
the procedures under which BOCs may seek relief from provisions of the Consent
Decree. (See "The Telephone Companies and Line of Business Restrictions"
above.) However, the bill would also impose stringent separate subsidiary
requirements on RHC electronic publishing ventures. In November 1993, Pacific
Bell filed an application with the CPUC stating its intent to enter the
electronic publishing business, either by itself or through an affiliate.
In January 1994, the Los Angeles Times and Pacific Telesis Electronic
Publishing Services, a newly created Pacific Telesis Group subsidiary,
announced a plan to form a joint venture to design and offer electronic
shopping information and transaction services beginning in late 1994. A
combination of business listings, classified and display advertising, consumer
ratings, and editorial and promotional material will form a comprehensive
electronic resource that will give consumers the product, service and business
information they want from one convenient, integrated source. The joint
venture will also offer consumers in-depth information on a wide variety of
topics, including home repair and maintenance, real estate rental and sales,
and auto, travel and entertainment services.
Personal Communications Services
In October 1993, the FCC issued an order allocating radio spectrum and
setting forth licensing requirements to provide PCS. PCS relies on a network
of transceivers that may be placed throughout a neighborhood, business complex
or community to provide customers with mobile voice and data communications.
The FCC established two different sizes of service areas nationwide for PCS:
47 large areas referred to as Major Trading Areas ("MTAs") and 487 smaller
areas. The MTA licenses are for 30 megahertz of spectrum. In any given area,
there will be as many as seven licenses, including two MTA licenses. Most of
the licenses will be awarded by competitive bidding in auctions expected in
late 1994 or early 1995. The Corporation plans to aggressively pursue PCS
licenses at these auctions and is well-placed to be part of the expected
multi-billion dollar market for PCS.
On December 23, 1993, the FCC awarded a "pioneer preference" to another
company for one of the two larger MTA licenses covering the Los Angeles, San
Diego, and Las Vegas market area. That company will receive the license
without charge. This is expected to place the successful bidder for the
remaining MTA license in that area at a significant competitive disadvantage
because of its higher cost structure. Winning bids in major PCS markets are
expected to require large capital expenditures. The Corporation has filed
petitions for review of the FCC decisions that granted pioneer preferences for
PCS licenses without charge with the U.S. Court of Appeals for the D.C.
Circuit. We are unable to predict the outcome of these appeals.
The Corporation's wholly-owned subsidiary, Telesis Technologies Laboratory,
Inc. ("TTL"), has been conducting PCS experiments and investigating various
technological issues under an experimental license granted by the FCC. With a
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spin-off of the Corporation's wireless operations, the Corporation will be
eligible to bid on PCS licenses in the service areas of the Telephone
Companies. The Corporation also believes that AirTouch will be eligible to
bid on the larger MTA licenses in areas where it does not provide cellular
service after the spin-off.
Some of the assets that have been engaged in PCS research and development work
were transferred to AirTouch in late 1993 in accordance with the terms of the
Separation Agreement between the Corporation and AirTouch. TTL employees
originally employed by AirTouch will transfer back to AirTouch before the
spin-off. Pacific Bell will form a new subsidiary to receive remaining assets
of TTL that have been engaged in PCS research and development work and it will
provide PCS services if the Corporation wins a license at auction. Future TTL
research will assess wireless broadband technologies, the effects of consumer
electronics on telecommunications networks, and continued work in the area of
PCS.
COMPETITION
Regulatory, legislative and judicial actions since the Consent Decree, as well
as advances in technology, have expanded the types of available communications
services and products and the number of companies offering such services.
Various forms of competition are growing steadily and are already having a
significant effect on the Telephone Companies' earnings, primarily Pacific
Bell's. An increasing amount of this competition is from large companies with
substantial capital, technological and marketing resources. There is also
increased competition among existing and new common carriers, including
subsidiaries of the RHCs and AT&T, for the provision of voice and data
communications services.
Toll Services Competition
In 1993, the CPUC continued Phase III of its ongoing investigation into
alternative regulatory frameworks (See "State Regulation" above). In
Phase III, the CPUC is considering how to lift its current ban on intra-
service area competition for toll and toll-related services and how to
rebalance Pacific Bell's rates.
In September 1993, the CPUC announced a decision providing that, beginning in
1994, long-distance and other telecommunications companies would be allowed to
compete with Pacific Bell and other local telephone companies in providing
toll service, among other services. The decision would have also lowered
local exchange company toll and switched access rates, while increasing basic
rates, bringing each closer to cost. Other rates would have also changed.
Overall, the CPUC's order was intended to be revenue neutral; that is, the
effect of rate decreases would be offset by the effect of rate increases.
In October 1993, the CPUC rescinded its September decision after questions
were raised about its decision-making process. The CPUC has requested
additional comments on its original decision. The Corporation expects a final
decision in 1994, but is unable to predict the revenue impacts of the decision
and the increased competition that will follow. In a future proceeding, the
CPUC intends to address whether to require LECs to provide a way for customers
to presubscribe to their carrier of choice for intra-service area toll
services.
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In 1993, Pacific Bell experienced a decline in revenues from services subject
to competition, while revenues from other services continued to grow. The
total impact of competition on revenues, however, cannot be quantified
separately from the effects of the recession in California. (See "California
Economy" on page F-7 of the 1994 Proxy Statement.)
In Nevada, the PSCN adopted a rule change effective October 1993 that permits
limited intra-service area competition. Interexchange carriers may complete
intra-service area calls either through dedicated special access or if the
customer initiates the call with certain designated prefixes.
Interstate Special Access Competition
Expanded interconnection for interstate special access services became
effective on June 16, 1993. Special access services are used primarily by
large businesses to connect their branch offices or to connect directly to
interexchange carriers. Expanded interconnection allows customers, including
other access providers, to locate their transmission facilities in an LEC
central office. This allows interexchange carriers ("IECs") to choose among
competing providers for transport into the LECs' central offices. (See
"Federal Regulation" above.)
Switched Transport Competition
Effective February 15, 1994, expanded interconnection became available for the
transport portion of interstate switched access services under similar price,
terms and conditions as for special access services. Switched access services
link IECs with most residential and business customers.
In recognition of the local transport competition which exists today and the
increased competition that will result from expanded interconnection, the FCC
has approved limited rate deaveraging by zones of central offices and volume
and term discounts for LEC access transport services, once certain conditions
are met.
In August 1993, the CPUC also issued a proposal to allow competition in the
provision of intrastate switched transport services. The CPUC proposes to
allow competitors to locate transmission facilities in Pacific Bell's central
offices; adopt a new transport rate structure that includes pricing
flexibility for dedicated traffic; and authorize competition for switched
transport services within the state. (See "State Regulation" and "Federal
Regulation" above.)
Open Network Access/Local Competition
Early in 1993, the CPUC initiated a rulemaking proceeding and set forth a
number of proposed policies, rules and issues for comment on ways to establish
a receptive environment for competitive providers of telecommunications
services. The rulemaking focuses on one approach: Requiring local exchange
carriers to unbundle "bottleneck" elements of their network and make those
elements available to unaffiliated providers on an open and nondiscriminatory
basis.
Pacific Bell's response to this rulemaking urges the CPUC to examine the full
set of issues that result from a competitive local exchange market. Among
such issues are: the need to establish a new universal service mechanism that
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spreads the subsidy burden to all telecommunications providers, to reform
pricing rules to be consistent with increasing competition, to remove entry
barriers including current in-state long distance restrictions on Pacific
Bell, to remove investment disincentives such as sharing and to establish
standards for interconnection, interoperability and unbundling of essential
facilities that apply to all competing networks and not just those of the
LECs. (See "State Regulation" above.)
Bypass
Artificially high prices for toll and access services create an economic
incentive for large business users (and IECs) to use alternative
communications systems capable of originating and/or terminating calls and
thus bypass the local exchange network. This bypass reduces the revenues that
the Telephone Companies collect from toll and access services to support the
total costs of the local exchange network and increases the amounts the
Telephone Companies have to recover from other services, notably basic
exchange services. The Telephone Companies are unable to determine precisely
to what extent bypass has occurred and may continue to occur in the future.
(See preceding sections, from "Toll Services Competition" through "Open
Network Access/Local Competition" above.)
To reduce the threat of bypass of the local networks, the Telephone Companies
have strongly supported the use of cost-based pricing policies before both
their state regulatory commissions and the FCC. (See "State Regulation" and
"Federal Regulation" above.)
Centrex
The Telephone Companies provide Centrex service to business customers in
California and Nevada. Centrex is a central office-based switching system for
customers who require sophisticated call transport and management capabilities
as part of their business communication systems. Businesses not using Centrex
service generally use Private Branch Exchange ("PBX") and other systems
provided by other companies. The Telephone Companies offer Centrex by
contract, as approved by the CPUC for Pacific Bell, as well as pursuant to
tariff. The ability to offer Centrex by contract gives the Telephone
Companies pricing flexibility as well as the opportunity to tailor the
specific features and conditions of a given transaction. The market for
multi-line business telephone products is very competitive and includes large
well-financed competitors.
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Directory Publishing
Other producers of printed directories offer products that compete with
certain Pacific Bell Directory SMART Yellow Pages products. Competitors
include large companies that have significant resources. Competition is not
limited to directory publishers, but includes newspapers, radio, television
and increasingly, direct mail. In addition, new advertising and information
products may compete directly or indirectly with the SMART Yellow Pages. The
Corporation is unable to predict the extent to which these competitors may
affect future revenues of the Corporation.
AIRTOUCH COMMUNICATIONS (SPIN-OFF OPERATIONS)
AirTouch Communications (formerly PacTel Corporation) and its wireless
operations will be spun off to the Corporation's shareholders in a one-for-one
stock distribution effective April 1, 1994.
The wireless operations of AirTouch Communications ("AirTouch") include
cellular, paging, vehicle location and other wireless telecommunications
services in the United States, Europe and Asia. AirTouch's worldwide cellular
interests represented 75.3 million POPs* and more than 1.2 million
proportionate subscribers at December 31, 1993. In the United States,
AirTouch has 34.9 million POPs** and controls or shares control over cellular
systems in ten of the thirty largest markets, including Los Angeles, San
Francisco, San Diego, Detroit and Atlanta. Internationally, AirTouch has
40.4 million POPs and holds significant ownership interests, with board
representation and substantial operating influence, in national cellular
systems operating in Germany, Portugal and Sweden and in cellular systems
under construction in three major metropolitan areas in Japan, including Tokyo
and Osaka. AirTouch is also the fourth largest provider of paging services in
the United States, with approximately 1.2 million units in service at
December 31, 1993.
--------------------
* POPs are the estimated market population multiplied by AirTouch's
ownership interest in the cellular licensee for the market. International
cellular information reflects networks under construction. Domestic
cellular subscriber information reflects subscribers to cellular systems
over which AirTouch has or shares operational control.
** POPs and proportionate subscribers for the Michigan/Ohio region reflect
both AirTouch's 50% interest in a joint venture between AirTouch and
Cellular Communications, Inc. ("CCI") and AirTouch's ownership of
approximately 12% of the equity in CCI at December 31, 1993.
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Principal AirTouch operations are discussed below.
AirTouch Cellular
AirTouch Cellular is one of the largest providers of cellular services in the
United States, with interests in some of the most attractive cellular markets
based upon total population and demographic characteristics. AirTouch's
United States cellular interests represented 34.9 million POPs and more than
1 million proportionate subscribers at December 31, 1993. AirTouch has or
shares operational control over cellular systems in Los Angeles, San
Francisco, San Diego, Atlanta, Detroit, Cleveland, San Jose, Sacramento,
Cincinnati and Kansas City. These cities represent ten of the thirty largest
cellular markets in the United States. AirTouch also has or shares
operational control over cellular systems in 34 additional markets, including
Columbus, Dayton and Toledo, Ohio, and owns minority interests in cellular
systems serving 10 other markets, including Dallas/Forth Worth, Tucson and
Las Vegas.
AirTouch has formed six regional networks, in Southern California, the San
Francisco Bay Area, the Sacramento Valley, Michigan/Ohio, Georgia and
Kansas/Missouri. Regional networks permit AirTouch to meet customers' needs
for broad areas of uninterrupted service, to carry out coordinated marketing
efforts and to reduce capital expenditures and administrative expenses.
Through its participation in marketing alliances such as MobiLink and Cellular
One, AirTouch provides national cellular service to its customers.
AirTouch's transactions with CCI and McCaw Cellular Communications, Inc.
("McCaw") are examples of the implementation of AirTouch's regional network
strategy. AirTouch's cellular network in Michigan/Ohio was created in 1991
through New Par, an equally owned joint venture between AirTouch and CCI
("New Par"), in which AirTouch's interests in Michigan and northwestern Ohio
were combined with CCI's interests in Cleveland, Cincinnati, Columbus and
elsewhere throughout Ohio to create one of the largest regional cellular
systems in the United States, covering an area with a total population of over
15 million. In connection with the formation of New Par, AirTouch acquired 5%
of the equity of CCI, agreed to purchase up to 12.44 million shares (including
shares underlying certain stock options) of CCI's stock in October 1995 at $60
per share (less the exercise price in the case of stock options) and obtained
the right to acquire all of CCI's remaining equity in stages over the next
several years. (See "Spin-off Operations" on page F-57 in Note L to the 1993
Consolidated Financial Statements contained in the 1994 Proxy Statement.)
AirTouch currently owns approximately 12% of CCI. In September 1993, AirTouch
formed an equally owned joint venture with McCaw ("CMT Partners") that holds
controlling interests in cellular systems serving markets in and around San
Francisco, San Jose and Kansas City, thereby permitting AirTouch to broaden
its coverage of the San Francisco Bay Area and providing it with shared
control over an additional regional network in Kansas/Missouri.
International Operations
AirTouch has been highly successful in obtaining significant interests in
cellular licenses in some of the world's most attractive markets.
In 1990, Mannesmann Mobilfunk GmbH ("MMO"), in which AirTouch currently holds
a 29.15% interest and is the second largest shareholder, won the second
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national digital cellular license in Germany. AirTouch's interest in MMO
includes a 2.25% interest which, under the terms of MMO's license, AirTouch is
under a current obligation to sell to small or medium-sized German businesses.
MMO began commercial operations in June 1992 and at December 31, 1993 had
approximately 493,000 subscribers. The system presently covers approximately
94% of the population, including all of the major cities and highways.
In 1991, Telecel Communicacoes Pessoais. S.A. ("Telecel"), in which AirTouch
holds a 23% interest, was chosen to construct and operate one of two national
digital cellular systems in Portugal. Telecel initiated service in October
1992 and at December 31, 1993 had approximately 40,000 subscribers. Telecel
currently covers all of Portugal's major cities and highways and approximately
92% of the population and is required under the terms of its license to cover
99% by October 1996.
In 1992, AirTouch's consortia were selected to construct and operate digital
cellular systems in the Tokyo, Kansai (Western) and Tokai (Central) regions of
Japan. AirTouch has a 15% interest in Tokyo Digital Phone Company and 13%
interests in each of Kansai Digital Phone Company and Tokai Digital Phone
Company. The three systems are expected to be operational by the end of 1994.
Such systems are expected to be able to offer service to approximately 74
million people, or 60% of the Japanese population, by 1997.
In February 1994, AirTouch agreed to acquire a 4.5% interest in a fourth
company, which plans to build a digital cellular system that will reach about
70% of the population of the Kyushu/Okinawa region when it begins offering
service in 1996. There are approximately 15 million people in the region,
which is the fourth most populous of Japan's 11 cellular regions.
In October 1993, AirTouch acquired a 51% interest in NordicTel Holdings AB
("NordicTel"), which owns and operates one of three national digital cellular
systems in Sweden, for $153 million. NordicTel's cellular system began
commercial operations in late 1992 and currently covers approximately 80% of
Sweden's population and all of the major cities.
Paging Operations
AirTouch had approximately 1.2 million paging units in service at December 31,
1993 in 100 markets throughout the United States, including Atlanta,
Dallas/Fort Worth, Detroit, Houston, Los Angeles, Phoenix, St. Louis, San
Diego, the San Francisco Bay Area, Seattle and Tampa/St. Petersburg. AirTouch
became one of the first paging companies in the United States to offer paging
service through retail outlets and the success of AirTouch's retail marketing
efforts has contributed significantly to the growth of its paging business.
AirTouch also owns significant interests in paging companies in Portugal,
Spain and Thailand. In September 1993, a joint venture in which AirTouch has
an 18.5% interest was awarded one of three national digital paging licenses in
France.
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Other Operations
AirTouch owns a majority interest in a provider of vehicle location services
("Teletrac") in six markets in the United States. Teletrac is in the start-up
phase of its operations and to date its services have not achieved a
significant degree of commercial acceptance. In February 1994, AirTouch
reduced Teletrac's workforce by 30%, to approximately 200 employees. In
addition, AirTouch provides air-to-ground telephone service in four domestic
cities. AirTouch also owns interests in a long distance telephone company in
Japan and a credit card verification business in South Korea.
EMPLOYEES
As of December 31, 1993, the Corporation and its subsidiaries employed 55,355
persons. This number does not include employees who will continue to be
employed by AirTouch Communications after the spin-off. About 70 percent of
the employees of the Corporation's continuing operations are represented by
unions. In September 1992, the unions which represent these employees
ratified labor contracts for a three-year term. The agreements provide for a
12 percent increase in wages, including job upgrades and a 13 percent increase
in pensions over the three-year term. In addition, the contracts include
incentives for early retirement, enhanced employment security, improvements in
work and family life benefits and increases in health and dental care
coverage. In 1993, Pacific Bell reduced the number of employees by 1,516,
leaving a total of 54,026 employees at year-end.
Looking ahead, Pacific Bell has begun a major effort to reengineer its
internal business processes. This effort confronts an increasingly
competitive and complex telecommunications environment by streamlining and
consolidating operations, including business offices, network, installation
and collection centers, as well as other facilities. As a result, Pacific
Bell has announced a force reduction program that will result in a net
reduction of 10,000 positions from 1994 through 1997. (See page F-13 of the
1994 Proxy Statement for discussion of related 1993 restructuring charge.)
The Pacific Telesis holding company and Pacific Bell deferred salary increases
for all managers, including officers, for an indefinite period of time pending
a review of 1994 business needs.
At Nevada Bell, an early retirement program was offered during November 1993
under which approximately 70 employees elected early retirement.
26
<PAGE>
EXECUTIVE OFFICERS OF THE REGISTRANT
The list below gives the names of executive officers as of March 28, 1994,
their present titles and the dates they were elected to these positions.
Name Age Title Since
S. L. Ginn* ........... 56 Chairman of the Board, President and
Chief Executive Officer .......... 4/88
P. J. Quigley* ........ 51 Group President .................... 1/88
C. L. Cox ............. 52 Group President .................... 1/88
R. W. Odgers* ......... 57 Executive Vice President - General
Counsel, External Affairs** and
Secretary......................... 3/88
L. L. Christensen* .... 59 Executive Vice President and
Chief Financial Officer .......... 5/92
J. R. Moberg* ......... 58 Executive Vice President - Human
Resources ........................ 9/87
W. E. Downing* ........ 54 Vice President ..................... 3/93
F. E. Miller .......... 41 Vice President-Corporate Strategy***
and Development ................... 3/93
A. Sarin .............. 39 Vice President-Organization Design . 3/93
M. S. Gyani ........... 42 Vice President and Treasurer ....... 3/93
Effective upon the spin-off of AirTouch Communications, the executive officers
and their titles will be as follows:
Name Age Title
P. J. Quigley* ........ 51 Chairman of the Board, President and
Chief Executive Officer
R. W. Odgers* ......... 57 Executive Vice President - General
Counsel, External Affairs and
Secretary
J. R. Moberg* ......... 58 Executive Vice President - Human Resources
W. E. Downing* ........ 54 Executive Vice President,
Chief Financial Officer and Treasurer
F. E. Miller .......... 41 Vice President - Corporate Strategy and
Development
All of the officers have held responsible managerial positions with the
Corporation or one of its subsidiaries for at least the past five years.
Officers are not elected for a fixed term, but serve at the discretion of the
Corporation's Board of Directors.
------------------
* Also executive officers of Pacific Bell.
** Executive Vice President - External Affairs since 11/92.
*** Vice President - Corporate Strategy since 3/94.
27
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